CONSOLIDATED FINANCIAL STATEMENTS

White Star Petroleum, LLC

As of December 31, 2018 and 2017 and for the years then ended

(with Independent Auditors’ Report therein)

Index to Consolidated Financial Statements

Independent Auditors’ Report

The Board of Managers
White Star Petroleum, LLC:

Report on the Financial Statements

We have audited the accompanying consolidated financial statements of White Star Petroleum, LLC and its subsidiaries, which comprise the consolidated balance sheets as of December 31, 2018 and 2017, and the related consolidated statements of earnings, changes in members’ equity (deficit), and cash flows for the years then ended, and the related notes to the consolidated financial statements.

Management’s Responsibility for the Financial Statements

Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with U.S. generally accepted accounting principles; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of consolidated financial statements that are free from material misstatement, whether due to fraud or error.

Auditors’ Responsibility

Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement.

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditors’ judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements.

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.

Opinion

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of White Star Petroleum, LLC and its subsidiaries as of December 31, 2018 and 2017, and the results of their operations and their cash flows for the years then ended in accordance with U.S. generally accepted accounting principles.

Emphasis of Matter

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company did not expect to remain in compliance with all of its financial and indebtedness covenants over the next 12 months, which would trigger an event of default to occur under its Revolving Credit Facility and its Term Loan, potentially accelerating repayment of those loans. Management has stated that substantial doubt exists about the Company's ability to continue as a going concern. Management's evaluation of the events and conditions management's plans regarding these matters are also described in notes 1 and 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. Our opinion is not modified with respect to this matter.

Other Matter

Our audit was conducted for the purpose of forming an opinion on the basic financial statements as a whole. The supplementary oil and gas information included in note 15 to the consolidated financial statements is presented for purposes of additional analysis and is not a required part of the basic consolidated financial statements. Such information has not been subjected to the auditing procedures applied in the audit of the basic financial statements, and accordingly, we do not express an opinion or provide any assurance on it.

Oklahoma City, Oklahoma
December 17, 2019

The accompanying notes to the consolidated financial statements are an integral part of these statements.

The accompanying notes to the consolidated financial statements are an integral part of these statements.

The accompanying notes to the consolidated financial statements are an integral part of these statements.

The accompanying notes to the consolidated financial statements are an integral part of these statements.

1. Basis of Presentation and Significant Accounting Policies

Description of the Company

White Star Petroleum, LLC (“White Star”, “we”, “us” or “our”) is an Oklahoma City, Oklahoma-based independent oil and natural gas company focused on the acquisition, development, exploration and production of oil, natural gas, and natural gas liquids (“NGL”) located in the Mid-Continent region of the United States.

Basis of Presentation and Consolidation

White Star is an Oklahoma limited liability company and is a wholly-owned direct subsidiary of White Star Petroleum Holdings, LLC (“White Star Holdings”). White Star Holdings is a Delaware limited liability company whose members include The Energy & Minerals Group (“EMG”) and other private equity investors (collectively, “the Sponsors”). 

The accompanying consolidated financial statements include the accounts of White Star and our subsidiaries, all of which are 100% owned, after all significant intercompany accounts and transactions have been eliminated upon consolidation. These statements have been prepared in accordance with generally accepted accounting principles in the United States (“GAAP”). 

Ability to Continue as a Going Concern

Based on our projections at year-end 2018, we did not expect to remain in compliance with all our financial and indebtedness covenants over the next 12 months and expected to have little or no availability on our Revolving Credit Facility during periods starting in 2019.  Falling out of compliance with our covenants would trigger an event of default to occur under our Revolving Credit Facility and our Term Loan, which would allow the banking syndicate of our Revolving Credit Facility and/or the Term Loan lender of our Term Loan (after complying with a standstill period) to accelerate repayment of their respective loans. The uncertainty associated with our ability to repay our debt if it were to prematurely come due and maintain adequate liquidity to repay our current liabilities as they came due raised substantial doubt about our ability to continue as a going concern as of year-end 2018.

We were actively exploring potential recapitalization options at year-end to increase our liquidity and obtain a more favorable covenant package and expected to execute a transaction in the first quarter of 2019; however, those efforts were ultimately unsuccessful.  Following a scheduled borrowing base redetermination, our borrowing base was reduced from $275 million at December 31, 2018 to $181 million on April 30, 2019.  The company did not have the ability to make the borrowing base deficiency payment of $94 million which became due at that time, precipitating an event of default under the Credit Facility.  Subsequently in May 2019, we also received default notices under our Term Loan and Senior Notes.   Consequently, the long-term debt related to the Senior Notes, Term Loan and Revolving Credit Facility are now current liabilities on the balance sheet.  In May 2019, we filed for Chapter 11 bankruptcy protection. See Note 2 – Chapter 11 Proceedings for additional information.

