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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001.
[_] TRANSITION REPORTING PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______ TO ______.
COMMISSION FILE NO. 0-21911
SYNTROLEUM CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 73-1565725
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1350 South Boulder, Suite 1100
Tulsa, Oklahoma 74119-3295
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (918) 592-7900
Securities registered pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
and
Preferred Share Purchase Rights
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 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. __
At March 1, 2002, the aggregate market value of the registrant's common stock
held by non-affiliates of the registrant was approximately $116 million based
on the closing price of such stock on such date of $5.90 per share (assuming
solely for this purpose that all of the registrant's directors, executive
officers and 10% stockholders are its affiliates).
At March 1, 2002, the number of outstanding shares of the registrant's common
stock was 33,282,707.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive proxy statement to be filed with the
Securities and Exchange Commission within 120 days of December 31, 2001 for its
2001 annual meeting of stockholders are incorporated by reference into Part III
of this Form 10-K.
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TABLE OF CONTENTS
Page
----
Part I
Item 1. Business...........................................................3
Item 2 Properties........................................................26
Item 3 Legal Proceedings.................................................26
Item 4. Submission of Matters to a Vote of Security Holders...............26
Executive Officers of the Registrant..............................26
Part II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters.............................................28
Item 6. Selected Financial Data...........................................29
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.............................30
Item 7A. Quantitative and Qualitative Disclosures about Market Risk........40
Item 8. Financial Statements and Supplementary Data.......................40
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure........................................41
Part III
Item 10. Directors and Executive Officers of the Registrant................41
Item 11. Executive Compensation............................................41
Item 12. Security Ownership of Certain Beneficial Owners and Management....41
Item 13. Certain Relationships and Related Party Transactions..............41
Part IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K..41
FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K includes forward-looking statements as
well as historical facts. These forward-looking statements include statements
relating to the Syntroleum Process and related technologies, gas-to-liquids
plants based on the Syntroleum Process, including the proposed Sweetwater
plant, anticipated costs to design, construct and operate these plants,
anticipated costs to make products from these plants, the timing of
commencement and completion of the design and construction of these plants,
obtaining required financing for these plants, the economic construction and
operation of GTL plants, the value and markets for plant products, the testing,
certification, characteristics and use of plant products, the continued
development of the Syntroleum Process (alone or with partners), anticipated
capital expenditures, use of proceeds from our 2000 public offering of common
stock, anticipated revenues, the sale of and costs associated with our real
estate inventory and any other statements regarding future growth, cash needs,
capital availability, operations, business plans and financial results. When
used in this document, the words "anticipate," "believe," "estimate," "expect,"
"intend," "may," "plan," "project," "should" and similar expressions are
intended to be among the statements that identify forward-looking statements.
Although we believe that the expectations reflected in these forward-looking
statements are reasonable, these kinds of statements involve risks and
uncertainties. Actual results may not be consistent with these forward-looking
statements. Important factors that could cause actual results to differ from
these forward-looking statements include the risks that the cost of designing,
constructing and operating commercial-scale GTL plants will exceed current
estimates, the schedule for construction of commercial-scale GTL plants will
extend beyond current estimated schedules, financing for design and
construction of commercial-scale GTL plants and our other activities may not be
available, commercial-scale GTL plants will not achieve the same results as
those demonstrated on a laboratory or pilot basis, GTL plants may experience
technological and mechanical problems, improvements to the Syntroleum Process
currently under development may not be successful, markets for GTL plant
products may not develop, plant economics may be adversely impacted by
operating conditions, including energy prices, construction risks and risks
associated with investments and operations in foreign countries, our ability to
implement corporate strategies, competition, intellectual property risks, our
ability to obtain necessary financing and other risks described under "Risk
Factors" and elsewhere in this Annual Report on Form 10-K.
As used in this Annual Report on Form 10-K, the terms "we," "our" or
"us" mean Syntroleum Corporation, a Delaware corporation, and its predecessors
and subsidiaries, unless the context indicates otherwise.
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PART I
Item 1. Business
Overview
We are a leading developer and licensor of a proprietary process for
converting natural gas to synthetic liquid hydrocarbons, a process generally
known as gas-to-liquids, or GTL, technology. We sell licenses to use our GTL
technology, the Syntroleum Process, for the production of fuels, and we plan to
develop and own GTL plants based on the Syntroleum Process that produce fuels
and refined specialty products. We anticipate that the Syntroleum Process will
be an attractive solution in many cases for companies with natural gas reserves
that are not economic to produce using traditional technology.
The Syntroleum Process produces synthetic liquid hydrocarbons, also
known as synthetic crude oil, that are substantially free of contaminants
normally found in conventional products made from crude oil. These synthetic
liquid hydrocarbons can be further processed into higher margin products
through conventional refining processes. These products include:
. Premium, ultra-clean liquid fuels, such as synthetic diesel,
kerosene, gasoline, naphtha, and fuel for fuel cells, and
. Specialty products, such as synthetic lubricants, process
oils, high melting point waxes, liquid normal paraffins,
drilling fluids, and chemical feedstocks.
We believe that the costs to produce ultra-clean fuels and specialty
products from natural gas using the Syntroleum Process can be competitive with
the costs to produce comparable quality products from conventional processes.
We also believe that these ultra-clean fuels meet or exceed new and proposed
environmental requirements.
Key advantages of our technology over traditional GTL technologies are
the use of air in the conversion process (in contrast to the requirement for
pure oxygen in other technologies) and the use of our proprietary catalysts,
which enhance the conversion efficiency of the catalytic reaction. We believe
these advantages will reduce capital and operating costs of GTL plants based on
the Syntroleum Process, while also permitting smaller unit sizes, including
mobile plants that could be placed on skids, barges and ocean-going vessels.
Based on our demonstrated research, we believe that the Syntroleum Process can
be economically applied in GTL plants with throughput levels from less than
10,000 to over 100,000 barrels per day. The advantages of our technology,
combined with the large worldwide resource base of stranded natural gas,
provide what we believe is a significant market opportunity for the use of the
Syntroleum Process by our company and our licensees to develop cost-effective
GTL plants.
We have successfully demonstrated many elements and variations of the
Syntroleum Process in pilot plant operations and laboratory tests, including
our joint participation in a 70 barrel per day GTL demonstration plant with one
of our licensees, ARCO, a subsidiary of BP. While we have not yet built a
commercial-scale GTL plant based on the Syntroleum Process, we are currently
developing a nominal 11,500 barrel per day specialty product GTL plant based on
the Syntroleum Process known as the Sweetwater plant to be constructed in
Western Australia. We are also evaluating the potential development of
additional GTL plants with our licensees and others, including facilities that
will produce synthetic fuels.
To date, we have entered into license agreements with the following
entities or their affiliates:
ARCO (a subsidiary of BP) Kerr-McGee Corporation
Commonwealth of Australia Marathon Oil Company
Enron Corp. Repsol-YPF, S.A.
Ivanhoe Energy Inc. Texaco Inc. (a subsidiary of
Chevron/Texaco)
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In addition, we have from time to time participated in joint
development, testing, marketing or strategic relationships with various
companies, including:
AMEC Process and Energy Ltd. Ivanhoe Energy Inc.
Criterion Catalyst Company L.P. The Lubrizol Corporation
DaimlerChrysler AG Lyondell Petrochemical
Company
FuelCell Energy Marathon Oil Company
GE Power Systems Nuevera (formerly Epyx
Corporation)
General Motors Corporation Tessag Industrie-Anlagen
GmbH
IdaTech (formerly Northwest Power Systems) Volkswagen of America
Business Strategy
Our objectives are to rapidly establish the Syntroleum Process as an
industry standard and maximize our market share relative to alternative GTL
technologies. Our business strategy to achieve these objectives involves the
following key elements:
Broadly License the Syntroleum Process. We intend to work with our
existing licensees to develop new GTL plants and to continue selling licenses
to use the Syntroleum Process. We estimate that there are over 200 oil and gas
companies with natural gas reserves located outside the United States. We
believe that many of these companies are potential licensees. We believe that
widespread licensing, combined with research and development activities to
further improve the Syntroleum Process, provide advantages over competing
technologies, strengthens our relationships with our existing licensees and
attracts new licensees.
