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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------
Form 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File No. 1-16383
CHENIERE ENERGY, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 95-4352386
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
333 Clay Street, Suite 3400
Houston, Texas 77002-4102
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (713) 659-1361
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $ 0.003 PAR VALUE AMERICAN STOCK EXCHANGE
(Title of Class) (Name of each exchange
on which registered)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b - 2 of the Act). Yes [ ] No [X]
The aggregate market value of the registrant's Common Stock held by
non-affiliates of the registrant was approximately $15,044,368 as of June 30,
2002 (based upon the June 28, 2002 closing market price of such common stock as
reported on The American Stock Exchange).
13,297,393 shares of the registrant's Common Stock were outstanding as of
March 26, 2003.
Documents incorporated by reference: The definitive proxy statement for the
registrant's Annual Meeting of Stockholders (to be filed within 120 days of the
close of the registrant's fiscal year) is incorporated by reference into Part
III.
CHENIERE ENERGY, INC.
Index to Form 10-K
PART I............................................................................................................3
Items 1. and 2. Business and Properties...........................................................................3
Item 3. Legal Proceedings........................................................................................23
Item 4. Submission of Matters to a Vote of Security Holders......................................................24
PART II..........................................................................................................25
Item 5. Market Price of and Dividends on the Registrant's Common Equity and Related Stockholder Matters..........25
Item 6. Selected Financial Data..................................................................................26
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations....................27
Item 7A. Quantitative and Qualitative Disclosures About Market Risk..............................................37
Item 8. Financial Statements and Supplementary Data..............................................................38
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.....................70
PART III.........................................................................................................70
Item 10. Directors and Executive Officers of the Registrant......................................................70
Item 11. Executive Compensation..................................................................................70
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.........70
Item 13. Certain Relationships and Related Transactions..........................................................70
Item 14. Controls and Procedures.................................................................................71
PART IV..........................................................................................................71
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.........................................71
SIGNATURES.......................................................................................................74
Gryphon Exploration Company Audited Financial Statements.........................................................77
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PART I
ITEMS 1. AND 2. BUSINESS AND PROPERTIES
GENERAL
Cheniere Energy, Inc., a Delaware corporation, is a Houston-based company
engaged in oil and gas exploration, development and exploitation and in the
development of a liquefied natural gas (LNG) receiving terminal business. The
LNG receiving terminal business consists of receiving deliveries of LNG from LNG
ships, processing such LNG to return it to a gaseous state and delivering it to
pipelines for transportation to purchasers. The terms Cheniere and the Company
refer to Cheniere Energy, Inc. and its subsidiaries. The Company has
historically focused on evaluating and generating drilling prospects using a
regional and integrated approach with a large seismic database as a platform.
Cheniere's management expects that the Company's active interpretation of 3D
seismic data and generation of prospects will continue, though its participation
in the drilling of wells within the coming year or two will be leveraged through
the sale of these prospects on a promoted basis to industry participants,
whereby the capital costs are borne by industry partners. The Company is also
focusing, and expects to continue to focus, its attention on the development of
its LNG receiving terminal business.
Cheniere has been publicly traded since July 3, 1996 under the name
Cheniere Energy, Inc. The Company's principal executive offices are located at
333 Clay Street, Suite 3400, Houston, Texas 77002, and its telephone number is
(713) 659-1361.
On October 16, 2000 the Company's stockholders approved a one-for-four
reverse stock split. The reverse stock split became effective on October 18,
2000 and reduced Cheniere's issued and outstanding shares from 43,989,572 shares
to 10,997,393 shares. All historical share and per share data appearing in this
document have been restated to reflect the reverse stock split.
As used in this Report, Mcf means thousand cubic feet, Mmcf means million
cubic feet, Bcf means billion cubic feet, Bbl means barrel or 42 U.S. gallons
liquid volume, Mbbl means thousand barrels, Mcfe means thousand cubic feet of
natural gas equivalent using the ratio of six Mcf of natural gas to one Bbl of
crude oil, condensate and natural gas liquids, Mmcfe means million cubic feet of
natural gas equivalent, Bcfe means billion cubic feet of natural gas equivalent,
and Mmbtu means million British thermal units. This Report includes various
other capitalized terms that are defined when first used.
ACCESS TO PUBLIC FILINGS
Cheniere provides public access to its annual reports on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to
these reports filed with the Securities and Exchange Commission (the "SEC")
under the Securities Exchange Act of 1934 (the "Exchange Act"). These reports
may be accessed free of charge through Cheniere's internet website (located at
www.cheniere.com), where the Company provides a link to the SEC's website (at
www.sec.gov).
GENERAL DEVELOPMENT OF BUSINESS
Cheniere Energy Operating Co., Inc. (Cheniere Operating) was incorporated
in Delaware in February 1996 for the purpose of engaging in the oil and gas
exploration business, initially on the Louisiana Gulf Coast. On July 3, 1996,
Cheniere Operating underwent a reorganization whereby Bexy Communications, Inc.,
a publicly held Delaware corporation (Bexy), received 100% of the outstanding
shares of Cheniere Operating, and the former stockholders of Cheniere Operating
received approximately 93% of the issued and outstanding Bexy shares. As a
result of the share exchange, a change in the control of the Company occurred.
The transaction was accounted for as a recapitalization of Cheniere Operating.
Bexy spun off its existing assets and liabilities to its original stockholders
and changed its name to Cheniere Energy, Inc. Cheniere Operating became a wholly
owned subsidiary of the Company.
Cameron Project. In 1996, Cheniere entered into an exploration agreement
with Zydeco Exploration, Inc. to acquire and process proprietary seismic data
along the transition zone (the area approximately 3-5 miles on either side of
the Gulf of Mexico shore line) in Cameron Parish, Louisiana, covering a
228-square-mile area (the Cameron Project). The 228-square-mile survey was
acquired jointly by Cheniere and its industry partner, and initial
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processing was completed in 1997. Interpretation of the data yielded drilling
prospects located onshore and in the state and federal waters of offshore
Louisiana. Leasing activity occurred over identified prospects throughout these
areas, and five prospects were drilled during 1999. In January 2000, Cheniere
reprocessed the Cameron data. Leasing over additional prospects began later in
2000 and continues to date. In September 2001, Cheniere acquired for $500,000
all rights to the Cameron Project from the industry partner with whom it had
jointly acquired the data in 1996 and 1997. Concurrent with this acquisition,
Cheniere sold the seismic data to a seismic marketing company for $2,500,000 and
a 50% share in licensing proceeds generated by the marketing company. In
September 2002, Cheniere sold its remaining interest in future licensing
proceeds to the marketing company for $825,000. Cheniere retains a license to
all of the seismic data for use in its exploration program. See Exploration
Programs.
Offshore Louisiana Area. In an effort to provide continued access to high
quality drilling prospects, the Company expanded beyond the Cameron Project and
into the shallow waters of the Gulf of Mexico. In 1999, Cheniere licensed 8,800
square miles of seismic data from Fairfield Industries (the Offshore Louisiana
Area). The Company also made a commitment (estimated to be approximately
$5,500,000 at the time) to fund the reprocessing of the entire 8,800-square-mile
seismic database.
On September 15, 2000 Cheniere entered into an agreement (the Gryphon
Transaction) with Warburg, Pincus Equity Partners, L.P. (Warburg), a global
private equity fund based in New York, to fund exploration and development in
the Offshore Louisiana Area through a newly formed private corporation, Gryphon
Exploration Company (Gryphon). The Company contributed to Gryphon: (i) the
Company's license from Fairfield Industries to seismic data covering the
Offshore Louisiana Area; (ii) the Company's interest in its Joint Exploration
Agreement with Samson Offshore Company (Samson), (iii) certain offshore leases,
including its Shark prospect on West Cameron Block 49, (iv) a well eventually
being drilled, (v) certain prepaid expenses and (vi) furniture and fixtures, all
in exchange for (i) the assumption by Gryphon of certain accounts payable and
(ii) 100% of the common stock of the subsidiary and cash. Warburg invested
$25,000,000 and received preferred stock, with an 8% accruing dividend,
convertible into 63.2% of Gryphon's common stock. In the event Gryphon's board
of directors approves a capital call and Gryphon delivers written notice of such
capital call to the terms of the agreement, Cheniere and Warburg have an option,
subject to certain customary conditions, to contribute to Gryphon their
respective shares of an additional $75,000,000 investment. The Gryphon
Transaction was consummated on October 11, 2000. See Investment in Gryphon
Exploration Company.
Offshore Texas Project Area. Between June 2000 and October 2000, Cheniere
acquired two licenses to approximately 6,800 square miles of seismic data
primarily in the shallow waters offshore Texas and also in the West Cameron area
in the Gulf of Mexico (the Offshore Texas Project Area) in separate transactions
with Seitel Data Ltd., a division of Seitel Inc., and JEBCO Seismic, L.P.
Cheniere had committed to reprocess all of the data from the Offshore Texas
Project Area at a cost of approximately $8,500,000, payable by Cheniere in
installments beginning in October 2000 and continuing through the final delivery
of reprocessed data, which is expected to occur in 2003.
In June 2001, Cheniere sold to Gryphon for $3,500,000 one of its two
licenses to the Seitel 3D seismic data. Gryphon paid $853,197 in cash to
Cheniere and agreed to pay $2,646,803 of Cheniere's obligations related to the
reprocessing of the data. Cheniere remained responsible for payment of the final
$1,061,692 in reprocessing charges upon final delivery of all reprocessed data,
which is anticipated to be received in 2003. This payment obligation was assumed
by Gryphon in connection with Cheniere's March 2002 sale of 51,400 shares of
Gryphon common stock to Gryphon. (See Note 12 in Notes to Consolidated Financial
Statements.) Cheniere retains one license to the seismic data.
In July 2001, Cheniere sold to Gryphon one of its two licenses to the Jebco
3D seismic data covering an additional 3,000 square miles. Gryphon agreed to pay
Cheniere's accounts payable of $1.3 million and the remaining commitment of $2.9
million related to the reprocessing of the data. In connection with the
transaction, Cheniere also transferred to Gryphon 6,740 shares of Gryphon common
stock, valued by the parties at approximately $418,000 or $62 per share, based
on the estimated fair market value of the Gryphon common stock, which considered
the fair value of such stock at the formation of Gryphon and any significant
changes in Gryphon's operations or market conditions since that date. The
proceeds at closing of $1.3 million were allocated as a reduction to the
carrying amount of Cheniere's investment in Gryphon ($418,000) and unproved oil
and gas properties ($882,000). Cheniere retains one license to the seismic data.
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Cheniere's existing data set covering the Cameron Project and the
reprocessed data set covering the Offshore Texas Project Area, as it is
delivered, provide to the Company the framework with which to identify potential
drilling prospects which may then be acquired through leasing at the area-wide
federal and state lease sales and from private mineral rights owners onshore,
through farm-ins (agreements whereby a third party owner of lease interests
grants to the Company the right to earn an assignment of an interest in the
lease, typically by drilling one or more wells), and through participation in
industry prospects. Cheniere plans to continue to identify potential drilling
prospects and may participate in any drilling activities by selling interests on
a promoted basis to industry participants.