Use of Estimates

The preparation of the financial statements requires estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, and expenses and related disclosure of contingent assets and liabilities. Actual results may differ from these estimates and assumptions used in the preparation of our financial statements.    

Cash and Cash Equivalents

We consider investments in all highly liquid instruments with original maturities of three months or less at the date of purchase to be cash equivalents. We maintain cash in accounts that may not be federally insured beyond certain limits; however, we have not experienced any losses in such accounts and believe we are not exposed to any significant credit risk on such accounts.

Accounts Receivable

Our receivables are primarily from purchasers of our oil, natural gas, and NGL production as well as from joint interest owners who participate in the drilling, completion and operation of our oil and natural gas wells. Receivables are considered past due if full payment is not received by the contractual due date. Our allowance for doubtful accounts is determined by considering a number of factors, including the length of time accounts are past due, our history of losses, and the customer or working interest owner’s ability to pay. Specific past due accounts are generally written off against the allowance for doubtful accounts after all attempts to collect the

balance are exhausted. Many of our receivables are from joint interest owners of the properties we operate. As such, we may have the ability to withhold future revenue disbursements to recover any non-payment of joint interest billings. As of December 31, 2018 and 2017, White Star had an allowance for doubtful accounts of $3.1 million, which is included in accounts receivable, net - joint interest and other on the consolidated balance sheets.

Accounts Payable

Included in accounts payable at December 31, 2018 and 2017, are book over drafts of approximately $13.9 million and $12.3 million, respectively, representing the amount by which checks issued but not presented to our bank for collection exceeded balances in applicable bank accounts.

Concentration of Credit Risk

We are subject to credit risk resulting from the concentration of our oil, natural gas, and NGL receivables with several significant purchasers. For the year ended December 31, 2018, the majority of our oil, natural gas, and NGL sales were to two purchasers. Approximately 42% of our total oil, natural gas, and NGL sales were to Phillips 66 and approximately 21% were to Devon Energy. No other purchasers accounted for more than 10% of our sales for the year ended December 31, 2018. For the year ended December 31, 2017, the majority of our oil, natural gas and NGL sales were also to two purchasers. The percentage of total sales to Devon Energy was approximately 37% and to Phillips 66 was approximately 25%. No other purchasers accounted for more than 10% of our sales for the year ended December 31, 2017. We do not believe the loss of any single purchaser would materially impact our operating results, as oil, natural gas, and NGL are fungible products with well-established markets and numerous purchasers in our operating regions.

Oil and Natural Gas Properties

We use the successful efforts method of accounting for oil and natural gas properties, whereby costs incurred to acquire interests in properties, to drill and equip exploratory wells that find proved reserves and to drill and equip development wells, including direct internal labor, are capitalized. Exploration costs, such as most geological and geophysical costs, are expensed as incurred. Under the successful efforts method of accounting, we capitalize exploratory drilling costs, including capitalized interest, pending determination of whether a well has found proved reserves in economically producible quantities. If proved reserves are found by an exploratory well, the associated capitalized costs become part of proved oil and natural gas properties; however, if proved reserves are not found, the capitalized costs associated with the well, net of any salvage value, are charged to exploration expense. Maintenance and repairs are expensed as incurred, except for costs of replacements or renewals that expand capacity or improve production, which are capitalized.

Unproved properties primarily consist of costs to acquire undeveloped leasehold.  When successful wells are drilled on undeveloped leaseholds, unproved property costs are transferred to proved properties and depleted on a units-of-production basis. Approximately $4.6 million and $12.4 million in unproved oil and natural gas properties was transferred to proved oil and natural gas properties during the years ended December 31, 2018 and 2017, respectively.

Property Impairments

Proved oil and natural gas properties are reviewed for impairment on a field-by-field basis annually, or more frequently if events and circumstances indicate a possible decline in the recoverability of the carrying value of such field. The estimated future cash flows expected in connection with the field are compared to the carrying amount of the field to determine if the carrying amount is recoverable. If the carrying amount of the field exceeds its estimated undiscounted future cash flows, the carrying amount of the field is reduced to its estimated fair value. For the year ended December 31, 2018, we recorded impairments of $388.0 million associated with proved properties, which are presented in property impairments in the consolidated statements of operations. Impairment was recorded primarily due to inability to fund proved undeveloped properties and decline in commodity prices No impairment of proved oil and natural gas properties was recorded for the year ended December 31, 2017. We cannot predict whether impairment charges may be required in the future as prices of oil and natural gas properties have a significant role in determining future impairments.