Develop and Own GTL Plants. We intend to own significant equity
interests in joint ventures with our licensees and other energy industry and
financial partners that will develop and own GTL plants for the production of
specialty products and fuels. For example, we are currently developing a
nominal 11,500 barrel per day Sweetwater plant to be constructed in Western
Australia, in which we will own a significant equity interest. In addition, we
are actively pursuing development of other GTL plants in various locations in
which we expect to own significant equity interest, including our combined
NGL/GTL project under development in the Talara region of Peru. We have also
signed a nonbinding letter of intent with Petroleum Geo-Services ASA to form a
joint venture to develop, market and operate mobile marine production
facilities based on the Syntroleum Process.
We generally retain the exclusive right to manufacture specialty
products under our license agreements. We believe that our proprietary reactor
designs and catalysts, combined with our improvements to existing refining
methods, will enable us to produce relatively high margin, high quality
specialty products more economically than conventional techniques.
Further Expand and Develop Product Markets. We intend to continue to
develop new markets for Syntroleum synthetic fuels and specialty products in
order to promote the construction of GTL plants by our licensees and to
establish markets for the products of GTL plants developed and owned by us. We
believe that our technology can cost-effectively provide environmentally
superior ultra-clean fuels for use in diesel, gasoline and jet engines. When
made from domestic natural gas, Syntroleum diesel fuels qualify as alternative
fuels under the Energy Policy Act. In addition, we have applied for
certification that Syntroleum diesel fuels made from foreign natural gas
qualify as alternative fuels under the Energy Policy Act. We also believe that
the availability of our fuels will foster the successful development and
economic application of fuel cells and other clean combustion technologies.
Further Reduce Costs through Networked Research and Development
Activities. We intend to continue research and development activities with a
focus on improving the efficiency of the Syntroleum Process, further reducing
capital and operating costs of GTL plants based on the Syntroleum Process, and
better understanding the unique qualities of, and markets for, the synthetic
products produced by the Syntroleum Process. We conduct research and
development activities using our own resources and through our network of joint
development arrangements with licensees and other industry partners. We believe
that this network will provide us and our
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licensees with important competitive advantages and enhance our ability to
attract additional licensees and joint development partners. We generally
obtain title or exclusive rights to inventions or improvements that result from
our joint development activities with others. We regularly review technological
advances of others in related fields and actively seek to acquire rights to
technologies that may enhance the Syntroleum Process.
The Syntroleum Advantage
We expect that products of the Syntroleum Process will become a
competitive source of supply for the anticipated demand for ultra-clean
synthetic transportation fuels and the existing market for fuels and specialty
products, based on our belief that these products can be:
. produced at costs competitive with costs to produce many
comparable products that are currently produced using
conventional processes, including diesel fuel, gasoline and
lubricants, assuming crude oil prices of at least $15.00 per
barrel and natural gas prices lower than $1.00 per thousand
cubic feet (levels at which stranded natural gas may be
purchased in many parts of the world),
. produced substantially free of contaminants normally found in
fuels and specialty products made from crude oil,
. used as blending stock to upgrade conventional fuels and
specialty products made from crude oil,
. used unblended in traditional combustion engines to
significantly reduce emissions,
. used in advanced combustion and fuel-cell engines that require
sulfur and aromatic-free fuels, and
. transported using the existing infrastructure for crude oil
and refined products.
The cost to produce a barrel of fuel includes the amortized plant or
refinery capital costs, the operating costs and the feedstock costs (cost of
natural gas in the case of the Syntroleum Process and cost of crude oil in the
case of conventional refineries). Based on our current technology, we expect
the combined capital and operating costs per installed barrel of capacity to be
higher for a GTL plant based on the Syntroleum Process than for a conventional
refinery. However, we believe lower prices for natural gas relative to crude
oil can result in a total cost per equivalent barrel of product from a GTL
plant based on the Syntroleum Process that is substantially less than the
equivalent total per barrel cost for conventional refineries. Specifically, we
believe the price of stranded natural gas used as a feedstock for the
production of synthetic crude oil compares favorably with the price of crude
oil in many markets. In addition, we believe conventional refineries will face
additional capital and operating costs to meet the recently adopted EPA
requirement to reduce the sulfur content level of diesel fuel to 15 parts per
million by 2006. The American Petroleum Institute estimates that a requirement
to reduce this sulfur content to 15 parts per million would add approximately
$4.20 per barrel of additional costs for conventional refining. In contrast,
the Syntroleum Process produces diesel fuel that already meets the new low
sulfur requirement, providing an incremental relative cost advantage compared
to conventional refineries.
We anticipate that the Syntroleum Process will be an attractive
solution in many cases for companies with natural gas reserves that are not
economic to produce using traditional methods. This is based on our belief that
the Syntroleum Process can be low cost, used in large or small formats,
adaptable and portable.
Market Potential
We believe that significant market potential exists for the Syntroleum
Process and its products due to the existing and growing demand for refined
fuels, the anticipated demand for ultra-clean fuels for both internal
combustion engines and fuel cells, the existing demand for high-quality
specialty products, and the large existing supply of stranded natural gas
worldwide.
We expect demand for products created through the Syntroleum Process
to result from the following.
Large Market for Transportation Fuels. The existing market for
transportation fuels is large, comprising 66% of the approximately 67 million
barrels per day of refined petroleum products produced worldwide in 2000, as
derived from information in the BP Statistical Review of World Energy, 2001.
Moreover, according to the Energy
5
Information Administration, estimates show that diesel fuel demand is growing
at a faster rate than the total demand for refined products due to the superior
fuel efficiency of the diesel engine. We believe that a significant portion of
the growing demand for transportation fuels can be satisfied through the
conversion of natural gas into ultra-clean Syntroleum fuels. We also believe
that even if substantial volumes of Syntroleum fuels were to flow into these
markets, these additional volumes would not cause a significant price
degradation based on the large size of the market. We estimate worldwide
consumption of refined petroleum products as follows:
Worldwide Consumption of Refined Petroleum Products
1990 1995 2000
------------------------- ----------------------- ---------------------
Product Volume % Volume % Volume %
- --------------------------- ----------- ------------ ---------- ----------- ---------- ---------
(millions of barrels per day)
Gasolines (1) ............. 15.6 28.6% 17.4 28.7% 19.4 29.1
Middle Distillates (2)..... 18.7 34.2 21.8 36.0 24.9 37.2
Others (3)................. 20.3 37.2 21.4 35.3 22.5 33.7
---- ---- ---- ---- ---- ----
Total...................... 54.6 100.0% 60.6 100.0% 66.8 100.0%
==== ======= ==== ======= ==== ======
- --------------------------
(1) Consists of aviation and motor gasoline and light distillate feedstock.
(2) Consists of jet and heating kerosenes, gas oils and diesel oils.
(3) Consists of fuel oil, refinery gas, propane, solvents, petroleum coke,
lubricants, bitumen, wax and refinery fuel and loss.
Source: Derived from information in the BP Statistical Review of World Energy,
2001.
Increasing Demand for Ultra-Clean Fuels. The market demand for
ultra-clean fuels in particular is increasing due to more stringent
environmental standards in most of the world's industrialized countries and the
need for vehicle manufacturers to respond to the challenge of producing
fuel-efficient engines that meet these standards. The burden of producing
cleaner fuels from conventional crude oil is expected to substantially increase
refining costs. We believe that these factors will promote the creation of
markets for premium ultra-clean fuels produced by the Syntroleum Process. In
addition, we believe that Syntroleum fuels, either alone or blended with
conventional fuels, can be used in existing and new generation diesel engines
on a cost-effective basis to meet or exceed current and scheduled fuel
specifications and emissions standards.
