| DORCHESTER MINERALS LP ITEM 1A RISK FACTORS Risks Related to Our Business Our cash distributions are highly dependent on oil and natural gas prices, which have historically been very volatile |
| Our quarterly cash distributions depend in significant part on the prices realized from the sale of oil and, in particular, natural gas |
| Historically, the markets for oil and natural gas have been volatile and may continue to be volatile in the future |
| Various factors that are beyond our control will affect prices of oil and natural gas, such as: • the worldwide and domestic supplies of oil and natural gas; • the ability of the members of the Organization of Petroleum Exporting Countries and others to agree to and maintain oil prices and production controls; • political instability or armed conflict in oil-producing regions; • the price and level of foreign imports; • the level of consumer demand; • the price and availability of alternative fuels; • the availability of pipeline capacity; • weather conditions; • domestic and foreign governmental regulations and taxes; and • the overall economic environment |
| The volatility of oil and natural gas prices reduces the accuracy of estimates of future cash distributions to unitholders |
| Terrorist attacks on oil and natural gas production facilities, transportation systems and storage facilities could have a material adverse impact on our business |
| Oil and natural gas production facilities, transportation systems and storage facilities could be targets of terrorist attacks |
| These attacks could have a material adverse impact if certain oil and natural gas infrastructure integral to our operations were interrupted, damaged or destroyed, thus preventing the sale of oil and natural gas |
| We do not control operations and development of the Royalty Properties or the properties underlying the Net Profits Interests that the operating partnership does not operate, which could impact the amount of our cash distributions |
| Essentially all of the producing properties we acquired from Republic and Spinnaker are royalty interests |
| As a royalty owner, we do not control the development of these properties or the volumes of oil and natural gas produced from them |
| The decision to develop these properties, including infill drilling, exploration of horizons deeper or shallower than the currently producing intervals, and application of enhanced recovery techniques will be made by the operator and other working interest owners of each property (including our lessees) and may be influenced by factors beyond our control, including but not limited to oil and natural gas prices, interest rates, budgetary considerations and general industry and economic conditions |
| As the owner of a fractional undivided mineral or royalty interest, our ability to influence development of these nonproducing properties is severely limited |
| Also, since one of our stated business objectives is to avoid the generation of unrelated business taxable income, we are prohibited from participation in the development of our properties as a working interest or other expense-bearing owner |
| The decision to explore for oil and natural gas 5 ______________________________________________________________________ [42]Table of Contents [43]Index to Financial Statements on these properties will be made by the operator and other working interest owners of each property (including our lessees) and may be influenced by factors beyond our control, including but not limited to oil and natural gas prices, interest rates, budgetary considerations and general industry and economic conditions |
| Our unitholders are not able to influence or control the operation or future development of the properties underlying the Net Profits Interests |
| The operating partnership is unable to influence significantly the operations or future development of properties that it does not operate |
| The operating partnership and the other current operators of the properties underlying the Net Profits Interests are under no obligation to continue operating the underlying properties |
| The operating partnership can sell any of the properties underlying the Net Profits Interests that it operates and relinquish the ability to control or influence operations |
| Any such sale or transfer must also simultaneously include the Net Profits Interests at a corresponding price |
| Our unitholders do not have the right to replace an operator |
| Our lease bonus revenue depends in significant part on the actions of third parties which are outside of our control |
| A significant portion of the Royalty Properties are unleased mineral interests |
| With limited exceptions, we have the right to grant leases of these interests to third parties |
| We anticipate receiving cash payments as bonus consideration for granting these leases in most instances |
| Our ability to influence third parties’ decisions to become our lessees with respect to these nonproducing properties is severely limited, and those decisions may be influenced by factors beyond our control, including but not limited to oil and natural gas prices, interest rates, budgetary considerations and general industry and economic conditions |
| The operating partnership may transfer or abandon properties that are subject to the Net Profits Interests |
| Our general partner, through the operating partnership, may at any time transfer all or part of the properties underlying the Net Profits Interests |
| Our unitholders are not entitled to vote on any transfer, however, any such transfer must also simultaneously include the Net Profits Interests at a corresponding price |
| The operating partnership or any transferee may abandon any well or property if it reasonably believes that the well or property can no longer produce in commercially economic quantities |
| This could result in termination of the Net Profits Interests relating to the abandoned well |
