Harken Agreements - Overview
On January 28, 1997, and November 19, 1997, the Company entered into agreements, (collectively, the "Harken Agreement") which gave the Company rights to acquire certain beneficial interests from Harken de Colombia, Ltd. ("HDC"), a subsidiary of Harken, of Irving, Texas. Harken is a medium-sized U.S. oil company.
In 1993, HDC entered a contract (the "Association Contract") with Ecopetrol, an industrial and commercial company owned by the Colombian state, for the exploration and exploitation of petroleum resources on lands covering an area of approximately 141,679 hectares and 9,545 square metres of exploration lands in Llanos Basin of Colombia with the exception of three blocks of land which were excluded from the Association Contract due to oil reserves having already been established. The exploration period of the Association Contract has been extended to June 9, 1999. On this date, provided that a portion of the lands are the subject of application to Ecopetrol to develop commercial discoveries, a partial relinquishment must be made so that not more than 50% of the original area is retained by HDC. However, notice by HDC of the area to be relinquished must be given by February 9, 1999. If no application to develop has been made, then all remaining lands subject to the Association Contract must be relinquished back to Ecopetrol. Partial relinquishment of approximately 40% of the lands originally covered by the Association Contract was made by HDC prior to entering into the Harken Agreement and there is no remaining obligation for partial relinquishment before June 9, 1999. HDC has retained sole rights over a small portion of the area of the Association Contract, covering the region in which Alcaravan No. I was drilled. The remaining area of the lands subject to the Association Contract constitute some 200,000 acres, are referred to as the "Alcaravan Contract Area", and constitute the only lands covered by the Association Contract which are subject to the Harken Agreement.
Terms of Harken Agreement
The Harken Agreement gave the Company certain options to earn interests to be held beneficially through HDC in the Alcaravan Contract Area on a prospect by prospect basis by paying certain fees in relation to prospect generation and administration and by paying a disproportionate share of the costs of drilling the first well on each prospect. The Harken Agreement obligates the Company to advance its share of costs in relation to prospects in which it participates and includes provisions which, in the event of failure by the Company to make such advances in a timely manner, may cause the Company to forfeit some or all of its interest in the Alcaravan Contract Area. The Company may be required to advance monies up to six months in advance of the actual work taking place. Any interests which the Company earns under the Harken Agreement are held beneficially through HDC. The Company cannot become a party to the underlying Association Contract, nor can it hold direct title to such interests. The Company has the ability to make representations to the operator at regularly convened management meetings, but HDC holds a controlling voting interest at such meetings and the Company can exercise little control over the nature, timing or cost of operations which are carried out by HDC under the Association Contract. The Company would be delivered its share of revenues outside Colombia and would be assessed by HDC for imputed Colombian taxes, based on the assumption that operations under the Harken Agreement are the only operations undertaken in Colombia by HDC. Additionally, the Harken Agreement places restrictions on the Company's ability to sell or otherwise dispose of its rights and obligations under the Harken Agreement, since any assignment may only take place with the prior written consent of HDC, which consent may be withheld without reason or regard. In the event that HDC becomes obligated to make any partial relinquishment of the Alcaravan Contract Area, such relinquishment will be made solely be agreement between HDC and Ecopetrol.
The Harken Agreement obligates the Company to pay to HDC a monthly overhead fee of $5,000 (U.S.), over and above the other fees, charges and overhead costs relating to activities under the Association Contract in which the Company participates.
Palo Blanco Prospect:
Under the Harken Agreement, the Company has earned a 25% interest, held beneficially through HDC, in the "Palo Blanco Prospect Area" (located within the southern part of the Alcavaran Contract Area) in the Llanos Basin, South America.