Impairment losses for unproved properties are recognized by amortizing the portion of the properties’ costs which management estimates will not be transferred to proved properties over the lives of the leases based on drilling plans, available financing, experience of successful drilling and the average holding period. For the years ended December 31, 2018 and 2017, we recorded impairment charges of $72.5 million and $23.7 million, respectively, to property impairments in the consolidated statements of operations related to unproved properties.

Depreciation, Depletion and Amortization

Depreciation, depletion and amortization of capitalized drilling and development costs of producing oil and natural gas properties are computed using the unit-of-production method on a field basis based on total estimated proved developed oil and natural gas reserves. Costs of acquiring proved properties, including leasehold acquisition costs transferred from unproved properties, are depleted using the unit-of-production method based on total estimated proved developed and undeveloped reserves.

Other Property and Equipment

Other property and equipment is recorded at cost. Upon retirement or disposition of assets, the cost and related accumulated depreciation are removed from the consolidated balance sheet with the resulting gain or loss, if any, reflected in the statement of operations. Depreciation of other property and equipment, with the exception of land, is computed using the straight-line method over the estimated useful lives of the related assets. Depreciation expense for other property and equipment was approximately $1.5 million and $1.1 million for the years ended December 31, 2018 and 2017, respectively.

Asset Retirement Obligations

We recognize liabilities for obligations associated with the retirement of tangible long-lived assets that result from the acquisition and development of our oil and natural gas properties. We recognize the fair value of a retirement obligation in the period in which the obligation is incurred. For oil and natural gas properties, this is the period in which an oil or natural gas well is acquired or drilled. The liability is then accreted each period through charges to depreciation, depletion and amortization expense, until it is settled, or the well is sold, at which time the liability is removed. The related asset retirement cost is capitalized as part of the carrying amount of our oil and natural gas properties and expensed through depletion of the asset.

Capitalized Interest

Interest is capitalized on expenditures made in connection with exploration and development projects to the extent of borrowings. Interest is capitalized using a weighted average interest rate based on outstanding borrowings. During the years ended December 31, 2018 and 2017, approximately $0.5 million and $0.4 million of interest expense was capitalized, respectively.

Revenue Recognition

Revenue from the sale of oil, natural gas and NGL is recognized when title passes, net of royalty interests. The sales method of accounting for natural gas imbalances is used in those circumstances where under-production or over-production of ownership percentage in a property has occurred. Under this method, a receivable or payable is recognized only to the extent an imbalance cannot be recouped from the reserves in the underlying properties. At December 31, 2018 and December 31, 2017, we had no material imbalances. For the year ended December 31, 2018, our sales revenue  was derived 64% from oil, 17% from natural gas and 19% from NGL. For the year ended December 31, 2017, our sales revenue  was derived 61% from oil, 20% from natural gas and 19% from NGL.

Gathering, Processing and Transportation

We generally sell oil and natural gas under two common types of agreements, both of which include a transportation charge. One is a net-back arrangement, under which we sell oil or natural gas at the wellhead and collect a lower relative price to reflect transportation costs to be incurred by the purchaser. In this case, we record sales at the net-back price received from the purchaser. Alternatively, we sell oil or natural gas at a specific delivery point, pay our own transportation to a third-party carrier, and receive a price with no transportation deduction. In this case, we record the separate transportation cost as gathering, processing and transportation. On May 9, 2018, we amended our long-term natural gas gathering and processing contract with EnLink which required the delivery of annual minimum amounts of natural gas through 2023 from a portion of our acreage.  See Note 12. Commitments and Contingencies for further discussion of agreement amendments.  

Fair Value of Financial Instruments

Our financial instruments consist primarily of cash, trade receivables, trade payables, long-term debt and derivatives. The carrying value of cash, trade receivables and trade payables are considered to be representative of their respective fair values due to the short-term maturity of those instruments. See Note 6. Debt and Note 8.  Fair Value Measurements for quantification of the fair value of our long-term debt and derivatives.

Derivatives

We routinely use derivative contracts to manage the impacts of commodity price fluctuations, protect returns on investments and provide more predictable cash flow. Such contracts are executed with counterparties that we believe to be of high credit quality.  Derivative instruments are required to be recorded on the consolidated balance sheet as either an asset or liability measured at fair value. Where we have the contractual right and intend to net settle, derivative assets and liabilities are reported on a net basis.

