November 5, 1998
Dear Shareholder:
The positive response and questions I received from my previous letter
to you on September 10, 1998, has prompted me to provide you with a
report on OCET development. First, however, let me update you on
other significant happenings at SGI since my last shareholder letter.
We have successfully completed restructuring the remaining $4.4
million of the Company's current debt. This debt restructuring is
part of management's plan to improve SGI's current financial position
and conserve operating capital. In a private exchange offering, which
began in early September, SGI's note and debenture holders were asked
to extend or exchange their existing notes, debentures and associated
interest for convertible debentures or preferred shares. Under the
terms of the exchange offering all principal payments on the notes and
convertible debentures have been deferred until September 30, 1999.
We are in negotiations with Addington (Zeigler's successor) to
purchase their Liquids From Coal ("LFC") interests, including the
ENCOAL demonstration plant, infrastructure, service agreements and
coal supply agreements at both Buckskin and North Rochelle and all
permits to build a commercial LFC plant at North Rochelle. We believe
acquiring those assets will facilitate construction of the first
commercial LFC plant.
We are very close to executing agreements with Mitsubishi to form a
new joint company. We are currently in the process of exchanging
documents between the parties and their attorneys, including
Mitsubishi's Southern California counsel. Logistics of coordinating
the various parties' comments between the United States and Japan is
taking much longer than anticipated, which is why we have not yet
closed this transaction. We must, therefore, be patient. Mitsubishi
has advised us that the agreements, once completed, are to be executed
in La Jolla. We are currently trying to arrange a convenient schedule
and expect this process to be completed shortly.
In our search for other strategic partners to develop the first
commercial LFC plant, we have formed a task force and have accelerated
our program of making formal LFC presentations to coal tar chemical
companies, transportation companies, major utility companies, and
Powder River Basin coal holders. Interest has been positive, and I am
encouraged by the progress we are making.
The following is a detailed status report on the OCET technology
development and the SGI Development Center:
OCET TECHNOLOGY DEVELOPMENT
1. The OCET process is being demonstrated in the Process Development
Unit ("PDU"), simulating refinery conditions, and we are obtaining
data on the effectiveness of the process utilizing Venezuelan and
Mexican feedstocks.
2. Commercial viability hinges on being able to reproduce and measure
process performance in terms of rate, yield and quality of resulting
deasphalted oil and to determine the capital and operating costs for
commercial OCET plants.
3. The analytical facilities are in place to produce reliable data on
all samples generated.
4. A market analysis is being conducted to assess the value of OCET
relative to other commercial processes such as ROSE (solvent
deasphalting) and delayed coking. The analysis will include a
comparison of capital and operating costs.
The OCET lab continues work that will demonstrate the commercial
viability of the OCET process. Development work has moved from
bench-scale processors, primarily built with glassware, to a
high-pressure, high-temperature PDU. The purpose of the PDU is to
demonstrate the efficacy of electric field enhanced solvent
deasphalting (the OCET process), under continuous flow process
conditions, which would normally be encountered in a refinery, as
compared to existing solvent deasphalting processes.
Construction of the PDU began early this year. Its design includes
the ability to store, move, heat and pressurize feed materials at
elevated temperatures and pressures and includes computer control of
test variables and logging of test data. We should complete the PDU
testing and have a significant body of reliable data in place for
evaluation by late December.
Our initial testing utilizes Venezuelan and Mexican feedstocks, with
emphasis on Venezuelan feedstocks, as that country has the world's
largest heavy crude oil reserves. Estimated at two hundred sixty
billion barrels, these heavy crude reserves in the Oranoco River
region all require upgrading. This region is under intense
development by four international petroleum joint ventures, which are
spending billions of dollars to develop this oil field.
The initial experimental concept for OCET is simple: Run the solvent
deasphalting process under ROSE conditions, which are well documented
in the literature and which we are now equipped to reproduce; gather
data on the results; repeat the procedure utilizing the OCET process;
and, compare the results. Initial testing will be with light crude
(because it is easier to handle), then heavy crude and then resid.
All of the feedstocks have been thoroughly characterized over the past
few months in our analytical laboratory to give a solid basis for our
development work. This comparison process involves gathering data for
each of three key product performance criteria (rate, yield and
quality) to determine capital and operating costs.