Increasingly Restrictive Environmental Legislation. Key domestic and
international environmental regulations and initiatives that affect the demand
for ultra-clean fuels include the Clean Air Act of 1970, which establishes
specific responsibilities for government and private industry to reduce
emissions from vehicles, factories and other pollution sources. In December
1999, the EPA issued rules mandating that sulfur levels in highway diesel fuel
be lowered from the current level of 500 parts per million to 15 parts per
million beginning in 2006. The burden placed on the petroleum refining and
automobile industries to meet these new gasoline and diesel sulfur levels is
significant. In the last eight years, the sulfur content of crude oil refined
in the U.S. has increased by 20 percent as a result of shifts in the production
mix of the world's crude oil.
The Energy Policy Act mandates that, by the year 2001, 75% of all
affected federal and state government vehicle purchases, and 90% of all
affected vehicle purchases by private alternative fuel suppliers, must be
alternative fuel vehicles. In addition, the Act provides the Department of
Energy with a goal of displacing 30% of transportation fuel with non-petroleum
replacement fuels, including alternative fuels, by the year 2010. For the goals
set forth by the Energy Policy Act to be successful, we believe an alternative
fuel must be found that offers consumers the convenience of using existing fuel
distribution systems, while at the same time meeting their expectations for
vehicle power and range performance.
Under the Corporate Average Fuel Economy standards established under
the 1975 Energy Policy and Conservation Act, mandatory fleet fuel economy
standards were imposed on all manufactures of passenger cars and light trucks
sold in the U.S. Automakers are turning to the use of diesel engines in their
attempts to supply the demand for these vehicles without violating these
Federal fuel-efficiency standards. While they do offer better fuel economy,
traditional diesel engines, when fueled by conventional diesel fuels, produce
higher emission levels of nitrous oxide and particulate matter. To comply with
more stringent environmental standards, automakers have been partnering with
oil companies to develop ultra-clean fuels for conventional diesel engines.
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States are also looking for emission reductions. For example, the
California Air Resources Board has announced plans to implement stringent new
regulation on transit bus emissions. Under the new regulation, agencies
electing to continue using older diesel buses will be required to implement new
emission controls to reduce exhaust emission and to use low-sulfur fuels
(containing a maximum of 15 parts per million) or to shift to alternative
fuels. The regulation also requires reduced exhaust particulate matter and
nitrogen oxides from new diesel engines. These reductions are expected to be
achieved only through the use of ultra-clean fuels.
Finally, the European Union is also seeking sharp reductions in engine
emissions. Sulfur content from the current level of 350 parts per million to
below 50 parts per million is currently mandated for diesel fuel by 2005. In
addition, the Commission of the European Communities has issued a proposal
which, if adopted, would require diesel fuel with a maximum sulfur content of
10 parts per million to be made available on a broad geographic basis within
each member state of the European Union by January 1, 2005. The proposal would
also require all diesel fuel to have a maximum sulfur content of 10 parts per
million by 2011.
We believe that Syntroleum fuels are positioned to take advantage of
the demand for ultra-clean fuels that we expect will develop as a result of
these environmental and emission standards. Syntroleum fuels are substantially
free of contaminants, including sulfur, aromatics and heavy metals, and
demonstrate high operating efficiency. As a result, we believe that Syntroleum
fuels, either alone or blended with conventional fuels, can be used in existing
and new generation diesel engines on a cost-effective basis to meet or exceed
current and scheduled fuel specifications and emissions standards. When made
from domestic natural gas, Syntroleum diesel fuels qualify as alternative fuels
under the Energy Policy Act. In addition, we have applied for certification
that Syntroleum diesel fuels made from foreign natural gas qualify as
alternative fuels under the Energy Policy Act. By eliminating the need for
specially equipped vehicles or refueling stations, Syntroleum ultra-clean fuels
can avoid the infrastructure problems that have challenged the widespread use
of other alternative fuels to date.
Existing Market for High-Quality Specialty Products. Synthetic crude
oil produced by the Syntroleum Process can be further refined into specialty
products using conventional refining processes that can be simplified to take
advantage of the ultra-clean nature of the synthetic feedstock. We retain the
exclusive right to manufacture these products using the Syntroleum Process
under our license agreements and intend to develop and own significant equity
interests in GTL plants designed to produce these specialty products. We
believe that Syntroleum specialty products have environmental and performance
characteristics that are superior to comparable conventional crude oil
products. For example, we expect our synthetic lube-base oil will meet or
exceed new high performance and emissions standards established by the United
States federal government and the automobile industry for lubricants in new
vehicles beginning in 2003. Our targeted specialty product markets include the
following:
. Lube-Base Oils. Lube-base oils have a variety of industrial
applications, including use as transformer oil, passenger car
motor oil, heavy-duty lubricants and synthetic basestock.
Worldwide demand for all lubricants is approximately 800,000
barrels per day. Historically, lube oil prices have varied
from approximately $40 per barrel for the lowest quality
grades to over $200 per barrel for the highest quality
synthetic grades.
Beginning in 2003, lubricants initially supplied with new
vehicles in the United States will be required to possess very
high performance and emissions characteristics, such as those
produced by the Syntroleum Process. The National Petroleum
Refining Association has estimated that 60% of the current
volume of lubricants produced will not meet these
specifications. We believe that this requirement will cause a
substantial increase in demand for high quality lubricants. We
have developed with others a proprietary process and catalyst
system for use in the production of high quality synthetic
lube oils.
. Process Oils. Process oils are used in a number of industries
involved in the production of chemicals, textiles, rubber and
plastics. These products have a wide variety of applications,
from mold release agents to ingredients in personal care
products. Process oils can also be used in electrical
transformers as a cooling and insulation agent. Historically,
prices for these products have ranged from $35 per barrel to
over $200 per barrel.
. Waxes. Waxes are longer linear chain hydrocarbon molecules
that are solid at room temperature and have a variety of
applications, including adhesives, coatings and other
products. These markets have primarily been supplied with
petroleum-derived waxes. Historically, prices have varied
7
between $30 per barrel for the lowest quality wax to over $150
per barrel for high melting point synthetic wax.
. Normal Paraffins. Normal paraffins are saturated linear
hydrocarbons with molecular ranges between ten and 15 carbon
atoms. These products must be 98% pure, have low odor levels
and be of water clear quality. They are primarily used in the
production of laundry detergent, cosmetics, pharmaceuticals,
paints, stains, aluminum rolling oils and other products.
Prices for normal paraffins historically have averaged between
$60 and $85 per barrel.
. Drilling Fluids. Drilling fluids are used in the drilling of
oil and gas wells as a coolant and lubricant for the drill bit
and to remove cuttings from the well bore as well as to
enhance safety during drilling operations by maintaining well
pressure. Drilling fluids mixed with well cuttings can
accumulate under offshore platforms. Crude oil-based fluids,
which have been used historically, degrade slowly and can
suffocate aquatic plant and animal life. In response to
increased environmental pressures, synthetic drilling fluids
have been developed and used in the Gulf of Mexico and other
offshore locations, where prices have generally ranged between
$250 and $300 per barrel. We have developed a synthetic
drilling fluid product that we expect will meet or exceed all
current applicable environmental requirements for use in the
drilling of oil and gas wells.
