Notes to Financial Statements

1. Organization and Significant Accounting Policies

Organization – Lubbock Energy Partners, LLC (the “Company”) was formed as a Texas Limited Liability Company on January 17, 2017. The Company’s principal business activities are focused on the acquisition and development of oil and gas properties in the United States. Our fiscal year-end is December 31.

Basis of Presentation – The financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”).

Use of Estimates – The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period.

Significant estimates include (i) oil and gas reserves that are used in the calculation of depreciation, depletion, amortization and impairment of the carrying value of oil and gas properties; (ii) production and commodity price estimates used to record oil and gas sales receivables; and (iii) the cost of future asset retirement obligations. The Company evaluates its estimates on an on-going basis and bases its estimates on historical experience and on various other assumptions we believe to be reasonable. Due to inherent uncertainties, including the future prices of oil and gas, these estimates could change in the near term and such changes could be material.

In early March 2020, the NYMEX WTI crude oil price decreased significantly due to the COVID-19 pandemic and although it has recovered to pre-COVID-19 levels, it remained low for most of 2020. Lower oil and gas prices not only decrease our revenues, but an extended decline in oil or gas prices may materially and adversely affect our future business, financial position, cash flows, results of operations, liquidity, ability to finance planned capital expenditures and the oil and gas reserves that we can economically produce.

Cash – The Company maintains its deposits of cash primarily in financial institutions, which may at times exceed amounts covered by insurance provided by the U.S. Federal Deposit Insurance Corporation (“FDIC”). The Company has not experienced any losses related to amounts in excess of FDIC limits.

Receivables – Accounts receivable consists primarily of accrued oil and gas production receivables and joint interest receivables from outside working interest owners. Generally, our oil and gas sales receivables are collected within one month. Management routinely assesses accounts receivable balances to determine their collectability and accrues an allowance for uncollectible receivables, when, based on the judgment of management, it is probable that a receivable will not be collected. Receivables are not collateralized. As of December 31, 2020, and 2019, the Company had not provided an allowance for doubtful accounts on its accounts receivable.

Oil and Gas Properties – The Company follows the full cost method of accounting for its oil and gas properties. Under the full cost method, all costs associated with the acquisition, exploration and development of oil and gas properties are capitalized and accumulated in a country-wide cost center. This includes any internal costs that are directly related to development and exploration activities but does not include any costs related to production, general corporate overhead or similar activities. Proceeds received from property disposals are credited against accumulated cost except when the sale represents a significant disposal of reserves, in which case a gain or loss is recognized. The sum of net capitalized costs and estimated future development and dismantlement costs for each cost center are subject to depreciation, depletion and amortization (“DD&A”) using the equivalent unit-of-production method, based on total proved oil and gas reserves. Excluded from amounts subject to DD&A are costs associated with unevaluated properties. The Company had no unevaluated properties as of or during the years ended December 31, 2020 or 2019.

Under the full cost method, net capitalized costs are limited to the lower of unamortized cost, or the cost center ceiling (the “Ceiling Test”). The cost center ceiling is defined as the sum of (i) estimated future net revenue, discounted at 10% per annum, from proved reserves, based on average prices per barrel of oil and per Mcf of natural gas at the first day of each month in the 12-month period prior to the end of the reporting period; and costs, adjusted for contract provisions and financial derivatives qualifying as accounting hedges and asset retirement obligations, (ii) the cost of unevaluated properties not being amortized, and (iii) the lower of cost or market value of unproved properties included in the cost being amortized, reduced by (iv) the income tax effects related to differences between the book and tax basis of the oil and gas properties, if any. If the net book value reduced by the related net deferred income tax liability (if any) exceeds the cost center ceiling limitation, a non-cash impairment charge is required in the period in which the impairment occurs. Since all of the Company’s oil and gas properties are located within the United States, the Company only has one cost center for which a quarterly Ceiling Test is performed.

Acquisitions – We account for acquisitions as business combinations if the acquired assets meet the definition of a business. If substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or a group of similar assets, the acquisition is not considered a business and is accounted for as an asset acquisition. This determination of whether the gross assets acquired are concentrated in a group of similar assets is based on whether the risks associated with managing and creating outputs from the assets are similar.

Asset Retirement Obligations – The Company recognizes a liability for the plugging, abandonment and remediation of its properties at the end of their productive lives. We compute the liability for asset retirement obligations (“ARO”) by calculating the present value of estimated future cash flows related to each property. This requires use of significant assumptions, including current estimates of plugging and abandonment costs, annual inflation of these costs, the productive lives of wells, and our credit-adjusted risk-free interest rate (all Level 3 inputs within the fair value hierarchy). Changes in any of these assumptions can result in significant revisions to the estimated asset retirement obligations.