As a part of its plans to quickly expand its exploration activities, in
December 2000, Cheniere entered into a consulting agreement with Aurora
Exploration, LLC (Aurora) to assist Cheniere in the interpretation of the
Company's seismic data sets. The initial term of the agreement was through March
2001, but it was extended through September 2001. Aurora, based in Lafayette,
LA, focused its efforts on the Texas and Louisiana offshore areas of the Gulf of
Mexico shelf, using a portion of Cheniere's licensed seismic data from the
Offshore Texas Project Area. Aurora also generated prospects in the shallow
water Main Pass area of offshore Louisiana, using other seismic data provided by
Cheniere.
LNG Receiving Terminal Development. In 2000, Cheniere undertook a
feasibility study to assess the long-term natural gas markets in the U.S. and,
in particular, the potential role of LNG in meeting a portion of the gas supply
deficit expected to develop later in this decade. Based on that analysis,
Cheniere's management concluded that LNG would become an economically viable
source of natural gas supply in the U.S.
In 2001, Cheniere assembled an experienced LNG project development team and
began a study to determine viable locations for LNG receiving terminals in the
U.S. The Company then acquired options to enter into long-term leases for two
terminal sites and an option to purchase one terminal site, all along the Texas
Gulf Coast. The options may be renewed through the payment of annual or
semiannual rentals.
In 2002, Cheniere engaged outside engineering, environmental and regulatory
consultants and substantially completed the project design and planning phase of
the Freeport project, including the preparation of materials to be filed with
the Federal Energy Regulatory Commission (FERC). The design work, the federal
and state regulatory coordination, and the 13 resource reports which comprise
the environmental filing to the FERC were substantially completed during the
year. It is anticipated that the FERC filing will be submitted in March 2003.
During the first half of 2002, the Company worked, with the assistance of
Petrie Parkman & Co. as its financial advisor, to identify and secure funding
for the development/pre-construction phase of the Freeport project. In August
2002, Cheniere entered into a Contribution Agreement with entities controlled by
Michael S. Smith providing for the formation of a limited partnership, Freeport
LNG Development, L.P. (Development) to develop the Freeport receiving terminal.
Under the terms of the Contribution Agreement, Cheniere contributed its
site lease option at Freeport, its technical expertise and know-how, and all of
the work in progress related to the Freeport project in exchange for a 40%
interest in Development. Michael S. Smith, through a controlled entity, Freeport
LNG Investments, LLC (Investments), will pay Cheniere $5,000,000 in installments
and contribute up to $9,000,000 to fund Freeport project expenses before
additional contributions may be required of Cheniere. Investments holds a 60%
interest in Development and Michael S. Smith will manage the project as chief
executive officer of Development. The transaction was consummated on February
27, 2003. On March 1, 2003, pursuant to an existing option agreement, Cheniere
sold a 10% interest in Development to a third party for $2,333,333, payable over
time. In connection with the closing of the transactions in 2003, Cheniere
issued warrants for the purchase of 1,000,000 shares of its common stock at a
price of $2.50 per share, exercisable for a period of 10 years. Cheniere
retained a 30% interest in Development.
BUSINESS STRATEGY
It is the Company's belief that the long-term outlook for natural gas
prices in the U.S. is one that will sustain prices at or above $3.00 per Mcf.
The Company believes that such an environment will favor not only domestic
exploration and production, but also LNG imports into the U.S. The Company's
objective is to develop its LNG receiving terminal business and to expand the
net value of its assets by building an oil and gas reserve base in a
cost-efficient manner, through its investment in Gryphon and through
exploitation of its seismic database to
5
facilitate identifying drilling prospects. Cheniere's exploration program
combines the use of regional seismic data in shallow water areas of the Gulf of
Mexico, advanced analytical technologies, a methodology that integrates
geoscience and engineering disciplines, and a core of experienced staff.
LNG Receiving Terminals
Cheniere has assembled a team of professionals with extensive experience in
the LNG industry. The Company has researched the LNG opportunity, developed a
plan to exploit the opportunity and initiated the process of identifying and
securing sites for LNG receiving terminals as well as undertaking the necessary
regulatory and permitting work to advance the project. A substantial portion of
the time and attention of Cheniere's employees is currently focused on
developing LNG terminals.
Seismic Data
Cheniere has acquired two significant seismic database assets: (i) a
license to a 228-square-mile seismic program covering the transition zone in
Cameron Parish (the Cameron Project described above), and (ii) a
6,800-square-mile seismic database comprising several seismic surveys in the
shallow waters offshore Texas (the Offshore Texas Project Area described above).
The offshore Texas database has been available previously to the industry and
was processed using a technique called dip move out (DMO). Cheniere has acquired
the DMO data and is underwriting the reprocessing of the data utilizing another
technology known as prestack time migration (PSTM). Both DMO and PSTM are
processing techniques which improve seismic data quality to more accurately
image subsurface features and delineate hydrocarbon accumulations. Of the two
techniques, PSTM is more advanced and technically accurate. The regional PSTM
data is the technology tool which management believes gives Cheniere a
competitive advantage.
Analysis and Methodology
Cheniere has developed a prospect generation infrastructure capable of
detailed analyses of large volumes of seismic, geological, and engineering data.
Cheniere employs a rigorous methodology which includes: 1) the detailed analyses
of existing fields to identify geological and geophysical attributes for use as
analogs, 2) regional trend mapping to extend prolific plays into under-explored
areas, 3) the use of workstation interpretation techniques to rapidly identify
prospects with attributes similar to those identified in the analog fields, 4)
the integration of seismic interpretation, well control, structure,
stratigraphy, timing, sourcing factors, and production data to quantify prospect
potential, and 5) the integration of the above sciences with experience and
conservative economic evaluation to focus the exploration program on highly
commercial projects. By conducting a thorough analysis of the data and strict
adherence to the methodology, Cheniere believes it can reduce the risk of dry
holes and achieve significant growth, while maintaining a competitive cost of
finding and development.
Experience
Cheniere has built a technical and management team that is experienced in
the Gulf of Mexico and in various technical specialties required for its
exploration program. The technical staff averages over 30 years of experience
exploring for oil and gas in the Gulf Coast. The Company believes this
experienced team allows it to be very productive in the generation and
acquisition of prospects.
LNG RECEIVING TERMINAL BUSINESS
LNG is natural gas that has been reduced to a fraction of its volume
through a sophisticated refrigeration process. The liquefication of natural gas
(into LNG) allows it to be transported long distances comparatively safely and
economically. Outside the U.S., utilization of LNG has grown dramatically, with
15 sites in 12 countries capable of producing 6 Tcf (gas equivalent) of LNG per
year and 42 terminals in 11 countries capable of importing LNG. In the U.S., due
mainly to an historically abundant supply of natural gas, LNG has not been a
major energy source. However, the recent experience of U.S. natural gas
producers' limited ability to increase supply and the increasing cost of
domestic exploration and production, the Company believes LNG will become a
competitive supply alternative to domestic natural gas and other import
alternatives. Assuming current construction costs of LNG-related facilities and
tankers, LNG can be economically produced and delivered as natural gas into U.S.
pipelines at a cost of $2.50 - $3.50/MMBtu.
6
Cheniere has been developing its LNG business since late 2000 and has made
substantial progress. After completing a U.S. gas market study and preliminary
terminal location study in 2000, Cheniere decided to focus on developing
terminals on the Texas and Louisiana Gulf Coast. Texas offers several important
advantages, including (i) it is the largest natural gas-consuming state in the
U.S., (ii) the government and general population are familiar with and
supportive of the energy industry, (iii) with the expected decline in
production, Texas will have under-utilized intrastate and interstate pipelines
with access to premium Midwest, Northeast, Mid-Atlantic and Southeast U.S.
markets, and (iv) Texas has an extended coast providing a number of ports with
adequate facilities for such a terminal. Louisiana, the third largest gas
consuming state in the U.S., offers otherwise identical advantages.
Cheniere secured lease options on sites in Freeport, Corpus Christi and
Brownsville, Texas and Sabine Pass, Louisiana. In connection with Cheniere's
acquisition of its option to lease the Freeport, Texas LNG receiving terminal
site, Cheniere issued 500,000 shares of common stock valued at $1,150,000 or
$2.30 per share, the closing price of the Company's common stock on the date of
the transaction. Additionally, Cheniere has committed to issue 750,000 shares of
its common stock to the seller of the lease option in April 2003, and Cheniere
will receive no additional consideration. Cheniere is also obligated to pay to
the seller of the lease option an overriding royalty interest equal to $0.03 per
Mcf on up to 1 Bcf per day of throughput from the LNG receiving terminals which
Cheniere develops. Under the terms of the option to lease the Freeport site, the
Company may exercise the option during the six-month period commencing on March
23, 2001, and such option is renewable for five additional six-month periods by
paying additional consideration of $125,000 every six months commencing on
September 23, 2001. In 2002, the Freeport site option was converted into a
long-term lease in the name of Development, and at the closing of the
partnership in February 2003, Development assumed the royalty obligation as it
relates to throughput at the Freeport facility.
In connection with Cheniere's acquisition of its option to lease the
Brownsville, Texas LNG terminal site, Cheniere paid $33,600 for a one-year
option commencing in June 2001. Such option was renewable for two additional
one-year periods for additional consideration of $33,600 per year, and the
Company renewed the option in June 2002.
Cheniere obtained a one-year purchase option to acquire the LNG terminal
site in Sabine Pass, Texas, commencing in November 2001, in exchange for initial
consideration of $200,000, of which $75,000 was paid in cash at closing and
$125,000 was due six months from closing, provided that such option was not
terminated at an earlier date. The purchase option expired during 2002, and no
additional consideration beyond the $75,000 was paid. Cheniere entered into
negotiations for an option to lease a different tract in Sabine Pass and
acquired such option in February 2003.
In December 2002, Cheniere entered into a non-binding Memorandum of
Understanding with Sherwin Alumina L.P. (Sherwin) providing for the negotiation
of a partnership agreement which would grant Sherwin a 33% interest in
Cheniere's Corpus Christi receiving terminal project in exchange for Sherwin's
agreement to fund the first $4,500,000 in project development costs. Completion
of the partnership agreement is scheduled to occur by April 15, 2003. In the
event that such an agreement is not consummated by that date, Sherwin will grant
to Cheniere a lease option on the terminal site lands in Corpus Christi. The
option rentals will be $100,000 per year for up to 5 years. Upon exercise of the
option, lease rentals would be $400,000 per year for an initial term of 33
years, renewable for two additional terms of 33 years each.
Initially, through its participation in Development, Cheniere plans to
permit the Freeport site with average annual capacity of 365 Bcf of gas per
year. Cheniere has commenced development of its Freeport, Texas site, including
(i) completing a feasibility study, (ii) initiating the preparation of forms and
collection of information for the permitting and Federal Energy Regulatory
Commission related filings, (iii) meeting with local agencies and planners and
(iv) conducting preliminary discussions concerning the financing of the project.