A change in a derivative’s fair value is required to be recognized in earnings unless specific hedge accounting criteria are met, or exemptions for normal purchases and normal sales exist. We have elected not to designate our derivative contracts as hedging instruments and, thus, recognize the change in our derivatives’ fair value in current earnings. We do not hold derivatives for speculative or trading purposes.

Long-Term Incentive Compensation

Long-term incentive compensation measurement is based on the grant date fair value of the award. Awards issued under these programs are recognized as either equity awards or liability awards based on their characteristics. Expense is recognized in the consolidated statements of operations as general and administrative expense over the requisite service period, net of estimated forfeitures. See Note 10. Incentive Units for further discussion of long-term incentive compensation.

General and Administrative

General and administrative expense is reported net of amounts reimbursed by working interest owners of our operated oil and natural gas properties and net of amounts capitalized pursuant to the successful efforts method of accounting.

Income Taxes

We are a single member limited liability company treated as a disregarded entity by White Star Holdings for income tax purposes. White Star Holdings is treated as a partnership for income tax purposes. As such, no income taxes are shown on the financial statements for the periods presented.

Recently Issued Accounting Standards Not Yet Adopted

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, which established ASC Topic 606, Revenue from Contracts with Customers (ASC 606). The standard’s core principle is that an entity shall recognize revenue when promised goods or services are transferred to customers in an amount reflecting the consideration the entity expects to receive in exchange. Additionally, the standard requires expanded disclosures related to revenue recognition. The standard will be effective for private companies for annual periods beginning after December 15, 2018 and interim periods beginning after December 15, 2019. The standard allows for either full retrospective adoption, meaning the standard is applied to all periods presented in the financial statements, or modified retrospective adoption, meaning the standard is applied only to the most current period presented. We will adopt the standard on January 1, 2019 using the modified retrospective approach. We aggregated and reviewed our contracts that are within the scope of ASC 606. Based on our evaluation, we do not anticipate the adoption of ASC 606 to have a material impact on our consolidated balance sheet or related consolidated statements of operations, member’s equity or cash flows. Based on the disclosure requirements of ASC 606, upon adoption, we expect to provide expanded qualitative and quantitative disclosures relating to our revenue recognition policies.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). This ASU will supersede the lease requirements in Topic 840,  Leases. Its objective is to increase transparency and comparability among organizations. This ASU provides guidance requiring lessees to recognize a right-of-use asset and related liability on the balance sheet for the rights and obligations arising from leases with durations greater than 12 months. Lessor accounting does not significantly change from Topic 840, except for some changes made to align with ASC 606 Revenue from Contracts with Customers. This ASU is effective for private companies beginning January 1, 2020 and will be applied using a modified retrospective transition method, which requires applying the new guidance to leases that exist or are entered into after the beginning of the earliest period in the financial statements. Although early adoption is permitted, we do not plan to early adopt. We are evaluating the impact this ASU will have on our financial statements.

Other accounting standards that have been issued or proposed by the FASB, or other standards-setting bodies, that require adoption at a future date are not expected to have a material impact on our financial statements upon adoption.

2. Chapter 11 Proceedings

On May 24, 2019, an involuntary petition was filed against White Star Petroleum, LLC with the United States Bankruptcy Court for the Western District of Oklahoma (the “Involuntary Case”).  On May 28, 2019, White Star Holdings, LLC, White Star Petroleum, LLC, White Star Petroleum II, LLC, White Star Petroleum Operating, LLC and WSP Finance Corporation (the “Debtors”) filed with the United States Bankruptcy Court for the District of Delaware a voluntary petition for relief under the Bankruptcy Code (the “Voluntary Cases”). The Voluntary Cases were consolidated into the Involuntary Case with a petition date for White Star Petroleum, LLC of May 24, 2019, and for each of the other Debtors, May 28, 2019. The Debtors’ chapter 11 cases are jointly administered for procedural purposes only under the lead case caption in White Star Petroleum Holdings, LLC et al., Case No. 19-12521 (JDL). Prior to the sale of properties to Contango Oil & Gas Company that closed on November 1, 2019, the Debtors continued to operate their business and manage their properties as debtors-in-possession pursuant to sections 1107(a) and 1108 of the Bankruptcy Code. On June 10, 2019, the Office of the United States Trustee for the District of Delaware appointed an Official Committee of Unsecured Creditors pursuant to section 1102 of the Bankruptcy Code.