Initially, the fair value of the ARO is recognized in the period in which it is incurred with a corresponding increase in the carrying amount of the related asset. The liability is accreted to its present value each period and the capitalized cost is depleted over the life of the related asset and subject to the Ceiling Test. If the liability is settled for an amount other than the recognized liability, an adjustment to the full-cost pool is recognized. The Company had no assets that are restricted for the purpose of settling AROs.

Revenue Recognition – Our revenues are primarily derived from the sales of oil and gas production and are primarily of oil. The Company’s oil and gas production is typically sold at delivery points to third-party purchasers under contract terms that are common in the oil and gas industry. These contracts typically provide for an agreed-upon index price, net of pricing differentials. The purchaser takes custody and possession, title and risk of loss of the oil at the delivery point; therefore, control passes at the delivery point. The Company recognizes revenue when control transfers to the purchaser. We receive payment from the sale of oil and gas production between one to three months after delivery. For property interests where we are not the operator, we record our share of the revenues and expenses based upon the information provided by the operators.

The Company reports revenue as the gross amount received before production taxes and transportation costs. Production taxes and transportation costs are reported separately in the accompanying statements of operations.

Fair Value Measurement – Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The three levels related to fair value measurements are as follows:

The estimated fair value of cash, accounts receivable, and accounts payable approximate the carrying amount due to the relatively short maturity of these instruments.

We evaluate the fair value on a non-recurring basis of properties acquired in business combinations, asset acquisitions and the related asset retirement obligations. The fair value of the oil and gas properties is determined based upon estimated future discounted cash flow, a Level 3 input, using estimated production which we reasonably expect, and estimated prices adjusted for differentials. Unobservable inputs include estimated future oil and gas production, prices, operating and development costs, and a discount rate of 10%, all Level 3 inputs within the fair value hierarchy.

Income Taxes – The Company is taxed as a partnership under the Internal Revenue Code. Consequently, federal income taxes are not payable, or provided for, by the Company. Members are taxed individually on their proportionate share of our earnings.

The state of Texas margin tax applies to legal entities conducting business in Texas. The tax is calculated by applying a tax rate to a base that considers both revenues and expenses and, therefore, has the characteristics of an income tax.

Uncertain tax positions are recognized in the financial statements only if that position is reasonably determined to be more-likely-than-not of being sustained upon examination by taxing authorities, based on the technical merits of the position. We recognize interest and penalties related to uncertain tax positions in income tax expense. As of December 31, 2020 and 2019, there were no uncertain tax positions.

2. Oil and Gas Properties

We own oil and gas properties within the Permian and Eagle Ford Basins in Texas presently operated on our behalf by entities owned by our Members. Our interests in these properties varies by project.

2019 Asset Acquisitions – Effective January 1, 2019, we completed the acquisition of interests in properties in Cochran County, Texas for cash totaling $1.1 million. We recognized associated asset retirement obligations of $889 thousand for this acquisition.

In a separate transaction in March 2019, we reacquired an interest in an oil and gas property that we had sold in 2017 to a third-party. In this transaction, we surrendered preferred stock in this third-party company issued to us in the initial sales transaction, assumed certain of the third-party’s unpaid obligations, mutually released claims against one another and accepted a note receivable from the third-party totaling $1.1 million. This note receivable was due March 1, 2020, bore interest at 5% per annum, required no payments until maturity and was secured by the third-party’s interest in another oil and gas property located in Karnes County, Texas that we also had an ownership interest in. The preferred stock we surrendered in this transaction had been previously distributed to our Members. These Members recontributed the preferred stock to us prior to closing this transaction.

The transaction is summarized below (in thousands):

Subsequent to the closing of this transaction, the Company paid the accounts payable and debentures obligations assumed at closing. The acquired property interest was subsequently disposed in June 2019.

2019 Disposition – In June 2019, we sold our oil and gas property interests in Cochran County, Texas including the interest acquired in the transaction discussed above. We received cash proceeds of $3.8 million and an additional interest in an existing property located in Karnes County, Texas. We recognized the acquired property interest at $210 thousand representing its estimated fair value at the date of acquisition as determined based on an independently prepared reserve report. A gain of $3.9 million was recognized for this sale of oil and gas properties in the statement of operations.

