Business Overview and History

Battalion Oil Corporation (BATL) is an independent energy company focused on the acquisition, production, exploration, and development of onshore liquids-rich oil and natural gas assets in the United States. The company's operations are primarily concentrated in the Delaware Basin, where it holds an extensive drilling inventory that it believes offers attractive long-term economics.

Battalion Oil Corporation was formed in 2019 through the combination of two predecessor companies, Halcón Resources Corporation and Battalion Oil. The company faced significant challenges in its early years due to the downturn in oil and gas prices in 2020, resulting in large impairment charges and a net loss of $229.7 million. To address these challenges, Battalion implemented cost-cutting measures and focused on improving operational efficiencies.

In 2021, the company's fortunes began to turn around as oil and gas prices recovered. Battalion generated net income of $18.5 million that year as it worked to develop its acreage position in the Delaware Basin in West Texas. The company invested in infrastructure projects, including a gathering and treating system to handle its sour gas production.

Throughout 2022 and 2023, Battalion continued to grow its production and cash flow, reporting net income of $18.5 million and a loss of $3.0 million, respectively. The company made progress on key projects, including the construction of an acid gas injection facility in its Monument Draw area to treat its sour gas. However, Battalion faced challenges from supply chain issues and cost inflation impacting the oil and gas industry.

Throughout its history, Battalion has worked to optimize its operations, manage costs, and develop its asset base in the Delaware Basin. The company has navigated a volatile commodity price environment and operational challenges while growing its production and cash flow. Battalion's focus on capital discipline and operational efficiency has been critical to its ability to weather industry downturns and position the company for long-term success.

Today, Battalion holds approximately 41,000 net acres in the Delaware Basin, with 91% of this acreage held by production (HBP). The company's asset base is concentrated in three contiguous blocks across Ward, Winkler, and Pecos Counties in Texas, providing it with a substantial remaining inventory of drilling locations.

Financial Performance

Battalion Oil has faced its share of challenges in recent years, as evidenced by its financial performance. In the fiscal year 2023, the company reported total revenue of $220.76 million and a net loss of $3.05 million. Its annual operating cash flow was $17.59 million, and it generated negative free cash flow of $28.85 million.

For the nine months ended September 30, 2024, Battalion reported total oil, natural gas, and NGLs revenues of $143.72 million, a decrease from $171.59 million reported in the same period of 2023. This decrease was primarily attributable to a decline in average realized prices, which dropped by approximately $2.22 per barrel of oil equivalent (Boe) compared to the prior year period, as well as lower production volumes.

In the most recent quarter (Q3 2024), Battalion reported revenue of $45.27 million and net income of $21.63 million. However, this represented a year-over-year decrease in revenue of 16.3% and a decrease in net income of 59.8% compared to Q3 2023, primarily due to lower average realized prices and production volumes.

Production and Operations

Battalion's production is primarily focused on oil, with natural gas and natural gas liquids (NGLs) also contributing to its output. For the nine months ended September 30, 2024, the company's oil production totaled 1.72 million barrels, down from 1.91 million barrels in the same period of 2023. Natural gas production for the same period was 5.95 million Mcf, down from 6.62 million Mcf in the prior year period. NGL production totaled 751,000 barrels, down from 917,000 barrels in the same period of 2023. These declines were primarily attributable to the timing of new well additions and natural production declines.

The company's operating expenses for the nine months ended September 30, 2024, totaled $138.04 million, compared to $155.27 million in the same period of 2023. Key components of these expenses included:

• Lease operating expenses of $34.19 million, relatively flat compared to the prior year but increasing on a per-unit basis to $9.87 per Boe in 2024 from $8.72 per Boe in 2023.

• Workover and other expenses decreased to $3.09 million from $4.67 million in the prior year period.
• Taxes other than income were $8.87 million, down slightly from $9.68 million in the prior year period.
• Gathering and other expenses decreased to $41.85 million from $48.86 million, primarily due to the commencement of volumes being treated by Battalion's acid gas treatment facility.

Liquidity and Capital Structure

The company's liquidity position has been a concern, with negative working capital of $43.88 million as of the end of 2023. To address this, Battalion has taken steps to reduce operating and capital costs, including implementing cost-cutting measures and streamlining its operations. Additionally, the company has obtained support from its three largest shareholders to purchase up to $30 million in additional preferred equity securities, which it believes will provide the necessary liquidity to fund its operations and meet its debt requirements for the next 12 months.