| Cash distributions are affected by production and other costs, some of which are outside of our control |
| The cash available for distribution that comes from our royalty and mineral interests, including the Net Profits Interests, is directly affected by increases in production costs and other costs |
| Some of these costs are outside our control, including costs of regulatory compliance and severance and other similar taxes |
| Other expenditures are dictated by business necessity, such as drilling additional wells in response to the drilling activity of others |
| Our oil and natural gas reserves and the underlying properties are depleting assets, and there are limitations on our ability to replace them |
| Our revenues and distributions depend in large part on the quantity of oil and natural gas produced from properties in which we hold an interest |
| Our producing oil and natural gas properties over time will all experience declines in production due to depletion of their oil and natural gas reservoirs, with the rates of decline varying by property |
| Replacement of reserves to maintain production levels requires maintenance, development or exploration projects on existing properties, or the acquisition of additional properties |
| The timing and size of any maintenance, development or exploration projects depends on the market prices of oil and natural gas and on other factors beyond our control |
| Many of the decisions regarding implementation of such projects, including drilling or exploration on any unleased and undeveloped acreage, will be made by third parties |
| In addition, development possibilities in the Hugoton field are limited by the developed nature of that field and by regulatory restrictions |
| 6 ______________________________________________________________________ [44]Table of Contents [45]Index to Financial Statements Our ability to increase reserves through future acquisitions is limited by restrictions on our use of cash and limited partnership interests for acquisitions and by our general partner’s obligation to use all reasonable efforts to avoid unrelated business taxable income |
| In addition, the ability of affiliates of our general partner to pursue business opportunities for their own accounts without tendering them to us in certain circumstances may reduce the acquisitions presented to our Partnership for consideration |
| Drilling activities on our properties may not be productive, which could have an adverse effect on future results of operations and financial condition |
| The operating partnership may undertake drilling activities in limited circumstances on the properties underlying the Net Profits Interests, and third parties may undertake drilling activities on our other properties |
| Any increases in our reserves will come from such drilling activities or from acquisitions |
| Drilling involves a wide variety of risks, including the risk that no commercially productive oil or natural gas reservoirs will be encountered |
| The cost of drilling, completing and operating wells is often uncertain and drilling operations may be delayed or canceled as a result of a variety of factors, including: • pressure or irregularities in formations; • equipment failures or accidents; • disputes with drill site landowners; • unexpected drilling conditions; • shortages or delays in the delivery of equipment; • adverse weather conditions; and • disputes with drill-site owners |
| Future drilling activities on our properties may not be successful |
| If these activities are unsuccessful, this failure could have an adverse effect on our future results of operations and financial condition |
| In addition, under the terms of the Net Profits Interests, the costs of unsuccessful future drilling on the working interest properties that are subject to the Net Profits Interests will reduce amounts payable to us under the Net Profits Interests by 96dtta97prca of these costs |
| Our ability to identify and capitalize on acquisitions is limited by contractual provisions and substantial competition |
| Our partnership agreement limits our ability to acquire oil and natural gas properties in the future, especially for consideration other than our limited partnership interests |
| Because of the limitations on our use of cash for acquisitions and on our ability to accumulate cash for acquisition purposes, we may be required to attempt to effect acquisitions with our limited partnership interests |
| However, sellers of properties we would like to acquire may be unwilling to take our limited partnership interests in exchange for properties |
| Our partnership agreement obligates our general partner to use all reasonable efforts to avoid generating unrelated business taxable income |
| Accordingly, to acquire working interests we would have to arrange for them to be converted into overriding royalty interests, net profits interests, or another type of interest that does not generate unrelated business taxable income in a manner similar to the treatment of Dorchester Hugoton’s properties in the combination |
| Third parties may be less likely to deal with us than with a purchaser to which such a condition would not apply |
| These restrictions could prevent us from pursuing or completing business opportunities that might benefit us and our unitholders, particularly unitholders who are not tax-exempt investors |
| The duty of affiliates of our general partner to present acquisition opportunities to our Partnership is limited, including pursuant to the terms of the Amended and Restated Business Opportunities Agreement |
| Accordingly, business opportunities that could potentially be pursued by us might not necessarily come to our attention, which could limit our ability to pursue a business strategy of acquiring oil and natural gas properties |
| 7 ______________________________________________________________________ [46]Table of Contents [47]Index to Financial Statements We compete with other companies and producers for acquisitions of oil and natural gas interests |