In order to exploit the opportunity to develop an LNG receiving terminal,
Cheniere will need to obtain additional equity or debt financing. Cheniere has
executed non-binding Memoranda of Understanding (MOUs) for the sale of 500 MMbtu
per day of natural gas from the proposed terminal and is pursuing discussions
with other consumers of natural gas to arrange for additional gas sales through
the terminal. Cheniere and Development have also held discussions with several
LNG suppliers. Assuming prompt regulatory approvals and adequate financing, and
subject to all of the risks inherent in a new venture of this type, as described
under the "Forward Looking Statements and Risk Factors" herein, construction of
the first terminal could commence as early as 2004 with LNG being imported in
2007. However, there can be no assurance whether or when such regulatory
approvals and financing may be obtained. See Forward Looking Statements and Risk
Factors.
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EXPLORATION PROGRAMS
The Company's current oil and gas exploration and development activities
are focused on two areas: (i) the Cameron Project, which covers an area
extending roughly three to five miles on either side of the westernmost 28 miles
of Louisiana coastline; and (ii) the Offshore Texas Project Area, which covers
approximately 6,800 square miles in the shallow waters offshore Texas and the
West Cameron Area of offshore Louisiana. Substantial infrastructure along the
Gulf Coast and in the shallow Gulf of Mexico should permit Cheniere to lower its
development costs compared to those in other geographic regions and facilitate
timely development of oil and gas discoveries. The Company's officers and
technical staff have extensive experience both onshore and offshore in the Gulf
Coast and believe the Company is well-positioned to evaluate, explore and
develop properties in these areas.
Cameron Project Seismic Exploration Program
Under the terms of an exploration agreement with an industry partner
covering the Cameron Project, Cheniere paid for certain seismic costs in the
amount of approximately $16,500,000 and acquired ownership of seismic data
covering the Cameron Project, among other interests that have subsequently
expired or terminated. After the termination of the exploration agreement,
Cheniere sold the seismic data to a seismic marketing company for $2,500,000 and
a 50% share in licensing proceeds generated by the marketing company. Cheniere
subsequently sold its remaining interest in future licensing proceeds to the
marketing company for $825,000. Cheniere retains a license to all of the seismic
data for use in its exploration program. Cheniere is also entitled to receive at
no additional cost any subsequent reprocessing of the data which may be
performed by the seismic marketing company.
Seismic Exploration Program in Offshore Texas Project Area
In June 2000, Cheniere acquired a license to approximately 1,900 square
miles of seismic data from Seitel Data Ltd., a division of Seitel Inc. In
October 2000, Cheniere exercised its option to expand the agreement with Seitel
Data Ltd. to cover an additional 1,900 square miles of seismic data. Together,
the licenses acquired from Seitel represent coverage of over 433 Outer
Continental Shelf blocks in the shallow waters offshore Texas and Louisiana in
the Gulf of Mexico.
In October 2000, Cheniere negotiated a Master Data Users Agreement with the
Houston-based firm, JEBCO Seismic L.P., to acquire 3,000 square miles (333
blocks) of seismic data in both state and federal waters offshore Texas,
bringing Cheniere's total data set in the shallow waters offshore Texas and
Louisiana to approximately 6,800 square miles of seismic coverage. Cheniere had
committed to reprocess all of the data from the Offshore Texas Project Area at a
cost of approximately $8,500,000, payable in installments beginning in October
2000 and continuing through the final delivery of reprocessed data, which is
expected to occur in 2003. As of December 31, 2002, Cheniere had received
reprocessed data for the 3,000 square miles of seismic data in the Jebco data
set and 2,200 of the approximately 3,800 square miles of seismic data in the
Seitel data set, representing 76% of the total reprocessing to be done in the
Offshore Texas Project Area.
Cheniere's exploration team generated and captured 16 prospects during 2001
and 2002 and sold interests in 14 of the prospects to industry partners,
retaining various overriding royalty interests and working interests ranging
from an overriding royalty interest (a share of the hydrocarbons produced from
an oil and gas property, free of the expense of production) of less than 1% to a
carried working interest (an agreement whereby Cheniere retains an interest in a
well but bears none, or only a portion of the cost of drilling the initial well)
of approximately 24%. Seven of the prospects sold during 2001 and 2002 have been
drilled by its industry partners, and Cheniere expects that the remaining
prospects sold during those years will be drilled by its industry partners
during 2003, but Cheniere does not serve as operator of the wells and does not
control the timing of such drilling activities.
Drilling Activities
In 1999, the Company drilled and completed two discovery wells located in
adjacent fault blocks on West Cameron Block 49 in Louisiana state waters: the
Redfish well and the Stingray well. The wells were tied into a common platform
and began production during September 1999. Both wells are located in shallow
waters of approximately 25 feet and were drilled into the Lower Miocene
formation, from 9,000 to 11,000 feet. Cheniere owned a 30% working interest in
the Redfish well and a 45% working interest in the Stingray well. In April 2002,
Cheniere sold its interest in these two wells and the common platform to the
operator of the wells.
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During 2000, the Company commenced drilling an additional exploration well
on West Cameron Block 49, known as the Shark well. In connection with the
Gryphon Transaction, Cheniere assigned its interest in the Shark well, which was
then being drilled, to Gryphon. Gryphon subsequently completed the well in
February 2001. Production of natural gas from the Shark well is handled through
a common platform which, since September 1999, has also handled production from
the Company's previously-owned Stingray and Redfish wells.
During 2001, Cheniere did not participate in the drilling of any wells.
In 2002, Cheniere did not participate directly in the drilling of any
wells. Eight wells, however, were drilled during the year by Cheniere's industry
partners on prospects generated by the Company. Six of the eight wells were
productive. Cheniere does not have a cost-bearing interest in the wells; it
holds overriding royalty interests (0.7% to 3.7%), some of which are convertible
into working interests of 8.4% at payout.
INVESTMENT IN GRYPHON EXPLORATION COMPANY
Cheniere owns 100% of the outstanding common stock of Gryphon and exercises
significant influence over Gryphon's financial and operating policies through
its participation on Gryphon's board of directors; however, Cheniere does not
participate in the day-to-day management of Gryphon, does not exercise control
over Gryphon and cannot effect a change in the management of Gryphon. Cheniere's
equity share of Gryphon's losses for 2002 was $2,184,847, calculated by applying
Cheniere's 100% common stock ownership interest to Gryphon's net loss of
$519,000, reducing such result for Gryphon's preferred dividend arrearages of
$5,844,746 for the year and limiting the cumulative amount of net loss
recognized to the balance of Cheniere's investment in Gryphon. During 2002,
Cheniere's basis of its investment in Gryphon was reduced to zero, but not below
zero, because Cheniere does not guarantee any obligations of Gryphon and is not
committed to provide additional financial support to Gryphon. The amount of
Gryphon's net loss that has not yet been recorded by Cheniere was $4,179,000 at
December 31, 2002. As of December 31, 2002, after giving effect to the
conversion of all shares of Gryphon's convertible preferred stock to shares of
Gryphon common stock, Cheniere had a 9.3% interest in Gryphon.
In the Gryphon Transaction, the Company contributed the license to 8,800
square miles of seismic data that it had originally licensed from Fairfield
Industries. The data covered more than 1,100 outer continental shelf blocks in
the shallow waters of the Gulf of Mexico (the Offshore Louisiana Area). Cheniere
also assigned its rights in its Joint Exploration Agreement with Samson, which
ran from March 2000 through August 2001.
During 2001, Gryphon drilled nine exploratory wells, yielding four
discoveries and five dry holes. During 2002, Gryphon drilled seven exploratory
wells, yielding three discoveries and four dry holes, and two development wells,
both of which were discoveries. As of March 13, 2003, Gryphon had ten wells on
production and one well being drilled. Depending on rig availability, Gryphon
anticipates drilling up to fourteen exploratory wells and four development wells
during 2003. Gryphon is also engaged in acquiring drilling prospects through
leasing at area-wide federal and state lease sales and through farm-ins of
leased acreage.
9
PRODUCTION AND SALES
The following table presents certain information with respect to oil and
natural gas production attributable to the Company, average sales prices
received and average production costs during 2002, 2001 and 2000. In April 2002,
Cheniere sold its interests in its West Cameron Block 49 wells.
Year Ended December 31,
-----------------------------------
2002 2001 2000
--------- ---------- ------------
Production:
Oil (bbls) 495 2,608 3,703
Gas (mcf) 91,470 542,774 1,459,897
Gas equivalents (mcfe) 94,441 558,422 1,482,117
Average sales prices:
Oil (per barrel) $ 20.03 $ 27.43 $ 29.78
Gas (per mcf) $ 2.58 $ 4.48 $ 3.79
Selected data per mcfe:
Average sales price $ 2.53 $ 4.25 $ 3.59
Production costs $ 0.95 $ 0.75 $ 0.26
Oil and gas depreciation,
depletion and amortization
excluding impairments $ 0.79 $ 1.84 $ 2.04
For the years ended December 31, 2002 and 2001, Gryphon had production of
3,550,000 Mcfe and 824,458 Mcfe, respectively. Gryphon had no production in
2000; it was formed in October 2000.
ACREAGE AND WELLS
The following table sets forth certain information with respect to the
Company's developed and undeveloped leased acreage as of December 31, 2002.
Developed Acres Undeveloped Acres (1)
------------------- -----------------------
Gross Net Gross Net
----- ------ ------- -------
Louisiana - - 10,000 9,500
Texas - - 720 171
----- ------ ------- -------
Total - - 10,720 9,671
===== ====== ======= =======
(1) The Company has no leases which expire in 2003.
At December 31, 2002, the Company had no working interest in any producing
wells; it has overriding royalty interests in six wells.
At December 31, 2002, Gryphon held interests in leases covering 29,428
gross (11,087 net) developed acres and 167,846 gross (129,111 net) undeveloped
acres. Gryphon has interests in 9 gross (3.2 net) producing wells at December
31, 2002.
DRILLING ACTIVITIES
All of Cheniere's drilling activities have been conducted through
arrangements with independent contractors. Cheniere owns no drilling equipment.
In 2000, the Company commenced drilling a well on its Shark Prospect, but prior
to completion the Company assigned its interest in the Shark well to Gryphon,
its unconsolidated affiliate in connection with the Gryphon Transaction in
October 2000. In 2001 and 2002, the Company did not participate in the drilling
of any wells. Although Cheniere did not participate directly in the drilling of
any wells in 2002, eight wells were drilled during the year by Cheniere's
industry partners on prospects generated by the Company. Six of the eight wells
were productive. Cheniere does not have a cost-bearing interest in the wells; it
10
holds overriding royalty interests (0.7% to 3.7%), some of which are convertible
into working interests of 8.4% at prospect payout.
During 2001, Gryphon drilled 9 gross (3.1 net) wells of which 4 gross (1.6
net) wells were successful. During 2002, Gryphon drilled 9 gross (3.1 net) wells
of which 5 gross (1.6 net) wells were successful.
