10-K 1 form10-k.htm PETROLEUM DEVELOPMENT CORP. 10-K 12-31-2006 form10-k.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K
 
T ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2006

or

£ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 000-07246


PETROLEUM DEVELOPMENT CORPORATION
(Exact name of registrant as specified in its charter)
 
Nevada
  
95-2636730
(State of incorporation)
  
(I.R.S. Employer Identification No.)

120 Genesis Boulevard
Bridgeport, West Virginia 26330
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code: (304) 842-3597

Securities Registered Pursuant to Section 12(b) of the Act:

Title of each class
  
Name of exchange on which registered
Common Stock, par value $.01 per share
  
NASDAQ Global Select Market

Securities Registered Pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes £ No T

Indicate by check mark if registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes £ No T 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days. Yes T No £

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. T

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or non-accelerated file. See definition of "accelerated filer and larger accelerated filer" in Rule 12b-2 of the Exchange Act:

Large Accelerated Filer £
Accelerated Filer T
Non-Accelerated Filer £

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes £ No T
 
As of April 30, 2007, 14,887,530 shares of the Registrant's Common Stock were issued and outstanding.

The aggregate market value of such shares held by non-affiliates of the Registrant on June 30, 2006, the last business day of the Registrant's most recently completed second quarter was $610,385,733 (based on the last traded price of $37.70).

DOCUMENTS INCORPORATED BY REFERENCE
None.
 

PETROLEUM DEVELOPMENT CORPORATION
INDEX TO REPORT ON FORM 10-K

 
 
       
   
PART I
Page
       
 
Item 1:
5
 
Item 1A:
15
 
Item 1B:
24
 
Item 2:
24
 
Item 3:
28
 
Item 4:
28
       
   
PART II
  
       
 
Item 5:
28
 
Item 6:
30
 
Item 7:
31
 
Item 7A:
49
 
Item 8:
51
 
Item 9:
52
 
Item 9A:
52
 
Item 9B:
57
       
   
PART III
  
       
 
Item 10:
57
 
Item 11:
60
 
Item 12:
74
 
Item 13:
75
 
Item 14:
76
       
   
PART IV
  
       
 
Item 15:
77
       
78

2

GLOSSARY OF TERMS

The following are abbreviations and definitions of terms commonly used in the oil and gas industry and this Form 10-K.

Bbl - One barrel, or 42 U.S. gallons of liquid volume.

Bcf - One billion cubic feet.

Bcfe - One billion cubic feet of natural gas equivalents.

Completion - The installation of permanent equipment for the production of oil or gas.

Credit Facility - A line of credit provided by a group of banks, secured by oil and gas properties.

DD&A - Refers to depreciation, depletion and amortization of the Company’s property and equipment.

Development well - A well drilled within the proved area of an oil or gas reservoir to the depth of a stratigraphic horizon known to be productive.

Division order - A contract setting forth the interest of each owner of an oil and gas property, and serves as the basis on which the purchasing company pays each owner’s respective share of the proceeds of the oil and gas purchased.

Dry hole - A well found to be incapable of producing hydrocarbons in sufficient quantities to justify completion as an oil or gas well.

Exploratory well - A well drilled to find and produce oil or natural gas reserves not classified as proved, to find a new productive reservoir in a field previously found to be productive of oil or natural gas in another reservoir or to extend a known reservoir.

Extensions and discoveries - As to any period, the increases to proved reserves from all sources other than the acquisition of proved properties or revisions of previous estimates.

Gross acres or wells - Refers to the total acres or wells in which the Company has a working interest.

Horizontal drilling - A drilling technique that permits the operator to contact and intersect a larger portion of the producing horizon than conventional vertical drilling techniques and may, depending on the horizon, result in increased production rates and greater ultimate recoveries of hydrocarbons.

MBbls - One thousand barrels.

Mcf - One thousand cubic feet.

Mcfe - One thousand cubic feet of natural gas equivalents, based on a ratio of 6 Mcf for each barrel of oil, which reflects the relative energy content.

MMbtu - One million British thermal units. One British thermal unit is the heat required to raise the temperature of a one-pound mass of water from 58.5 to 59.5 degrees Fahrenheit.

MMcf - One million cubic feet.

MMcfe - One million cubic feet of natural gas equivalents.

Natural gas liquids - Liquid hydrocarbons that have been extracted from natural gas, such as ethane, propane, butane and natural gasoline.

Net acres or wells - Refers to gross acres or wells multiplied, in each case, by the percentage working interest owned by the Company.

Net production - Oil and gas production that is owned by the Company, less royalties and production due others.

