| SWIFT ENERGY CO Item 1A Risk Factors The nature of the business activities conducted by Swift Energy subjects it to certain hazards and risks |
| The following is a summary of some of the material risks relating to our business activities |
| Other risks are described in Items 1 and 2 Business and Properties “Competition” and “Regulations” and “Item 7A Quantitative and Qualitative Disclosures About Market Risk |
| ” Our oil and gas exploration and production business involves high risks and we may suffer uninsured losses |
| These risks include blowouts, explosions, adverse weather effects and pollution and other environmental damage, any of which could result in substantial losses to the Company 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 |
| Increased hurricane activity over the past two years has resulted in production curtailments and physical damage to the Company’s Gulf Coast operations |
| Although the Company currently maintains insurance coverage that it considers reasonable and that is similar to that maintained by comparable companies in the oil and gas industry, it is not fully insured against certain of these risks, either because such insurance is not available or because of the high premium costs and deductibles associated with obtaining such insurance |
| A substantial decrease in oil and natural gas prices would adversely affect our financial results |
| Our future revenues, net income, cash flow, and the value of our oil and natural gas properties depend primarily upon market prices for oil and natural gas |
| Oil and natural gas prices historically have been volatile and will likely continue to be volatile in the future |
| The recent record high oil and natural gas prices may not continue and could drop precipitously in a short period of time |
| The prices for oil and natural gas are subject to wide fluctuation in response to relatively minor changes in the supply of and demand for oil and natural gas, market uncertainty, worldwide economic conditions, weather conditions, currency exchange rates, and political conditions in major oil producing regions, especially the Middle East |
| A significant decrease in price levels for an extended period would negatively affect us in several ways: • our cash flow would be reduced, decreasing funds available for capital expenditures employed to increase production or replace reserves; • certain reserves would no longer be economic to produce, leading to both lower cash flow and proved reserves; • our lenders could reduce the borrowing base under our bank credit facility because of lower oil and natural gas reserves values, reducing our liquidity and possibly requiring mandatory loan repayments; and • access to other sources of capital, such as equity or long term debt markets, could be severely limited or unavailable in a low price environment |
| Consequently, our revenues and profitability would suffer |
| Our level of debt could reduce our financial flexibility, and we currently have the ability to incur substantially more debt, including secured debt |
| As of December 31, 2005, our total debt comprised approximately 37prca of our total capitalization |
| Although our bank credit facility and indentures limit our ability and the ability of our restricted subsidiaries to incur additional indebtedness, we will be permitted to incur significant additional indebtedness, including secured indebtedness, in the future if specified conditions are satisfied |
| All borrowings under our bank credit facility are effectively senior to our outstanding 7-5/8prca senior notes and 9-3/8prca senior subordinated notes to the extent of the value of the collateral securing those borrowings |
| Our current level of indebtedness: • will require us to dedicate a substantial portion of our cash flow to the payment of interest; • will subject us to a higher financial risk in an economic downturn due to substantial debt service costs; 19 _________________________________________________________________ [73]Table of Contents • may limit our ability to obtain financing or raise equity capital in the future; and • may place us at a competitive disadvantage to the extent that we are more highly leveraged than some of our peers |
| Higher levels of indebtedness would increase these risks |
| Estimates of proved reserves are uncertain, and revenues from production may vary significantly from expectations |
| The quantities and values of our proved reserves included in this report are only estimates and subject to numerous uncertainties |
| Estimates by other engineers might differ materially |
| The accuracy of any reserves estimate is a function of the quality of available data and of engineering and geological interpretation |
| These estimates depend on assumptions regarding quantities and production rates of recoverable oil and natural gas reserves, future prices for oil and natural gas, timing and amounts of development expenditures and operating expenses, all of which will vary from those assumed in our estimates |
| These variances may be significant |
| Any significant variance from the assumptions used could result in the actual amounts of oil and natural gas ultimately recovered and future net cash flows being materially different from the estimates in our reserves reports |
| In addition, results of drilling, testing, production, and changes in prices after the date of the estimates of our reserves may result in substantial downward revisions |
| These estimates may not accurately predict the present value of net cash flows from our oil and natural gas reserves |
| At December 31, 2005, approximately 50prca of our estimated proved reserves were undeveloped |
| Recovery of undeveloped reserves generally requires significant capital expenditures and successful drilling operations |
| The reserves data assumes that we can and will make these expenditures and conduct these operations successfully, which may not occur |
| If we cannot replace our reserves, our revenues and financial condition will suffer |
| Unless we successfully replace our reserves, our long- term production will decline, which could result in lower revenues and cash flow |
| When oil and natural gas prices decrease, our cash flow decreases, resulting in less available cash to drill and replace our reserves and an increased need to draw on our bank credit facility |
| Even if we have the capital to drill, unsuccessful wells can hurt our efforts to replace reserves |
| Additionally, lower oil and natural gas prices can have the effect of lowering our reserves estimates and the number of economically viable prospects that we have to drill |
| Drilling wells is speculative and capital intensive |
| Developing and exploring properties for oil and natural gas requires significant capital expenditures and involves a high degree of financial risk, including the risk that no commercially productive oil or gas reservoirs will be encountered |