OIL AND GAS RESERVES
Substantially all of the information herein regarding estimates of
Cheniere's proved reserves, related future net revenues and PV-10 is taken from
reports generated by Ryder Scott Company, the Company's independent petroleum
engineers, in accordance with the rules and regulations of the SEC. The
independent engineers' estimates were based upon a review of production
histories and other geologic, economic, ownership and engineering data provided
by the Company.
December 31, 2002
Proved Reserves
---------------------------------------------------------
Oil Gas
(Bbls) (Mcf) Mcfe PV-10 (1)
---------- ---------- ---------- -------------
Cheniere Reserves
Offshore Texas 3,917 1,175,000 1,198,502 $ 4,495,345
Offshore Louisiana 63 158,000 158,378 $ 636,118
---------- ---------- ---------- -------------
Proved Reserves 3,980 1,333,000 1,356,880 $ 5,131,463
========== ========== ========== =============
Proved Developed Reserves 1,605 502,000 511,630 $ 1,938,335
========== ========== ========== =============
Equity Interest in Reserves of
Unconsolidated Affiliate (2)
Proved Reserves 371,808 27,508,000 29,738,848 $ 106,939,136
========== ========== ========== =============
Proved Developed Reserves 165,421 16,332,000 17,324,526 $ 62,854,965
========== ========== ========== =============
(1) The PV-10 amount (present value of estimated pre-tax future net revenues
discounted at 10%) is calculated using year-end prices of $29.23 per barrel
of oil and $4.64 per Mcf of gas.
(2) Includes Cheniere's proportional share, based on its 100% common stock
ownership, of the proved reserves, proved developed reserves and PV-10 value
of Gryphon. Such proportional share of Gryphon reserves and PV-10 value is
based upon Cheniere's ownership of 100% of Gryphon's common stock and will
be reduced to 9.3% upon the conversion of Gryphon's preferred shares
outstanding at December 31, 2002. Upon such conversion, Cheniere's equity
interest in Gryphon's proved reserves and PV-10 value would be reduced to
2,765,713 Mcfe and $9,945,340, respectively. See General Development of
Business.
There are numerous uncertainties inherent in estimating quantities of
proved reserves and in projecting future rates of production and future amounts
and timing of development expenditures, including many factors beyond the
control of the Company. Reserve engineering is a subjective process of
estimating underground accumulations of crude oil and natural gas that cannot be
measured in an exact manner, and the accuracy of any reserve estimate is a
function of the quality of available data and of engineering and geological
interpretation and judgment. Estimates of proved undeveloped reserves are
inherently less certain than estimates of proved developed reserves. The
quantities of oil and gas that are ultimately recovered, production and
operating costs, the amount and timing of future development expenditures,
geologic success and future oil and gas sales prices may all differ from those
assumed in these estimates. In addition, the Company's reserves may be subject
to downward or upward revision based upon production history, purchases or sales
of properties, results of future development, prevailing oil and gas prices and
other factors. Therefore, the present value shown above should not be construed
as the current market value of the estimated oil and gas reserves attributable
to the Company's properties.
In accordance with SEC guidelines, the estimates of future net revenues
from the Company's proved reserves and the present value thereof are made using
oil and gas sales prices in effect as of the dates of such estimates and are
held constant throughout the life of the properties except where such guidelines
permit alternate treatment, including, in the case of gas contracts, the use of
fixed and determinable contractual price escalations. The Company may receive
amounts different than the estimates for a number of reasons, including changes
in prices.
11
See Supplemental Information to Consolidated Financial Statements.
Estimates of the Company's proved oil and gas reserves were not filed with or
included in reports to any other federal authority or agency other than the SEC
during the fiscal year ended December 31, 2002.
COMPETITION AND MARKETS
Competition in the industry is intense, particularly with respect to the
acquisition of producing properties and proved undeveloped acreage. The Company
competes with the major oil companies and other independent producers of varying
sizes, all of which are engaged in the exploration, development and acquisition
of producing and non-producing properties. Many of the Company's competitors
have financial resources and exploration and development budgets that are
substantially greater than those of the Company, which may adversely affect the
Company's ability to compete.
Although the LNG receiving business is in its developmental stages, several
companies are exploring the possibility of engaging or developing an LNG
business. Many of these companies have financial resources and exploration and
development budgets that are substantially greater than those of the Company,
which may adversely affect the Company's ability to compete.
The Company anticipates selling a portion of its interest in certain
prospects as a means of funding its participation in the development of these
properties. The Company anticipates that competition will arise from other
companies seeking drilling funds from potential working interest partners. There
can be no assurance that the Company will be successful in securing funds in
this manner.
The availability of a ready market for and the price of any hydrocarbons
produced by the Company will depend on many factors beyond the control of the
Company, including the extent of domestic production and imports of foreign oil,
the marketing of competitive fuels, the proximity and capacity of natural gas
pipelines, the availability of transportation and other market facilities, the
demand for hydrocarbons, the political conditions in international oil-producing
regions, the effect of federal and state regulation of allowable rates of
production, taxation, the conduct of drilling operations and federal regulation
of natural gas. In the past, as a result of excess deliverability of natural
gas, many pipeline companies curtailed the amount of natural gas taken from
producing wells, shut in some producing wells, significantly reduced gas taken
under existing contracts, refused to make payments under applicable take-or-pay
provisions and have not contracted for gas available from some newly completed
wells. The Company can give no assurance that such conditions will not arise
again.
In addition, the restructuring of the natural gas pipeline industry has
eliminated the gas purchasing activity of traditional interstate gas
transmission pipeline buyers. Producers of natural gas, therefore, have been
required to develop new markets among gas marketing companies, end-users of
natural gas and local distribution companies. All of these factors, together
with economic factors in the marketing area, generally may affect the supply
and/or demand for oil and gas and thus the prices available for sales of oil and
gas.
In addition, in the event the Company completes LNG receiving facilities,
the profitability of its operations and the price of its gas will be dependent
on the availability of liquefied natural gas, the volume and price of domestic
production of natural gas, the marketing of competitive fuels, the proximity and
capacity of natural gas pipelines, the availability of transportation and other
market facilities, the demand for hydrocarbons, the political conditions in
international oil-producing regions, taxation and the domestic demand for
natural gas.
GOVERNMENT REGULATION
The Company's oil and gas exploration, production and related operations
are, and its LNG receiving facility will be, subject to federal and state
statutes and extensive rules and regulations promulgated by federal and state
agencies. Failure to comply with such laws can result in substantial penalties.
The regulatory burden on the oil and gas industry increases the Company's cost
of doing business and affects its profitability. Because such laws are
frequently amended or reinterpreted, the Company is unable to predict the future
cost or impact of complying with them.
Cheniere's construction and operation of the proposed LNG receiving
terminals will be subject to extensive federal, state and local laws and
regulations, including laws and regulations relating to safety, as well as laws
and regulations governing environmental protection and pollution control. These
laws and regulations will require the
12
acquisition of certain permits or other authorizations before construction and
operation of the terminal may occur. For example, in order to site, construct
and operate the proposed receiving terminal, Cheniere will be required to apply
for and receive authorization from the FERC under Section 3 of the Natural Gas
Act of 1938 (NGA). While Cheniere believes that the likelihood is great that it
will be able to obtain all permits and approvals necessary for the construction
and operation of the proposed facilities, including NGA Section 3 authorization
from FERC, Cheniere cannot guarantee that it will be able to do so. Nor can
Cheniere guarantee that the authorizations and permits will not include
unfavorable terms or conditions. The permits and authorizations required for
various operations and activities are, in many instances, subject to revocation,
modification and renewal by the issuing authorities.
While these compliance activities increase the cost of planning, installing
and operating facilities, Cheniere does not expect environmental and other
regulatory compliance matters to have a material adverse effect on its financial
position or results of operations. However, because such laws and regulations
are frequently changed and may impose increasingly stricter requirements,
Cheniere is unable to predict the ultimate cost of complying with such laws and
regulations.
Production
In most, if not all, areas in which the Company conducts activities,
statutes concerning the production of oil and natural gas authorize
administrative agencies to adopt rules which, among other matters, (i) regulate
the operation of, and production from, both oil and gas wells, (ii) determine
the reasonable market demand for oil and gas, and (iii) establish allowable
rates of production. Such regulation may restrict the rate at which the
Company's wells may produce oil or gas, with the result that the amount or
timing of the Company's revenues could be adversely affected.
MMS Regulation
The Company may conduct certain activities on federal oil and gas leases
which the Minerals Management Service (MMS) administers. The MMS grants leases
through competitive bidding. These leases contain relatively standardized terms
and require compliance with detailed MMS regulations and orders pursuant to The
Outer Continental Shelf Lands Act (OCSLA) (which regulations and orders are
subject to change by the MMS). For offshore operations, lessees must obtain MMS
approval for exploration plans and development and production plans prior to the
commencement of such operations. In addition to permits which may be required
from other agencies (such as the Coast Guard, the Army Corps of Engineers and
the Environmental Protection Agency), lessees must obtain a permit from the MMS
prior to the commencement of drilling. The MMS has adopted regulations requiring
offshore production facilities located on the Outer Continental Shelf (OCS) to
meet stringent engineering and construction specifications. The MMS also has
regulations restricting the flaring or venting of natural gas, and has amended
such regulations to prohibit the flaring of liquid hydrocarbons and oil without
prior authorization except under certain limited circumstances. Also, the MMS
has promulgated other regulations governing the plugging and abandonment of
wells located offshore and the removal of all production facilities. To cover
the various obligations of lessees on the OCS, the MMS generally requires that
lessees post substantial bonds or other acceptable assurances that such
obligations will be met. The cost of such bonds or other surety can be
substantial and there is no assurance that the Company will be able to obtain
such bonds or other surety in all cases.
In March 2000, the MMS amended its regulations governing the calculation of
royalties and the valuation of crude oil produced from federal leases. This rule
modifies the valuation procedures for both arm's length and non-arm's length
crude oil transactions to decrease reliance on oil posted prices and assign a
value to crude oil that better reflects its market value. The Company cannot
predict how it will be affected by this regulation.
In April 1997, after two years of study, the MMS withdrew proposed changes
to the way it values natural gas for royalty payments and requested comment on
two alternative options for natural gas valuation. The changes as originally
proposed would have established an alternative market-based method to calculate
royalties on certain natural gas sold to affiliates or pursuant to non-arm's
length sales contracts. Informal discussions among the MMS and industry
officials are continuing, although it is uncertain whether, and what, changes
may be proposed regarding gas royalty valuation.
Bonding and Financial Responsibility Requirements
The Company is required to obtain bonding, or otherwise demonstrate
financial responsibility at varying
13
levels, by governmental agencies in connection with obtaining state or federal
leases or acting as an owner or operator on such leases or of exploration and
production related facilities. These bonds may cover such obligations as
plugging and abandonment of unproductive wells, removal and closure of related
exploration, production facilities and pollution liabilities. The costs of such
bonding and financial responsibility requirements can be substantial, and there
can be no assurance that the Company will be able to obtain such bonds and/or
otherwise demonstrate financial responsibility in all cases.