On May 28, 2019, we received $28.5 million in committed debtor-in-possession financing (“DIP Financing”) to pay the expenses of chapter 11 and provide supplemental liquidity. Our DIP Financing was provided by certain of our syndicate of Revolving Credit Facility lenders and contains covenants customary for facilities of its type and size.  It also provides the DIP Financing lenders with a superiority, priming lien on substantially all of the Company’s assets, subject to certain customary exclusions.

Subject to certain exceptions, under the Bankruptcy Code, the Debtors may assume, assign or reject certain executory contracts and unexpired leases subject to the approval of the Court and certain other conditions. Generally, the rejection of an executory contract or unexpired lease is treated as a pre-petition breach of such executory contract or unexpired lease and, subject to certain exceptions, relieves the Debtors of performing their future obligations under such executory contract or unexpired lease but entitles the contract counterparty or lessor to a pre-petition general unsecured claim for damages caused by such deemed breach. Counterparties to such rejected contracts or leases may assert unsecured claims in the Bankruptcy Court against the applicable Debtors’ estate for such damages. Generally, the assumption of an executory contract or unexpired lease requires the Debtors to cure existing monetary defaults under such executory contract or unexpired lease and provide adequate assurance of future performance. Accordingly, any description of an executory contract or unexpired lease with the Debtor in these financial statements, including where applicable a quantification of the Company’s obligations under any such executory contract or unexpired lease with the Debtor is qualified by any overriding rejection rights the Company has under the Bankruptcy Code. Further, nothing herein is or shall be deemed an admission with respect to any claim amounts or calculations arising from the rejection of any executory contract or unexpired lease and the Debtors expressly preserve all of their rights with respect thereto.

See Note 1 – Basis of Presentation and Significant Accounting Policies and Note 6 – Debt for further discussion.

3. Property Acquisitions

Lighthouse Oil and Gas

On March 14, 2017, we closed the acquisition of Lighthouse Oil and Gas LP and certain of its affiliates (“Acquired Companies”) for $107.5 million, after customary post-closing adjustments (“Lighthouse Acquisition”). White Star Holdings issued approximately 99.3 million Series B common units at $0.85 per unit ($84.4 million) in exchange for a portion of the equity in the Acquired Companies, which White Star Holdings then contributed to White Star. The remainder of the Lighthouse Acquisition was funded by White Star with approximately $18.5 million of borrowings under our Revolving Credit Facility, after customary post-closing adjustments. In addition, approximately 5.2 million Series B common units at $0.85 per unit ($4.4 million) and approximately $0.2 million in cash were held back at closing of the Lighthouse Acquisition and were distributed to the former equity holders of the Acquired Companies, less any post-closing adjustments, in June 2017. The Acquired Companies were portfolio companies of EMG, but were not controlled by EMG, with a portion of the Series B common units issued to an affiliate of EMG. Subsequent to closing, we consolidated the Acquired Companies into one entity named White Star Petroleum II, LLC. We now own 100% of the equity interests in White Star Petroleum II, LLC.

The Lighthouse Acquisition was accounted for as a business combination using the acquisition method of accounting. Accordingly, we allocated the purchase price of the acquired assets and liabilities assumed based on their fair value as of the acquisition date. The consolidated balance sheet as of December 31, 2017, includes the following purchase price allocation:

The fair value allocated to oil and natural gas properties and asset retirement obligations is based on inputs that are not observable in the market and therefore represent Level 3 inputs. We incurred approximately $1.0 million of acquisition costs related to the Lighthouse Acquisition, which are included in general and administrative expenses in the consolidated statements of operations.

Other

Throughout 2017, we closed on other transactions for proved properties totaling approximately $26 million, after customary closing adjustments, which increased our position in Alfalfa, Grant, Noble, Payne, Logan, and Garfield counties.  These acquisitions were funded with borrowings under our Revolving Credit Facility. There were no material acquisitions of oil and gas properties in 2018.

4.  Dispositions

In December 2018, we sold non-strategic properties located in Noble county to a third party for cash proceeds of $6.6 million, before customary closing adjustments, with no gain or loss recognized. The transaction included $1.6 million of seller financing to be paid over the next year. The sale included approximately 21,600 net acres of developed leasehold. The sale also included producing properties with production totaling approximately 437  boe/d. The disposed properties represented an immaterial portion of the Company’s proved reserves. 

