Ring Energy, Inc. Annual report pursuant to Section 13 and 15(d)

Annual report pursuant to Section 13 and 15(d)

DERIVATIVE FINANCIAL INSTRUMENTS

DERIVATIVE FINANCIAL INSTRUMENTS

12 Months Ended

Dec. 31, 2022

Derivative Instruments and Hedging Activities Disclosure [Abstract]

The Company is exposed to fluctuations in crude oil and natural gas prices on its production. It utilizes derivative strategies that consist of either a single derivative instrument or a combination of instruments to manage the variability in cash flows associated with the forecasted sale of our future domestic oil and natural gas production. While the use of derivative instruments may limit or partially reduce the downside risk of adverse commodity price movements, their use also may limit future income from favorable commodity price movements.

From time to time the Company enters into derivative contracts to protect the Company’s cash flow from price fluctuation and maintain its capital programs. The Company has historically used either costless collars, deferred premium puts, or swaps for this purpose. Oil derivative contracts are based on WTI Crude Oil prices and natural gas contacts are based on Henry Hub or Waha Hub. A “costless collar” is the combination of two options, a put option (floor) and call option (ceiling) with the options structured so that the premium paid for the put option will be offset by the premium received from selling the call option. Similar to costless collars, there is no cost to enter into the swap contracts. On swap contracts, there is no spread and payments will be made or received based on the difference between WTI and the swap contract price. The deferred premium put contract has the premium established upon entering the contract, and due upon settlement of the contract.

The use of derivative transactions involves the risk that the counterparties, which generally are financial institutions, will be unable to meet the financial terms of such transactions. All derivative contracts have been with lenders under our credit facility. Non-performance risk is incorporated in the discount rate by adding the quoted bank (counterparty) credit default swap (CDS) rates to the risk free rate. Beginning September 1, the Company assumed the derivative liabilities (novated hedges) associated with its acquisition of the Stronghold assets (see "Note 5 - ACQUISITIONS & DIVESTITURES"), which are subject to master netting agreements. Additional derivative contracts with the same counterparty are also subject to netting. Still, in accordance with ASC 815-10-50-4B, the Company continues to classify the fair value of all its derivative positions on a gross basis in its corresponding Balance Sheets.

The Company’s derivative financial instruments are recorded at fair value and included as either assets or liabilities in the accompanying Balance Sheets. The Company has not designated its derivative instruments as hedges for accounting purposes, and, as a result, any gains or losses resulting from changes in fair value of outstanding derivative financial instruments and from the settlement of derivative financial instruments are recognized in earnings and included as a component of "Other Income (Expense)" under the heading "Gain (loss) on derivative contracts" in the accompanying Statements of Operations.

The following presents the impact of the Company’s contracts on its balance sheets for the periods indicated.


	As of December 31,
	2022		2021
Commodity derivative instruments, marked to market:

Derivative assets, current	16,193,327		—
Discounted deferred premiums	(11,524,165)		—
Derivatives assets, current, net of premiums	$	4,669,162	$	—

Derivative assets, noncurrent	7,606,258		—
Discounted deferred premiums	(1,476,848)		—
Derivative assets, noncurrent, net of premiums	$	6,129,410	$	—

Derivative liabilities, current	$	13,345,619	$	29,241,558

Derivative liabilities, noncurrent	$	10,485,650	$	—

The components of “Gain (loss) on derivative contracts” are as follows for the respective periods:


	For the years ended December 31,
	2022		2021		2020
Oil derivatives:
Realized gain (loss) on oil derivatives	$	(61,875,870)	$	(53,511,332)	$	22,522,591
Unrealized gain (loss) on oil derivatives	40,546,123		(24,143,120)		(2,164,779)
Gain (loss) on oil derivatives	$	(21,329,747)	$	(77,654,452)	$	20,357,812

Natural gas derivatives:
Realized gain (loss) on natural gas derivatives	(650,084)		743,178		—
Unrealized gain (loss) on natural gas derivatives	447,172		(941,867)		1,008,256
Gain (loss) on natural gas derivatives	$	(202,912)	$	(198,689)	$	1,008,256

Gain (loss) on derivative contracts	$	(21,532,659)	$	(77,853,141)	$	21,366,068

The components of “Cash (paid) received for derivative settlements, net” are as follows for the respective periods:


	For the years ended December 31,
	2022		2021		2020
Cash flows from operating activities
Cash (paid) received on oil derivatives	$	(61,875,870)	$	(53,511,332)	$	22,522,591
Cash (paid) received on natural gas derivatives	(650,084)		743,178		—
Cash (paid) received from derivative settlements	$	(62,525,954)	$	(52,768,154)	$	22,522,591

The following tables reflect the details of current derivative contracts as of December 31, 2022 (Quantities are in barrels (Bbl) for the oil derivative contracts and in million British thermal units (MMBtu) for the natural gas derivative contracts.):


	Oil Hedges (WTI)
	2023		2024

Swaps:
Hedged volume (Bbl)	389,250		894,000
Weighted average swap price	$	77.55	$	66.94

Deferred premium puts:
Hedged volume (Bbl)	773,500		91,000
Weighted average strike price	$	90.64	$	83.75
Weighted average deferred premium price	$	15.25	$	17.32

Two-way collars:
Hedged volume (Bbl)	487,622		475,350
Weighted average put price	$	52.16	$	67.88
Weighted average call price	$	62.94	$	83.32

Three-way collars:
Hedged volume (Bbl)	66,061		—
Weighted average first put price	$	45.00	$	—
Weighted average second put price	$	55.00	$	—
Weighted average call price	$	80.05	$	—


	Gas Hedges (Henry Hub)
	2023		2024

NYMEX Swaps:
Hedged volume (MMBtu)	159,890		552,000
Weighted average swap price	$	2.40	$	4.61

Two-way collars:(1)
Hedged volume (MMBtu)	2,258,317		1,712,250
Weighted average put price	$	3.18	$	4.00
Call hedged volume (MMBtu)	2,140,317		1,712,250
Weighted average call price	$	4.89	$	6.29


	Gas Hedges (basis differential)
	2023	2024

Waha basis swaps:
Hedged volume (MMBtu)	1,339,685	—
Weighted average swap price	X((2)	$	—

(1) The two-way collars for the first quarter of 2023 include 2x1 collars where the put volumes of 236,000 are two times the call volumes of 118,000.

(2) The WAHA basis swaps in place for the calendar year of 2023 consist of two derivative contracts, each with a fixed price of the Henry Hub natural gas price less a fixed amount (weighted average of $0.55 per MMBtu).