To earn the 25% interest in the Palo Blanco Prospect Area, the Company paid a $250,000 (U.S.) prospect fee to HDC, which included acquisition and seismic costs, and 33.3334% of the costs of the Estero No. 1 well. This well discovered a new oil accumulation and was tested at the rate of 4,116 barrels of oil per day ("BOPD") of 16.4° API gravity oil, from a 38 feet net interval within the Cretaceous Ubaque Formation. (API gravity refers to the density (weight per unit volume) of crude oil on a scale adopted by the American Petroleum Institute). On the API scale, the higher the gravity, the lighter the oil. 16.4° API gravity oil would be termed a heavy oil.) The reservoir exhibited porosities averaging 25% and permeabilities in excess of 2 Darcies (a "Darcy" is the unit by which permeability is measured). The low API gravity of the oil in the Palo Blanco discovery means that it is heavier than most other oils in the Llanos Basin, which will complicate production plans, since it must either be mixed with a lighter crude or heated before it is transferred to a pipeline. HDC is reviewing the available options for crude export. Initial test production from Estero No. I began in August 1998 by trucking oil to the nearby Guarimena Field and work began on building a short pipeline spur of approximately 2.3 miles to link into the existing Guarimena pipeline. This spur is expected to be completed by the end of 1998 and will enable oil to be produced at a rate of up to 2,200 BOPD.
HDC spudded the first appraisal well, Estero No. 3 on December 14, 1997 and it reached a total depth of 10,980 feet in Paleozoic rocks on February 3. Log analysis indicates that the Ubaque sandstone which was productive in Estero No. 1 is almost completely absent in Estero No. 3, either because of a transition to shale or because part of the section may be cut out by a fault. Shows were encountered in Ubaque sands with poor porosity below the level of the Estero No. 1 production and these will be tested in Estero No. 3.
Oil and gas shows were encountered in the basal Tertiary Mirador Formation in both Estero No. 1 and Estero No. 3 and log analysis indicates that this zone may be capable of oil production, possibly with high water cuts. Such analysis is subject to considerable uncertainty because the formation waters in this area are of low but variable, salinity. Oil shows were encountered in low porosity sandstones within the Paleozoic sequence of Estero No. 3. However, initial testing of this zone through a liner failed to produce hydrocarbons. The rig was moved off location, and further testing of Estero No. 3, including the Ubaque, Guadalupe and Mirador zones was carried out. The testing of the Guadalupe and Mirador zones failed to disclose commercial quantities of oil.
As a result of the initial log analysis results of Estero No. 3 reserve estimates for the Ubaque of the Palo Blanco discovery have been downgraded until further information is available to determine the lateral extent of the sand which was productive in Estero No. 1. Chapman Petroleum Engineering Ltd., of Calgary, Alberta, performed a reserve and economic evaluation of the oil reserves owned by the Company in the Palo Blanco area as at March 1, 1998. Chapman concluded that the Estero No. 1 well for the Ubaque zone contains estimated net remaining, proven, developed, non-producing oil reserves of 331.3 thousand stock tank barrels based on reservoir parameters derived from log analysis, production test data, and an anticipated recovery factor of 25%, and an effective drainage area of 300 acres. A 3-D seismic program was recorded over the area in early 1998. The results of this survey (which have not been released by the operator), testing of Estero No. 3 and pressure information from extended test production of Estero No. 1 should provide additional information on the size of the Ubaque accumulation. No reserves were assigned to the Mirador Formation. The results of forthcoming development and pipeline engineering studies will assist in determining the number of additional drilling locations which the Palo Blanco accumulation will support. In the meantime, a conservative view has been taken of the accumulation and proven and probable recoverable reserves for Palo Blanco have been confined to the Ubaque in the immediate area of Estero No. 1. The Company's share of costs associated with the 3-D program, test production, first phase pipeline installation and engineering feasibility work fall within the provisions of the Harken Loan Agreement.
"Proved oil reserves" are the estimated quantities of crude oil which geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions.
"Proved developed oil reserves" are reserves that can be expected to be recovered through existing wells with existing equipment and operating methods.
"Proved undeveloped reserves" are 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.
Anteojos Prospect:
The Company participated in the drilling of the Canacabare No. I well, which was spudded on March 10, 1998 and reached a total depth of 8,410 feet on March 27, 1998. Following the evaluation of electric logs, the group elected to run 7 inch casing in the well and test a number of zones. The Company has prepaid to HDC its $1,500,000 (U.S.) (33.334%) share of the estimated completed well costs and has also paid a prospect generation fee of $50,000 (U.S.), in order to earn a 25% beneficial interest in this prospect. The Company has the right to participate in any subsequent well drilled on this Prospect by paying 25% of the costs. The Canacabare No. I well has not been tested and substantial cost overruns have been incurred.