Natural Gas Marketing and Transportation
The FERC regulates the transportation and sale for resale of natural gas in
interstate commerce pursuant to the NGA and the Natural Gas Policy Act of 1978
(the NGPA). In the past, the federal government has regulated the prices at
which natural gas could be sold. Deregulation of wellhead sales of natural gas
began with the enactment of the NGPA in 1978. In 1989, Congress enacted the
Natural Gas Wellhead Decontrol Act (the Decontrol Act) which removed all NGA and
NGPA price and non-price controls affecting wellhead sales of natural gas
effective January 1, 1993. While sales by producers of natural gas can currently
be made at uncontrolled market prices, Congress could reenact price controls in
the future.
Commencing in April 1992, the FERC issued its Order No. 636 and related
clarifying orders (Order No. 636), which, among other things, restructured the
interstate natural gas industry and required interstate pipelines to provide
transportation services separate, or unbundled, from the pipelines' sales of
natural gas. Order No. 636 and certain related proceedings have been the subject
of a number of judicial appeals and orders on remand by the FERC. Order No. 636
has largely been upheld on appeal. The Company cannot predict when these
remaining appeals will be completed or their impact on the Company. The FERC
continues to address Order 636-related issues (including capacity brokering,
alternative and negotiated ratemaking and transportation policy matters) in a
number of pending proceedings. It is unclear what impact, if any, increased
competition within the natural gas industry under Order Nos. 636, et al., will
have on the Company's activities. Although Order No. 636 could provide the
Company with additional market access and more fairly applied transportation
service rates, Order No. 636 could also subject the Company to more restrictive
pipeline imbalance tolerances and greater penalties for violations of these
tolerances.
The FERC has announced its intention to re-examine certain of its
transportation-related policies, including the appropriate manner in which
interstate pipelines release transportation capacity under Order No. 636, and
the use of market-based rates for interstate gas transmission. While any
resulting FERC action would affect the Company only indirectly, the FERC's
current rules and policy statements may have the effect of enhancing competition
in natural gas markets by, among other things, encouraging non-producer natural
gas marketers to engage in certain purchase and sale transactions. The Company
cannot predict what action the FERC will take on these matters, nor can it
accurately predict whether the FERC's actions will achieve the goal of
increasing competition in markets in which the Company's natural gas is sold.
However, the Company does not believe that it will be treated materially
differently than other natural gas producers and marketers with which it
competes.
OCSLA requires that all pipelines operating on or across the OCS provide
open-access, non-discriminatory service. Although the FERC has opted not to
impose the regulations of Order No. 509, in which the FERC implemented OCSLA, on
gatherers and other non-jurisdictional entities, the FERC has retained the
authority to exercise jurisdiction over those entities, if necessary, to permit
non-discriminatory access to service on OCS. In this regard, the FERC issued a
Statement of Policy (Policy Statement) regarding the application of its
jurisdiction under the NGA and OCSLA over natural gas facilities and service on
OCS. In the Policy Statement, the FERC concluded that facilities located in
water depths of 200 meters or more shall be presumed to have a primary purpose
of gathering up to the point of interconnection with the interstate pipeline
grid. The FERC has determined that gathering facilities are outside of its
jurisdiction, and thus it will no longer regulate the rates and services of such
OCS facilities under the NGA. While it is not possible to determine what the
actual impact of this new policy will be, it is possible that the Company could
experience an increase in transportation costs associated with its OCS natural
gas production and possibly reduced access to OCS transmission capacity.
The FERC has also issued numerous orders approving the sale and abandonment
of natural gas gathering facilities previously owned by interstate pipelines and
has acknowledged that if the FERC does not have jurisdiction over services
provided thereon, then such facilities and services may be subject to regulation
by state authorities in accordance with state law. A number of states have
either enacted new laws or are considering the inadequacy of existing laws
affecting gathering rates and/or services. In addition, the FERC's approval of
transfers of previously
14
regulated gathering systems to independent or pipeline-affiliated gathering
companies that are not subject to FERC regulation may affect both the costs and
the nature of gathering services that will be available to interested producers
or shippers in the future. The effects, if any, of state and federal gathering
policies on the Company's operations are uncertain.
Oil Sales and Transportation Rates
Sales of crude oil, condensate, and gas liquids by the Company are not
currently regulated under federal or state law and are made at market prices.
The FERC regulates the transportation of oil in interstate commerce pursuant to
the Interstate Commerce Act. However, the price a Company receives from the sale
of these products is affected by the cost of transporting the products to
market. Effective as of January 1, 1995, the FERC implemented regulations
establishing an indexing system for transportation rates for oil pipelines,
which would generally index such rates to inflation, subject to certain
conditions and limitations. Over time, these regulations could increase the cost
of transporting crude oil, liquids, and condensate by pipeline. The Company is
not able to predict with certainty what effect, if any, these regulations will
have on it; but other factors being equal, these regulations may tend to
increase transportation costs or reduce wellhead prices for such commodities.
Operating Hazards and Environmental Matters
The oil and gas business involves a variety of operating risks, including
the risk of fire, explosions, blow-outs, pipe failure, casing collapse,
abnormally pressured formations and environmental hazards such as oil spills,
natural gas leaks, ruptures and discharge of toxic gases, the occurrence of any
of which could result in substantial losses to the Company due to injury or loss
of life, severe damage to or destruction of property, natural resources and
equipment, pollution or other environmental damage, clean-up responsibilities,
regulatory investigation and penalties and suspension of operations. Such
hazards may hinder or delay drilling, development and on-line production
operations.
Extensive federal, state and local laws and regulations applicable to oil
and gas operations regulate the discharge of substances into the environment or
otherwise relate to the protection of the environment. These laws and
regulations may require the acquisition of a permit before drilling commences,
restrict or prohibit the types, quantities and concentration of substances that
can be released into the environment or wastes that can be disposed of in
connection with drilling and production activities, prohibit drilling activities
on certain lands lying within wetlands or other protected areas and impose
substantial liabilities for pollution or releases of hazardous substances
resulting from drilling and production operations. Failure to comply with these
laws and regulations may also result in civil and criminal fines and penalties.
Moreover, state and federal environmental laws and regulations may become more
stringent.
The Comprehensive Environmental Response, Compensation and Liability Act
(CERCLA), also known as the Superfund law, imposes liability, without regard to
fault or the original conduct, on certain classes of persons who are considered
to be responsible for the release of a hazardous substance into the environment.
These persons include the owner or operator of the disposal site or sites where
the release occurred and companies that disposed or arranged for the disposal of
the hazardous substances. Under CERCLA, such persons may be subject to joint and
several liability for the costs of cleaning up the hazardous substances that
have been released into the environment, for damages to natural resources and
for the costs of certain health studies, and it is not uncommon for neighboring
landowners and other third parties to file claims for personal injury and
property damage allegedly caused by the release of hazardous substances.
The Company's operations may be subject to the Clean Air Act (CAA) and
comparable state and local requirements. Amendments to the CAA were adopted in
1990 and contain provisions that may result in the gradual imposition of certain
pollution control requirements with respect to air emissions from the operations
of the Company. The EPA and states have been developing regulations to implement
these requirements. The Company may be required to incur certain capital
expenditures in the next several years for air pollution control equipment in
connection with maintaining or obtaining permits and approvals addressing other
air emission-related issues. The Company does not believe, however, that its
operations will be materially adversely affected by any such requirements.
In addition, the U.S. Oil Pollution Act (OPA) requires owners and operators
of facilities that could be the source of an oil spill into waters of the United
States (a term defined to include rivers, creeks, wetlands and coastal
15
waters) to adopt and implement plans and procedures to prevent any spill of oil
into any waters of the United States. OPA also requires affected facility owners
and operators to demonstrate that they have at least $35 million in financial
resources to pay for the costs of cleaning up an oil spill and compensating any
parties damaged by an oil spill. Such financial assurances may be increased to
as much as $150 million if a formal assessment indicates such an increase is
warranted.
Operations of the Company are also subject to the federal Clean Water Act
(CWA) and analogous state laws. In accordance with the CWA, the state of
Louisiana has issued regulations prohibiting discharges of produced water in
state coastal waters, effective July 1, 1997. Producers may be required to incur
certain capital expenditures in the next several years in order to comply with
the prohibition against the discharge of produced waters into Louisiana coastal
waters or increase operating expenses in connection with offshore operations in
Louisiana coastal waters. Pursuant to other requirements of the CWA, the EPA has
adopted regulations concerning discharges of storm water runoff. This program
requires covered facilities to obtain individual permits, participate in a group
permit or seek coverage under an EPA general permit.
In addition, the disposal of wastes containing naturally occurring
radioactive material, which are commonly generated during oil and gas
production, is regulated under state law. Typically, wastes containing naturally
occurring radioactive material can be managed on site or disposed of at
facilities licensed to receive such waste at costs that are not expected to be
material.
OPERATIONAL RISKS AND INSURANCE
The Company anticipates that any wells established by it will be drilled by
proven industry contractors. Based on financial considerations, the Company may
choose to utilize turnkey drilling contracts that limit its financial and legal
exposure. Under a turnkey drilling contract, a negotiated price is agreed upon
and the money is placed in escrow. The drilling contractor then assumes all of
the risk and expense, including any cost overruns, of drilling a well to
contract depth and completing any agreed upon evaluation of the wellbore. Upon
performance of all these items, the escrowed money is released to the
contractor. Circumstances may arise where the Company is unable to secure a
turnkey contract on satisfactory terms. In this case, the Company may decide to
drill, or cause to be drilled, the applicable test well(s) on either a footage
or day-rate basis. Under a footage drilling contract, the operator pays to the
drilling contractor an agreed sum per foot drilled. Under a day-rate drilling
contract, the operator pays an agreed sum for each day of drilling required to
reach contract depth. All risk and expense, including cost overruns, of drilling
a well to total depth lies with the operator in both footage and day-rate
contracts. The drilling of such test wells will be subject to the usual drilling
hazards such as cratering, explosions, uncontrollable flows of oil, gas or well
fluids, fires, pollution and other environmental risks. The Company's activities
are also subject to perils specific to marine operations, such as capsizing,
collision and damage or loss from severe weather. These hazards can cause
personal injury and loss of life, severe damage to and destruction of property
and equipment, pollution or environmental damage and suspension of operations.
In accordance with customary industry practices, the Company intends to maintain
insurance against some, but not all, of such risks and some, but not all, of
such losses. The occurrence of a significant event not fully insured or
indemnified against could materially and adversely affect the Company's
financial condition and operations. Moreover, no assurance can be given that the
Company will be able to maintain adequate insurance in the future at rates
considered reasonable by the Company.
EMPLOYEES
The Company had 14 full-time employees as of March 26, 2003.
FORWARD-LOOKING STATEMENTS AND RISK FACTORS
This annual report contains certain statements that may be deemed
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended (Securities Act), and Section 21E of the United Stated
Securities Exchange Act of 1934, as amended (Exchange Act). Readers of this
annual report are cautioned that such forward-looking statements are not
guarantees of future performance and that actual results, developments and
business decisions may differ from those envisaged by such forward-looking
statements.