On May 9, 2018, we amended our long-term natural gas gathering and processing contract with EnLink Oklahoma Gas Processing, LP (“EnLink”). As part of this amendment, we conveyed to EnLink a one percent overriding royalty interest on EnLink gathered volumes from current and future wells on existing leases (“ORRI”). The relative fair value of the ORRI was approximately $3.8 million. See Note 6. Debt and Note 12. Commitments and Contingencies for additional information.

In November 2017, we sold non-strategic properties located in Payne, Noble and Pawnee counties to a third party for cash proceeds of $1.8 million, before customary closing adjustments, with no gain or loss recognized. The sale included approximately 20,000 net acres of developed leasehold. The sale also included producing properties with production totaling approximately 150 boe/d. The disposed properties represented an immaterial portion of the Company’s proved reserves. 

In July 2017, we sold our interest in our midstream gathering system to 4 AM Midstream, LLC (“4 AM”) for $47.0 million, before customary closing adjustments, and recognized a $7.7 million gain on the sale. Approximately $5.3 million of the purchase price was placed into escrow at closing, $0.5 million of which was released to us in October 2017, and the remainder of which was released to us in 2018. In connection with the transaction, we entered into crude oil and natural gas gathering agreements with 4 AM covering a defined dedication area with a fixed-fee structure for a 20-year term.

5. Asset Retirement Obligations

The following table summarizes the changes in our future asset retirement obligations for the periods presented:

Our primary asset retirement obligations relate to future plugging and abandonment costs on our oil and natural gas properties, which are on based on the use of significant unobservable inputs (Level 3). Revisions in estimated liabilities during the periods presented relate primarily to changes in estimates of asset retirement costs.

6.  Debt

The carrying amount and fair value of our debt is as follows:

Note: December 31, 2018 fair value of our debt is not included due to lack of available information.

(1)For the year ended December 31, 2018, the average effective interest rate of the Senior Notes is 10.0%.

(2)For the year ended December 31, 2018, the average effective interest rate of the Term Loan is 10.0%

(3)For the year ended December 31, 2018, the average effective interest rate of the Revolving Credit Facility is 5.6%

Senior Notes are considered Level 2 fair value instruments as their fair values are derived from quoted prices, but they are not actively traded in the market.

Senior Notes

The Senior Notes mature on September 15, 2022, with a principal amount of $10.3 million, and interest is payable at an annual rate of 9.0%, semi-annually in arrears on March 15 and September 15 of each year. For the years ended December 31, 2018 and 2017, we recorded approximately $0.9 million in interest expense for the Senior Notes each year. The discount on the Senior Notes is amortized to the maturity date of the notes using the effective interest method and recorded as interest expense in the consolidated statements of operations. The Company received a notice of default under the Senior Notes for failure to pay interest in May 2019.

Term Loan

On May 9, 2018 we entered into a five-year second lien Term Loan with EnLink as part of the amendment of our existing Gas Gathering and Processing Agreement (see Note 12. Commitments and Contingencies for further information on the amendment). The principal amount of the Term Loan is $58.0 million. The carrying amount of the Term Loan is $52.3 million, which is net of $5.4 million unamortized discount and $0.3 million unamortized debt issuance cost. Interest is payable on the Term Loan every quarter at an annual rate of 8.0%, beginning in the first quarter of 2020. The discount on the Term Loan is amortized over the five-year term using the

effective interest method and recorded as interest expense in the consolidated statements of operations. For the year ended December 31, 2018, we recorded approximately $3.2 million in interest expense on the Term Loan.

In November 2018, in conjunction with our Revolving Credit Facility borrowing base redetermination we amended our Term Loan such that the $19.5 million payment due March 31, 2019 is broken out into two payments and increased by $1.0 million, with $9.75 million due on April 1, 2019 and $10.75 million due on October 1, 2019. Additionally, each of the $2.75 million payments due September 30, 2020 and December 31, 2020 were increased to $4.0 million, and the March 30, 2023 payment was reduced from $9.5 million to $6.0 million.

In February 2019, in conjunction with our Revolving Credit Facility borrowing base redetermination, we amended our term Loan such that the $9.75 million due on April 1, 2019 was moved to May 15, 2019. The Company did not make the $9.75 million payment and received a notice of default under the Term Loan in May 2019.

Revolving Credit Facility

As of December 31, 2018, the Revolving Credit Facility had a borrowing base and total commitments of $275 million, matures on June 30, 2020, and is subject to scheduled semi-annual borrowing base redeterminations based on our oil and natural gas reserves as of June 30 and December 31. As of December 31, 2018, we had $244.0 million in outstanding borrowings under the Revolving Credit Facility excluding our letters of credit of approximately $1.6 million. 