NYMEX - New York Mercantile Exchange, the exchange on which commodities, including crude oil and natural gas futures contracts, are traded.

3

Oil - Crude oil or condensate.

Operator - The individual or company responsible for the exploration, development and production of an oil or gas well or lease.

Present value of proved reserves - The present value of estimated future revenues, discounted at 10% annually, to be generated from the production of proved reserves determined in accordance with Securities and Exchange Commission guidelines, net of estimated production and future development costs, using prices and costs as of the date of estimation without future escalation, without giving effect to (i) estimated future abandonment costs, net of the estimated salvage value of related equipment, (ii) non-property related expenses such as general and administrative expenses, debt service and future income tax expense, or (iii) depreciation, depletion and amortization.

Proved developed non-producing reserves - Reserves that consist of (i) proved reserves from wells which have been completed and tested but are not producing due to lack of market or minor completion problems which are expected to be corrected and (ii) proved reserves currently behind the pipe in existing wells and which are expected to be productive due to both the well log characteristics and analogous production in the immediate vicinity of the wells.

Proved developed producing reserves - Proved reserves that can be expected to be recovered from currently producing zones under the continuation of present operating methods.

Proved developed reserves - The combination of proved developed producing and proved developed non-producing reserves.

Proved reserves - The estimated quantities of crude oil, natural gas, and natural gas liquids which geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions, i.e., prices and costs as of the date the estimate is made.  Prices include consideration of changes in existing prices provided only by contractual arrangements, but not on escalations based upon future conditions.

Proved undeveloped reserves ("PUD") - Proved reserves that are expected to be recovered from new wells on undrilled acreage, or from existing wells where a relatively major expenditure is required for recompletion.

Recompletion - A recompletion occurs when the producer reenters a well to complete (i.e., perforate) a new formation from that in which a well has previously been completed.

Royalty - An interest in an oil and gas lease that gives the owner of the interest the right to receive a portion of the production from the leased acreage (or of the proceeds of the sale thereof), but generally does not require the owner to pay any portion of the costs of drilling or operating the wells on the leased acreage.  Royalties may be either landowner’s royalties, which are reserved by the owner of the leased acreage at the time the lease is granted, or overriding royalties, which are usually reserved by an owner of the leasehold in connection with a transfer to a subsequent owner.

SEC - The United States Securities and Exchange Commission.

Standardized measure of discounted future net cash flows - Present value of proved reserves, as adjusted to give effect to (i) estimated future abandonment costs, net of the estimated salvage value of related equipment, and (ii) estimated future income taxes.

Tcf - One trillion cubic feet.

Undeveloped acreage - Leased acreage on which wells have not been drilled or completed to a point that would permit the production of commercial quantities of oil and gas, regardless of whether such acreage contains proved reserves.

Working interest - An interest in an oil and gas lease that gives the owner of the interest the right to drill for and produce oil and gas on the leased acreage and requires the owner to pay a share of the costs of drilling and production operations.  The share of production to which a working interest is entitled will be smaller than the share of costs that the working interest owner is required to bear to the extent of any royalty burden.

Workover - Operations on a producing well to restore or increase production.

4

PART I

ITEM 1: BUSINESS

Petroleum Development Corporation is an independent energy company engaged primarily in the development, production and marketing of natural gas and oil. Since it began oil and gas operations in 1969, the Company has grown primarily through drilling and development activities, the acquisition of producing natural gas and oil wells and the expansion of its natural gas marketing activities. As of December 31, 2006, the Company has interests in approximately 3,100 wells located in the Rocky Mountain Region, Appalachian Basin and Michigan with gross proved reserves of 719 billion cubic feet equivalent of natural gas (“Bcfe”, based on one barrel of oil equaling six thousand cubic feet equivalent of natural gas (“Mcfe”)) of which the Company's share is 323 Bcfe. The Company's share of production for the fourth quarter of 2006 averaged 52,000 Mcfe per day.

Unless the context otherwise requires, the terms "PDC" or "Company" refer to Petroleum Development Corporation, its subsidiaries and proportionately consolidated drilling partnerships, collectively. The Company’s corporate headquarters are located at 120 Genesis Boulevard, Bridgeport, West Virginia 26330 where the telephone number is (304) 842-3597.

Business Segments
 
The Company’s operations are divided into four segments for management and reporting purposes: (1) drilling and development, (2) natural gas marketing, (3) oil and gas sales and (4) well operations and pipeline income. See Note 17 to the consolidated financial statements.