All statements, other than statements of historical facts, so included in
this annual report that address activities, events or developments that the
Company intends, expects, projects, believes or anticipates will or may
16
occur in the future, including, without limitation: statements regarding the
Company's business strategy, plans and objectives and statements expressing
beliefs and expectations regarding the ability of the Company to successfully
raise the additional capital necessary to meet its obligations, the ability of
the Company to secure the leases necessary to facilitate anticipated drilling
activities and the ability of the Company to attract additional working interest
owners to participate in the exploration and development of oil and gas
reserves, are forward-looking statements within the meaning of the Act. These
forward-looking statements are and will be based on management's then-current
views and assumptions regarding future events.
The following are some of the important factors that could affect the
Company's financial performance or could cause actual results to differ
materially from estimates contained in the Company's forward-looking statements.
The important factors are not exclusive.
The Company is subject to the expenses, difficulties and uncertainties generally
associated with early stage companies.
Cheniere has a limited operating history with respect to its oil and gas
exploration activities, and the Company has not yet started operating any LNG
receiving facilities. Cheniere faces all of the risks inherent in the
establishment and growth of any new business. From the Company's inception,
Cheniere has incurred losses and may continue to incur losses, depending on
whether it generates sufficient revenue either from producing reserves acquired
through acquisitions or drilling activities or from the eventual commencement of
LNG receiving operations. Cheniere may be unable to implement and complete its
business plan, and the Company's business may be ultimately unsuccessful. These
factors make evaluating Cheniere's business and forecasting its future operating
results difficult. Furthermore, any continued losses and any delays in the
implementation or completion of the Company's business plan may have a material
adverse effect on Cheniere's business, its results of operations, its financial
condition and the market price of its common stock.
The Company's future growth and profitability are highly dependent on the
success of its exploration program and the development of its LNG receiving
terminal business.
The primary focus of Cheniere's operations has been identifying drilling
prospects, but Cheniere is also currently focusing on developing its LNG
receiving facilities. Almost all of the Company's assets are represented by
investments to date in its exploration program, including the seismic data
related thereto. Through its drilling in 1999 and 2000, Cheniere has established
only limited proved reserves (oil and gas reserves that geological and
engineering data demonstrate with reasonable certainty to be recoverable in
future years from known reservoirs under existing economic and operating
conditions). Furthermore, the Company has achieved only limited oil and gas
production as of the date of this report. Cheniere's future growth and
profitability therefore depend heavily on the success of its exploration program
in locating additional proved reserves and achieving additional oil and gas
production or the development of its LNG receiving facilities. Failure to locate
such additional reserves and to achieve additional production may have a
material adverse effect on Cheniere's business, results of operations and
financial condition.
Failure to obtain approvals and permits from governmental and regulatory
agencies with respect to the Company's LNG project could have a detrimental
effect on the project and on the Company.
Cheniere is currently focusing on developing its LNG receiving facilities.
The transportation of LNG is highly regulated, and Cheniere has yet to obtain
several governmental and regulatory approvals and permits required in order to
complete and maintain its LNG project. Company management estimates that it may
take two to three years of work to obtain the approvals and permits necessary to
proceed with the construction and operation of an LNG receiving terminal. The
Company has no control over the outcome of the review and approval process. If
Cheniere is unable to obtain the approvals and permits, the Company may not be
able to recover its investment in the project. In addition, failure to obtain
these approvals and permits may have a material adverse effect on the Company's
business, results of operations and financial condition.
Failure of LNG to become a competitive factor in the U.S. oil and gas industry
could have a detrimental effect on the Company's ability to implement and
complete its business plan.
In the U.S., due mainly to an abundant supply of natural gas, LNG has not
historically been a major energy source. Furthermore, LNG may not become a
competitive factor in the U.S. oil and gas industry. The failure of LNG
17
to become a competitive supply alternative to domestic natural gas and other
import alternatives may have a material adverse effect on Cheniere's ability to
implement and complete its business plan as well as the Company's business,
results of operations and financial condition.
The Company may not be able to obtain additional financing on terms that are
acceptable to the Company, which could harm its ability to conduct business.
As of December 31, 2002, Cheniere had $1,848,820 of current assets and a
working capital deficit of $1,413,235. Because of its low level of current
assets, the Company may need additional capital for a number of purposes. If the
Company is unable to obtain additional financing, it could significantly harm
Cheniere's ability to conduct its business, including its ability to take
advantage of opportunities that come from its exploration program and its
ability to construct LNG terminals. Cheniere's needs for additional financing
include the following:
. Additional capital may be required to pay for Cheniere's share of costs
relating to the drilling of prospects and development of those that are
successful, to exercise lease options and to acquire additional oil and gas
leases. The total amount of the Company's capital needs will be determined
in part by the number of prospects generated within its exploration
program, by the working interest that the Company retains in those
prospects and by the Company's ability to identify partners willing to bear
a portion of drilling costs which would otherwise be attributable to the
Company.
. The Company may need capital to fund its pro-rata share of the capital
calls by Gryphon that are approved by Gryphon's board of directors. If the
Company subscribes to its pro-rata portion of such capital calls but fails
to fund, it would lose its ability to subscribe to any future capital calls
and would suffer further dilution of its holdings in Gryphon. In 2002,
Gryphon made cash calls in the aggregate amount of $30,000,000, which were
funded entirely by Warburg, in March, June, September and November 2002.
Cheniere declined to participate in these cash calls and its interest in
Gryphon has been reduced from 20.2% to 9.3% on an as-converted basis, as of
December 31, 2002. It is anticipated that Gryphon will make cash calls for
additional funds. The Company's share of such future capital calls could
total up to approximately $1,400,000. If the Company elects not to fund its
pro-rata portion of such capital calls, and Warburg funds its portion, as
they would be entitled to do, and as they have since the formation of
Gryphon, the Company's ownership percentage of Gryphon's common stock on an
as-converted basis will be further reduced (to as low as 8%). See Liquidity
and Capital Resources - Exploration Funding under Item 7 of this report.
. The Company will need substantial additional funds to execute its plan for
developing and expanding its LNG receiving terminal business, including
engineering, environmental, marine, regulatory, construction and legal
work, including any such work involved in permitting and FERC filings
related to Cheniere's second and third sites. Such costs are estimated to
be approximately $3,000,000 per year for each terminal to be developed.
Additional capital could be obtained from a combination of funding sources,
many of which may have a material adverse effect on the Company's business,
results of operations and financial condition. These potential funding sources
include:
. cash flow from operating activities, which is sensitive to prices the
Company receives for its oil and natural gas,
. borrowings from financial institutions, which may subject the Company to
certain restrictive covenants, including covenants restricting the
Company's ability to raise additional capital or pay dividends,
. debt offerings, which would increase the Company's leverage and add to its
need for cash to service such debt,
. additional offerings of the Company's equity securities, which would cause
dilution of its common stock,
. sales of portions of its working interest in the prospects within its
exploration program, which would reduce future revenues from its
exploration program,
18
. sale to an industry partner of a participation in the Company's exploration
program, which would reduce future revenues from its exploration program,
. sale of all or a portion of the Company's producing oil and gas properties,
which would reduce future revenues,
. additional sales of interests in the Company's LNG projects and
. arrangement of a business development loan from, or prepayment of terminal
use fees by, prospective sellers or purchasers of LNG.
Cheniere's ability to raise additional capital will depend on the results
of its operations and the status of various capital and industry markets at the
time such additional capital is sought. Accordingly, capital may not become
available to the Company from any particular source or at all. Even if
additional capital becomes available, it may not be on terms acceptable to the
Company. Failure to obtain additional financing on acceptable terms may have a
material adverse effect on the Company's business, results of operations and
financial condition.
Because of the Company's lack of diversification, factors harming the oil and
gas industry in general, including downturns in prices for oil and gas, would be
especially harmful to it.
The Company is an independent energy company and is not actively engaged in
any other industry. Cheniere's revenues and profits are substantially dependent
on the oil and gas industry in general and the prevailing prices for oil and gas
in particular. Circumstances that harm the oil and gas industry in general will
have an especially harmful effect on Cheniere. Oil and gas prices have been and
are likely to continue to be volatile and subject to wide fluctuations in
response to any of the following factors:
. relatively minor changes in the supply of and demand for oil and gas,
. political conditions in international oil producing regions,
. the extent of domestic production and importation of oil in relevant
markets,
. the level of consumer demand,
. weather conditions,
. the competitive position of oil or gas as a source of energy as compared
with other energy sources,
. the refining capacity of oil purchasers and
. the effect of federal and state regulation on the production,
transportation and sale of oil and gas.
It is likely that adverse changes in the oil market or the regulatory
environment would have an adverse effect on the Company's business, results of
operations and financial condition, including its ability to develop and
implement its LNG project and to obtain capital from lending institutions,
industry participants, private or public investors or other sources.
The Company experiences intense competition in the oil and gas industry, which
may make it difficult for the Company to succeed.
The oil and gas industry is highly competitive. If Cheniere is unable to
compete effectively, it will not succeed. A number of factors may give the
Company's competitors advantages over Cheniere. For example, most of the
Company's current and potential competitors have significantly greater financial
resources and a significantly greater number of experienced and trained
managerial and technical personnel than the Company does. In addition, the
businesses of such competitors are in many cases more diversified than that of
Cheniere. Cheniere may not be able to compete effectively with such companies.
Moreover, the oil and gas industry competes with other industries in supplying
the energy and fuel needs of industrial, commercial and other consumers.
Increased competition
19
causing over-supply and depressed prices could have a substantially negative
impact on Cheniere's operating revenues.
Fluctuation in energy prices or supply of liquefied natural gas could adversely
affect our LNG receiving terminals business.
If LNG prices are higher than prices of domestically produced natural gas
or natural gas derived from other sources, our ability to compete with such
suppliers may be negatively impacted. In addition, in the event the supply of
LNG is limited or restricted for any reason, our ability to profitably operate
an LNG receiving facility could be materially impacted. Revenues generated by an
LNG receiving terminal depend on the volume of LNG processed and the price of
the natural gas produced, both of which can be affected by the price of natural
gas and natural gas liquids.
The Company is subject to significant operating hazards and uninsured risks, one
or more of which may create significant liabilities for it.
The Company's oil and gas operations are subject to all of the risks and
hazards typically associated with the exploration for and the development and
production of oil and gas. In accordance with customary industry practices, the
Company intends to maintain insurance against some, but not all, of these risks
and losses. Moreover, the Company may not be able to maintain adequate insurance
in the future at rates it considers reasonable. The occurrence of a significant
event not fully insured or indemnified against could seriously harm the
Company's business, results of operations and financial condition.
Risks in drilling operations include cratering, explosions, uncontrollable
flows of oil, gas or well fluids, fires, pollution and other environmental
risks. The Company's activities are also subject to perils specific to marine
operations, such as capsizing, collision and damage or loss from severe weather.