Increasing Demand for Fuel Cells. We believe that Syntroleum fuels
have the potential to become ideal fuels for fuel cells and to significantly
enhance commercial opportunities for many fuel-cell applications. The absence
of sulfur, aromatics and heavy metals from Syntroleum fuels allows for
simplified fuel cell processor design, construction and operation. As the
storage and processing of the fuel for a fuel cell are simplified, the physical
size of fuel-cell components can be reduced. Because Syntroleum fuels have
almost twice the hydrogen content of other liquid fuels, including methanol,
Syntroleum fuels enable greater utility and wider application of fuel-cell
power for vehicles. We believe that Syntroleum fuels can be distributed using
the existing conventional fuel distribution infrastructure and have lower
toxicity and similar solubility compared to conventional fuels. A fuel cell is
a device that combines hydrogen, which can be derived from a fuel like natural
gas, propane, methanol, gasoline or diesel, with oxygen from the air to produce
electric power without combustion. Fuel-cell systems have advantages over
conventional power generation systems including low or no pollution, higher
fuel efficiency, greater flexibility in installation and operation, quiet
operation, low vibration and potentially lower maintenance and capital costs.
Fuel cells are being developed to support a variety of markets, including
transportation and continuous stationary (residential and commercial power).
Supply of Natural Gas
Natural Gas Resource Base. Set forth below and elsewhere in this
Annual Report on Form 10-K are estimates of identified reserves of oil and
natural gas. These estimates do not constitute proved reserves in accordance
with the regulations of the Securities and Exchange Commission. Under
Securities and Exchange Commission regulations, proved oil and gas reserves are
the estimated quantities of crude oil, natural gas and natural gas liquids,
which geological and engineering data demonstrate with reasonable certainty to
be recoverable in future years from known reservoirs under existing economic
and operating conditions (i.e., prices and costs as of the date the estimate is
made). We compiled these estimates of identified reserves from the referenced
industry publications and other publicly available reports to identify the
magnitude of the gas resource base. We have not independently verified this
information. Accordingly, we cannot assure you as to the existence or
recoverability of the estimates of identified reserves of oil and natural gas
set forth in this Annual Report on Form 10-K. References below and elsewhere in
this Annual Report on Form 10-K to the conversion of identified amounts of
natural gas into amounts of synthetic crude oil assume that all of the
referenced natural gas could be converted at anticipated conversion rates.
Actual amounts of synthetic crude oil produced will vary based on the ability
of the producer to extract the natural gas, the composition of the natural gas
and process conditions selected for the plant, and this variance may be
material.
World natural gas reserves provide an extensive resource base from
which Syntroleum fuels and specialty products can be produced. According to
information derived from the BP Statistical Review of World Energy, 2001, and
the Department of Energy, worldwide identified natural gas reserves are
estimated to be approximately 5,304 trillion cubic feet.
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The following table presents the 2000 worldwide identified natural gas
reserves, consumption and ratio of reserves to consumption (i.e., reserve life)
by region.
Identified 2000 Worldwide Natural Gas Reserves, Consumption and Reserve Life
Region Reserves Consumption Reserve Life
------ -------- ----------- ------------
(trillion cubic (trillion cubic (years)
feet) feet)
Central and South America............................ 244.6 3.2 76.4
Africa and the Middle East........................... 2,249.0 8.7 258.5
Asia................................................. 365.1 10.2 35.8
Europe............................................... 183.9 16.2 11.4
North America........................................ 258.8 27.0 9.6
Russia and other former Soviet Union regions......... 2,002.6 19.3 103.8
Total............................................ 5,304.0 84.6 62.7
- ---------------------------
Source: Information derived from BP Statistical Review of World Energy, 2000,
and the Department of Energy.
Identified natural gas reserves have grown at a rapid rate. Identified
natural gas reserves in 1990 were estimated to be approximately 4,207 trillion
cubic feet, according to the BP statistical Review of World Energy 2001.
However, in 2000, these reserves were estimated to be approximately 5,304
trillion cubic feet. This increase occurred despite the fact that, over the
same time frame, demand for natural gas increased 22%.
Natural Gas Field Size Distribution. The table below lists an estimate
of the distribution, by field size, of the world's natural gas fields. Only 179
of these fields are larger than five trillion cubic feet, which is generally
considered to be the minimum size necessary to support the development of a
full-scale liquefied natural gas (LNG) plant based on a typical 20-year plant
life.
The World's Natural Gas Fields
Number of
Reserves Fields
- -------- ------
(trillion cubic feet)
Between 50 and 500........................ 16
Between 5 and 50.......................... 163
Between 1 and 5........................... 641
Between .5 and 1.......................... 668
Between .25 and .5........................ 940
Between .1 and .25........................ 1,620
Between .01 and .1........................ 5,085
Less than .01............................. 6,243
-----
Total................................. 15,376
======
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Source: IHS Energy Group, 1998.
Based on field size and portability, we believe GTL plants based on
the Syntroleum Process can potentially access over 9,133 of the world's natural
gas fields, representing approximately 95% of the total reserves held in these
fields. Assuming a typical 30-year plant life, of the 15,376 natural gas fields
shown above approximately:
. 16 contain sufficient reserves to support ten or more 50,000
barrels per day plants,
. an additional 163 contain sufficient reserves to support one
or more 50,000 barrels per day plants,
. an additional 641 contain sufficient reserves to support one
or more 10,000 to 50,000 barrels per day plants,
. an additional 668 contain sufficient reserves to support one
or more 5,000 to 10,000 barrels per day plants, and
. an additional 940 contain sufficient reserves to support one
or more 2,500 to 5,000 barrels per day plants.
9
An additional 6,705 of these 15,376 fields contain sufficient reserves to
support a portable 2,000 barrels per day plant for a shorter plant life.
Stranded Natural Gas Reserves. The Oil and Gas Journal has estimated
that of the world's identified natural gas reserves, approximately 60%, or
3,182 trillion cubic feet, currently have no economic market (equivalent to
approximately 310 billion barrels of synthetic crude oil).
The term "stranded gas" generally refers to gas which exists in
reservoirs that have been discovered, but no economic market can be found for
the production, or production would be too prolific for the limited markets
available. Typically, this low value gas is managed by either not producing, or
"shutting in," the gas, flaring or venting the gas, or reinjecting the gas into
the geologic formation from which it is produced.
The large amount of stranded natural gas throughout the world is
caused by a combination of four primary factors. First, much of the world's
stranded natural gas is located in fields of less than five trillion cubic
feet, which is generally considered the minimum size necessary to support the
development of a full-scale LNG plant for a typical 20-year plant life. The
small size of many of these fields makes the production of natural gas from the
fields uneconomical. Second, much of the world's stranded natural gas is
located in areas where there is no local market and the distance to large
natural gas consuming areas is great. This makes transportation costs high and
often renders development projects uneconomic. Third, even in circumstances
where a transportation system is available for natural gas, the cost of
transporting natural gas in a gaseous state is generally substantially higher,
on an energy equivalent basis, than that of oil. Finally, we estimate that the
worldwide LNG market is approximately 2.4 million oil-equivalent barrels per
day, which is relatively small compared to the approximately 44 million barrels
per day transportation fuels markets. Natural gas can also be converted to
ammonia and methanol. Based on industry publications, we currently estimate
that the market for ammonia on a barrel of oil equivalent basis is
approximately 1.5 million barrels per day and the market for methanol on a
barrel of oil equivalent basis is approximately 443,439 barrels per day. These
markets are small relative to the size of the worldwide natural gas resource
base and relative to the approximately 67 million barrels per day market for
crude oil and related products.
We believe that energy companies with stranded natural gas reserves
will be able to cost-effectively use our GTL technology to produce Syntroleum
fuels and products that can be sold in well-developed global markets. As a
result, we believe these companies would be able to generate a return on the
exploration and development expenditures associated with their stranded natural
gas reserves.