| The budgeted costs of drilling, completing, and operating wells are often exceeded and can increase significantly when drilling costs rise |
| Drilling may be unsuccessful for many reasons, including title problems, weather, cost overruns, equipment shortages, and mechanical difficulties |
| Moreover, the successful drilling or completion of an oil or gas well does not ensure a profit on investment |
| Exploratory wells bear a much greater risk of loss than development wells |
| We may incur substantial losses and be subject to substantial liability claims as a result of our oil and natural gas operations |
| We are not insured against all risks |
| Losses and liabilities arising from uninsured and underinsured events could materially and adversely affect our business, financial condition, or results of operations |
| Our oil and natural gas exploration and production activities are subject to all of the operating risks associated with drilling for and producing oil and natural gas, including the possibility of: • Hurricanes or tropical storms; • environmental hazards, such as uncontrollable flows of oil, natural gas, brine, well fluids, toxic gas, or other pollution into the environment, including groundwater and shoreline contamination; 20 _________________________________________________________________ [74]Table of Contents • abnormally pressured formations; • mechanical difficulties, such as stuck oil field drilling and service tools and casing collapse; • fires and explosions; • personal injuries and death; and • natural disasters |
| Any of these risks could adversely affect our ability to conduct operations or result in substantial losses |
| We may elect not to obtain insurance if we believe that the cost of available insurance is excessive relative to the risks presented |
| In addition, pollution and environmental risks generally are not fully insurable |
| If a significant accident or other event occurs and is not fully covered by insurance, it could adversely affect our financial condition |
| We are exposed to the risk of fluctuations in foreign currencies, primarily the New Zealand dollar |
| Fluctuations in rates between the New Zealand dollar and US dollar impact our financial results from our New Zealand subsidiaries since we have receivables, liabilities, and natural gas and NGL sales contracts denominated in New Zealand dollars |
| We do not hedge against the risks associated with fluctuations in exchange rates |
| Although we may use hedging techniques in the future, we may not be able to eliminate or reduce the effects of currency fluctuations |
| As a result, exchange rate fluctuations could have an adverse impact on our operating results |
| We have incurred a write-down of the carrying values of our properties in the past and could incur additional write-downs in the future |
| Under the full cost method of accounting, SEC accounting rules require that on a quarterly basis we review the carrying value of our oil and gas properties on a country-by-country basis for possible write-down or impairment |
| Under these rules, capitalized costs of proved reserves may not exceed a ceiling calculated at the present value of estimated future net revenues from those proved reserves, determined using a 10prca per year discount and unescalated prices in effect as of the end of each fiscal quarter |
| Capital costs in excess of the ceiling must be permanently written down |
| This write-down resulted in a charge to earnings and a reduction of stockholders’ equity, but did not impact our cash flow from operating activities |
| If commodity prices decline or if we have significant downward reserves revisions, we could incur additional write-downs in the future |
| Substantial acquisitions or other transactions could require significant external capital and could change our risk and property profile |
| To finance acquisitions, we may need to substantially alter or increase our capitalization through the use of our bank credit facility, the issuance of debt or equity securities, the sale of production payments, or by other means |
| These changes in capitalization may significantly affect our risk profile |
| Additionally, significant acquisitions or other transactions can change the character of our operations and business |
| The character of the new properties may be substantially different in operating or geological characteristics or geographic location than our existing properties |
| Furthermore, we may not be able to obtain external funding for any such acquisitions or other transactions or to obtain external funding on terms acceptable to us |
| Reserves on acquired properties may not meet our expectations, and we may be unable to identify liabilities associated with acquired properties or obtain protection from sellers against associated liabilities |
| Property acquisition decisions are based on various assumptions and subjective judgments that are speculative |
| Although available geological and geophysical information can provide information about the potential of a property, it is impossible to predict accurately a property’s production and profitability |
| In addition, we may have difficulty integrating future acquisitions into our operations, and they may not achieve our desired profitability objectives |
| Likewise, as is customary in the industry, we generally acquire oil and gas acreage without any warranty of title except through the transferor |
| In many instances, title opinions are not obtained if, in our judgment, it would 21 _________________________________________________________________ [75]Table of Contents be uneconomical or impractical to do so |
| Losses may result from title defects or from defects in the assignment of leasehold rights |
| While our current operations are primarily in Louisiana, Texas, and New Zealand, we may pursue acquisitions of properties located in other geographic areas, which would decrease our geographical concentration, and could also be in areas in which we have no or limited experience |
| In addition, our assessment of acquired properties may not reveal all existing or potential problems or liabilities, nor will it permit us to become familiar enough with the properties to assess fully their capabilities and deficiencies |
| Inspections may not reveal structural and environmental problems, such as pipeline corrosion or groundwater contamination |
| We may not be able to obtain contractual indemnities from the seller for liabilities that it created |
| We may be required to assume the risk of the physical condition of acquired properties in addition to the risk that the properties may not perform in accordance with our expectations |
| Prospects that we decide to drill may not yield oil or natural gas in commercially viable quantities |