OCET and conventional solvent deasphalting processes must be compared
fairly so that the true value of OCET can be assessed. To do this,
each step must be optimized through a carefully planned and executed
set of experiments using the new PDU. To date, we have demonstrated
that the PDU is capable of processing crude oil and solvent at
refinery-like conditions. Concurrently, we are developing an economic
model for OCET and competing processes. This model will allow us to
define potential project operating and capital costs for the process
and, therefore, the economic advantages we bring to the market place.
SGI DEVELOPMENT CENTER
The SGI Development Center, located in the same building as the OCET
laboratory, is currently working on the following projects:
1. Development of methods to substantially increase the value of Coal
Derived Liquid ("CDL") by conversion and separation into higher-value
chemicals.
2. Development of a variant of the OCET process for removing coal
fines from CDL, increasing its value as a feedstock for anode binder
pitch used to produce graphite anodes for steel and aluminum refining.
3. Invention of a new liquid level sensing device for which a patent
application is being filed.
4. Installation of new analytical equipment, including a distillation
laboratory as well as many other laboratory upgrades, which provides
SGI with sophisticated petroleum analytical capabilities. These
analytical capabilities are being offered to other companies on a
contract-services basis.
During the past year, the SGI Development Center has gained
significant expertise in coal liquids chemistry and product
development. Early this year the Center conducted an extensive study,
which projected the market value of CDL when converted to certain
value-added chemicals. The Center is formulating a series of projects
that will reduce to practice the methods necessary to refine CDL into
these chemicals. Several projects are on-going to develop methods for
extraction of motor fuels and high-value phenolic products from the
middle CDL fraction. In addition, the Development Center has entered
into an agreement with Penn State University to provide one barrel of
CDL middle distillate, produced in our lab, for Penn State's jet fuel
development work with the DOE and DOD. In return, Penn State will
cooperate in the development of liquid fuels from the same middle
distillate fraction. This agreement, plus recent presentations and
meetings with the DOE, are the first steps in what we hope will become
a much closer association with both entities.
The SGI Development Center has recently completed development work
related to LFC, using the OCET process to demonstrate that electric
fields can provide a 20% increase in the efficiency of coal fines
removal from CDL versus centrifuging. While this is our first
application of the OCET process outside the petroleum industry, it
demonstrates the value of the process as a tool for industrial
separations. We are continuing to evaluate the possibilities for
value-added applications of OCET in industries other than the
petroleum industry.
The development of the PDU has posed some significant process control
challenges. One in particular was the measurement of fluid level in
confined spaces while subjected to high temperatures, pressures and
electric fields. Commercial products proved unworkable, so the team
at the Development Center invented a new level sensor, which appears
to be unique in its ability to sense the level of hydrocarbon liquids,
while simultaneously detecting the presence of water. We are in the
process of filing a patent application. Initial research and
discussions indicate several possible commercial applications for this
device in petroleum refining, fuel distribution and instrumentation
industries.
In December of 1997, SGI purchased over $1.5 million worth of
laboratory equipment and analytical instruments from UNOCAL's Brea
Research Center and also employed additional highly-qualified
technical staff. In my last letter to you I described that this
purchase was made for approximately $40,000 as a result of SGI
offering its services to UNOCAL to dismantle and transport the
equipment. As a result of this purchase, the Laboratory capability
has significantly improved and now includes trace metals analysis to
parts per million, analytical distillation and separations (with and
without vacuum), gas chromatography, thermal gravimetric analysis,
viscosity and density measurement, extensive material preparation and
analysis, and prototype process equipment design and development
capabilities for separations and thermal processes. This now allows
us to perform outside service contracts, which have already produced,
and will continue to produce, revenue.
With all the positive developments covered in this letter, as well as
in my previous letter, it is discouraging to see the price of our
stock being driven so low. It is currently, in my view, extremely
undervalued. I believe one of the reasons for the severe decline in
our share price is shorting. Shorting is accomplished by selling
stock you do not own. The shorted stock must be borrowed. One way
that shareholders can help to prevent this damaging shorting of our
stock is to call your broker and instruct him/her to move your SGI
stock into a Type One or cash account with specific instructions that
your stock is not to be loaned or borrowed.
I believe this letter and my recent shareholder letter should provide
you with a fair appraisal of the progress SGI has made in achieving
its business objectives. I hope that in understanding that progress
you will share my confidence in SGI. I believe the Company is making
steady progress toward the commercialization of its technology assets,
and that we will be in a position to make significant announcements in
the near future.
Thank you for your cooperation and support.
Best regards,
Joseph A. Savoca
Chairman/CEO
JAS/ncp
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