Miradores Association Contract:
HDC made application to Ecopetrol for a new association contract covering the Miradores Contract Area of approximately 30,000 acres, to the south of the Palo Blanco Prospect and thought to include part of the accumulation discovered by Estero No. 1. HDC received details of the terms and conditions of this new association contract in mid-December and gave notice to the Company of such terms and conditions on December 19, 1997. HDC signed the contract on December 29, 1997, and it has been executed by Ecopetrol. The Company responded that it would participate with HDC in the Miradores Association Contract and paid an administrative fee of $50,000 (U.S.) in connection with such election to participate. As part of its election, the Company has committed to pay 33.3334% of all costs of the first well drilled on the extension of the Palo Blanco Prospect in the Miradores Contract Area and pay a prospect fee of $50,000 (U.S.) on approving the Authority for Expenditure for such well in order to earn a 25% beneficial interest in that part of the prospect which lies within the Miradores Contract Area. The Company would have the right to participate in any subsequent well drilled on this Prospect by paying 25% of its costs.
The Company has an option to participate in any seismic program recorded on any undrilled prospect on this Miradores Contract Area by paying 33.3334% of all costs for a 25% beneficial interest (not to include the current seismic program on Palo Blanco) and will pay a $50,000 (U.S.) prospect fee for each additional prospect identified in the Miradores Contract Area in which the Company elects to participate. In early 1998, HDC undertook a 3-D seismic program over that part of the Miradores Contract which includes the possible extension of the Palo Blanco discovery and adjacent exploration areas. The Company elected to participate in this seismic survey and is responsible for a weighted average share of 30.56% of the costs, a major portion of which is covered under the terms of the Harken Loan Agreement.
Other Exploration Acreage under Alcaravan or Miradores Contract Areas:
The Company was required to make an election on or before May 30, 1998 whether or not to participate in exploration areas other than those described above. The Company elected not to participate.
Harken Loan Agreement
Under the terms of a loan agreement entered into on April 8, 1998 between Harken and the Company (the "Harken Loan Agreement"), Harken undertook to advance the Company the sum of up to $2,600,000 (U.S.) for a period up to November 30, 1998, secured against the collateral of one half of the 25% beneficial interest earned by the Company in the Palo Blanco prospect. Under the Harken Loan Agreement, upon receiving a request from the Company, Harken advanced funds to cover all cash calls made in respect of the Company's share of all appraisal, development and production activities on the Alcaravan and Miradores Contract Areas during the period of the Harken Loan Agreement, such funds to be added to the outstanding amount of the loan. Funds to pay interest and management fees associated with the Harken Loan Agreement were also drawn down against the loan. All funds advanced bear interest payable monthly at an annual rate of six percent. During the period of the Harken Loan Agreement, the Company will pay a management fee of $37,500 (U.S.) per month to Harken. In return for this management fee, Harken will provide the Company with technical and management advice in relation to its Colombian activities. The Harken Loan Agreement may be terminated by the Company at any time before November 30, 1998, without penalty, by repayment of the loan and any accrued interest. As at November 25, 1998, the entire $2,600,000 (U.S.) has been drawn down under the Harken Loan Agreement. The Company is also indebted to Harken for an additional approximately $1,400,000 (U.S.)
Management
Management of the Company has endeavoured to raise either equity or debt financing in order to repay the Company's indebtedness under the Harken Loan Agreement. As a result of the poor market conditions, these efforts were unsuccessful, and management, therefore, negotiated the buyout agreement with Harken. Failure to repay the Harken loan will result in the Company's interest in the Alcaravan Association Contract and the Miradores Association Contract being reduced to 12½%, and the Company would lose its ability to participate in any further prospects. The Company would be entitled to its proportionate share of production revenue from the Estero No. 1 well. The Company, however, would be required to pay its proportionate share of the costs of constructing the pipeline, and management is, therefore, of the opinion that no revenue would be generated in the foreseeable future. Management recommends that the Company's shareholders approve the special resolution authorizing the sale of the Company's interest in the Alcaravan Association Contract and the Miradores Association Contract to Harken. As a shareholder of Harken, the Company would participate indirectly in any benefits achieved through the development of the Colombian properties and other assets held by Harken.
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A sorry tale indeed. They are offering dissenter's rights. I'm gonna look pretty closely at those provisions.
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