Licensing Arrangements
We currently market four types of license agreements. Our master
license agreement generally grants to the licensee the non-exclusive right to
enter into an unlimited number of site license agreements to construct GTL
plants based on the Syntroleum Process to produce fuels worldwide. Our volume
license agreement generally grants to the licensee the non-exclusive right to
enter into an unlimited number of site license agreements to construct GTL
plants based on the Syntroleum Process, subject to specified aggregate
production capacity limits. Our regional license agreement generally grants to
the licensee the non-exclusive right to enter into an unlimited number of site
license agreements to construct GTL plants based on the Syntroleum Process
within a designated region. Finally, our site license agreement generally
grants to the licensee the non-exclusive right to use the Syntroleum Process in
a GTL plant at a single, specified location for the life of the plant. This
type of license may be granted under our master, regional or volume license
agreements or may be granted to licensees for a specific site who have not
otherwise entered into a master, regional or volume license agreement. The
licenses generally exclude the right to use the Syntroleum Process in North
America as well as in China and India due to intellectual property protection
concerns.
By entering into a master, volume or regional license agreement, a
licensee secures pricing terms for site licenses and obtains the right to use
the Syntroleum Process, the right to acquire catalysts from us for which we
charge a fixed mark-up over our cost and the right to future improvements in
our GTL technology. To date, we have entered into master license agreements
with ARCO (a subsidiary of BP), Ivanhoe Energy, Marathon and Texaco (a
subsidiary of Chevron Texaco), and we have entered into volume license
agreements with the Commonwealth of Australia, Enron, Kerr-McGee and
Repsol-YPF. We intend to continue to market the Syntroleum Process for license
primarily to companies with significant stranded natural gas reserves.
At the inception of a master, volume or regional license agreement,
the licensee generally makes an initial deposit to us, which is credited
against future site-specific license fees. The amount of the initial deposit
depends on market conditions and, in the case of volume and regional license
agreements, the volume limitation and the size and
10
location of the region covered. We have received an aggregate of $38 million
in cash as initial deposits and option fees under our existing license
agreements. In some cases, we have acquired technologies or commitments to
provide funding for future development activities in lieu of initial cash
deposits. For a discussion of license fees, see "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Operating
Revenues--License Revenues."
As part of our network model for improving our GTL technology, we
generally acquire a royalty-free, non-exclusive license to any invention or
improvement to the Syntroleum Process that is developed by the licensee,
together with the right to grant corresponding sublicenses to our other
licensees who have granted us similar rights. Licensees also generally acquire
the right to use subsequent inventions or improvements to the Syntroleum
Process that we acquire from other licensees. Our license agreements may be
terminated by the licensee, with or without cause, upon 90 days' notice to us.
Key Testing and Commercial Projects
The following sets forth our progress to date in implementing our
business strategy. Although we have made significant progress towards
commercializing the Syntroleum Process, we cannot assure you that licensees
will construct any plants under their license agreements, that we will be able
to obtain financing for specialty product or fuels gas-to-liquids plants, that
design and construction of any of these plants will be successfully completed,
that any of these plants will be commercially successful or that these plants
will be constructed or utilized on a cost-effective basis. See "Risk Factors."
In addition to our nominal two barrel per day pilot plant and
laboratory facilities located in Tulsa, Oklahoma, which are the primary sites
for our research and development activities, we have been or are currently
involved in several projects and initiatives, including the following.
Cherry Point Project. We were a joint participant with ARCO in a 70
barrel per day GTL demonstration plant located at ARCO's Cherry Point refinery
in the State of Washington. The plant began operating in July 1999 and
operated successfully until it was shut down at the completion of testing
shortly after June 30, 2000. ARCO funded the construction and operation of
this plant under our joint development agreement. Plant operations exceeded
our expectations and successfully demonstrated a number of key aspects of our
proprietary autothermal reformer and moving bed reactor designs and related
catalyst performance. This plant has been recently disassembled and moved to
Tulsa, Oklahoma where we expect to reassemble the plant as part of our
expected fuels project with the DOE discussed below. The data and experience
generated from our participation in plant operations will be useful in our
efforts to apply these reactor designs on a commercial basis both for fuels
and specialty product plants. We are currently conducting engineering studies
with others for commercial-scale plants using these reactor designs.
Sweetwater Project. We are developing a nominal 11,500 barrel per day
specialty product plant in Australia that we call the Sweetwater plant. We
currently anticipate that this plant will produce synthetic lube oil, normal
paraffins, process oils and light paraffins. The plant will use a fixed tube
reactor design which produces a high yield of the desired products with high
wax content and has lower scale-up risks than other reactor designs and will
include additional refining equipment necessary to produce the targeted
specialty products. We plan to construct this plant through a joint venture
with other parties who we expect will furnish a significant portion of the
needed equity financing . In February 2000, we selected a site for the plant
about four kilometers from the North West Shelf liquid natural gas facility on
the Burrup Peninsula of Western Australia. We have entered into a firm,
lump-sum engineering, procurement and construction contract, an operation and
maintenance contract, a natural gas supply contract and other contracts for
this plant. We currently expect the capital costs of the Sweetwater plant to
be funded primarily by senior and subordinated debt at the project level, as
well as equity financing from third parties, together with our own equity
contribution. We are currently in discussions with several parties regarding
equity financing for the Sweetwater project. However, we cannot assure you
that we will be successful in obtaining either the debt or equity financing
for this project.
Joint Venture to Provide Contract GTL Services. We have entered into
a nonbinding letter of intent with Petroleum Geo-Services ASA to form a joint
venture to develop, market and operate mobile, marine-based production
facilities that use the Syntroleum Process. If the transaction is completed,
the joint venture will be a separate operating company offering contract GTL
services to gas producers to convert natural gas from offshore fields into
synthetic hydrocarbon products. Use of these services could enable
monetization of gas that is normally flared or otherwise wasted. Under the
letter of intent, the planned joint venture will have its initial operations
in
11
Aberdeen, Scotland and will be the exclusive means by which we and PGS offer
mobile, marine-based contract GTL services to third parties. Formation of the
joint venture is subject to negotiation and execution of definitive agreements
by the parties. We cannot assure you that the joint venture will be formed or
commence actual business operations.
DOE Project. During the third quarter of 2001, the U.S. Department of
Energy (DOE) concluded an agreement with Integrated Concepts & Research
Corporation (ICRC) to provide funding to a team of companies for the GTL
Ultra-Clean Fuels Production and Demonstration Project for which preliminary
approval was announced by us in October 2000. We are the prime subcontractor
for this project under an agreement with ICRC. Under the terms of the
agreement, the DOE will fund $16 million of the $36 million project, and the
other project participants will provide the remaining $20 million. We are
currently in discussions with Marathon Oil Company and others regarding their
participation in this project. Under the program, Syntroleum's Cherry Point
GTL facility, which has been disassembled and relocated from ARCO's Cherry
Point Refinery in Washington State to a site near Tulsa, Oklahoma, is expected
to become the basis for construction of a new GTL facility expected to produce
up to approximately 70 barrels per day of Syntroleum ultra-clean diesel fuel
and synthetic naphtha. The relocation of the Cherry Point GTL facility to
Tulsa, Oklahoma was completed in 2001. Construction of the new facility in
Tulsa is currently expected to begin in 2002, with fuel production expected to
commence in 2003. The fuels from this facility are expected to be tested by
other project participants in advanced power train and emission control
technologies and are also expected to be tested in bus fleets by the
Washington Metropolitan Area Transit Authority and the U.S. National Park
Service at Denali National Park in Alaska. Completion of the project is
subject to continued congressional appropriation of project funds. In
addition, construction of this project will be subject to the risks of delay
inherent in any large construction project.