| Many of these competitors have substantially greater financial and other resources than we do |
| Any future acquisitions will involve risks that could adversely affect our business, which our unitholders generally will not have the opportunity to evaluate |
| Our current strategy contemplates that we may grow through acquisitions |
| We expect to participate in discussions relating to potential acquisition and investment opportunities |
| If we consummate any additional acquisitions, our capitalization and results of operations may change significantly and our unitholders will not have the opportunity to evaluate the economic, financial and other relevant information that we will consider in connection with the acquisition, unless the terms of the acquisition require approval of our unitholders |
| Additionally, our unitholders will bear 100prca of the dilution from issuing new common units while receiving essentially 96prca of the benefit as 4prca of the benefit goes to our general partner |
| Acquisitions and business expansions involve numerous risks, including assimilation difficulties, unfamiliarity with new assets or new geographic areas and the diversion of management’s attention from other business concerns |
| In addition, the success of any acquisition will depend on a number of factors, including the ability to estimate accurately the recoverable volumes of reserves, rates of future production and future net revenues attributable to reserves and to assess possible environmental liabilities |
| Our review and analysis of properties prior to any acquisition will be subject to uncertainties and, consistent with industry practice, may be limited in scope |
| We may not be able to successfully integrate any oil and natural gas properties that we acquire into our operations or we may not achieve desired profitability objectives |
| A natural disaster or catastrophe could damage pipelines, gathering systems and other facilities that service our properties, which could substantially limit our operations and adversely affect our cash flow |
| If gathering systems, pipelines or other facilities that serve our properties are damaged by any natural disaster, accident, catastrophe or other event, our income could be significantly interrupted |
| Any event that interrupts the production, gathering or transportation of our oil and natural gas, or which causes us to share in significant expenditures not covered by insurance, could adversely impact the market price of our limited partnership units and the amount of cash available for distribution to our unitholders |
| We do not carry business interruption insurance |
| The vast majority of the properties subject to the Net Profits Interests are geographically concentrated, which could cause net proceeds payable under the Net Profits Interests to be impacted by regional events |
| The vast majority of the properties subject to the Net Profits Interests are all natural gas properties that are located almost exclusively in the Hugoton field in Oklahoma and Kansas |
| Because of this geographic concentration, any regional events, including natural disasters, that increase costs, reduce availability of equipment or supplies, reduce demand or limit production may impact the net proceeds payable under the Net Profits Interests more than if the properties were more geographically diversified |
| The number of prospective natural gas purchasers and methods of delivery are considerably less than would otherwise exist from a more geographically diverse group of properties |
| As a result, natural gas sales after gathering and compression tend to be sold to one buyer in each state, thereby increasing credit risk |
| Under the terms of the Net Profits Interests, much of the economic risk of the underlying properties is passed along to us |
| Under the terms of the Net Profits Interests, virtually all costs that may be incurred in connection with the properties, including overhead costs that are not subject to an annual reimbursement limit, are deducted as production costs or excess production costs in determining amounts payable to us |
| Therefore, to the extent of the 8 ______________________________________________________________________ [48]Table of Contents [49]Index to Financial Statements revenues from the burdened properties, we bear 96dtta97prca of the costs of the working interest properties |
| If costs exceed revenues, we do not receive any payments under the Net Profits Interests |
| However, except as described below, we are not required to pay any excess costs |
| The terms of the Net Profits Interests provide for excess costs that cannot be charged currently because they exceed current revenues to be accumulated and charged in future periods, which could result in our not receiving any payments under the Net Profits Interests until all prior uncharged costs have been recovered by the operating partnership |
| The practice of combining several years’ Net Profits Interests that have excess costs has enabled the operating partnership to recoup excess costs out of revenues from a greater number of properties, deferring to some degree payments to us with respect to such Net Profits Interests |
| Damage claims associated with the production and gathering of our oil and natural gas properties could affect our cash flow |
| The operating partnership owns and operates the gathering system and compression facilities acquired from Dorchester Hugoton |
| Casualty losses or damage claims from these operations would be production costs under the terms of the Net Profits Interests and could adversely affect our cash flow |
| We may indirectly experience costs from repair or replacement of aging equipment |
| Some of the operating partnership’s current working interest wells were drilled and have been producing since prior to 1954 |