These hazards can cause personal injury and loss of life, severe damage to and
destruction of property and equipment, pollution or environmental damage and
suspension of operations.
In the event the Company completes the LNG receiving terminal, the
operations of such facility will be subject to the inherent risks normally
associated with those operations, including explosions, pollution, release of
toxic substances, fires, hurricanes and adverse weather conditions and other
hazards, each of which could result in damage to or destruction of the Company's
facilities or damages to persons and property. In addition, the Company's
operations face possible risks associated with acts of aggression on our assets.
If any of these events were to occur, the Company could suffer substantial
losses. The Company will maintain insurance against these types of risks to the
extent and in the amounts that it believes are reasonable. Its financial
condition and operations could be adversely affected if a significant event
occurs that is not fully covered by insurance.
The Company is subject to significant exploration risks, including the risk that
it may not be able to find or produce enough oil and gas to generate any
profits.
The Company's exploration activities involve significant risks, including
the risk that it may not be able to find or produce enough oil and gas to
generate any profits. The wells drilled by the Company may not discover any oil
or gas. Further, there is no way to know in advance of drilling and testing
whether any prospect will yield oil or gas in sufficient quantities to make
money for the Company. In addition, the Company is highly dependent on seismic
activity and the related application of new technology as a primary exploration
methodology. This methodology, however, requires greater pre-drilling
expenditures than traditional drilling strategies. Even when fully used and
properly interpreted, 3D seismic data can only assist the Company in identifying
subsurface reservoirs and hydrocarbon indicators, and will not allow the Company
to determine conclusively if hydrocarbons will in fact be present and
recoverable. If the Company's exploration efforts are unsuccessful, its business
and financial condition will be substantially harmed.
The Company may not be able to acquire the oil and gas leases it needs to
sustain profitable operations.
In order to engage in oil and gas exploration in the areas covered by its
3D seismic data, the Company must first acquire rights to conduct exploration
and recovery activities on such properties. Cheniere may not be successful in
acquiring farm-outs (agreements whereby the Company, as owner of lease
interests, grants to a third party the right to earn an assignment of an
interest in the lease, typically by drilling one or more wells), seismic
permits, lease
20
options, leases or other rights to explore for or recover oil and gas. Both the
United States Department of the Interior and the States of Texas and Louisiana
award oil and gas leases on a competitive bidding basis. Non-governmental owners
of the onshore mineral interests within the area covered by the Company's
exploration program are not obligated to lease their mineral rights to the
Company except where the Company has already obtained lease options. In
addition, other major and independent oil and gas companies with financial
resources significantly greater than Cheniere's may bid against Cheniere for the
purchase of oil and gas leases. If the Company is unsuccessful in acquiring
these leases, permits, options and other interests, the area covered by the
Company's 3D seismic data that could be explored through drilling will be
significantly reduced, and Cheniere's business, results of operations and
financial condition will be substantially harmed.
If the Company is unable to obtain satisfactory turnkey contracts, it may have
to assume additional risks and expenses when drilling wells.
Cheniere anticipates that any wells drilled in which it has an interest
will be drilled by established industry contractors under turnkey contracts that
limit its financial and legal exposure. Under a turnkey drilling contract, a
negotiated price is agreed upon and the money placed in escrow. The contractor
then assumes all of the risk and expense, including any cost overruns, of
drilling a well to contract depth and completing any agreed upon evaluation of
the wellbore. Upon performance of all these items, the escrowed money is
released to the contractor.
Circumstances may arise, however, where a turnkey contract is not
economically beneficial to the Company or is otherwise unobtainable from proven
industry contractors. In such instances, the Company may decide to drill wells
on a day-rate basis. Under a day-rate drilling contract, the operator pays an
agreed sum for each day of drilling required to reach contract depth. All risk
and expense of drilling a well to total depths lies with the operator in
day-rate contracts. The drilling of such test wells would subject the Company to
the usual drilling hazards such as cratering, explosions, uncontrollable flows
of oil, gas or well fluids, fires, pollution and other environmental risks. The
Company would also be liable for any cost overruns attributable to drilling
problems that otherwise would have been covered by a turnkey contract. These
liabilities, if incurred, may have a materially adverse impact on Cheniere's
business and financial condition.
Existing and future United States governmental regulation, taxation and price
controls could seriously harm the Company.
Oil and gas production and exploration are subject to comprehensive
federal, state and local laws and regulations controlling the exploration for
and production and sale of oil and gas and the possible effects of such
activities on the environment. Failure to comply with such rules and regulations
can result in substantial penalties and may harm the Company. Present, as well
as future, legislation and regulations could cause additional expenditures,
restrictions and delays in the Company's business, the extent of which cannot be
predicted and which may require the Company to limit substantially, delay or
cease operations in some circumstances. In most areas where the Company plans to
conduct activities, there are statutory provisions regulating the production of
oil and natural gas which may restrict the rate of production and adversely
affect revenues. The Company plans to acquire oil and gas leases in the Gulf of
Mexico, which, if acquired, would be granted by the federal government and
administered by the U.S. Department of Interior Minerals Management Service. The
Department strictly regulates the exploration, development and production of oil
and gas reserves in the Gulf of Mexico. Such regulations could seriously harm
the Company's operations in the Gulf of Mexico. The federal government regulates
the interstate transportation of oil and natural gas, through the Federal Energy
Regulatory Commission (FERC). The FERC has in the past regulated the prices at
which oil and gas could be sold. Federal reenactment of price controls or
increased regulation of the transport of oil and natural gas could seriously
harm the Company.
The Company's operations are also subject to extensive federal, state and
local laws and regulations governing the discharge of oil and hazardous
materials into the environment or otherwise relating to environmental
protection. These laws and regulations may require the acquisition of a permit
before drilling commences, restrict or prohibit the types, quantities and
concentration of substances that can be released into the environment or wastes
that can be disposed of in connection with drilling and production activities,
prohibit drilling activities on certain lands lying within wetlands or other
protected areas and impose substantial liabilities for pollution or releases of
hazardous substances resulting from drilling and production operations. Failure
to comply with these laws and regulations may also result in civil and criminal
fines and penalties. Moreover, state and federal environmental laws and
regulations may become more stringent.
21
Federal laws and regulations such as the Comprehensive Environmental
Response, Compensation and Liability Act (CERCLA), the Clean Air Act (CAA), the
Oil Pollution Act of 1990 (OPA) and the Clean Water Act (CWA) and analogous
state laws have continually imposed increasingly strict requirements for water
and air pollution control, solid waste management and strict financial
responsibility and remedial response obligations relating to oil spill
protection. The cost of complying with such environmental legislation could have
a general harmful effect on the Company's operations.
There is only limited trading in the Company's common stock, which makes its
stock more difficult to sell than the stock of companies with more active
markets.
There is only limited trading in Cheniere's common stock, which makes its
stock more difficult for an investor to sell than the stock of companies with
more active markets. For the year 2002, the average daily trading volume of
Cheniere's common stock on The American Stock Exchange was approximately 17,000
shares.
The Company has not paid dividends and does not expect to do so in the
foreseeable future, so its stockholders will not be able to receive a return on
their investment without selling their shares.
The Company has not paid dividends since its inception and does not expect
to in the foreseeable future, so Cheniere's stockholders will not be able to
receive a return on their investments without selling their shares. The Company
presently anticipates that all earnings, if any, will be retained for
development of its business. Any future dividends will be subject to the
discretion of the Company's board of directors and will depend on, among other
things, future earnings, the Company's operating and financial condition, its
capital requirements and general business conditions.
The Company's stockholders could experience dilution in the value of their
shares because of additional issuances of shares.
Any issuance of common stock by the Company may result in a reduction in
the book value per share or market price per share of its outstanding shares of
common stock and will reduce the proportionate ownership and voting power of
such shares. The Company has 45,000,000 authorized shares of stock, consisting
of 40,000,000 shares of common stock and 5,000,000 shares of preferred stock. As
of December 31, 2002, approximately 67% of the shares of the common stock
remained unissued. The board of directors has the power to issue any and all of
such shares without shareholder approval. It is likely that the Company will
issue shares of common stock, among other reasons, in order to raise capital to
sustain operations and/or to finance future oil and gas exploration projects. In
addition, the Company has reserved 2,593,521 shares of the common stock for
issuance upon the exercise of outstanding warrants and 2,000,000 shares of the
common stock for issuance upon the exercise of stock options. As of December 31,
2002, there were 1,983,611 issued and outstanding options to purchase common
stock. To the extent that outstanding warrants and options are exercised, the
percentage ownership of common stock of the Company's stockholders will be
diluted. Moreover, the terms upon which the Company will be able to obtain
additional equity capital may be adversely affected because the holders of
outstanding warrants and options can be expected to exercise them at a time when
the Company would, in all likelihood, be able to obtain any needed capital on
terms more favorable than the exercise terms provided by such outstanding
securities. In the event of the exercise of a substantial number of warrants and
options, within a reasonably short period of time after the right to exercise
commences, the resulting increase in the amount of the Company's common stock in
the trading market could substantially adversely affect the market price of the
common stock or the Company's ability to raise money through the sale of equity
securities.
The Company depends on key personnel and could be seriously harmed if it lost
their services.
Cheniere depends on its executive officers for various activities. The
Company does not maintain key person life insurance policies on any of its
personnel. The loss of the services of any of these individuals could seriously
harm the Company. Although Cheniere has agreements relating to compensation and
benefits with certain of its executive officers, Cheniere does not have any
employment contracts or other agreements with key personnel binding them to
provide services for any particular term. In addition, the Company's future
success will depend in part on its ability to attract and retain additional
qualified personnel. Cheniere currently has 14 full-time employees.
22
The Company depends on industry partners and could be seriously harmed if they
do not perform satisfactorily, which is usually not within the Company's
control.
Because the Company has few employees and limited operating revenues, it is
and will continue to be largely dependent on industry partners for the success
of the Company's oil and gas exploration projects. Cheniere could be seriously
harmed if its industry partners do not perform satisfactorily on projects that
affect it. The Company often has and will continue to have no control over
factors that would influence the performance of its partners.
The Company is controlled by a small number of principal stockholders who may
exercise a proportionately larger influence on Cheniere than its stockholders
with smaller holdings.
Cheniere is controlled by a small number of principal stockholders who may
cause events to occur that are not in the interests of the Company's
stockholders with smaller holdings. BSR Investments, Ltd. (BSR) is an entity
controlled by the mother of Charif Souki, Cheniere's chairman. BSR owns
approximately 10% of the outstanding common stock. Accordingly, it is likely
that BSR will have significant influence on the election of Cheniere's directors
and on its management, operations and affairs, including the ability to prevent
or cause a change in control of the Company.
Anti-takeover provisions of the certificate of incorporation, bylaws and
Delaware law could adversely impact a potential acquisition by third parties
that may ultimately be in the financial interests of the Company's stockholders.