2020 Asset Acquisitions – During 2020, we made acquisitions of two property interests for cash totaling $4.7 million. We recognized associated asset retirement obligations of $2.1 million for these acquisitions. The acquisitions consisted of interests in properties located in Karnes and Cochran Counties, Texas.

Separately in 2020, we acquired an additional property interest located in Karnes County, Texas by foreclosure of the $1.1 million note receivable from a third-party issued to us in 2019.

Ceiling Test Impairments – We recognized impairments totaling $2.4 million in 2020 and $2.5 million in 2019 for the excess of the net capitalized cost of our oil and gas properties above the cost center ceiling limitations.

3. Asset Retirement Obligations

The following table summarizes the changes in ARO (in thousands):

4. Commitments and Contingencies

Litigation – From time to time, the Company may be subject to litigation or other claims in the normal course of business.

Environmental Matters – Due to the nature of the oil and gas industry, we are exposed to environmental risks. We have various policies and procedures to minimize and mitigate the risks from environmental contamination. We are not aware of any material environmental claims existing as of December 31, 2020; however, there can be no assurance that current regulatory requirements will not change or that unknown potential past non-compliance with environmental laws or other environmental liabilities will not be discovered on our properties.

5. Related Party Transactions

Our oil and gas properties within the Eagle Ford Basin are operated on our behalf by Caldera Operating Company LLC (“Caldera”), an entity controlled by a Member. Our oil and gas properties within the Permian Basin are operated on our behalf by Extex Operating Company (“Extex”), an entity controlled by another Member. All revenues, lease operating expenses, and production taxes and transportation costs are processed by Caldera or Extex and settled monthly.

We pay Caldera and Extex administrative fees as operators of our properties. In 2020, Caldera was paid administrative fees totaling $93 thousand and Extex was paid $89 thousand. In 2019, Caldera was paid administrative fees totaling $64 thousand and Extex was paid $68 thousand.

At December 31, 2020 and 2019, payable to related parties includes $22 thousand and $34 thousand, respectively, for reimbursement of expenses related to our oil and gas properties.

6. Subsequent Events

The Company has evaluated events and transactions subsequent to the balance sheet date and through October 21, 2021, the date the financial statements were available to be issued.

On October 4, 2021, we entered into Purchase and Sale Agreement with U.S. Energy Corp. (“U.S. Energy”) for the sale of all of our oil and gas properties. The transaction will also include certain wells, contracts, technical data, records, personal property and hydrocarbons associated with the assets being sold.

The initial base purchase price for the assets is $125,000 in cash and 6,568,828 shares of U.S. Energy’s common stock subject to customary working capital and other adjustments as set forth in the Purchase and Sale Agreement.

The transaction is expected to close in the fourth quarter of 2021, subject to satisfaction of customary closing conditions, including approval by U.S. Energy’s shareholders, the performance by the parties of their obligations and covenants under the Purchase and Sale Agreement, the delivery of certain documentation by the parties and the absence of any injunction or other legal prohibitions preventing consummation of the transaction.

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Supplemental Oil and Gas Information

(Unaudited)

Oil and Gas Reserve Information

Proved oil and gas reserves are those quantities of crude oil and natural 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. Estimated proved developed oil and gas reserves can be expected to be recovered through existing wells with existing equipment and operating methods. The Company reports all estimated proved reserves held under production-sharing arrangements utilizing the “economic interest” method.

Proved oil and gas reserves have been estimated by independent, third-party petroleum engineers, Onpoint Resources, LLC. These reserve estimates have been prepared in compliance with the Securities and Exchange Commission rules and accounting standards based on the unweighted average prices per barrel of oil and per Mcf of natural gas at the first day of each month in the 12-month period prior to the end of the reporting period.

There are numerous uncertainties inherent in estimating quantities of proved reserves and projecting future rates of production and timing of development expenditures. The reserve data in the following tables only represent estimates and should not be construed as being exact.

The following reserves schedule sets forth the changes in estimated quantities of proved crude oil reserves:

Our proved reserve quantities at December 31, 2019 were about the same as at December 31, 2018. The impact of 2019 production, revisions of previous estimates caused by declines in the average prices per barrel of oil and per Mcf of natural gas and divestitures were offset by acquisitions we completed. We made acquisitions of reserves in Cochran and Karnes Counties, Texas and disposed of other properties within Cochran County, Texas.

The increase in proved quantities for the year ended December 31, 2020 was due principally to acquisitions made in Karnes and Cochran Counties, Texas which added 1.8 million barrels of oil equivalent (“BOE”).