As of September 30, 2024, Battalion's financial position included:

• Cash and cash equivalents of $29.83 million

• A debt-to-equity ratio of 4.30
• A current ratio of 0.47
• A quick ratio of 0.47
• $4.70 million available for letters of credit under the Amended Term Loan Agreement

To support its drilling program and debt reduction efforts, Battalion issued $38.78 million and $19.50 million of preferred equity in Q1 2024 and Q2 2024, respectively.

Strategic Initiatives and Outlook

Despite the financial challenges, Battalion Oil has continued to make progress on the operational front. In the first quarter of 2024, the company brought its previously announced acid gas injection (AGI) project online, which has helped to reduce its operating expenses by $4.26 per barrel of oil equivalent (Boe) compared to the first quarter of 2023. The AGI facility has been processing gas since March 2024 and has achieved a new record of 32 million cubic feet per day (MMcf/d) of throughput.

Furthermore, Battalion has resumed its drilling operations in the Monument Draw area, completing two wells in the first quarter of 2024 and planning to drill two additional wells in the second quarter. The company's next two-well pad in Monument Draw is scheduled to be completed in the late third quarter or early fourth quarter of 2024.

In a significant strategic move, Battalion entered into an Agreement and Plan of Merger with Fury Resources, Inc. in December 2023. This agreement has been amended several times, with the latest amendment in September 2024 reducing the merger consideration to $7.00 per share and requiring the existing preferred equity holders to roll over 100% of their preferred equity. This proposed merger represents a potential transformative event for the company, although it introduces additional uncertainty and potential risks for Battalion Oil's future.

Risks and Challenges

Battalion Oil faces several risks and challenges that could impact its future performance. These include:

1. Commodity price volatility: The company's financial results are heavily dependent on the prices of oil, natural gas, and natural gas liquids, which can be highly volatile and subject to fluctuations beyond the company's control.

2. Operational challenges: The company's operations in the Delaware Basin, particularly the treatment of sour gas, have faced some challenges, including delays and higher-than-expected costs associated with its AGI facility.

3. Debt and liquidity concerns: As mentioned earlier, Battalion's liquidity position has been a concern, and it will need to continue to manage its debt and working capital effectively to ensure its long-term sustainability.

4. Regulatory and environmental risks: The oil and gas industry is subject to extensive regulations and environmental concerns, which could impact the company's operations and increase its compliance costs.

5. Merger uncertainty: The ongoing negotiations and amendments to the merger agreement with Fury Resources, Inc. introduce additional uncertainty and potential risks for Battalion Oil's future.

6. Production declines: The company has experienced declines in production volumes across oil, natural gas, and NGLs, which it will need to address through its drilling program and operational improvements.

7. Cost pressures: Inflationary pressures on maintenance, power, and chemical costs have impacted Battalion's operating expenses, particularly in lease operating expenses.

Conclusion

Battalion Oil Corporation has faced significant challenges in recent years, as evidenced by its financial performance, production declines, and liquidity concerns. However, the company has continued to make progress on the operational front, with the successful implementation of its AGI project and the resumption of its drilling activities in the Monument Draw area.

As Battalion navigates the current market environment, it will need to remain focused on cost control, efficient operations, and the exploration of strategic alternatives to enhance shareholder value. The proposed merger with Fury Resources, Inc. represents a potential transformative opportunity, but it also introduces uncertainty and risks that will need to be carefully managed.

The company's substantial acreage position in the Delaware Basin and its continued efforts to optimize its asset base provide a foundation for potential future growth. However, Battalion will need to address its production declines, manage its debt and liquidity issues, and successfully navigate the volatile commodity price environment to ensure its long-term sustainability.

Given the ongoing uncertainties and risks faced by the company, investors should closely monitor Battalion Oil's progress and its ability to execute its strategic initiatives while managing its financial and operational challenges. The outcome of the proposed merger, the company's ability to reverse production declines, and its success in managing costs and improving operational efficiencies will be critical factors in determining Battalion's future prospects in the competitive and ever-changing oil and gas industry.