Cheniere's certificate of incorporation, bylaws and the Delaware General
Corporation Law contain provisions that may discourage unsolicited takeover
proposals. These provisions could have the effect of inhibiting fluctuations in
the market price of the Company's shares that could result from actual or
rumored takeover attempts, preventing changes in its management or limiting the
price that investors may be willing to pay for shares of common stock. These
provisions, among other things, authorize the board of directors to designate
the terms of and to issue new series of preferred stock, to limit the personal
liability of directors, to require the Company to indemnify directors and
officers to the fullest extent permitted by applicable law and to impose
restrictions on business combinations with some interested parties.
A significant portion of the value of the Company is derived from its ownership
interest in Gryphon, over which the Company exercises no day-to-day control.
Cheniere owns 100% of the outstanding common stock of Gryphon (9.3%
effective ownership after giving effect to the conversion of Gryphon's preferred
stock outstanding at December 31, 2002) and a significant portion of the
Company's value is derived from this investment. Cheniere exercises significant
influence, primarily through board participation. Cheniere does not exercise
control over Gryphon and therefore does not have the ability to effect a change
of control of Gryphon. Accordingly, Gryphon's management team could make
business decisions without Cheniere's consent that could impair the value of
Cheniere's investment in Gryphon.
ITEM 3. LEGAL PROCEEDINGS
The Company has been and may in the future be involved as a party to
various legal proceedings, which are incidental to the ordinary course of
business. Management regularly analyzes current information and as necessary,
provides accruals for probable liabilities on the eventual disposition of these
matters. In the opinion of management and legal counsel, as of December 31,
2002, there were no threatened or pending legal matters that would have a
material impact on the Company's consolidated results of operations, financial
position or cash flows.
In February 2002, the Company received a copy of a lawsuit styled Fairfield
Industries Incorporated (Fairfield) vs. Cheniere Energy, Inc. and Gryphon
Exploration Company, which was filed in district court in Harris County, Texas.
The lawsuit related to a seismic license agreement between Fairfield and
Cheniere, which was later assigned to Gryphon. In the lawsuit, Fairfield alleged
that Cheniere and Gryphon conspired to defraud the plaintiff of certain transfer
payments, which may be owed by Cheniere in connection with the transfer to
Gryphon of the initial seismic contributed at the time of its formation. In
March 2002, Fairfield, Gryphon, and the Company settled this lawsuit. Existing
and contingent obligations to Fairfield by Cheniere totaling $2,500,000 have
been fully
23
discharged through agreement by Gryphon to make current and contingent payments
in exchange for the transfer of 30,000 Gryphon common shares from Cheniere to
Gryphon.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
24
PART II
ITEM 5. MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS
Beginning on March 5, 2001, the common stock of the Company has traded on
The American Stock Exchange under the symbol CXY. Effective March 24, 2003, the
Company changed its symbol from CXY to LNG. Between December 14, 2000 and March
2, 2001, Cheniere's common stock traded on the OTC Bulletin Board under the
symbol CHEX. Between April 11, 1997 and December 13, 2000, the common stock of
the Company traded on The Nasdaq SmallCap Market under the symbol CHEX. From the
time the Company first traded publicly until April 11, 1997, the Company's
common stock traded on the OTC Bulletin Board. The table below presents the high
and low daily closing sales prices of the common stock, as reported by the OTC
Bulletin Board and The American Stock Exchange, for each quarter during 2001 and
2002.
High Low
----------- ------------
Three Months Ended
March 31, 2001 $ 3.38 $ 2.09
June 30, 2001 $ 2.88 $ 1.85
September 30, 2001 $ 2.19 $ 0.90
December 31, 2001 $ 1.25 $ 0.75
Three Months Ended
March 31, 2002 $ 1.50 $ 0.93
June 30, 2002 $ 1.50 $ 0.82
September 30, 2002 $ 1.30 $ 0.90
December 31, 2002 $ 1.35 $ 0.80
As of March 26, 2003, there were 13,297,393 shares of the Company's common
stock outstanding held by approximately 2,800 beneficial owners.
The Company has never paid a cash dividend on its common stock. The Company
currently intends to retain earnings to finance the growth and development of
its business and does not anticipate paying any cash dividends on the common
stock in the foreseeable future. Any future change in the Company's dividend
policy will be made at the discretion of the Company's board of directors in
light of the financial condition, capital requirements, earnings and prospects
of the Company, and any restrictions under any credit agreements, as well as
other factors the board of directors deems relevant.
Equity Compensation Plan Disclosure Table - The following table summarizes
the Company's use of equity securities as a form of compensation for services
rendered to the Company.
Number of securities to be Weighted-average Number of securities
issued upon exercise of exercise price of remaining available for
outstanding options, outstanding options, future issuance under equity
warrants and rights warrants and rights compensation plans
-------------------------- -------------------- ----------------------------
Equity compensation plans
approved by security holders 1,983,611 $ 2.07 16,389
Equity compensation plans not
approved by security holders 450,000 $ 2.92 -
-------------------------- ----------------------------
Total 2,433,611 $ 2.22 16,389
========================== ============================
The Company has issued warrants for the purchase of 450,000 shares of its
common stock at exercise prices ranging from $1.20 to $11.50 per share as
additional compensation for various services rendered to the Company, including
assistance in private placements of equity securities, investor relations and
marketing of LNG terminal capacity, as well as pursuant to the terms of an
employment agreement.
25
ITEM 6. SELECTED FINANCIAL DATA
Selected financial data set forth below are derived from the Company's
audited Consolidated Financial Statements for the periods indicated. The
financial data should be read in conjunction with the Management's Discussion
and Analysis of Financial Condition and Results of Operations and the Company's
Consolidated Financial Statements and Notes thereto included elsewhere in this
report.
Year Ended
December 31,
-------------------------------------------------------------------------
2002 2001 2000 1999 1998
-------------- ------------- ------------- ------------- -----------
Revenues $ 239,055 $ 2,372,632 $ 5,320,432 $ 1,614,055 $ -
Production costs 90,038 420,242 388,637 128,859 -
Depreciation, depletion and amortization 368,562 1,243,828 3,371,383 1,361,644 39,171
Ceiling test write-down - 5,126,248 - - -
General and administrative expenses 3,475,362 4,291,963 1,938,659 1,908,805 1,619,307
Loss from operations (3,694,907) (8,709,649) (378,247) (1,785,253) (1,658,478)
Interest income (expense) 7,733 18,578 23,916 31,530 20,634
Equity in net loss of affiliate (1) (2,184,847) (2,974,191) (426,649) - -
Gain on sale of properties 340,257 - - - -
Loss on extinguishment of debt (100,544) - - - -
Net loss (5,632,308) (11,665,262) (780,980) (1,753,723) (1,637,844)
Net loss per share (basic and diluted) (2) (0.42) (0.89) (0.07) (0.27) (0.41)
Cash dividends per share $ - $ - $ - $ - $ -
Weighted average shares outstanding
(basic and diluted) (2) 13,297,393 13,035,256 10,732,678 6,449,104 4,003,864
December 31,
-------------------------------------------------------------------------
2002 2001 2000 1999 1998
------------ ------------ ------------- ------------- --------------
Cash $ 590,039 $ 610,718 $ 1,888,562 $ 1,175,950 $ 143,868
Oil and gas properties, proved, net 842,882 1,929,124 6,727,613 9,459,041 -
Oil and gas properties, unproved 16,751,347 16,236,962 18,253,731 20,648,923 20,000,425
Total assets 21,059,390 25,023,676 34,665,618 34,481,275 20,840,474
Long-term notes payable - - - - 2,025,020
Total liabilities 3,262,055 1,874,401 1,604,410 6,735,537 4,523,144
Total stockholders' equity 17,797,335 23,149,275 33,061,208 27,745,738 16,317,330
(1) Represents the Company's equity in the net loss of Gryphon. See Note 7 to
the Company's Consolidated Financial Statements.
(2) Net loss per share and weighted average shares outstanding have been
restated to give effect to the one-for-four reverse stock split which was
effective in October 2000. See Note 2 to Consolidated Financial Statements.
26
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
Cheniere is engaged in oil and gas exploration, development and
exploitation and in the development of an LNG receiving terminal business. The
Company has historically focused on evaluating and generating drilling prospects
using a regional and integrated approach with a large seismic database as a
platform. The Company is currently focusing, and expects to continue to focus,
its attention and resources on the development of its LNG receiving terminal
business. Cheniere's management expects that the Company's active interpretation
of 3D seismic data and generation of prospects will continue, through its
participation in the drilling of wells will be accomplished through farmout
arrangements and back-in interests, whereby the capital costs are borne by
industry partners.
PRODUCTION AND PRODUCT PRICES
Information concerning the Company's production and average prices received
for the years ended December 31, 2002, 2001 and 2000 is presented in the
following table.
Year Ended December 31,
-------------------------------------
2002 2001 2000
--------- --------- -----------
Production:
Oil (Bbls) 495 2,608 3,703
Gas (Mcf) 91,470 542,774 1,459,897
Gas equivalents (Mcfe) 94,441 558,422 1,482,117
Average sales prices:
Oil (per Bbl) $ 20.03 $ 27.43 $ 29.78
Gas (per Mcf) $ 2.58 $ 4.48 $ 3.79
RESULTS OF OPERATIONS - COMPARISON OF THE FISCAL YEARS ENDED DECEMBER 31, 2002
AND 2001
The Company's financial results for the year ended December 31, 2002
reflect a loss of $5,632,308, or $0.42 per share (basic and diluted), compared
to a loss of $11,665,262 or $0.89 per share (basic and diluted) in 2001. The
major factors contributing to the Company's loss in 2002 were: general and
administrative expenses of $3,475,362 and equity in loss of unconsolidated
affiliate of $2,184,847 (including accrued dividend obligations totaling
$5,844,746 for the year, payable by Gryphon, related to its preferred stock).
Oil and gas revenues decreased to $239,055 in 2002 from $2,372,632 in 2001
as a result of decreased production volumes (94,441 Mcfe in 2002 compared with
558,422 Mcfe in 2001). The decline in production volumes primarily results from
the sale of the Company's two producing wells at West Cameron Block 49 in April
2002. Adding to the effect of declining production was a decrease in average gas
prices to $2.58 per Mcf in 2002 compared to $4.48 per Mcf in the prior year.
Production costs decreased 79% to $90,038 in 2002 from $420,242 in 2001.
Depreciation, depletion and amortization (DD&A) decreased to $368,562 in
2002 from $1,243,828 in 2001 as a result of both the decline in the Company's
production volumes, described above, and a lower DD&A rate per unit ($0.79 per
Mcfe versus $1.84 per Mcfe). The Company's DD&A rate has declined due to its
change in emphasis toward selling prospects for front-end fees plus carried
interests, as opposed to direct participation in drilling costs, and due to the
effect of ceiling test write-downs recorded in 2001.
Gross general and administrative (G&A) expenses totaled $5,915,444 in 2002,
compared to $5,073,963 in 2001. The most significant component of the increase
between years was in consulting fees, which increased by $1,207,248 to
$2,391,011 in 2002, compared to $1,183,763 in 2001. The increased consulting
expense in 2002 principally related to p