| The 132-mile Oklahoma gas pipeline gathering system acquired from Dorchester Hugoton was originally installed in or about 1948, and because of its age is in need of periodic repairs and upgrades |
| Should major components of this system require significant repairs or replacement, the operating partnership may incur substantial capital expenditures in the operation of the Oklahoma properties previously owned by Dorchester Hugoton prior to the consummation of the combination, which, as production costs, would reduce our cash flow from these properties |
| Our cash flow is subject to operating hazards and unforeseen interruptions for which we may not be fully insured |
| Neither we nor the operating partnership are fully insured against certain of these risks, either because such insurance is not available or because of high premium costs |
| Operations that affect the properties are subject to all of the risks normally incident to the oil and natural gas business, including blowouts, cratering, explosions and pollution and other environmental damage, any of which could result in substantial decreases in the cash flow from our overriding royalty interests and other interests due to injury or loss of life, damage to or destruction of wells, production facilities or other property, clean-up responsibilities, regulatory investigations and penalties and suspension of operations |
| Any uninsured costs relating to the properties underlying the Net Profits Interests will be deducted as a production cost in calculating the net proceeds payable to us |
| Governmental policies, laws and regulations could have an adverse impact on our business and cash distributions |
| Our business and the properties in which we hold interests are subject to federal, state and local laws and regulations relating to the oil and natural gas industry as well as regulations relating to safety matters |
| These laws and regulations can have a significant impact on production and costs of production |
| For example, both Oklahoma and Kansas, where properties that are subject to the Net Profits Interests are located, have the ability, directly or indirectly, to limit production from those properties, and such limitations or changes in those limitations could negatively impact us in the future |
| As another example, Oklahoma regulations currently require administrative hearings to change the concentration of gas production wells from one well for each 640 acres in the Guymon-Hugoton field (the location of former Dorchester Hugoton properties) |
| Previously, certain interested parties have sought regulatory 9 ______________________________________________________________________ [50]Table of Contents [51]Index to Financial Statements changes in Oklahoma for “infill,” or increased density, drilling similar to that which is available in Kansas, which allows one well for each 320 acres |
| Should Oklahoma change its existing regulations to readily permit infill drilling, it is possible that a number of producers will commence increased density drilling in areas adjacent to the properties in Oklahoma that are subject to the Net Profits Interests |
| If the operating partnership or other operators of our properties do not do the same, our production levels relating to these properties may decrease or mineral owners may demand increased density drilling |
| Capital expenditures relating to increased density on the properties underlying the Net Profits Interests would be deducted from amounts payable to us under the Net Profits Interests |
| Environmental costs and liabilities and changing environmental regulation could affect our cash flow |
| As with other companies engaged in the ownership and production of oil and natural gas, we always expect to have some risk of exposure to environmental costs and liabilities because the costs associated with environmental compliance or remediation could reduce the amount we would receive from our properties |
| The properties in which we hold interests are subject to extensive federal, state, tribal and local regulatory requirements relating to environmental affairs, health and safety and waste management |
| Governmental authorities have the power to enforce compliance with applicable regulations and permits, which could increase production costs on our properties and affect their cash flow |
| Third parties may also have the right to pursue legal actions to enforce compliance |
| It is likely that expenditures in connection with environmental matters, as part of normal capital expenditure programs, will affect the net cash flow from our properties |
| Future environmental law developments, such as stricter laws, regulations or enforcement policies, could significantly increase the costs of production from our properties and reduce our cash flow |
| Our oil and gas reserve data and future net revenue estimates are uncertain |
| Estimates of proved reserves and related future net revenues are projections based on engineering data and reports of independent consulting petroleum engineers hired for that purpose |
| The process of estimating reserves requires substantial judgment, resulting in imprecise determinations |
| Different reserve engineers may make different estimates of reserve quantities and related revenue based on the same data |
| Therefore, those estimates should not be construed as being accurate estimates of the current market value of our proved reserves |
| If these estimates prove to be inaccurate, our business may be adversely affected by lower revenues |
| We are affected by changes in oil and natural gas prices |
| Oil prices and natural gas prices may experience inverse price changes |
| Risks Inherent In An Investment In Our Common Units Cost reimbursement due our general partner may be substantial and reduce our cash available to distribute to our unitholders |
| Prior to making any distribution on the common units, we reimburse the general partner and its affiliates for reasonable costs and expenses of management |