Talara Project. During the fourth quarter of 2001 we announced plans
to develop an integrated NGL/GTL (natural gas liquids/gas-to-liquids) project
in the Talara Basin of Northwest Peru. We expect to develop this project in
three phases. Phase I is expected to consist of construction of a nominal
2,000 barrel per day NGL plant to upgrade and replace an existing plant. Phase
II is expected to involve the expansion of the NGL plant and the construction
of a 5,000 barrel per day GTL plant. Phase III is expected to involve
expansion of the GTL facility if additional natural gas reserves and
production in the area are developed. In connection with this proposed
project, we signed a license contract with the government of Peru under which
we have acquired exploration and production rights to the offshore Peruvian
oil and gas block designated as Z-1. Previous exploration activity in the area
has identified possible gas and condensate prospects, which we believe have
remained undeveloped up to now due to lack of an adequate market for the gas.
We anticipate that development of these prospects would facilitate the third
phase of the Talara project. Completion of this project is subject to
satisfaction of several conditions including negotiation and execution of
definitive gas purchase agreements, engineering, procurement and construction
agreements and other agreements, site acquisition and financing. We cannot
assure you that this project will commence actual operations. In addition,
this project will be subject to the risks of delay inherent in any large
construction project.
DOD Project. During the first quarter of 2002, we announced that
Congress had appropriated $3.5 million for a proposed Flexible JP-8 (single
battlefield fuel) program under the Department of Defense Appropriation Bill,
2002. We expect to negotiate a contract with the DOD to participate in the
program, which will provide for the design of a marine-based fuel-production
plant, as well as testing of synthetically-made JP-8 fuel in military diesel
and turbine engine applications. We cannot assure you that we will be
successful in concluding a contract with DOD to participate in this program.
Research and Development
One of our key strategies is to continue to lower the capital and
operating cost of our GTL technology through research and development. We have
spent approximately $8.3 million in 1999, $12.6 million in 2000 and $16.2
million in 2001 on pilot plant and research and development facilities and
activities. Our continued research and development efforts will take place in
four primary areas: process design, catalyst development, reactor design and
heat integration/power recovery. For a discussion of our efforts in these
areas, see "--The Syntroleum Process."
We lease a 4,500 square foot laboratory and own a 16,500 square foot
laboratory facility located on approximately 95 acres of land where we are
engaged in extensive development and testing of Syntroleum products. These
facilities also house our product refining research and development activities,
including hydrogen saturation, hydroisomerization, hydrocracking and
distillation capabilities, as well as a fully automated dual train bench scale
hydroprocessing unit. We have recently completed construction of a large scale
hydroprocessing pilot unit that is
12
currently operational. Our laboratories currently have 24 fixed tube reactors,
two fluidized bed reactors, and seven continuous stirred tank reactors in
which automated tests are run and catalyst systems are evaluated and
developed. We also have arrangements with a number of universities and
companies for a full range of state-of-the-art catalyst evaluation.
As of March 1, 2002, we had 81 employees in our laboratory, pilot
plant and engineering departments, 53 of whom are chemists, engineers or other
degreed professionals (21 with masters or Ph.D. degrees) devoted to research
and development activities. A number of other chemists, engineers and
professionals that are employed by our licensees and joint development
partners also contribute to the further development and commercialization of
the Syntroleum Process.
Sales and Marketing
We intend to maintain an active marketing and sales effort to promote
the Syntroleum Process through several channels. We have been and will
continue to be an active participant at industry conferences relating to GTL
processes. We also intend to continue to write and publish papers on topics
regarding the implications of GTL technology to the energy and transportation
industries. Additionally, we will continue to educate and inform our
customers through the use of multi-media and print presentations. We also
intend to continue our efforts to establish brand recognition for specialty
products to be produced by our specialty plants. "Syntroleum" is a registered
trademark and service mark in the United States, and applications are pending
to register the trademark in various foreign countries.
In addition, RWE (formerly Tessag), AMEC and other engineering
companies are familiar with our GTL technology and have assisted us in
marketing the Syntroleum Process. Our agreements with engineering firms
sometimes provide these firms with the right to market the Syntroleum Process.
We believe that these relationships will expand our marketing effort in a
cost-effective manner. As of March 31, 2002, we had 14 employees in our
business development and marketing departments, seven of whom hold advanced
degrees, and we also retain a full-time sales representative in London,
England. We also have representation relationships with several other
organizations and individuals covering Europe, portions of Africa and Russia.
The Syntroleum Process
The Syntroleum Process involves two catalytic reactions. The first
reaction converts natural gas into synthesis gas through our proprietary
autothermal reformer reactor, and the second reaction converts the synthesis
gas into hydrocarbons through the Fischer-Tropsch reaction over a proprietary
catalyst. The following diagrams illustrate the elements involved in these
reactions, but are not in exact proportions.
Step 1
Conversion of Natural Gas to Synthesis Gas
Synthesis Gas
Natural Gas Air Steam (diluted with Nitrogen) Water
Catalyst
CH/4/ + O/2/ + N/2/ + H/2/0 -------------> CO + H/2/ + N/2/ + H/2/O
Step 2
Fischer - Tropsch Synthesis
SynthesisGas
(dilutedwithNitrogen) Hydrocarbons Nitrogen Water
Catalyst
H/2/ + CO + N/2/ -----------> C/n/H/( 2n+2)/ + N/2/ + H/2/O
Our goal in developing this process has been to substantially reduce
both the capital and operating costs and the minimum economic size of a GTL
plant. We have developed and continue to develop variations of our basic
process design in an effort to further lower costs and increase the
adaptability of the Syntroleum Process to a wide variety of potential
applications.
13
Although we believe that the Syntroleum Process can be utilized in
commercial-scale GTL plants, we cannot assure you that commercial-scale GTL
plants based on the Syntroleum Process will be successfully constructed and
operated or that these plants will yield the same economics and results as
those demonstrated on a pilot plant basis. In addition, improvements to the
Syntroleum Process currently under development may not prove to be
commercially applicable. See "Risk Factors--Risks Relating to our Technology."
Fischer-Tropsch Catalyst Systems
We have developed several different proprietary catalysts systems for
use in the Fischer-Tropsch reaction in order to allow for matching a catalyst
system to a particular reactor design and provide more flexibility in matching
the Syntroleum Process to the desired application.
Based upon pilot tests of catalysts that we have manufactured, we
believe that a number of proprietary catalyst systems meet or exceed the
activity and selectivity targets necessary for commercial application in some
current Syntroleum Process designs, including the catalysts associated with
the moving bed reactor recently operated at the pilot plant jointly developed
with ARCO at ARCO's Cherry Point refinery.
Most Fischer-Tropsch catalysts produce a very waxy synthetic crude
oil. Typically, more than 50% of a barrel of synthetic crude oil is solid at
room temperature due to the high wax content. These waxy hydrocarbons are
typically processed through a hydrocracker to convert them into liquid
hydrocarbons at room temperature that can be further processed into
transportation fuels. Our proprietary "high alpha" catalyst produces a very
waxy synthetic crude oil which can be further processed through hydrocracking
to make liquid synthetic fuels, or, with other refining processes, the waxy
portion can be converted into higher value specialty products such as
synthetic lubricants.
Under our arrangements with various catalyst manufacturers, the
manufacturers have manufactured, in their respective commercial facilities,
batches of our catalysts in quantities sufficient to confirm that the
performance of these catalysts is comparable to the same catalyst produced by
us and that these catalysts can be produced in commercial quantities at
targeted cost levels. We estimate that the useful life of our Fischer-Tropsch
catalysts will be three to five years under normal operating conditions.
We plan to improve existing catalysts and continue to develop
additional catalyst formulations for use in the Syntroleum Process. Catalyst
development is a complex process requiring significant scientific skill and
resources. We have in the past and intend to continue to devote substantial
resources to research and development activities to produce Fischer-Tropsch
catalysts with improved activity rates, selectivity and active life, all at
reasonable manufacturing cost. In addition, we intend to enhance our catalyst
development activities through catalyst joint development programs with our
joint development partners and catalysis experts retained on a consulting
basis.