Interest under the Revolving Credit Facility was based on the prime rate or LIBOR plus a margin that varies based on the utilization of the facility. We incurred approximately $13.5 million and $8.2 million in interest expense for years ended December 31, 2018 and 2017, respectively, related to the Revolving Credit Facility.

In April 2018, our Revolving Credit Facility was amended to, among other things:

In November 2018, our Revolving Credit Facility was amended to, among other things:

In November 2018, in conjunction with our Revolving Credit Facility borrowing base redetermination we amended our Term Loan such that the $19.5 million payment due March 31, 2019 is broken out into two payments and increased by $1.0 million, with $9.75 million due on April 1, 2019 and $10.75 million due on October 1, 2019. Additionally, each of the $2.75 million payments due September 30, 2020 and December 31, 2020 were increased to $4.0 million, and the March 30, 2023 payment was reduced from $9.5 million to $6.0 million.

As of December 31, 2018, our financial covenants were as follows (each as more specifically defined in the Revolving Credit Facility): 

Subsequent to December 31, 2018, the Company entered into additional amendments of its Revolving Credit Facility and Term Loan. The January 31, 2019 Fifth Amendment of Revolving Credit Agreement provided for, among other things:

The February 27, 2019 Sixth Amendment of Revolving Credit Agreement and Second Amendment of Term Loan Credit Agreement provided for, among other things:

Further, the Sixth Amendment of Revolving Credit Agreement provided for, among other things:

Regarding changes from the fifth amendment to the sixth amendment, as described above, the Borrowing Base Agreement entered into in connection with the Fifth Amendment to the Revolving Credit Agreement previously extended the $5 million borrowing base reduction, set to automatically occur on February 1, 2019, to February 28, 2019.  The Borrowing Base Agreement entered into in connection with the Sixth Amendment to the Revolving Credit Agreement eliminated all monthly $5 million borrowing base reductions until April 30, 2019 and provided that the borrowing base would be reduced to $181 million at that time.

See Note 1 – Basis of Presentation and Significant Accounting Policies and Note 2 – Chapter 11 Proceedings for further discussion.

7. Derivative Financial Instruments

We use derivative instruments to manage our exposure to commodity price risk. We record all derivative instruments at fair value within the accompanying consolidated balance sheets. The fair values of the derivative instruments are determined primarily based on inputs that are derived from observable data at commonly quoted intervals for the full term of the derivatives and are therefore considered Level 2 in the fair value hierarchy.

As of December 31, 2018 and December 31, 2017, our derivative instruments consisted of the following types of instruments:

We have elected not to designate our derivative instruments as cash flow hedging instruments; therefore, the changes in fair value are recognized each period in earnings as a component of revenues. The contracts are placed with major financial institutions or with counterparties that management believes to be of high credit quality.

Our open derivative instruments as of December 31, 2018, are as follows:

The following tables summarize the fair value and location of each classification of the derivative instrument recorded in the consolidated balance sheets for the periods presented on a gross basis and after same-counterparty netting:

The following table summarizes gains and losses relating to oil, natural gas, and NGL derivatives reflected in the consolidated statements of operations for the periods presented:

8. Fair Value Measurements

We use a three-level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follows:

Level 1 – Unadjusted quoted prices for identical assets or liabilities in active markets.

Level 2 – Quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; and model-derived valuations whose inputs or significant value drivers are observable.

Level 3 – Unobservable inputs that reflect our own assumptions.

The fair values of our commodity derivative instruments are determined based primarily on inputs that are derived from observable data at commonly quoted intervals for the full term of the derivatives and are therefore considered Level 2 in the fair value hierarchy as of December 31, 2018.

The following table summarizes the valuation of financial instruments by pricing levels that were accounted for at fair value on a recurring basis:

Term Loan and ORRI

The fair values of our Term Loan and the ORRI conveyed to EnLink were determined using a discounted cash flow approach. For the Term Loan, our calculation was based on the payment terms of the loan as well as an assumed market interest rate used as the discount rate. For the ORRI our calculation was based on the future expected cash flows of the affected wells and an assumed discount rate. The fair values are significantly influenced by the discount rate assumptions, which are derived by us and are unobservable. 

Accordingly, the fair values of the Term Loan and the ORRI are classified as Level 3 in the fair value hierarchy. See Note 6. Debt for additional information.

Property Impairments

Proved oil and natural gas properties are reviewed for impairment on a field-by-field basis annually, or more frequently if events and circumstances indicate a possible decline in the recoverability of the carrying value of such field. Due to the unavailability of relevant comparable market data, a discounted cash flow method is used to determine the fair value of proved oil and natural gas properties. The discounted cash flow method estimates future cash flows based on the use of significant unobservable inputs (Level 3), including future production and related expenses, forward commodity prices, productive life of field and discount rate.