| The reimbursement of expenses could adversely affect our ability to pay cash distributions to our unitholders |
| Our general partner has sole discretion to determine the amount of these expenses, subject to the annual limit of 5prca of an amount primarily based on our distributions to partners for that fiscal year |
| The annual limit includes carry-forward and carry-back features, which could allow costs in a year to exceed what would otherwise be the annual reimbursement limit |
| In addition, our general partner and its affiliates may provide us with other services for which we will be charged fees as determined by our general partner |
| Our net income as reported for tax and financial statement purposes may differ significantly from our cash flow that is used to determine cash available for distributions |
| Net income as reported for financial statement purposes is presented on an accrual basis in conformity with accounting principles generally accepted in the United States of America |
| Unitholder K-1 tax statements are calculated based on applicable tax conventions, and taxable income as calculated for each year will be allocated 10 ______________________________________________________________________ [52]Table of Contents [53]Index to Financial Statements among unitholders who hold units on the last day of each month |
| Distributions, however, are calculated on the basis of actual cash receipts, changes in cash reserves, and disbursements during the relevant reporting period |
| Consequently, due to timing differences between the receipt of proceeds of production and the point in time at which the production giving rise to those proceeds actually occurs, net income reported on our financial statements and on unitholder K-1’s will not reflect actual cash distributions during that reporting period |
| Our unitholders have limited voting rights and do not control our general partner, and their ability to remove our general partner is limited |
| Our unitholders have only limited voting rights on matters affecting our business |
| The general partner of our general partner manages our activities |
| Our unitholders only have the right to annually elect the managers comprising the Advisory Committee of the Board of Managers of the general partner of our general partner |
| Our unitholders do not have the right to elect the other managers of the general partner of our general partner, on an annual or any other basis |
| Our general partner may not be removed as our general partner except upon approval by the affirmative vote of the holders of at least a majority of our outstanding common units (including common units owned by our general partner and its affiliates), subject to the satisfaction of certain conditions |
| Our general partner and its affiliates do not own sufficient common units to be able to prevent its removal as general partner, but they do own sufficient common units to make the removal of our general partner by other unitholders difficult |
| These provisions may discourage a person or group from attempting to remove our general partner or acquire control of us without the consent of our general partner |
| As a result of these provisions, the price at which our common units trade may be lower because of the absence or reduction of a takeover premium in the trading price |
| The control of our general partner may be transferred to a third party without unitholder consent |
| Our general partner has agreed not to withdraw voluntarily as our general partner on or before December 31, 2010 (with limited exceptions), unless the holders of at least a majority of our outstanding common units (excluding common units owned by our general partner and its affiliates) approve the withdrawal |
| However, the general partner may transfer its general partner interest to a third party in a merger or in a sale of all or substantially all of its assets without the consent of our unitholders |
| Other than some transfer restrictions agreed to among the owners of our general partner relating to their interests in our general partner, there is no restriction in our partnership agreement or otherwise for the benefit of our limited partners on the ability of the owners of our general partner to transfer their ownership interests to a third party |
| The new owner of the general partner would then be in a position to replace the management of our Partnership with its own choices |
| Our general partner and its affiliates have conflicts of interests, which may permit our general partner and its affiliates to favor their own interests to the detriment of unitholders |
| We and our general partner and its affiliates share, and therefore compete for, the time and effort of general partner personnel who provide services to us |
| Officers of our general partner and its affiliates do not, and are not required to, spend any specified percentage or amount of time on our business |
| In fact, our general partner has a duty to manage our Partnership in the best interests of our unitholders, but it also has a duty to operate its business for the benefit of its partners |
| Some of our officers are also involved in management and ownership roles in other oil and natural gas enterprises and have similar duties to them and devote time to their businesses |
| Because these shared officers function as both our representatives and those of our general partner and its affiliates and of third parties, conflicts of interest could arise between our general partner and its affiliates, on the one hand, and us or our unitholders, on the other, or between us or our unitholders on the one hand and the third parties for which our officers also serve management functions |
| As a result of these conflicts, our general partner and its affiliates may favor their own interests over the interests of unitholders |
| 11 ______________________________________________________________________ [54]Table of Contents [55]Index to Financial Statements We may issue additional securities, diluting our unitholders’ interests |