| There is no way to predict in advance of drilling and testing whether any particular prospect will yield oil or natural gas in sufficient quantities, if at all, to recover drilling or completion costs or to be economically viable |
| The use of seismic data and other technologies and the study of producing fields in the same area will not enable us to know conclusively prior to drilling whether oil or natural gas will be present |
| We cannot assure you that the analogies we draw from available data from other wells, more fully explored prospects, or producing fields will be applicable to our drilling prospects |
| In addition, a variety of factors, including geological and market-related, can cause a well to become uneconomical or only marginally economical |
| For example, if oil and natural gas prices are much lower after we complete a well than when we identified it as a prospect, the completed well may not yield commercially viable quantities |
| In many instances, title opinions on our oil and gas acreage are not be obtained if in our judgment it would be uneconomical or impractical to do so |
| As is customary in the industry, we generally acquire oil and gas acreage without any warranty of title except as to claims made by, through, or under the transferor |
| Although we have title to developed acreage examined prior to acquisition in those cases in which the economic significance of the acreage justifies the cost, there can be no assurance that losses will not result from title defects or from defects in the assignment of leasehold rights |
| Our use of oil and natural gas price hedging contracts involves credit risk and may limit future revenues from price increases and expose us to risk of financial loss |
| We enter into hedging transactions for our oil and natural gas production to reduce exposure to fluctuations in the price of oil and natural gas, primarily to protect against declines in prices |
| Our hedges at year-end 2005 consisted of mainly natural gas price floors with strike prices lower than the period end prices |
| Our hedging transactions have also consisted of financially settled crude oil and natural gas forward sales contracts with major financial institutions as well as crude oil price floors |
| We intend to continue to enter into these types of hedging transactions in the foreseeable future |
| Hedging transactions expose us to risk of financial loss in some circumstances, including if production is less than expected, the other party to the contract defaults on its obligations, or there is a change in the expected differential between the underlying price in the hedging agreement and actual prices received |
| Hedging transactions other than floors may limit the benefit we would have otherwise received from increases in the price for oil and natural gas |
| Additionally, hedging transactions other than floors may expose us to cash margin requirements |
| We may have difficulty competing for oil and gas properties or supplies |
| We operate in a highly competitive environment, competing with major integrated and independent energy companies for desirable oil and gas properties, as well as for the equipment, labor, and materials required to develop and operate such properties |
| Many of these competitors have financial and technological resources substantially greater than ours |
| The market for oil and gas properties is highly competitive and we may lack technological information or expertise available to other bidders |
| We may incur higher costs or be unable to acquire and develop desirable properties at costs we consider reasonable because of this competition |
| Our business depends on oil and natural gas transportation facilities, some of which are owned by others |
| 22 _________________________________________________________________ [76]Table of Contents The marketability of our oil and natural gas production depends in part on the availability, proximity, and capacity of pipeline systems owned by third parties |
| The unavailability of or lack of available capacity on these systems and facilities could result in the shut-in of producing wells or the delay or discontinuance of development plans for properties |
| Although we have some contractual control over the transportation of our product, material changes in these business relationships could materially affect our operations |
| Federal and state regulation of oil and natural gas production and transportation, tax and energy policies, changes in supply and demand, pipeline pressures, damage to or destruction of pipelines and general economic conditions could adversely affect our ability to produce, gather and transport oil and natural gas |
| Governmental laws and regulations are costly and stringent, especially those relating to environmental protection |
| Our domestic exploration, production, and marketing operations are subject to complex and stringent federal, state, and local laws and regulations governing the discharge of substances into the environment or otherwise relating to environmental protection |
| These laws and regulations affect the costs, manner, and feasibility of our operations and require us to make significant expenditures in our efforts to comply |
| Failure to comply with these laws and regulations may result in the assessment of administrative, civil, and criminal penalties, the imposition of investigatory and remedial obligations, and the issuance of injunctions that could limit or prohibit our operations |
| In addition, some of these laws and regulations may impose joint and several, strict liability for contamination resulting from spills, discharges, and releases of substances, including petroleum hydrocarbons and other wastes, without regard to fault or the legality of the original conduct |
| Under such laws and regulations, we could be required to remove or remediate previously disposed substances and property contamination, including wastes disposed or released by prior owners or operations |
| Changes in or additions to environmental laws and regulations occur frequently, and any changes or additions that result in more stringent and costly waste handling, storage, transport, disposal, or cleanup requirements could have a material adverse effect our operations and financial position |
| Our operations outside of the United States could also be subject to similar foreign governmental controls and restrictions pertaining to protection of human health and the environment |
| These controls and restrictions may include the need to acquire permits, prohibitions on drilling in certain environmentally sensitive areas, performance of investigatory or remedial actions for any releases of petroleum hydrocarbons or other wastes caused by us or prior owners or operators, closure, and restoration of facility sites, and payment of penalties for violations of applicable laws and regulations |