Drilling and Development

The Company drills wells not only for itself, but also for its investor partners. When the Company drills wells for others it earns profit above the cost of the wells. Beginning with the last Company-sponsored partnership of 2005 (for which revenue generating activities did not commence until early 2006), partnership wells are drilled on a “cost-plus” basis, where the Company bills investors for the actual cost of the wells plus an agreed upon mark-up above the costs. Prior to that, most of the Company’s third-party drilling activities were conducted on a footage-based basis, where the Company drills the wells for a fixed price per foot drilled with additional chargeable items per the drilling agreement.

Since 1984, the Company has sponsored limited partnerships formed to engage in drilling operations. The Company typically purchases a 20% to 37% ownership working interest in these drilling limited partnerships. In 2006, the Company, through one private drilling partnership, raised approximately $90 million in investor subscriptions, making it one of the largest sponsors of oil and gas partnership programs in the United States, as it has been for the last several years. PDC’s working interest is 37% in the 2006 partnership. Through the partnerships, the Company has been able to expand its drilling opportunities, reduce its drilling risk through greater diversification, and share the costs of the infrastructure necessary to support such activities.

Natural Gas Marketing

The Company’s wholly-owned subsidiary, Riley Natural Gas ("RNG"), purchases, aggregates and resells natural gas developed by the Company and other producers. This allows the Company to diversify its operations beyond natural gas drilling and production. RNG has established relationships with many of the natural gas producers in the Appalachian Basin and has significant expertise in the natural gas end-user market. In addition, RNG has extensive experience in the use of risk management strategies, which the Company utilizes to help manage the financial impact of changes in the price of natural gas and oil on the Company and its partnerships. RNG also manages the marketing of oil and gas for the Company's wells outside the Appalachian Basin, but does not market gas or oil for the non-affiliated producers in those areas.

Oil and Gas Sales

Revenue and expenses from the production and sale of oil and natural gas from the Company’s interests in oil and gas wells is reported in this segment. The Company has interests in approximately 3,100 wells ranging from a few percent to 100%. During 2006, approximately 9% of the Company’s production was generated by Appalachian Basin wells, 8% by Michigan Basin wells and 83% by Rocky Mountain Region wells. As of the end of 2006, the Company's total proved reserves were located as follows: Appalachian Basin (11%), Michigan (7%) and Rocky Mountain Region (82%). The majority of the Company's undeveloped acreage is in the Rocky Mountain Region and the Company's planned drilling for 2007 will be focused in that area. See Note 3 to the consolidated financial statements for disclosure of significant customers.

5

Well Operations and Pipeline Income

The Company operates approximately 95% of the wells in which it owns an interest. When the Company owns less than 100% of the working interest in a well, it charges the other owners a competitive fee for operating the well. These revenues and the associated costs are reflected in the Well Operations segment.

Areas of Operations

The Company's operations are divided into three regions: the Appalachian Basin, Michigan, and the Rocky Mountain Region. The Company has conducted operations in the Appalachian Basin since its inception in 1969, in Michigan since 1997, and in the Rocky Mountain Region since 1999. The Company includes its North Dakota operations in the Rocky Mountain Region.
 
In all three regions, the Company has historically targeted developmental natural gas reserves at depths of less than 10,000 feet. In some areas of the Rocky Mountain Region, Michigan and the Appalachian Basin, the wells also produce oil in conjunction with natural gas. Recently the Company has begun to drill to progressively deeper targets in the Rocky Mountain Region. In particular, the Company has drilled several wells with depths of more than 12,000 feet and horizontal wells with a total drilled footage approaching 20,000 feet. The Company’s management believes these deeper and horizontal wells, although more expensive to drill, offer attractive economics and reserves. The probability of encountering problems when drilling wells at depths greater than 12,000 feet or horizontally is generally greater than when drilling a vertical well of lesser depth. With increasing costs for and declining availability of proved developed drilling locations, the Company’s management believes the additional risk associated with exploratory drilling is justified by the potential to generate additional proved locations at a significantly lower cost than would be required to purchase proved undeveloped locations.

Business Strategy

The Company's primary objective is to increase shareholder value by expanding its oil and natural gas reserves, production and revenues through a strategy that includes the following key elements:

Drill and Develop

Drilling developmental natural gas wells has been the mainstay of the Company’s drilling program for a number of years. The Company drilled 231 wells in 2006, compared to 242 wells in 2005. In addition, the Company seeks to maximize the value of its existing wells through a program of well recompletions. The Company’s management believes that it will be able to drill a substantial number of new wells on its current undeveloped leased properties. As of December 31, 2006, the Company had leases or other development rights to 200 undeveloped acres in the Michigan Basin, 12,800 undeveloped acres in the northern Appalachian Basin and 187,500 undeveloped acres in the Rocky Mountain Region. The Company also plans to recomplete about 164 Wattenberg Field wells (Colorado) during 2007.