| We can and may issue additional common units and other capital securities representing limited partnership units, including options, warrants, rights, appreciation rights and securities with rights to distributions and allocations or in liquidation equal or superior to the securities described in this document, however, a majority of the unitholders must approve such issuance if (i) the partnership securities to be issued will have greater rights or powers than our common units or (ii) if after giving effect to such issuance, such newly issued partnership securities represent over 20prca of the outstanding limited partnership interests |
| If we issue additional common units, it will reduce our unitholders’ proportionate ownership interest in us |
| This could cause the market price of the common units to fall and reduce the per unit cash distributions paid to our unitholders |
| In addition, if we issued limited partnership units with voting rights superior to the common units, it could adversely affect our unitholders’ voting power |
| Our unitholders may not have limited liability in the circumstances described below and may be liable for the return of certain distributions |
| Under Delaware law, our unitholders could be held liable for our obligations to the same extent as a general partner if a court determined that the right of unitholders to remove our general partner or to take other action under our partnership agreement constituted participation in the “control” of our business |
| The general partner generally has unlimited liability for the obligations of our Partnership, such as its debts and environmental liabilities, except for those contractual obligations of our Partnership that are expressly made without recourse to the general partner |
| In addition, Section 17-607 of the Delaware Revised Uniform Limited Partnership Act provides that, under certain circumstances, a unitholder may be liable for the amount of distribution for a period of three years from the date of distribution |
| Because we conduct our business in various states, the laws of those states may pose similar risks to our unitholders |
| To the extent to which we conduct business in any state, our unitholders might be held liable for our obligations as if they were general partners if a court or government agency determined that we had not complied with that state’s partnership statute, or if rights of unitholders constituted participation in the “control” of our business under that state’s partnership statute |
| In some of the states in which we conduct business, the limitations on the liability of limited partners for the obligations of a limited partnership have not been clearly established |
| We are dependent upon key personnel, and the loss of services of any of our key personnel could adversely affect our operations |
| Our continued success depends to a considerable extent upon the abilities and efforts of the senior management of our general partner, particularly William Casey McManemin, its Chief Executive Officer, James E Raley, its Chief Operating Officer, and H C Allen, Jr, its Chief Financial Officer |
| The loss of the services of any of these key personnel could have a material adverse effect on our results of operations |
| We have not obtained insurance or entered into employment agreements with any of these key personnel |
| We are dependent on service providers who assist us with providing Schedule K-1 tax statements to our unitholders |
| There are a very limited number of service firms that currently perform the detailed computations needed to provide each unitholder with estimated depletion and other tax information to assist the unitholder in various United States income tax computations |
| There are also very few publicly traded limited partnerships that need these services |
| As a result, the future costs and timeliness of providing Schedule K-1 tax statements to our unitholders is uncertain |
| 12 ______________________________________________________________________ [56]Table of Contents [57]Index to Financial Statements Disclosure Regarding Forward-Looking Statements Statements included in this report which are not historical facts (including any statements concerning plans and objectives of management for future operations or economic performance, or assumptions or forecasts related thereto), are forward-looking statements |
| These statements discuss future expectations, contain projections of results of operations or of financial condition or state other “forward-looking” information |
| These forward-looking statements are made based upon management’s current plans, expectations, estimates, assumptions and beliefs concerning future events impacting us and therefore involve a number of risks and uncertainties |
| We caution that forward-looking statements are not guarantees and that actual results could differ materially from those expressed or implied in the forward-looking statements |
| Because these forward-looking statements involve risks and uncertainties, actual results could differ materially from those expressed or implied by these forward-looking statements for a number of important reasons, including those discussed under “Risk Factors” and elsewhere in this report |
| You should read these statements carefully because they may discuss our expectations about our future performance, contain projections of our future operating results or our future financial condition, or state other “forward-looking” information |
| Before you invest, you should be aware that the occurrence of any of the events herein described in “Risk Factors” and elsewhere in this report could substantially harm our business, results of operations and financial condition and that upon the occurrence of any of these events, the trading price of our common units could decline, and you could lose all or part of your investment |