Future Net Cash Flows

Future cash inflows as of December 31, 2020 and 2019 were calculated using an unweighted arithmetic average prices per barrel of oil and per Mcf of natural gas at the first day of each month in the 12-month period prior to the end of the reporting period, except where prices are defined by contractual arrangements. Operating costs, production and ad valorem taxes and future development costs are based on current costs with no escalation.

The following table sets forth unaudited information concerning future net cash flows for proved oil and gas reserves. The standardized measure presented does not include the effects of income taxes as the Company is taxed as a partnership and not subject to federal income taxes. This information does not purport to present the fair market value of the Company’s oil and gas assets, but does present a standardized disclosure concerning possible future net cash flows that would result under the assumptions used.

The following table sets forth the principal sources of change in the discounted future net cash flows:

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Notes to Unaudited Condensed Financial Statements

1. Organization and Significant Accounting Policies

Organization – Lubbock Energy Partners, LLC (the “Company”) was formed as a Texas Limited Liability Company on January 17, 2017. The Company’s principal business activities are focused on the acquisition and development of oil and gas properties in the United States. Our fiscal year-end is December 31.

Basis of Presentation – These interim financial statements are unaudited and have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) regarding interim financial reporting. Certain disclosures have been condensed or omitted from these financial statements. Accordingly, they do not include all the information and notes required by accounting principles generally accepted in the United States of America (“GAAP”) for complete financial statements, and should be read in conjunction with our audited financial statements and notes thereto for the year ended December 31, 2020.

In the opinion of management, the accompanying unaudited condensed financial statements include all adjustments, consisting of normal recurring adjustments, necessary to fairly present the financial position as of, and the results of operations for, all periods presented. In preparing the accompanying financial statements, management has made certain estimates and assumptions that affect reported amounts in the condensed financial statements and disclosures of contingencies. Actual results may differ from those estimates. The results for interim periods are not necessarily indicative of annual results.

Use of Estimates – The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period.

Significant estimates include (i) oil and gas reserves that are used in the calculation of depreciation, depletion, amortization and impairment of the carrying value of oil and gas properties; (ii) production and commodity price estimates used to record oil and gas sales receivables; and (iii) the cost of future asset retirement obligations. The Company evaluates its estimates on an on-going basis and bases its estimates on historical experience and on various other assumptions we believe to be reasonable. Due to inherent uncertainties, including the future prices of oil and gas, these estimates could change in the near term and such changes could be material.

2. Oil and Gas Properties

2020 Acquisitions – In May 2020, we acquired a property interest located in Cochran County, Texas for cash totaling $5 thousand. We recognized associated asset retirement obligations of $1.1 million for this acquisition.

Separately in June 2020, we acquired an additional interest in an existing property located in Karnes County, Texas by foreclosure of the $1.1 million note receivable from a third-party issued to us in 2019.

Ceiling Test Impairments – We recognized an impairment of $2.4 million in 2020 for the excess of the net book value of our oil and gas properties above the cost center ceiling limitation.

3. Asset Retirement Obligations

The following table summarizes the changes in ARO (in thousands):

4. Commitments and Contingencies

Litigation – From time to time, the Company may be subject to litigation or other claims in the normal course of business.

5. Related Party Transactions

Our oil and gas properties within the Eagle Ford Basin are operated on our behalf by Caldera Operating Company LLC (“Caldera”), an entity controlled by a Member. Our oil and gas properties within the Permian Basin are operated on our behalf by Extex Operating Company (“Extex”), an entity controlled by another Member. All revenues, lease operating expenses, and production taxes and transportation costs are processed by Caldera or Extex and settled monthly.

We pay Caldera and Extex administrative fees as operators of our properties. During the nine months ended September 30, 2021, Caldera was paid administrative fees totaling $133 thousand and Extex was paid $86 thousand. During the nine months ended September 30, 2020, Caldera was paid administrative fees totaling $62 thousand and Extex was paid $61 thousand.

At September 30, 2021 and December 31, 2020, payable to related parties includes $233 thousand and $22 thousand, respectively, for reimbursement of expenses for our oil and gas properties.

6. Subsequent Events

The Company has evaluated events and transactions subsequent to the balance sheet date and through March 1, 2022, the date the financial statements were available to be issued.

On October 4, 2021, we entered into Purchase and Sale Agreement with U.S. Energy Corp. (“U.S. Energy”) for the sale of all of our oil and gas properties. The transaction also included certain wells, contracts, technical data, records, personal property and hydrocarbons associated with the assets being sold. This transaction was completed on January 5, 2022 for a total purchase price of $125,000 in cash and 6,568,828 shares of U.S. Energy’s common stock.

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