Fischer-Tropsch Reactor Designs
We have tested at our pilot plant several different proprietary
Fischer-Tropsch reactor designs and associated catalysts for use in the
Syntroleum Process. These include multiple fixed bed and moving bed reactors.
In addition, under its agreement with Syntroleum, ARCO constructed and
operated a 70 barrel per day GTL pilot plant that tested the moving bed
reactor on a larger scale. As discussed elsewhere, we have recently moved this
plant to Tulsa, Oklahoma where we expect to reconstruct it for additional
operation. We have several pending United States and foreign patent
applications related to our Fischer-Tropsch reactors.
Heat Integration and Power Recovery
Compression is the primary energy consumer in the Syntroleum Process.
Engineering studies conducted by various engineering companies have
demonstrated that the heat generated by the two catalytic reactions in the
Syntroleum Process can be captured in the form of mechanical and electrical
energy sufficient to supply all of a GTL plant's needs plus a surplus for
other uses, if desired. We have developed several heat integration and power
recovery schemes with partners such as GE Power Systems to broaden the
flexibility of the Syntroleum Process and, in some cases, lower the capital
cost as well as the number of pieces of major equipment necessary for
operation of a GTL plant.
Different configurations of GTL plants based on the Syntroleum
Process can also change the energy sources within the plant and the excess
energy produced. For example, a steam turbine can be incorporated into the
process and utilize the steam produced by the auto-thermal reformer and
Fischer-Tropsch reactions to produce energy for
14
compression, and electrical power for commercial sale. In addition, we have
developed a configuration that utilizes the low-heating-value residue stream
from the process as feedstock for a specially designed gas turbine that can
utilize very low-heating-value gas. Several of these heat integration and
power recovery schemes are the subject of United States patents and patent
applications and foreign patent applications and are a part of our joint
development efforts with others.
Product Upgrading
Synthetic liquid hydrocarbons made from the Syntroleum Process can be
refined into fuels using conventional refining processes such as
hydrocracking. However, we believe that because of the purity and uniform
nature of the synthetic hydrocarbon molecules, conventional process
configurations and conditions may not be optimum. We have developed new
processes to further refine synthetic liquid hydrocarbons made from the
Syntroleum Process in a manner that maximizes the value of the refined product
streams, while minimizing the processing cost. In August 2000, we began
offering our licensees access to proprietary hydrocracking technology
optimized for converting synthetic crude oil into ultra-clean, sulfur-free
synthetic transportation fuels, primarily diesel and jet fuels.
Advantages Over Competing Processes
We believe that the method by which our process uses air directly
from the atmosphere is a unique characteristic and a primary competitive
advantage of the Syntroleum Process. Competitive processes for the conversion
of natural gas into synthetic hydrocarbons generally utilize either steam
reforming or a combination of steam reforming and partial oxidation with pure
oxygen in the conversion of natural gas to synthesis gas. Steam reformers
react steam with natural gas to produce synthesis gas. A conventional steam
reformer is a relatively complex unit that consists of a large fired heater
with catalyst-filled tubes. Because the reaction operates at high temperature
and pressure, the tubes are made of exotic alloys and are expensive. Operating
costs are increased due to the endothermic nature of the process, which
requires a continuous input of heat. Processes that utilize a combination of
steam reforming and partial oxidation with pure oxygen also require an air
separation plant to produce pure oxygen. The air separation plant must be
constructed with expensive metals and materials, because its operation
involves very low temperatures and requires significant energy input, as well
as operating risks inherent in handling pure oxygen. Moreover, the use of pure
oxygen generates synthesis gas that is free of nitrogen. While the
Fischer-Tropsch reaction in competitive processes is designed to occur without
the presence of nitrogen, the Syntroleum Process is designed to utilize the
nitrogen in the Fischer-Tropsch process to remove a portion of the heat
generated by the process. Use of the auto thermal reformer reactor in the
Syntroleum Process also provides advantages over competitive processes because
of its relatively low capital and operating costs. In addition to lowering the
capital cost, the elimination of an air separation plant and steam reformer
has the additional advantage of reducing the size and complexity and lowering
the energy requirements of GTL plants based on the Syntroleum Process.
We believe that another advantage of the Syntroleum Process is the
absence in several design configurations of recycle loops necessary in some
competitive processes, which also tends to lower capital costs. In the
Fischer-Tropsch stage of some competitive processes, a recycle loop is
utilized in order to maximize the output of hydrocarbons and help control the
heat generated by the reaction. As a result, these processes are designed to
avoid the introduction of inert gases (including nitrogen) into the process,
which would otherwise build up in the system and hinder the reaction.
Feedstocks
The Syntroleum Process is designed to produce approximately 6 million
British thermal units of liquid hydrocarbons from between 9.5 and 13 million
British thermal units of natural gas feedstock. Conversion efficiency varies
depending on gas composition and process conditions selected for each plant.
One of the benefits of the Syntroleum Process is its ability to utilize
natural gas containing nitrogen and carbon dioxide, up to specified levels,
without removing these impurities prior to consumption by the plant. However,
natural gas that contains sulfur, metals and other materials that poison
catalysts must be processed in order to remove these contaminants prior to the
use of the natural gas in the first catalytic reaction.
Byproducts and Emissions
A byproduct of the Syntroleum Process is synthesized water that, with
treatment to remove organic materials, could be sold commercially as
industrial or irrigation water in areas where sufficient demand exists. Based
15
on pilot plant tests, we believe that slightly more than one barrel of
synthesized water can be produced for each barrel of synthetic crude oil
produced.
Depending on the process configuration, emissions from the Syntroleum
Process are expected to include nitrous oxide, carbon monoxide, carbon dioxide
and light hydrocarbons, which we believe will generally be within applicable
emissions standards. Spent catalysts are expected to be processed by a
catalyst reclaimer, which will recover useful metals and be responsible for
disposal of the nonreclaimed portion of the catalyst.
Intellectual Property
Our success depends on our ability to obtain, protect, and enforce
our intellectual property rights, to successfully avoid infringing the valid
and enforceable intellectual property rights of others and, if necessary, to
defend against any alleged infringements. We regard the protection of our
proprietary technologies as critical to our future success and we rely on a
combination of patent, copyright, trademark and trade secret law and
contractual restrictions to protect our proprietary rights. We pursue
protection of the Syntroleum Process primarily through patents and trade
secrets. It is our policy to seek, when appropriate, protection for our
proprietary products and processes by filing patent applications in the United
States and selected foreign countries and to encourage or further the efforts
of others who have licensed technology to us to file patent applications. Our
ability to protect and enforce these rights involves complex legal, scientific
and factual questions and uncertainties.
We currently own, or have licensed rights to more than 120 patents or
patent applications pending in the United States and various foreign countries
that relate in general to one or more embodiments of the Syntroleum Process.
We cannot assure you that additional patents will be granted with
respect to any patent applications filed by us or our licensors. Any patents
issued or licensed to us might not provide us with commercial benefit or might
be infringed, invalidated or circumvented by others. The approval or rejection
of our patent applications by the U.S. Patent Office may take several years.
The availability of patents in foreign markets, and the nature of any
protection against competition that may be afforded by such patents, is often
difficult to predict and varies significantly from country to country.
Moreover, we or our licensors may choose not to seek, or may, for a variety of
reasons, be unable to obtain, patent protection in a country that might become
an important market for our GTL technology.
In addition to patent protection, we also rely significantly on trade
secrets, know-how and technological advances, which we seek to protect, in
part, through confidentiality agreements with our collaborators, licensees,
employees and consultants. If these agreements are breached, we might not have
adequate remedies for the breach. In addition, our trade secrets and
proprietary know-how might otherwise become known or be independently
discovered by others.