Cash, Accounts Receivable, and Accounts Payable

The carrying amounts for cash, accounts receivable, and accounts payable approximate fair value due to their short-term nature.

9. General and Administrative Expenses

General and administrative expenses include the following:

10. Incentive Units 

In June 2017, White Star Carry Partners, LLC (“White Star Carry Partners”) granted a total of 325,867 Class A Incentive Units (the “Class A Units”) to certain employees and others for the purpose of providing incentives to them. The Class A Units are intended to constitute profits interests and are deemed share-based payment transactions classified as equity instruments. The value of the Class A Units is derived from the White Star Holdings Incentive Units held by White Star Carry Partners.

The grant date fair value of the Class A Units was $0.7 million.  For the year ended December 31, 2017, $0.3 million was recognized as an increase to general and administrative expense. All fair value measurements were estimated using third-party option pricing models. Incentive unit expense is recorded within general and administrative expense and member’s equity in the consolidated statements of operations and consolidated statements of member’s equity.

11. Related Party Transactions

In March 2017, we closed a transaction with the equity holders of Lighthouse Oil & Gas LP which is a related party, see Note 3. Acquisitions for additional information.

12. Commitments and Contingencies

Commitments

We have several contractual commitments, executed in the ordinary course of business, including gathering and processing contracts and operating and capital leases. On May 31, 2017, we entered into a sale-leaseback transaction for our primary field office in Stillwater, Oklahoma for $4.9 million. This transaction resulted in capital lease classification for the field office, and as such, we recognized an asset and related obligation within our consolidated balance sheet for approximately $4.9 million. The minimum lease payments are included in the table below under “Field Office Capital Lease”. In March 2018, we entered into a new vehicle lease agreement that extends certain vehicle leases to 2023. Additionally, in July 2018 we entered into a new vehicle lease agreement that expires in 2023.

The following table presents our minimum undiscounted future payments under leases as of December 31, 2018:

Gathering and Processing

On May 9, 2018, we amended our long-term natural gas gathering and processing contract with EnLink which required the delivery of annual minimum amounts of natural gas through 2023 from a portion of our acreage.  We were required to make annual deficiency payments for any shortfalls in delivering the minimum volume commitments (“MVC”) under the contract. The amendment eliminated our minimum volume commitments in exchange for an upfront payment of $19.5 million (plus $0.2 million in transaction related fees), a five-year second lien Term Loan of $58.0 million, and a one percent overriding royalty interest on EnLink gathered volumes from current and future wells on existing leases. This transaction resulted in a $53.5 million loss on settlement of contract in our consolidated statement of operations for the year ended December 31, 2018, of which $3.8 million related to the overriding royalty interest conveyance. As such, we no longer have any future gathering and processing commitments.

Litigation Matters

We are periodically subject to lawsuits, investigations and disputes, including matters relating to commercial transactions, environmental and health and safety matters. A liability is recognized for any contingency that is probable of occurrence and reasonably estimable. We continually assess the likelihood of adverse judgments of outcomes in these matters, as well as potential ranges of possible losses (taking into consideration any insurance recoveries), based on a careful analysis of each matter with the assistance of outside legal counsel and, if applicable, other experts. None of these actions are expected to have a material adverse impact. We will continue to monitor the impact that litigation could have on us and will assess the impact of future events on our financial position, results of operations and cash flows. As of December 31, 2018, we did not have any litigation liabilities that require an accrual.

Environmental Matters

We are subject to existing federal, state and local laws and regulations governing environmental quality, the discharge and disposal of substances into the environment, and greenhouse gas emissions. The environmental laws and regulations to which we are subject also require us to remove or remedy the effect on the environment of the disposal or release of specified substances at current and former operating sites. We manage our exposure to environmental liabilities by using an evaluation process that seeks to identify pre-existing contamination or compliance concerns and addresses the potential liability. As of December 31, 2018, we do not have any environmental remediation liabilities that require an accrual.

13. Supplemental Cash Flow Information

Additions to properties and equipment as presented within cash flows from investing activities include cash payments for cost of properties, equipment, and facilities. The cost of properties includes the initial capitalization of drilling costs associated with all exploratory wells whether or not they were deemed to have a commercially sufficient quantity of proved reserves.

The following summarizes cash paid for interest, as well as non-cash investing and financing activities: