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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
/X/ Quarterly report under Section 13 or 15(d) of the Securities Exchange Act
of 1934 for the quarterly period ended March 31, 1999.
/ / Transition report under section 13 or 15(d) of the Securities Exchange Act
of 1934 for the transition period from ______________to ___________ .
COMMISSION FILE NUMBER: 0-9474
POTOMAC ENERGY CORPORATION
(FORMERLY MIDWESTERN RESOURCES, INC.)
(NAME OF SMALL BUSINESS ISSUER IN ITS CHARTER)
OKLAHOMA 73-1088064
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2601 NORTHWEST EXPRESSWAY, SUITE 1100W
OKLAHOMA CITY, OKLAHOMA 73112-7293
(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (405) 840-1427
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act during the past 12 months (or such
shorter period that the registrant was required to file such reports), and has
been subject to such filing requirements for the past 90 days. Yes No X
--- ---
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE
PRECEDING FIVE YEARS
Check whether the registrant filed all documents and reports required to be
filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of
securities under a plan confirmed by a court. Yes No
--- ---
APPLICABLE ONLY TO CORPORATE ISSUERS
As of September 1, 1999, 7,974,270 shares of issuer's Common Stock, $.01 par
value per share, were outstanding.
TRANSITIONAL SMALL BUSINESS DISCLOSURE
FORMAT (CHECK ONE):
Yes No X
--- ---
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TABLE OF CONTENTS
Page
PART I--FINANCIAL INFORMATION ----
Item 1. Financial Statements
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Consolidated Balance Sheets, March 31, 1999 and December 31, 1998 ...............3
Consolidated Statements of Operations and Accumulated Deficit for the
Period from Inception (April 7, 1997) to March 31, 1999 and
the Three Month Periods Ended March 31, 1999 and March 31, 1998............. 4
Consolidated Statements of Cash Flows for the Period from Inception
(April 7, 1997) to March 31, 1999 and the Three Month Periods Ended
March 31, 1999 and March 31, 1998........................................... 5
Notes to Consolidated Condensed Financial Statements ........................... 6
Item 2. Management's Discussion and Analysis or Plan of Operations.......................8
PART II--OTHER INFORMATION
Item 1. Legal Proceedings...............................................................20
Item 2. Changes in Securities and Use of Proceeds.......................................20
Item 3. Submission of Matters to a Vote of Security Holders.............................21
Item 4. Other Information...............................................................21
Item 5. Exhibits and Reports on Form 8-K................................................21
Signatures...............................................................................21
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CAUTIONARY STATEMENT RELATING TO FORWARD LOOKING INFORMATION
Certain statements in this Report and the documents referenced herein
constitute "forward-looking statements" within the meaning of Section 21E of the
Securities Exchange Act of 1934, as amended. Certain, but not necessarily all,
of such forward-looking statements can be identified by the use of
forward-looking terminology such as "believes," "expects," "may," "will,"
"should" or "anticipates" or the negative thereof or other variations thereon or
comparable terminology, or by discussions of strategies that involve risks and
uncertainties. Such forward-looking statements involve known and unknown risks,
uncertainties and other factors which may cause the actual results, levels of
activity, performance or achievements of Potomac Energy Corporation, or industry
results, to be materially different from any future results, levels of activity,
performance or achievements expressed or implied by such forward-looking
statements. As a result of the foregoing and other factors, no assurance can be
given as to future results, levels of activity and achievements and neither
Potomac Energy Corporation nor any other person assumes responsibility for the
accuracy and completeness of these statements.
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PART I
ITEM 1. FINANCIAL STATEMENTS
POTOMAC ENERGY CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
CONSOLIDATED BALANCE SHEETS
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12/31/98 3/31/99
(UNAUDITED)
----------------- ----------------
ASSETS
Current Assets:
- --------------
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Cash $ 218,788 $ 22,409
Accounts Receivable 1,615 4,084
Marketable Securities - -
----------------- ----------------
Total Current Assets 220,403 26,493
Property & Equipment
- --------------------
Furniture & Equipment 27,818 27,922
Office Equipment, capital leases 46,379 46,379
Leasehold improvements 6,912 6,912
Oil and Gas Interests, non-producing , Full Cost Method 472,331 517,090
Coal interest, non-producing 20,909 19,090
----------------- ----------------
574,349 617,393
Less Accumulated Depreciation (6,287) (9,792)
----------------- ----------------
568,062 607,601
Other Assets
- ------------
Organization Costs - -
Deposits 4,061 4,061
----------------- ----------------
TOTAL ASSETS $ 792,526 $ 638,155
================= ================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts Payable $ 120,248 $ 137,800
Accured Taxes, other than income 17,953 19,893
Current portion of capital
Lease obligations 17,384 18,426
----------------- ----------------
Total Liabilities 155,585 176,119
----------------- ----------------
Long-Term Portion of Capital
Lease Obligations 21,923 15,779
----------------- ----------------
Commitments and Contingencies
Stockholders' Equity:
Common Stock, $.01 Par Value, 50,000,000 shares Authorized and
7,869,270 and 7,914,270 Issued and Outstanding,
Respectively 78,693 79,143
Additional Paid-In Capital 2,035,886 2,035,436
Deficit Accumulated During Development Stage (1,499,561) (1,668,322)
----------------- ----------------
Total Stockholders' Equity 615,018 446,257
----------------- ----------------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY $ 792,526 $ 638,155
================= ================
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SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
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POTOMAC ENERGY CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
CONSOLIDATED STATEMENTS OF OPERATIONS AND ACCUMULATED DEFICIT (UNAUDITED)
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Period from Inception
7-Apr-97 Three Months Three Months
to Ended Ended
31-Mar-99 31-Mar-99 31-Mar-98
----------------- ------------------ --------------
REVENUES
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Income $ - $ - $ -
Foreign Currency 830 - -
Interest Income 10,164 974 1,007
----------------- ------------------ --------------
TOTAL REVENUES $ 10,994 $ 974 $ 1,007
================= ================== ==============
EXPENSES
Advertising $ 7,652 $ 1,610 $ -
Auto 3,671 1,999 -
Bank charges 2,079 152 415
Computer Expense 3,000 - -
Consulting 466,688 31,861 -
Stock-Based Non-Employee Compensation Expense 92,159 - -
Contributions 250 - -
Depreciation 9,792 3,505 -
Dues & Subscriptions 6,186 136 -
Employee Benefit Program 9,835 426 -
Insurance 7,576 7,158 -
Interest 5,396 2,612 -
Meal & Entertainment 24,616 7,174 -
Miscellaneous 17,224 3,281 -
Office Expense 3,071 527 -
Office Supplies 6,103 75 389
Payroll Tax 16,379 5,199 -
Professional fees 116,574 12,515 247,888
Rent & Lease 31,937 10,068 -
Salaries 162,077 60,740 -
Stock-Based Employee Compensation Expense 606,250 - -
SEC Related Expense 20,320 3,217 -
Taxes 7,639 - -
Telephone 17,253 6,399 -
Travel 35,591 11,083 -
TOTAL EXPENSES $ 1,679,316 $ 169,735 $ 248,692
================= ================== ==============
NET LOSS - DEFICIT ACCUMULATED DURING DEVELOPMENT STAGE $ (1,668,322) $ (168,761) $ (247,692)
================= ================== ==============
Net Loss Per Share $ (0.21) $ (0.02) $ (0.05)
================= ================== ==============
Weghted Average Number of Common Shares Outstanding 7,914,270 7,908,270 5,043,820
================= ================== ==============
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SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS
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POTOMAC ENERGY CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
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Period from
Inception Three Months Three Months
(April 7, 1997) Ended Ended
to
31-Mar-99 31-Mar-99 31-Mar-98
--------------- --------------- --------------
Cash Flows from Operating Activities:
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Net Loss $ (1,668,322) $ (168,761) $ (247,685)
Adjustment to Reconcile Net Loss to Net Cash
Provided (used) by Operations:
Stock Compensation:
Compensation Expense 606,250 - 125,000
Consulting Expense: 92,159 - -
Depreciation 9,792 3,505 -
(Increase) Decrease:
Accounts Receivable (4,084) (2,469) 150,000
Increase (Decrease):
Accounts Payable 159,022 17,552 (105,000)
Accrued taxes 19,893 1,940 -
Deposits (4,061) - -
NET CASH USED BY OPERATING ACTIVITIES (789,351) (148,233) (77,685)
=============== =============== ==============
Cash Flows from Investing Activities:
Exploration of Oil and Gas Properties: (267,090) (44,759) -
Exploration of Coal Properties: (19,090) 1,819 -
Purchase of Poperty & Equipment (34,835) (104) -
Purchase of Investment (37,777) - -
Sale of Investments 37,777 - -
Stock Issued During reorganziation 5,793 - -
Organization Costs (21,222) - -
NET CASH USED BY INVESTING ACTIVITIES (336,444) (43,043) -
=============== =============== ==============
Cash Flows from Financing Activities:
Sale of Stock 1,160,377 - 75,000
Paid in Capital - - -
Payments on Long-Term Debt: (12,173) (5,102) -
--------------- --------------- --------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 1,148,204 (5,102) 75,000
--------------- --------------- --------------
NET INCREASE (DECREASE) IN CASH 22,409 (196,379) (2,685)
Cash at Beginning of Period - 218,788 102,782
--------------- --------------- --------------
CASH AT END OF PERIOD $ 22,409 $ 22,409 $ 100,097
=============== =============== ==============
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SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS
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POTOMAC ENERGY CORPORATION AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
MARCH 31, 1999
NOTE A--BASIS OF PRESENTATION-
The consolidated condensed interim financial statements included herein have
been prepared by the company, without audit, pursuant to the rules and
regulations of the Securities and Exchange Commission. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principals have been condensed or
omitted pursuant to such rules and regulations, although the Company believes
that the disclosures are adequate to make the information presented not
misleading.
These statements reflect all adjustments, consisting of normal recurring
adjustments, which, in the opinion of management, are necessary for fair
presentation of the information contained therein. It is suggested that these
consolidated condensed financial statements be read in conjunction with the
financial statements and notes thereto included in the Company's annual report
on Form 10-K for the year ended December 31, 1998. The Company follows the same
accounting policies in preparation of interim reports.
Results of operations for the interim periods are not indicative of annual
results.
NOTE B- NATURE OF OPERATIONS-
NATURE OF OPERATIONS: Potomac Energy Corporation (Potomac), an Oklahoma
corporation, is involved in identifying, investigating, exploring, and, where
determined advantageous, developing, mining, refining, and marketing oil and gas
and coal deposits. Potomac is currently a public company registered on the
NASDAQ.
DEVELOPMENT STAGE ENTERPRISE: Potomac is a development stage enterprise and has
yet to generate any revenue from oil and gas or coal sales and has no assurance
of future revenues from such sales. Both oil and gas and coal exploration and
development are speculative in nature and, as such, involves a high degree of
risk. The Company plans to spend significant amounts on the acquisition and
exploration of properties. These costs may require the Company to raise
additional capital through debt or equity financing. Such additional financing
may require the encumbrance of Company assets or agreements with other parties
where others pay some of the costs of exploration in exchange for an interest in
the property. The Company has acquired interests in properties internationally.
Such plans have additional risks because, in some cases, the country where the
acquisition occurs may be considered politically and/or economically unstable.
RISKS AND UNCERTAINTIES: The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Significant estimates include depreciation, depletion, and amortization of
proved oil and gas and coal reserves. Oil and gas and coal reserve estimates
used as the basis for depletion are inherently imprecise and are expected to
change as future information becomes available.
PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the
accounts of the Company; its wholly-owned subsidiary, Potomac Exploration
Acquisition Corporation (PEAC), an Oklahoma corporation, and PEAC's wholly-owned
subsidiary, Potomac Energy (BVI), Ltd., a British Virgin Islands corporation;
and the Company's predecessor, Potomac Energy (Bermuda), Ltd., a Bermuda
corporation. The Company's other predecessor, Midwestern-Oklahoma Energy
Resources Corporation, an Oklahoma corporation, had no activity prior to the
reorganization. Magdalena Energia, LLC, a Texas limited liability company, a
wholly owned subsidiary, did not have any recordable transactions during 1998.
All material intercompany accounts and transactions have been
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eliminated.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATMENTS--CONTINUED
POTOMAC ENERGY CORPORATION AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
MARCH 31, 1999
NOTE C--JOINT INTEREST OPERATIONS
In April, 1998, the Company entered into an agreement to undertake a feasibility
study for the mining of coal and generation of electricity in the Guaduas Field
located in Central Colombia, South America. The agreement with Erasmos Almanza
La Torre, in his capacity as General Manager of Global Drilling de Colombia,
provides for an interest in coal contracts in the area once the project's
feasibility has been established. Almanza holds association contracts with
Ecocarbone, the state agency of Colombia that oversees the production of coal.
In December, 1998, the Company organized a wholly-owned subsidiary, Magdalena
Energia, LLC, a Texas limited liability company, to manage its coal and
generation of energy interests located in Colombia. As of December 31, 1998, no
assets had been transferred and no transactions had occurred in Magdalena. In
February, 1999, the Company formed Carbones de Guaduas, Ltd., a Colombian
corporation with Grupo Energia, LLC as a 50% partner, and the contract with
Almanza discussed above was transferred to the new corporation.
NOTE D--STOCK OPTIONS
On April 18, 1998, the Company's predecessor, Potomac (Bermuda), granted stock
options to purchase 950,000 shares of common stock during various periods, which
expire April, 1999 through December, 2003, at an exercise price of $1.00 except
for 50,000 shares which have an exercise price of $.50. On October 14, 1998, the
Company granted options to purchase 125,000 shares of common stock, which expire
December, 2003, at an exercise price of $1.00. The Company has elected to follow
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" (APB 25). Under APB 25, no compensation expense is recognized when
the exercise price of stock options equals the market price of the underlying
stock on the date of the grant.
PEC established the Potomac Energy Corporation Non-Qualified Stock Option Plan
(the "Option Plan" or "Plan") on January 28, 1999. The Option Plan provides for
the grant of non-qualified stock options ("Options"), with stock appreciation
rights ("SARs") to employees, directors, independent contractors and consultants
of the Company. The total number of shares of Common Stock authorized and
reserved for issuance under the Option Plan is 550,000. As of the date of this
Report, 325,000 Options have been granted under the Option Plan.
The Board of Directors (the "Board") administers the Plan and the authority to
interpret and construe the Plan, and determine all questions arising under the
Plan and any agreement made pursuant to the Plan. Options under the Option Plan
may be granted only to persons ("Eligible Persons") who at the time of grant are
directors, executive officers, employees and independent contractors and
consultants of the Company and its subsidiaries.
Options may be granted by the Board on terms and conditions determined solely by
the Board. No Option shall be exercisable more than 10 years after the date of
grant. The maximum number of shares of stock for which an Eligible Person may be
granted Options in any calendar year may not exceed 25 percent of the aggregate
number of shares of stock with respect to which Options may be granted under the
Option Plan. The exercise prices of Options are determined by the Board, but in
no event may such price be less than 85 percent of the fair market value of the
stock on the date of grant. Options granted are not transferable except by will
or by the laws of descent and distribution or with the consent of the Company.
No Option under the Plan may be granted after December 31, 2008.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Statements in this Quarterly Report on form 10-Q concerning the Company's
outlook or future economic performance; anticipated profitability, gross
billings, commissions and fees, expense or other financial items; and statements
concerning assumptions made or exceptions to any future events, conditions,
performanc3e or other matter are "forward looking statements" as that term is
defined under the Federal Securities Laws. Forward-looking statements are
subject to risks, uncertainties, and other factors, which would cause actual
results to differ materially from those stated in such statements. Such risks,
and uncertainties and factors include, but are not limited to (I) risks
associated with acquisitions, (ii) competition, (iii) the Company's quarterly
operating results have fluctuated in the past and are expected to fluctuate in
the future, (iv) the Company's business experiences seasonality, (v) the loss of
services of certain key individuals could have a material adverse effect on the
Company's business, financial condition or operating results.
BACKGROUND
Potomac Energy Corporation ("PEC" or the "Company") (formerly
Midwestern Resources, Inc.) was formed in 1980 under the laws of the State of
Oklahoma and became inactive and its corporate charter was suspended in 1983. In
March 1998, the Company was reincorporated under the name "Midwestern-Oklahoma
Energy Resources Corporation." Effective June 17, 1998, Potomac Energy (Bermuda)
Ltd., a Bermuda corporation ("Potomac (Bermuda)"), merged with and into Potomac
Exploration Acquisition Corporation, a wholly-owned subsidiary of the Company
("Potomac Acquisition"), pursuant to a Plan of Reorganization and Agreement of
Merger dated June 12, 1998 (the "Merger"). As a condition of the Merger, on June
17, 1998, the outstanding Common Stock of the Company was reverse split on the
basis of one share for each 41.40846 outstanding shares, which resulted in
578,261 shares of Common Stock being outstanding immediately prior to the Merger
(the "Reverse Stock Split"). In consummation of the Merger, the Company issued
7,050,000 shares of its Common Stock to the former shareholders of Potomac
(Bermuda) and the Company's name was changed to "Potomac Energy Corporation."
The Merger was accounted for as a reverse acquisition of the Company by Potomac
(Bermuda). Potomac (Bermuda) was formed on April 7, 1997. Immediately prior to
the Merger, the Company did not have any assets or liabilities. All references
to the "Company" includes Potomac Energy Corporation and its subsidiaries,
unless the context indicates otherwise
The Company is a development stage company engaged in the exploration
and development of oil, gas and coal properties outside of North America. The
Company, through its subsidiaries, owns interests in prospective areas located
in Colombia, South America, which are in the initial stages of exploration and
development. Prior to the Merger, Potomac (Bermuda) had not conducted any
operations other than the acquisition of the interests in the Rosablanca
Association Contract and the Montecristo Association Contract for exploration
and development of the Rosablanca and Montecristo Blocks within the Middle
Magdalena Valley Basin, Colombia, South America. The Rosablanca and Montecristo
Blocks are in the initial stages of exploration. In May 1998, the Company
acquired an interest in the Guaduas Association Contract for the exploration,
development and mining of coal. See Item 2. Description of Property " -- Middle
Magdalena Valley Basin" and " -- Rosablanca and Montecristo Association
Contracts" and "---Guaduas Association contracts." The Company also may seek to
acquire additional oil, gas and coal exploration opportunities in Colombia which
management believes may have large reserve potential; however, there is no
assurance that additional interests will be acquired or if acquired will be
capable of commercial development and production.
EXPLORATION STRATEGY
The Company's oil, gas and coal exploration and development operations
are currently focused entirely on its activities in Colombia, South America. The
oil and gas exploration and development operations are conducted through the
Colombian branch of Potomac Energy (BVI) Ltd., a wholly-owned British Virgin
Islands subsidiary corporation ("Potomac (BVI)"). The coal and electrical power
exploration and development operations are conducted through Carbones de
Guaduas, Ltd. a Colombian corporation which is 100 percent
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jointly owned by Magdalena Energia, LLC, a wholly-owned Texas subsidiary limited
liability company ("Magdalena Energia"), and Grupo Energia, LLC, a Texas
subsidiary limited liability company wholly-owned by Arena Power, L.P a Houston
based U.S. corporation (Grupo Energia). The dependence on the activities in
Columbia is likely to be reflected in both the short-term performance and the
Company's long-term financial results. The Company may serve as operator with
respect to those properties acquired pursuant to association contracts in which
the Company obtains a controlling interest or holds the largest ownership
interest; however, it is anticipated that the Company will also participate in
the development of properties operated by third parties and in some cases may
delegate operations to a third party. The Company also intends to pursue oil,
gas and electrical power opportunities domestically within the United States.
The Company's business strategy includes:
/ / Establishing production, cash flow and reserve value by exploring for
and developing and purchasing producing oil and gas properties, both
in South America and within the United States;
/ / Establishing and/or purchasing gas storage facilities and generators
within the United States;
/ / Building the Company's base of operations by initially concentrating
its development activities within Colombia and within the United States
in Oklahoma, Kansas and Texas;
/ / Acquiring additional properties with potential for development drilling
to establish and maintain a significant inventory of undeveloped
prospects and to establish and enhance the Company's foundation for
future growth;
/ / Serving as operator of its wells, mines and power generation facilities
to ensure technical performance and reduce costs;
/ / Establish relationships with other energy companies to access their
undeveloped properties, geological data and financial resources;
/ / Managing financial risk and mitigating technical risk by drilling in
known productive trends with multi-geologic potential, diversifying
investment over the interests in the Company's primary operating areas,
developing properties that provide a balance between short and long
term reserves, and establishing and maintaining a balance among the
company's oil, gas, coal and electrical generation activities; and
/ / Maintaining low general and administrative expenses.
Oil, gas and coal exploration and development is a speculative business
and involves a high degree of risk. The Company is subject to all the risks
normally incident to drilling for and producing oil and gas, as well as mining
of coal, including hazards such as high-pressured formations, blowouts,
cratering, fires, spills, cave-ins, or other hazards or conditions, any of which
could result in damage to or loss of life or property. In accordance with
industry practice, the Company is not fully insured against these risks nor are
all such risks insurable. Payment of such potential liabilities would reduce the
funds available for exploration, drilling and production and could have a
material adverse effect on the Company.
The Company has expended and plans to continue to expend significant
amounts of capital on the acquisition and exploration of its oil, gas and coal
interests. Even if the results of such activities are favorable, subsequent
drilling and mining at significant costs must be conducted on a property to
determine if commercial development of the property is feasible. Oil and gas
drilling, as well as coal mining, may involve unprofitable efforts, not only
from dry holes but from wells and mines that are productive but do not produce
sufficient net revenues to return a profit after operating and other costs. It
is difficult to project the costs of implementing an exploratory drilling and
mining program due to the inherent uncertainties of drilling and mining in
unknown formations, the costs associated with encountering various conditions,
such as high-pressured zones and tools lost in
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the hole, and changes in drilling and mining plans and locations as a result of
prior exploratory wells, mines or additional seismic data and interpretations
thereof. The marketability of oil, gas and coal which may be acquired or
discovered by the Company will be affected by the quality of the production and
by numerous factors beyond its control, including market fluctuations, the
proximity and capacity of oil and gas pipelines and processing equipment,
government regulations, including regulations relating to prices, taxes,
royalties, land tenure, importing and exporting of oil and gas and environmental
protection. There can be no assurance the Company will be able to discover,
develop and produce sufficient reserves in Colombia or elsewhere to recover the
costs and expenses incurred in connection with the acquisition, exploration and
development thereof and achieve profitability.
COLOMBIA--OVERVIEW
The Company's success currently depends entirely on its drilling
and mining exploration activities in Colombia. This dependence is likely to be
reflected in both the short-term performance and the Company's long-term
financial results.
One of the Company's principal asset is a 25 percent interest in
the Association Contracts that relate to Rosablanca and Montecristo Blocks
located in the Middle Magdalena Valley Basin three miles Northwest of Bogota,
Colombia, South America (the "Rosablanca and Montecristo Association
Contracts"). As of the date of this report, a well has not been drilled by the
Company on either of the Rosablanca and Montecristo Blocks. The Rosablanca and
Montecristo Association Contracts were issued by Empresa Colombiana de Petroleos
("Ecopetrol"), the state-owned Colombian oil company, in November 1997, and
provide generally for a six-year exploration phase followed by a 22-year
production period, with partial relinquishments of acreage, excluding commercial
fields, required commencing at the end of the sixth year of the Rosablanca and
Montecristo Association Contracts. The Company currently intends to participate
in the drilling of the initial exploratory well on the Magdalena Valley Basin
before the end of 1999. See Item 2. Description of Property "--Rosablanca and
Montecristo Association Contracts." The Rosablanca and Montecristo Association
Contracts entitle the Company to engage in exploration, development and
production activities on approximately 695,000 acres (173,750 net acres) located
in the Middle Magdalena Valley Basin, before any relinquishment to Ecopetrol.
The second potentially significant asset is the Company's 50
percent interest in the Guaduas Association Contract. The Guaduas Association
Contract entitles the Company and its partner to engage in exploration,
development and production activities on approximately 6,000 acres (3,000 net
acres) located in the Middle Magdalena Valley Basin, before any relinquishment
to Eco-Carbon. As of the date of this Report, coal mining has not begun on the
Guaduas Block. However, the Company is currently in the process of conducting
coring operations to specifically identify potential coal reserves. The Guaduas
Association Contract was acquired from a third party in May 1998, and provides
generally for a two-year exploration phase followed by a 10 year production
period with no relinquishments. See Item 2. Description of Property "--Guaduas
Association Contract."
Colombia is the fourth largest country in South America, with a
total land area of more than 1,038,700 square kilometers, with a population of
35.9 million people (1993 census). The official language is Spanish and the
official currency is the Colombian peso. Colombia has a democratic form of
government. While Colombia experiences insurgency and national political
protests, the Colombian economy has been among the best performers in Latin
America during the past 20 years. According to publicly available information,
Colombia's Gross Domestic Product ("GDP") has grown by an average of four
percent annually in the last 10 years, approximately twice the average for Latin
America. Colombia is the only country in South America that did not have a
single year of negative GDP or declining per capita income growth in the 1980s
and the 1990s. Colombia recently introduced legislation to attract foreign
investment in energy projects. The measures include the exemption of new oil
operations from the $1 per barrel tax, which was levied in 1992 to finance
protection of oil operations.
According to publicly available information, the United States is
Colombia's largest trading partner, accounting for more than 43 percent of that
country's total imports and 38 percent of its total exports.
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The United States is also the top provider of eight of Colombia's 15 largest
imports. United State oil companies now account for 11 of the 18 largest foreign
oil concerns operating in Colombia. Colombia is Latin America's third leading
crude exporter to the United States, after Venezuela and Mexico. Colombia is
also Latin America's leading coal exporter to the United States and Europe.
Colombia is the only country in South America that has seaports on
both the Pacific and Atlantic Oceans, which provide access to major oil markets.
The country has three main crude oil export pipelines leading to the port of
Covenas in Colombia. The pipeline from Cano Limon has a maximum capacity of
200,000 barrels of oil per day ("BOPD"), and two pipelines from Vasconia with
300,000 and 500,000 BOPD capacities. In 1997, Colombia exported over 30 million
short tons of coal and expects to double coal production to at least 60 million
short tons by 2005.
Columbia is currently investing in the expansion of its
electric generating capacity (currently about 11 GigaWatts), with plans to add
over four additional GW by the year 2000 and an additional six GW by the year
2010. Investments by the private sector, combined with ongoing privatization of
public utilities, will reduce the public ownership share of generating capacity
to less than one-third of the total. By the end of 1997, foreign investors owned
over 40% of the country's generating capacity, worth about $4 billion.
Columbia's plans for the power sector favor investment in thermoelectric
generating capacity (primarily natural gas) at the expense of hydroelectricity.
Coal-fired capacity (currently about seven percent of the total ) will also
increase. The diversification of electric generating capacity reflects concern
over the impact of droughts on hydroelectric generation, which has periodically
forced the country to ration electricity.
About 20% of the power generated in Columbia is traded on the country's
electricity exchange, with the balance sold under term contracts. As of February
1998, 120 energy companies (including generators, transporters, distributors,
and marketers) were listed on the exchange. In addition to domestic supply,
Colombia imports some electricity from Venezuela. Per an interconnection
established in July 1998 Colombia exports electricity to neighboring Ecuador,
which is experiencing significant electricity shortages.
The geology of Colombia has been studied since the mid-1800s and has
continued to the present, amassing some detail of the tectonic framework and
related stratigraphy. During the evolution of the geological knowledge of
Colombia, oil and natural gas exploration has been pursued in the Llanos,
Putumayo and Magdalena basins. Exploration in the Magdalena Valley Basin began
in 1918 with the drilling of the Guataqui wells in the Girardot subbasin,
followed in 1951 by the Ortega discovery. Since the mid-1980's the oil industry
has been the single largest component of economic growth, with total Colombian
oil reserves currently estimated to be approximately 3.7 billion barrels of
recoverable oil. As of December 1993, 210 exploratory wells had been drilled,
resulting in the discovery of 30 fields.
Two major physiographic features dominate the geography of Colombia. To
the west lie the Andes mountains, which, north of the Ecuador border, bifurcate
into three ranges, the Western, Central and Eastern Cordillera, extending toward
the Caribbean coast. These ranges are separated by the Cauca and Magdalena
valleys, respectively. To the east lies the Llanos, a savanna within the bounds
of the Orinoco Basin, which extends over the remainder of the country.
Association contracts acquired from either Empresa Colombiana de
Petroleos, the Colombian national oil company ("Ecopetrol") or Empresa
Colombiana de Carbones, the Colombian national coal company ("Ecocarbon"), after
being approved by all proper Colombian governmental authorities as well as the
board of Ecopetrol or Ecocarbon, are mutually executed by the parties and
subsequently recorded as a public deed in Colombia. Therefore, ownership of an
association contract is public record and protected by Colombian law. The
Rosablanca, Montecristo and Guaduas Association Contracts are on file and
available for public inspection at each respective agency.
RISKS INHERENT IN FOREIGN OPERATIONS
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There are risks inherent in the fact that the Company has acquired and
intends to continue to acquire interests in oil, gas and coal properties located
outside of North America in some cases in countries which may be considered
politically and economically unstable.
Foreign properties, operations or investments may be adversely affected
by local political and economic developments, exchange controls, currency
fluctuations, royalty and tax increases, retroactive tax claims, renegotiations
of contracts with governmental entities, expropriation, import and export
regulations and other foreign laws or policies governing operations of
foreign-based companies, as well as by laws and policies of the United States
affecting foreign trade, taxation and investment. In addition, as the Company's
operations are governed by foreign laws, in the event of a dispute, the Company
may be subject to the exclusive jurisdiction of foreign courts or may not be
successful in subjecting foreign persons to the jurisdiction of courts in the
United States. The Company may also be hindered or prevented from enforcing its
rights with respect to a governmental instrumentality because of the doctrine of
sovereign immunity.
The Company's business is subject to political risks inherent in all
foreign operations. While Colombia has no history of nationalizing its business
nor expropriation of foreign assets, the Company's oil, gas and coal operations
are subject to certain risks, including (I) loss of revenue, property, and
equipment as a result of unforeseen events such as expropriation,
nationalization, war and insurrection, (ii) risks of increases in taxes and
governmental royalties, (iii) renegotiations of contracts with governmental
entities, and (iv) changes in laws and policies governing operations of
foreign-based companies in Colombia. Guerrilla activity in Colombia has
disrupted the operation of oil and gas projects in certain areas in Colombia but
has not affected the Company's interest in the Rosablanca and Montecristo
Association Contracts. Guerrilla activity in Colombia has not disrupted coal
operations in any areas in Colombia to date. This may or may not continue in the
future. The Colombian government continues its efforts through negotiation and
legislation to reduce the problems and effects of insurgent groups, including
regulations containing sanctions such as impairment or loss of contract rights
on companies and contractors if found to be giving aid to such groups. The
associate parties will continue to cooperate with the government, and do not
expect that future guerrilla activity will have a material impact on the
exploration and development of the Rosablanca, Montecristo and Guaduas
Association Contracts. However, there can be no assurance that such activity
will not occur or have such an impact and no opinion can be given on what steps
the government may take in response to any such activity. Colombia is among
several nations whose progress in stemming the production and transit of illegal
drugs is subject to annual certification by the President of the United States.
As of the date of this report, Colombia has received such certification. The
consequences of the failure to receive certification generally include the
following: all bilateral aid, except anti-narcotics and humanitarian aid, has
been or will be suspended; the Export-Import Bank of the United States and the
Overseas Private Investment Corporation will not approve financing for new
projects in Colombia; United States representatives at multilateral lending
institutions will be required to vote against all loan requests from Colombia,
although such votes will not constitute vetoes; and the President of the United
States and Congress retain the right to apply future trade sanctions. Each of
these consequences of the failure to receive such certification could result in
adverse economic consequences in Colombia and could further heighten the
political and economic risks associated with the Company's operations in
Colombia.
JOINT VENTURE ARRANGEMENTS
As a means of diversifying exploration risks, the Company has and
expects to continue to enter into joint venture arrangements for the exploration
and development of properties acquired under association contracts initially
obtained by the Company or acquire only partial interests in oil and gas
properties through joint venture agreements with other oil and gas corporations
that may, by the terms of such joint venture agreements, be the operators of
such properties and joint ventures. Although the Company can take certain steps
to determine if the risk of the exploration activities to be conducted by the
designated operator of such joint ventures is appropriately spread over a number
of prospects within a contract area of an association contract, there can be no
assurance that the risk will be so allocated, that the exploration activities
will be carried out by the operator in a manner deemed appropriate by the
Company or that the activities will be successful. In addition, the Company's
ability to continue its exploration and development activities may be
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dependent upon the decision of its joint venture partner or partners to continue
exploration and development activities and to finance their respective portions
of the costs and expenses of the joint venture exploration activities. If the
Company's joint venture partner does not elect to continue and to finance its
obligations to the joint venture, the Company may be required to accept an
assignment of the partners interest therein and assume its financing obligations
of further development or relinquish the Company's interest in the joint venture
or the association contract.
MARKETS
In the event the Company's exploration and development activities result in the
discovery and production of oil and gas and upon Ecopetrol's declaration of the
commerciality of the Company's discovery, oil produced from the Rosablanca and
Montecristo Blocks may be sold to Ecopetrol or to third parties provided that 75
percent of the purchase price is paid in United States currency and the
remainder in Colombian pesos. In the event the production is required to satisfy
internal demand for oil in Colombia, the Company may be required to sell some or
all of its production to Ecopetrol at prevailing market prices. It is
anticipated that any oil and gas production of the Company from its Colombian
operations will be sold to Ecopetrol under contracts that provide for
cancellation by either party with notice. In the event of cancellation by
Ecopetrol, the Company would be required to arrange for the export and sale of
its production.
In the event the Company's exploration and development activities
result in the discovery and production of coal, Ecocarbon has agreed to a waiver
of its declaration of the commerciality of the Company's discovery, for a
minimum period of ten years. After such time the company would be able to apply
for another waiver of commericality. Should this waiver not be granted, then the
coal produced from the Guaduas Blocks may be sold to Ecocarbon or to third
parties provided that 75 percent of the purchase price is paid in United States
currency and the remainder in Colombian pesos. In the event the production is
required to satisfy internal demand for coal in Colombia, the Company may be
required to sell some or all of its production to Ecocarbon at prevailing market
prices. It is anticipated that any coal production of the Company from its
Colombian operations will be sold to third parties under contracts that provide
for cancellation by either party with notice.
Since the early 1970's the market price for crude oil has been
significantly affected by policies adopted by the member nations of the
Organization of Petroleum Exporting Countries ("OPEC"). Members of OPEC
establish prices and production quotas among themselves for petroleum products
from time to time with the intent of controlling the current global supply and
consequently price levels. The Company is unable to predict the effect, if any,
which OPEC policy or price changes would have on any decision of Ecopetrol to
continue or cancel production purchase contracts with the Company or the effect
such policies and price changes might have on the ability of the Company to
otherwise profitability export and market the Company's production from Colombia
in the event Ecopetrol should elect to cancel productions purchase contracts
which may be entered into for the purchase of the Company's production.
Changes in natural gas, crude oil, coal and electrical prices
significantly affect the revenues and cash flows of the Company attributable to
production and the value of its properties. Declines in the prices of the
Company's products could have a material adverse effect on the business and
financial condition of the Company. The Company is unable to predict whether the
prices of crude oil, natural gas, coal and electrical power will rise, stabilize
or decline in the future.
REGULATION
The Company's operations are subject to regulations imposed by the
local regulatory authorities including, without limitation, currency regulation,
import and export regulation, taxation and environmental controls. The
regulations also generally specify, among other things, the extent to which
properties may be acquired or relinquished, permits necessary for spacing and
drilling of wells, mining of coal, measures required for preventing waste of
oil, gas and coal resources and, in some cases, rates of production and sales
prices to be
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charged to purchasers. Specifically, Colombian operations are governed by a
number of ministries and agencies including Ecopetrol, the Ministry of Mines and
Energy, and the Ministry of the Environment. It is possible that the
administration and enforcement of current environmental laws and regulations or
the passage of new environmental laws or regulations in Colombia could result in
substantial costs and liabilities in the future or in delays in obtaining the
necessary permits to conduct and expand the Company's Colombian operations. The
Company has experienced and may continue to experience delays in obtaining the
necessary environmental permits to expand its Colombian operations.
EMPLOYEES
The Company's operations are managed from its offices in Oklahoma City,
with a staff of five employees, and use professional consulting services as
needed. The Company's employees are not represented by a labor organization. The
Company and its subsidiaries consider the relations with its employees and
consultants to be good.
DESCRIPTION OF PROPERTY:
MIDDLE MAGDALENA VALLEY BASIN
The Company has identified and completed the preliminary
investigation of the potential for oil, gas and coal deposits existing in the
Middle Magdalena Valley Basin three miles northwest of Bogota, Colombia. The
Company has acquired a 25 percent interest in the Rosablanca and Montecristo
Association Contracts on a joint-venture basis granting rights to explore for
and develop oil and gas in certain specified properties known as the Rosablanca
and the Montecristo Blocks (sometimes referred to as the Rosablanca II Block)
located in the Middle Magdalena Valley Basin. The Rosablanca Block covers
approximately 326,000 acres and the Montecristo Block covers approximately
369,000 acres. The Company has also acquired a 50 percent interest in the
Guaduas Association Contracts on a joint-venture basis granting rights to
develop coal in certain specified properties known as the Guaduas Block located
in the Middle Magdalena Valley Basin. The Guaduas Block covers approximately
6,000 acres.
Oil, gas and coal reserves have been investigated and explored in
the Magdalena Valley Basin since as early as 1940. The first commercial oil and
gas field was established by Trocco Oil in 1951 with proven recoverable reserves
in excess of 800 million barrels. Through the use of advanced technologies and
exploration techniques such as seismic, gravimetric and magneto metric surveys,
combined with now historically proven data and exploratory drilling, additional
potentially large reserves have been identified and recovered throughout the
Middle Magdalena Valley Basin. Several independent oil companies such as Trident
Energy, Harken Oil and Gas, and Seven Seas along with major oil and gas
producers such as Exxon, Inc. and Texaco, Inc. have made important recent
discoveries that have drawn international attention to all of Central and South
America. Exxon is currently the single largest exporter of coal from Colombia.
As of December 31, 1998, approximately 1,642 kilometers of 2-D
seismic data had been acquired and reprocessed on the Rosablanca Block and the
Montecristo Block. Interpretation of the seismic data on the Montecristo Block
is in process. Additionally, interpretation of the seismic data on the LaLuna
and Rosablanca formations and at the Basal Cretaceous formations are being
generated. The LaLuna and Rosablanca formations have tested over 10,000 barrels
of oil per day each on the adjacent Bolivar Association Contract. Based on
analysis and processing of such data, it is estimated that the combined
potential for recoverable oil reserves from the Rosablanca and Montecristo
Blocks could exceed one billion barrels. Exploration is first being concentrated
in the area of the Texaco Las Lajas well located on the Montecristo Block. The
original Texaco exploratory well had oil and gas shows in which the La Luna
formation, but was not drilled deep enough to test the Rosablanca formation.
This well is located on what appears to be a sizable structural feature.
Pursuant to an agreement dated February 27, 1997 (the "GHK
Agreement"), Potomac (Bermuda)
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and GHK Company, L.L.C., an Oklahoma limited liability company ("GHK"), agreed
to jointly acquire and develop any association contracts related to the
Rosablanca Block and the Montecristo Block acquired by Potomac (Bermuda) or GHK.
Under the GHK Agreement, the applications to acquire the association contract
was assigned to GHK for the purpose of allowing the association contracts on the
specified blocks to be acquired by GHK. With respect to any association contract
obtained, GHK agreed to assign a 25 percent interest in such association
contract to Potomac Energy (BVI) Ltd., a British Virgin Islands wholly-owned
subsidiary corporation of the Company ("Potomac (BVI)). GHK is designated as
operator under the association contracts obtained. The GHK Agreement further
provided that (i) upon issuance of the association contracts, GHK will to pay
Potomac (Bermuda) $150,000, (ii) GHK will provide any initial guarantee for the
performance of exploratory activity under the association contracts as required
by Ecopetrol, (iii) following issuance of each such association contract,
Potomac Energy Corporation had three months to (A) qualify Potomac (BVI) to do
business in Colombia, (B) reimburse GHK 25 percent of any initial guarantees
required by Ecopetrol, and (C) demonstrate financial capability to pay 25
percent of the costs to perform the first year obligations of the association
contract, and (iv) cause Potomac (BVI) to enter into an International Operating
Agreement with accounting procedure for each contract area naming GHK's branch
company as operator. Pursuant to the Merger, Potomac Acquisition acquired and
assumed all obligations of Potomac (Bermuda) under the agreement with GHK.
Following execution the GHK Agreement was assigned and transferred by GHK to
Seven Seas Petroleum, Inc. ("Seven Seas") and by Omnipresent Exploration to
Potomac (BVI). As of the date of this Report, Potomac (BVI) is qualified to do
business in Colombia. As of March 31, 1999, the Company was in full compliance
with the terms of the GHK Agreement.
As of December 31, 1998, the Company had completed 10 surface
scraping on the Guaduas Block which showed approximately 31 coal seams two to
ten meters thick ranging from the surface to a depth of 72 feet. Early analysis
of the quality of the coal is estimated at 14,000 BTU, .07 percent sulfur and 5
percent ash. These shows indicated the need for further review and analysis by
the Company. As a result, the Company began coring operations to further
identify specific coal seams, thickness, and a real extent. As of March 31, 1999
coring operation were in progress on a three to six well program. This drill is
not yet complete as of the date of this report
Pursuant to agreement dated August 8, 1998 (the "Erasmos
Agreement"), the Company agreed to acquire from Erasmo Alfredo Almanza Latorre,
a Colombian citizen, the Association Contract for Small Carbon Exploration and
Exploitation on the Guaduas Block issued to him by Ecocarbon. Under the Erasmos
Agreement, the association contract was assigned to PEC. On December 2, 1998,
the Company agreed to sell a 50 percent interest in the Association Contract
related to the Guaduas Block to Arena Power, L.P., a Houston based U.S.
corporation (the "Arena Agreement"). The Arena Agreement provides for the
establishment of a Colombian corporation, Carbones de Guaduas, Ltd., of which
the Company and Arena will jointly own on an equal basis through their
respective wholly-owned subsidiaries, Magdalena Energia, LLC and Grupo Energia,
LLC. The Company transferred the Guaduas Association Contract to Carbones de
Guaduas on January 28, 1999. Carbones de Guaduas is designated as operator under
the association contracts. The Arena Agreement further provides that (i) upon
establishment of the Colombia corporation, Arena will match the Company's
initial developmental costs, (ii) Arena and the Company will then share equally
all future developmental costs, and (iii) Arena and the Company will equally
provide any initial guarantee for the performance of exploratory activity under
the association contracts as required by Ecocarbon.
ROSABLANCA AND MONTECRISTO ASSOCIATION CONTRACTS
On November 19, 1997, the Association Contracts related to the
Rosablanca Block and Montecristo Block (the " Rosablanca and Montecristo
Association Contracts") were awarded to the Colombian branch of Seven Seas and
the Company became entitled to receive a 25 percent interest in the Association
Contracts, subject to the GHK Agreement. In connection with obtaining the
Rosablanca and Montecristo Association Contracts, Seven Seas was not required to
provide any form of financial guarantee of performance for the Rosablanca and
Montecristo Association Contracts.
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The Rosablanca and Montecristo Association Contracts provide generally
for a three-to-six year exploration phase followed by a 22-year production
period, with partial relinquishments of acreage, excluding commercial fields,
required commencing at the end of the sixth year of each contract. Under the
terms of each contract, Seven Seas and the Company are required over a
three-to-six-year period to undertake and complete certain work commitments
involving exploration and development of the Rosablanca Block and the
Montecristo Block. Seven Seas and the Company are required during the first two
years of the contracts to reprocess existing seismic data (300 kilometers on the
Rosablanca Block and 500 kilometers on the Montecristo Block), acquire and
interpret landstat images and perform surface geological and geochemical work,
and shoot and evaluate 100 kilometers of new two dimensional seismic and, at the
election of the Company and Seven Seas, during the third year to drill one
exploratory well. In the event after the first two years, the Company and Seven
Seas elect to drill an exploratory well, they will be required to relinquish and
reduce their interest in the block to not more than 247,100 acres (100,000
hectares). The contract will terminate at the end of the third year, unless an
extension is granted by Ecopetrol pursuant to application or a commercial field
has been discovered. The exploration period may be further extended beyond the
third year upon annual application to and approval by Ecopetrol for up to three
years. During each year of this extension, Seven Seas and the Company will be
required to drill one additional exploratory well that penetrates a hydrocarbon
producing formation. In the event such work commitments are not completed as
required, the contract rights will be forfeited. Furthermore, if a commercial
field is discovered during the initial three-year period of the contract or any
extension thereof, the block or contract area will be reduced 50 percent, two
years thereafter will be reduced 50 percent of the remaining block or contract
area and two years thereafter will be further reduced to the commercial fields
that are producing or under development plus a reserve belt 2.5 kilometers wide
surrounding each Commercial Field within the block or contract area. Upon
application to and approval by Ecopetrol, the period for retention of the block
or contract area may be extended for up to four years.
Under the terms of the contracts, Ecopetrol will receive a royalty
equal to 20 percent of production (after pipeline tariffs are deducted) on
behalf of the Colombian government and, in the event a commercially feasible
discovery is made, Ecopetrol will acquire a 50 percent interest in the remaining
production, bear 50 percent of the development costs, and reimburse Seven Seas,
the Company and other joint venture partners, from Ecopetrol's share of future
production, for 50 percent of the costs of certain exploration activities. Upon
acceptance of a field as commercial, Ecopetrol will acquire a 50 percent
interest therein and the interests of the other parties to the contract,
including the Company, will be reduced by 50 percent; all decisions regarding
the development of a commercial field will be made by an Executive Committee
consisting of representatives of the parties to the contract who will vote in
proportion to their respective interests in such contract. Decisions of the
Executive Committee will be made by the affirmative vote of the holders of over
50 percent of the interests in the contract.
If any commercial field in the respective contract areas produces in
excess of 60 million barrels, Ecopetrol's interest in production and costs for
such contract area increases from 50 percent to 75 percent as the ratio of the
accumulated income attributable to Seven Seas, the Company or any other joint
venture partner other than Ecopetrol to the accumulated development, exploration
and operating costs of such parties (less any expenses reimbursed by Ecopetrol)
increases from one to one to three to one.
Under the terms of the Association Contracts, in the event a discovery
is made and is not deemed to be commercially feasible by Ecopetrol, Seven Seas
and the Company may expend up to $2 million over a one-year period to further
develop the field, 50 percent of which will be reimbursed if Ecopetrol
subsequently accepts the commercial feasibility thereof. If Ecopetrol does not
declare the field commercial, the joint venture may continue to develop the
field at its own expense. In such event, Ecopetrol will have the right to
acquire a 50 percent interest therein upon payment of 50 percent of Direct
Exploration Costs and 200 percent of the Additional Exploration Costs expended
by the joint venture, which payment may be made out of Ecopetrol's share of
future production.
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GUADUAS ASSOCIATION CONTRACTS
On August 8, 1998, the Association Contract related to the Guaduas
Block was acquired by the Company and on January 28, 1999 was transferred to
Carbones de Guaduas, Ltd. The Company has a 50 percent interest in the
Association Contract, subject to the Erasmos and Arena Agreements. In connection
with obtaining the Guaduas Association Contract, neither the Company nor Arena
were required to provide any form of financial guarantee of performance of the
Guaduas Association Contract.