To support future development activities the Company has conducted exploratory drilling in the past and will continue exploratory drilling plans in 2007. The goal of the exploration program is to develop several significant new areas for the Company to include in its future development drilling activity.

Acquire

The Company's acquisition efforts are focused on producing properties that fit well within existing operations or in areas where the Company is establishing new operations. Preferred properties have most of their value in producing wells, behind pipe reserves or high quality proved undeveloped locations. Acquisitions have historically offered economies in management and administration costs, and the Company’s management believes that with its growing operations staff it can acquire and manage more producing wells without incurring substantial increases in its administrative costs. See Notes 2, 15 and 16 to Consolidated Financial Statements.

Diversify and Focus

With operations in the Rocky Mountains, Michigan and the Appalachian Basin, the Company has proven its ability to grow through operations in geographically diverse areas. While these areas provide geographic diversification, within each area, the Company has concentrated positions that lend themselves to effective development and operation. The Company plans to conduct the majority of its drilling activities in the Rocky Mountain Region during 2007, but will continue to seek additional opportunities for expansion in areas where the Company's experience and expertise can be applied successfully.

6

Manage Risk

The Company seeks opportunities to reduce the risks inherent in the oil and gas industry in a variety of ways. For a number of years, an integral part of the Company's strategy has been to concentrate on development drilling and geographical diversification to reduce risk levels associated with natural gas and oil drilling, production and markets. Development drilling is less risky than exploratory drilling and is likely to generate cash returns more quickly. Development drilling will remain the foundation of the Company’s drilling activities in 2007. However, the Company’s management believes the increasing cost of high quality development locations has made exploratory drilling relatively more attractive for future efforts. Exploratory wells have the potential of identifying new development opportunities at a significantly lower cost than the current cost of acquiring proven locations. While successful exploratory efforts could add to the Company’s future drilling opportunities at favorable costs, under the successful efforts method of accounting, exploratory dry holes are expensed at the time it is recognized that they are unproductive. This could result in greater short-term expenses and a reduction in the near-term profitability of the Company.

To help offset the relatively high business risk inherent in the oil and gas industry the Company maintains a conservative financial structure. The Company’s management believes that successful natural gas marketing is essential to risk management and profitable operations in a deregulated gas market. To further this goal, the Company utilizes RNG to manage the marketing of the Company’s oil and natural gas and its use of oil and gas commodity derivatives as risk management tools. This allows the Company to maintain better control over third party risk in sales and derivative activities. The Company uses natural gas and oil derivatives to reduce the effects of volatile energy prices.

Available Information Posted on the Company's Website

The Company files Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, registration statements and other items with the Securities and Exchange Commission ("SEC"). PDC provides free access to all of these SEC filings, as soon as reasonably practicable after filing, on its internet site located at www.petd.com. The Company will also make available to any shareholder, without charge, a copy of its Annual Report on Form 10-K as filed with the SEC. For a copy of the Company’s Annual Report, or any other filings, please contact: Petroleum Development Corporation, Investor Relations and Communications Department, P.O. Box 26, Bridgeport, WV 26330, or call toll free (800) 624-3821.

 In addition to the Company's SEC filings, other information, including the Company's press releases, current drilling program sales, Bylaws, Committee Charters, Code of Business Conduct and Ethics, Shareholder Communication Policy, Board Nomination Procedures and the Whistleblower and Qualified Legal Compliance Committee Hotline, is also available at the Company’s internet site, www.petd.com.

The public may read and copy any materials the Company files with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Room 1580, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet site (www.sec.gov) that contains reports, proxies, information statements and other information regarding issuers, like PDC, that file electronically with the SEC.

Natural Gas Industry Overview

Natural gas is one of the largest energy sources in the United States. The estimated 21.9 Tcf of natural gas consumed in 2006 represented approximately 22% of the total energy used in the United States. Natural gas is consumed in the United States as follows: 35% by industrial end-users as feedstock for products such as plastic and fertilizer or as the energy source for producing products such as glass; 21% and 14% by residential and commercial end-users, respectively, for uses including heating, cooling and cooking; 28% by utilities for the generation of electricity; and 2% for other users. (Source U.S. Energy Information Administration)

The Company’s management believes that the market for natural gas will continue to grow in the future. Natural gas burns cleaner than most fossil fuels and produces less greenhouse gas per unit of energy released. Relative to other energy sources, natural gas usage and losses during transportation from source to destination are slight, averaging only about 2% of the natural gas energy. The delivery of natural gas is among the safest means of distributing energy to customers, as the natural gas transmission system is fixed and is located underground.

The deregulation of the natural gas industry and a favorable regulatory environment have resulted in end-users' ability to purchase natural gas on a competitive basis from a greater variety of sources. Increasing international demand for petroleum combined with supply constraints kept oil prices near record high levels throughout 2006. Continuing increases in world energy demand appear likely in 2007 and beyond. This makes natural gas more competitive in domestic markets as a replacement for oil and increases the value of domestic oil and natural gas reserves.

The Company’s management believes that the foregoing factors, together with the increased availability of natural gas as a form of energy for residential, commercial and industrial uses, should increase the demand for natural gas as well as create new markets for natural gas, even at prices that are high by historical standards.

7

Because local supplies of natural gas are inadequate to meet demand in some sections of the United States, areas including the West Coast and the Northeast import natural gas from producing areas via interstate natural gas pipelines. The cost of transporting natural gas from the major producing areas to markets creates a price advantage for production located closer to the consuming regions. Natural gas producers in the Appalachian Basin and Michigan benefit from proximity to the Northeastern and Midwestern United States markets.

In contrast, much of the production in the Rocky Mountains is transported significant distances to end user markets. As a result, the price received for gas in the Rocky Mountains is generally less than the price received in areas closer to the primary consuming areas. The Rocky Mountain Region is believed to hold substantial undeveloped natural gas resources. Recent and planned additions to pipeline capacity in the region have made the area more attractive for development. Although in the near term, gas from the region will generally sell for less than gas in the Appalachian and Michigan Basins, development costs per Mcfe may be less.

Operations

Exploration and Development Activities

The Company's development activities focus on the identification and drilling of new productive wells, the acquisition of existing producing wells from other operators, and maximizing the value of the Company’s current properties through infill drilling, recompletions, and other production enhancements.

Prospect Generation

The Company's staff of professional geologists is responsible for identifying areas with potential for economic production of natural gas and oil. These geologists have decades of cumulative experience evaluating prospects and drilling natural gas and oil wells. They utilize results from logs, seismic data and other tools to evaluate existing wells and to predict the location of economically attractive new natural gas and oil reserves. To further this process, the Company has collected and continues to collect logs, core data, production information and other raw data available from state and private agencies, other companies and individuals actively drilling in the regions being evaluated. From this information the geologists develop models of the subsurface structures and formations that are used to predict areas for prospective economic development.

On the basis of these models, the Company's land department obtains available natural gas and oil leaseholds, farmouts and other development rights in these prospective areas. In most cases to secure a lease, the Company pays a lease bonus and annual rental payments, converting, upon initiation of production, to a royalty. In addition, overriding royalty payments may be made to third parties in conjunction with the acquisition of drilling rights initially leased by others. As of December 31, 2006, the Company had leasehold rights to approximately 200,500 acres available for development. See "Properties--Oil and Natural Gas Leases."

Drilling Activities

When prospects have been identified, leased and all regulatory approvals obtained, the Company develops these properties by drilling wells. In 2006, the Company drilled a total of 222 development wells, which 216 wells were designated successful. As of December 31, 2006, 82 of the 216 successful wells were awaiting gas pipeline connection. As of April 30, 2007, 67 of the wells awaiting pipeline connection were connected and turned in line. Typically, the Company will act as driller-operator for these prospects, frequently selling interests in the wells to Company-sponsored partnerships and other entities that are interested in exploration or development of the prospects. The Company retains a working interest in each well it drills.

The Company also drilled nine exploratory wells in 2006, eight (including one pending determination as of December 31, 2006) were determined to be productive and one was determined to be dry. Costs related to the dry hole of $1.3 million were expensed in 2006. The Company plans to conduct additional exploratory drilling activities in 2007. See "Financing of Company Drilling and Development Activities" and “Drilling and Development Activities Conducted for Company Sponsored Partnerships” for additional discussion regarding the Company's drilling activities.

Much of the work associated with drilling, completing and connecting wells, including drilling, fracturing, logging and pipeline construction is performed under the Company’s direction by subcontractors specializing in those operations, as is common in the industry. When judged advantageous, material and services used by the Company in the development process are acquired through competitive bidding by approved vendors. The Company also directly negotiates rates and costs for services and supplies when conditions indicate that such an approach is warranted.

8

The following tables summarize the Company's development and exploratory drilling activity for the last five years. There is no correlation between the number of productive wells completed during any period and the aggregate reserves attributable to those wells.

   
Development Wells Drilled
  
   
Total
  
Productive
  
Dry
  
   
Drilled
  
Net
  
Drilled
  
Net
  
Drilled
  
Net
  
2002
    
70
   
13.7
   
70