The Guaduas Association Contract provides generally for a two-year
exploration phase followed by a 10-year production period, with no
relinquishments of acreage or commerciality of field required until the end of
the 10-year production period. Under the terms of the contracts, Carbones de
Guaduas is required over a two-year period to undertake and complete certain
work commitments involving exploration of the Guaduas Block. Carbones de Guaduas
is required during the first two years of the contracts to complete a
professional engineering study which includes developing and completing
topography of the 6,000 acres, analyzing and evaluating potential coal reserves,
conducting coring of three or more locations to a depth of 100 feet on at least
1,000 acres, and completing and submitting a detailed mining plan for the
extraction and exploitation of coal reserves. After the first two years, in the
event the Company and Arena Power through Carbones de Guaduas elect to mine
coal, they will be required to have a plan for using the coal or exporting the
coal, including storage and transportation. The contract will terminate at the
end of the second year, unless the Company and Arena Power through Carbones de
Guaduas elect to move to the production phase. The exploration period may be
further extended beyond the second year upon annual application to and approval
by Ecocarbon for up to three years. The production period may be further
extended beyond the ten years upon annual application to and approval by
Ecocarbon for up to 25 years. In the event such work commitments are not
completed as required, the contract rights will be forfeited.
Under the terms of the contracts, Ecocarbon will not receive a royalty
until the end of the first 10-year production period. After the first ten-year
production period, Ecocarbon will receive a royalty equal to 20 percent of
production (after export tariffs are deducted) on behalf of the Colombian
government.
The Company's net income, as defined under Colombian law, from
Colombian sources is subject to Colombian corporate income tax at a rate of 35
percent. An additional remittance tax is imposed upon remittance of profits
abroad at a rate of seven percent.
PLAN OF DEVELOPMENT
ROSABLANCA AND MONTECRISTO BLOCKS
Seven Seas and the Company have established a 24-month plan of
exploration and development of the Rosablanca and Montecristo Blocks. Under this
plan, established in November of 1997, in addition to the minimum work
commitments under the Rosablanca and Montecristo Association Contracts (the cost
of which is estimated to be approximately $750,000),Seven Seas and the Company
propose to (i) the obtain and process new two-dimensional seismic (75 kilometers
on the Montecristo Block and 50 kilometers on the Rosablanca Block) at an
estimated cost of $550,000, (ii) identify and drill one exploratory well on the
Rosablanca Block at an estimated cost of $500,000, (iii) drill one horizontal
well on the Rosablanca Block at an estimated cost of $1,750,000, (iv) drill
three additional horizontal wells on the Rosablanca Block at an estimated cost
of $3,750,000, and (v) reenter and deepen an existing well on the Montecristo
Block at an estimated cost of $500,000. As of March 31, 1999, Seven Seas had
requested environmental approval for the shooting of additional two-dimensional
seismic (75 kilometers on the Montecristo Block and 50 kilometers on the
Rosablanca Block). Currently, this shooting is anticipated to begin in the
fourth quarter of 1999. Additionally, Seven Seas has agreed to begin the
environmental approval process to reenter and deepen the existing well on the
Montecristo Block, however, no specific time frame for this well has been
determined. The timing and undertakings under this development plan as it
continues to be achieved will depend upon a number of factors, most of which
will not be within the control of the Company, including availability of capital
resources of the
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Company and its joint venture partners, the results of geological and
geophysical surveys and analysis, the expected or actual results of each
development undertaking or operation which in large part may be affected by the
anticipated or current cost of such operations and the prices of crude oil and
natural gas, general domestic and international economic conditions within and
without the oil and gas industry, and Colombian legal and regulatory compliance.
Therefore, there can be no assurance that such plan of exploration and
development will be successful or will be completed as anticipated as of the
date of this report.
GUADUAS BLOCK-
The Company has established a 12-month plan of development of the
Guaduas Block. Under this plan, established in December 1998, the Company and
Arena Power propose, in addition to the work commitments outlined in the
Association Contract, to (i) drill at least five core holes at an estimated cost
of $100,000, (ii) identify, analyze and evaluate based on the core data obtained
a preliminary estimate of coal reserves with the assistance of third-party
accredited and licensed mining engineering firm at an estimated cost of $25,000,
(iii) begin full mining operations should reserves warrant as the first phase of
a three phase mining and electrical power generation project with an estimated
cost to be $8,000,000 ($1,000,000 as equity capital by the Company and
$7,000,000 as debt financing).
Early analysis of the quality of the coal is estimated at 14,000 BTU,
.07 percent sulfur and 5 percent ash. Arena and the Company are studying the
feasibility for developing a coal-fueled power plant that will provide power for
a major oil and gas production company, several industrial customers, and serve
the national grid. The Company and Arena Power estimate that the initial 100
Mega-watt plant will be constructed in two 50 Mega-watt phases. The first phase
will be operational in late 2000 and the second phase is expected to be
commissioned in late 2001. Provided a suitable steam host is identified, a
combined heat and power (CHP) co-generation installation will be made;
otherwise, a conventional steam turbine method will be employed.
Initial technical and economic studies are proceeding on the power
generation plants in advance of executing power purchase/merchant sale
agreements and initiating engineering, procurement, and construction activities
for the initial 50 Mega-watt power plant. The Company and Arena are identifying
partners with the required expertise to pursue exploration of the coal deposits.
It is expected that the project will require initial developmental costs of
$2,000,000 and a total project financing of approximately $100 million for both
50 Mega-watt phases.
UNCERTAINTY OF FUTURE ESTIMATES OF OIL AND NATURAL GAS RESERVES
As of the date of this report, the Company does not have any proved
oil, gas or coal reserves. However, it is anticipated that through development
of the Company's interest in the Middle Magdalena Valley Basin and other
properties acquired and developed, the Company will obtain and provide to the
shareholders of the Company, through annual reports or other means, estimates of
the Company's reserves. Estimates of the Company's proved oil, gas and coal
reserves and projected future net revenues will be based on reserve reports
prepared by independent engineers. The estimation of reserves requires
substantial judgment on the part of the petroleum and mining engineers,
resulting in imprecise determinations, particularly with respect to new
discoveries. Different reserve engineers may make different estimates of reserve
quantities and revenues attributable thereto based on the same data. Estimates
of proved undeveloped reserves, which in the future may comprise a substantial
portion of the Company's reserves, are by their nature less than certain. The
accuracy of any reserve estimate depends on the quality of the available data as
well as engineering and geological interpretation and judgment. Results of
drilling, mining, testing and production and changes in the assumptions
regarding decline and production rates, crude oil prices, coal prices,
electrical prices, revenues, taxes, capital expenditures, operating expenses,
geologic success and quantities of recoverable crude oil may vary substantially
from those assumed in the estimates, may result in revisions to such estimates
and could materially affect the estimated quantities and related value of
reserves set forth herein. The estimates of future net revenues will reflect
oil, gas and coal prices as of the date of estimation, without escalation. There
can be no assurance, however, that such prices will be realized or that the
estimated production volumes will be produced
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during the periods indicated. Future performance that deviates significantly
from the reserve reports could have a material adverse effect on the Company.
Therefore, this can be no assurance that such plan of development will be
successful or will be completed as anticipated as of the date of this Report.
RESULTS OF DEVELOPMENT STAGE OPERATIONS
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE AUDITED
CONSOLIDATED FINANCIAL STATEMENTS AND NOTES.
Potomac (Bermuda) was formed on April 7, 1997. Prior to the Merger, PEC
was inactive and did not have any assets or liabilities. Effective June 17,
1998, Potomac (Bermuda) merged with and into Potomac Acquisition and became a
wholly-owned subsidiary of PEC. The Merger was accounted for as a reverse
acquisition of PEC by Potomac (Bermuda) under the purchase method of accounting.
Therefore, the following discussion and analysis of results of operations
discussed below are only those of to Potomac (Bermuda) prior to the Merger. See
"--Background."
The Company is a development stage company that during the three month
period ending March 31, 1999, did not have any revenue and incurred a net loss
of $168,761. There is no assurance that the Company will have revenues from oil,
gas or coal sales in the future. The only revenue received by Potomac during the
three months ending March 31, 1999 was from interest income of $974 earned or
accrued on cash and cash equivalents. During the first three months ending March
31, 1999, Potomac continued to fulfill it's work commitments on the Rosablanca,
Montecristo and Guaduas Association Contracts and in connection therewith
incurred $44,376 in professional fees and consulting expenses and incurred
miscellaneous expenses of $125,359. Other than the activities associated with
fulfilling the required work commitments of the Rosablanca, Montecristo and
Guaduas Association Contracts, Potomac did not conduct any operating activities
during the first three months ending March 31, 1999.
YEAR 2000 COMPUTER SYSTEM COMPLIANCE
The Company's computer systems are year 2000 compliant. The Company's
computer systems which employed two digit year date format rather than four
digit date format have been programmed to comply with year 2000 requirements on
a system-by-system basis. Currently, the Company utilizes a WindowsNT operating
system which operates off of a Dell manufactured server.
ACCOUNTING STANDARDS ISSUED BUT NOT YET ADOPTED
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which requires disclosures related to
trading and holding of derivative instruments and the conduct of hedging
activities. This statement is effective for financial statements of the Company
for the year beginning after June 15, 1999. Management of the Company believes
that adoption of SFAS No. 133 will not have a material effect on the Company's
financial statements.
EFFECTS OF RELATED ENERGY (OIL, GAS AND COAL) PRICE FLUCTUATIONS
In the event the Company's exploration activities result in significant
production of crude oil, natural gas or coal the Company's operations and the
value of its assets, including producing and non-producing assets, will be
subject to the effects of fluctuations in crude oil, natural gas and coal
prices. As a result of the instability and volatility of prices and the surplus
of crude oil and natural gas, and current market conditions within the oil and
gas industry, financial institutions have become more selective in the energy
lending area and have reduced the percentage of existing reserves that may
qualify for the borrowing base to support energy loans.
In the future, the Company anticipates that its principal source of
cash flows, if any, will be from the production and sale of crude oil, natural
gas and coal reserves that are depleting assets. Cash flows from production
sales depends upon the quantity of production and the price obtained for such
production. Generally, an
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increase in prices allows a company to finance its operations to a greater
extent with internally generated funds, may allow a company to obtain equity
financing more easily or on better terms and lessens the difficulty of
attracting financing alternatives available to a company from industry partners
and non-industry investors. However, price increases heighten the competition
for energy association contracts, leases and other contractual arrangement,
increase the costs of exploration and development activities, and because of
potential price declines, increase the risks associated with the purchase of
producing properties while prices are at higher levels.
A decline in oil, gas and coal prices (i) reduces internally generated
cash flows which in turn reduces the funds available for exploration for and
replacement of reserves, (ii) increases the difficulty of obtaining equity
financing and worsens the terms on which such financing may be obtained, (iii)
reduces the number of available oil, gas and coal properties on reasonable
economic terms, (iv) may result in the expiration of oil, gas and coal
contractual interests based upon the potential reserves in relation to
exploration and development costs, (v) results in marginally productive oil, gas
and coal mines being abandoned as non-commercial, and (vi) increases the
difficulty of attracting financing alternatives available from industry partners
and non-industry investors. However, price declines reduce the competition for
oil, gas and coal interests and, correspondingly, reduce the prices paid for
such interests or result in obtaining such interests on more favorable terms.
Furthermore, exploration and production costs generally decline, although the
decline may not be at the same rate of decline of energy prices.
SEASONALITY
It is anticipated that the results of operations of the Company will be
somewhat seasonal due to seasonal fluctuations in the price for crude oil,
natural gas, coal and electrical kilowatts. Historically, crude oil prices have
been generally higher in the third and fourth quarters and natural gas prices
have been generally higher in the fourth quarter. Electrical kilowatts tend to
be higher in the third quarter. Due to these seasonal price fluctuations, it is
anticipated that results of operations for individual quarterly periods may not
be indicative of results that may be realized on an annual basis.
INFLATION AND CHANGES IN PRICES
Inflation principally affects the costs required to drill, complete and
operate oil and gas wells as well as mine coal. In recent years inflation has
had a minimal effect on such costs. However, increases and decreases in drilling
or mining activities, which generally a linked to crude oil, natural gas and
coal price increases and decreases, have resulted in the increase and decrease
of exploration, development and exploitation costs on an industry-wide basis.
LIQUIDITY AND CAPITAL RESOURCES
Potomac has financed its development state activities through the
sale of equity securities and does not have any borrowing facilities or
arrangements in place to fund its capital commitments. During the twelve months
ended December 31, 1998, net cash used by operating activities totaled $392,020
cash provided by financing activities totaled $741,036. During the three months
ended March 31, 1999, net cash used by operating activities totaled $148,233,
net cash used by financing activities totaled $5,102. As of March 31, 1999,
Potomac had working capital of $ (149,626) compared to working capital of
$83,396 at March 31, 1998.
Under the terms of the Rosablanca and Montecristo Association
Contracts, the Company has certain minimum work commitments on a joint venture
basis with Seven Seas, the Company's share of such costs is estimated to be
approximately $750,000. In addition to the minimum work commitments, the Company
has established a 24-month plan of development of the Rosablanca and Montecristo
Blocks at an estimated cost of $3,496,984. Under the terms of the Guaduas
Association Contract, the Company has certain minimum work
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commitments on a joint venture basis with Arena Power, the Company's share of
such costs is estimated to be approximately $387,500. In addition to the minimum
work commitments, the Company has established a 24-month plan of development of
the Guaduas Blocks at an estimated cost of $1,000,000. The Company anticipates
that the costs of development of the Rosablanca, Montecristo and Guaduas Blocks
will be funded with proceeds from the sale of equity and debt securities and,
although unlikely, borrowings. There is no assurance that such funding will be
available in which event the Company may forfeit its interests in the Blocks.
PART II
ITEM 1. LEGAL PROCEEDINGS
Not applicable.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Effective June 17, 1998, Potomac Energy (Bermuda) Ltd., a Bermuda
corporation ("Potomac (Bermuda)"), merged with and into Potomac Exploration
Acquisition Corporation, a wholly-owned subsidiary of the Company ("Potomac
Acquisition"), pursuant to a Plan of Reorganization and Agreement of Merger
dated June 12, 1998 (the "Merger"). As a condition of the Merger, on June 17,
1998, the outstanding Common Stock of the Company was reverse split on the basis
of one share for each 41.40846 outstanding shares, which resulted in 579,270
shares of Common Stock being outstanding immediately prior to the Merger. In
consummation of the Merger, the Company issued 7,050,000 shares of its Common
Stock to the former shareholders of Potomac (Bermuda) and the Company's name was
changed to "Potomac Energy Corporation."
COMMON STOCK
Pursuant to its Certificate of Incorporation, the Company authorized up
to 50,000,000 shares of Common Stock, $.001 par value. As of the date of this
report, the issued and outstanding capital stock of the Company consists of
7,974,270.
OUTSTANDING STOCK OPTIONS
As of the date of this Report, the Company has granted stock options to
purchase 1,275,000 shares of Common Stock during various periods, expiring April
1999 through December 2003, at exercise prices of $.50 to $1.25 per share, with
a weighted average exercise price of $.1.00 per share. In addition, the Company
has reserved an additional 225,000 shares of Common Stock for issuance of stock
options, pursuant to the Company's Stock Option Plan.
ITEM 3. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 4. OTHER INFORMATION
Not applicable.
ITEM 5. EXHIBITS AND REPORTS ON FORM 8-K.
(a) EXHIBITS:
Not applicable.
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(b) REPORTS ON FORM 8-K.
Not applicable.
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
Registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
POTOMAC ENERGY CORPORATION
(Formerly Midwestern Resources, Inc.)
(Registrant)
By: /s/JAMES E. FRAZIER
----------------------------------------------
James E. Frazier, Chief Financial Officer.
Date: September 15, 1999
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