It is our policy to honor the valid, enforceable intellectual
property rights of others. Our success depends on our ability to avoid
infringing these rights and, if need be, defending ourselves against any
claims of infringement. While we have made efforts to avoid any such
infringement, commercialization of our GTL technologies may give rise to
claims that the technologies infringe upon the patents or other proprietary
rights of others.
Although it is our policy to regularly review patents that may have
applicability in the GTL industry, we may not become aware of these patents or
rights until after we have made a substantial investment in the development
and commercialization of those technologies. Legal actions could be brought
against us, our partners or our licensees claiming damages and seeking an
injunction that would prevent us, our partners or our licensees from testing,
marketing or commercializing the affected technologies. Major energy companies
seeking to gain a competitive advantage may have an interest in bringing one
of these actions. If such an action was successful, in addition to potential
liability for damages, we, our partners or our licensees could be required to
obtain a license in order to continue to test, market or commercialize the
affected technologies. Any required license might not be made available or, if
available, might not be available on acceptable terms, and we could be
prevented entirely from testing, marketing or commercializing the affected
technology. We may have to expend substantial resources in litigation, either
in enforcing our patents, defending against the infringement claims of others,
or both. Many possible claimants, like the major energy companies that have or
may be developing proprietary GTL technologies competitive with the Syntroleum
Process, have significantly more resources to spend on litigation. We have
conducted a review of several hundred existing patents applicable to the GTL
field and believe that we are not
16
infringing on the valid, enforceable patents of others. We have not been
notified of any claim that our GTL technology infringes the proprietary rights
of any third party. However, we cannot assure you that third parties will not
claim infringement by us with respect to past, present or future GTL
technologies.
In any potential intellectual property dispute involving us, our
licensees could also become the target of litigation. Our license agreements
require us to indemnify the licensees against specified losses, including the
losses resulting from patent and trade secret infringement claims, subject to
a cap of 50% of the license fees received. Our indemnification and support
obligations could result in substantial expenses and liabilities to us. These
expenses or liabilities could have a material adverse effect on our business,
operating results and financial condition. See "Risk Factors--Risks Relating
to our Technology."
Employees
We had 125 employees at March 1, 2002, including 60 employees involved
in research and development and pilot plant operations, 14 employees in business
development and marketing, 21 employees in engineering, and 30 employees in
finance, legal, information technology and administration. None of our employees
are represented by a labor union. We have experienced no work stoppages and
believe that our relations with our employees are excellent.
Government Regulation
We will be subject to extensive federal, state and local laws and
regulations relating to the protection of the environment, including laws and
regulations relating to the release, emission, use, storage, handling,
cleanup, transportation and disposal of hazardous materials and employee
health and safety. In addition, our GTL plants will be subject to the
environmental and health and safety laws and regulations of any foreign
countries in which these plants are to be located. For example, our Sweetwater
project will require us to comply with extensive Australian environmental,
health and safety laws. Violators of these laws and regulations may be
subject to substantial fines, criminal sanctions or third party lawsuits. We
may be required to install costly pollution control equipment or, in some
extreme cases, curtail operations to comply with these laws. These laws and
regulations may also limit or prohibit activities on lands lying within
wilderness areas, wetlands or other protected areas. Our operations in the
United States are also subject to the federal "Superfund" law, and similar
state laws, which can impose joint and several liability for site cleanup,
regardless of fault, upon statutory categories of parties, including our
company, that sent wastes offsite for disposal and current owners and
operators of property. Environmental laws and regulations often require the
acquisition of a permit or other authorization before activities may be
conducted and compliance with laws and regulations, and any requisite permits,
can increase the costs of designing, installing and operating our GTL plants.
For example, we are required to obtain numerous Australian environmental,
health and safety permits in connection with our Sweetwater project.
GTL plants will generally be required to obtain permits under
applicable state and federal clean air and water laws and various permits for
industrial siting and construction. Emissions from a GTL plant, primarily from
the gas turbine, will contain nitrous oxides and may require abatement
equipment to be installed in order to meet state and federal permit
requirements. Additionally, GTL plants will be required to adhere to state
and federal laws applicable to the disposal of byproducts produced, including
waste water and spent catalyst.
Although we do not believe that compliance with environmental and
health and safety laws in connection with our current operations will have a
material adverse effect on us, we cannot predict with certainty the future
costs of complying with environmental laws and regulations and containing or
remediating contamination. In the future, we could incur material liabilities
or costs related to environmental matters, and these environmental liabilities
or costs (including fines or other sanctions) could have a material adverse
effect on our business, operating results and financial condition. We do not
currently carry environmental impairment liability insurance to protect us
against these contingencies but may, in the future, seek to obtain insurance
in connection with our participation in the construction and operation of GTL
plants if coverage is available at reasonable cost and without unreasonably
broad exclusions.
Operating Hazards
Operations at our GTL plants will involve a risk of incidents
involving personal injury and property damage due to the operation of
machinery in close proximity to individuals and the highly flammable nature of
natural gas and the materials produced at these plants. The frequency and
severity of personal injury and property damage
17
incidents will affect our operating costs, insurability and relationships with
customers, employees and regulators. Any significant frequency or severity of
these incidents, or the general level of compensation awards, could affect our
ability to obtain insurance and could have a material adverse effect on our
business, operating results and financial condition.
MANAGEMENT AND DISPOSITION OF REAL ESTATE AND MISCELLANEOUS ASSETS
Our predecessor, SLH Corporation, owned real estate assets which we
are currently liquidating. These assets reflect the remaining assets of a real
estate development business that was conducted by Lab Holdings in association
with a previously owned life insurance company that was sold in 1990. Real
estate assets, as of December 31, 2001, consisted of land in Houston, Texas
comprised of 255 acres of undeveloped land and 69 residential lots available
for sale known as the "Houston Project." The total real estate inventory had
an aggregate carrying value at December 31, 2001 of approximately $3.0 million.
Our real estate assets are owned by our subsidiary, Scout Development
Corporation. The Houston Project is owned by 529 Partners, Ltd., a Texas
limited partnership in which Scout holds a 75% interest. 529 Partners is
developing the property for residential and light commercial purposes. During
2001, 529 Partners sold 125 lots of the Houston Project for residential use
for approximately $2.6 million. We expect that the balance of the tract will
be developed by 529 Partners for residential use and ultimate sale.
Our other assets at December 31, 2001 included (1) $46,532,000 of
cash, government securities and current receivables, (2) an investment in a
privately owned developer of proprietary bone substitute technology, which had
a carrying value of approximately $506,000, (3) an investment in a privately
held venture capital limited partnership, which had a carrying value of
$476,000, (4) and an equity investment in a recently renovated hotel in Tulsa,
Oklahoma. During 2001 we sold our 49.9% partnership interest in a retail
shopping center in Gillette, Wyoming for a gain of $1.9 million. We plan to
liquidate these remaining investments, other than the cash, government
securities and current receivables, in an orderly manner to maximize their
value to stockholders.
We believe that the real estate properties are adequately covered by
insurance with coverages for real and personal property, commercial general
liability, commercial crime, garage keepers legal liability, earthquake,
flood, windstorm and hail.
Our subsidiary, Scout, is subject to contingent obligations under
leases and other instruments incurred in connection with real estate
activities and other operations. We believe that adequate accruals have been
made for the contingent liabilities on our financial statements and that none
of these are deemed to be material, individually or in the aggregate.
Scout is subject to several United States environmental laws,
including: the Clean Air Act, the Comprehensive Environmental Response,
Compensation, and Liability Act, the Emergency Planning and Community
Right-to-Know Act, the Federal Water Pollution Control Act, the Oil Pollution
Act of 1990, the Resource Conservation and Recovery Act, the Safe Drinking
Water Act and the Toxic Substances Control Act. Scout is also subject to the
United States environmental regulations promulgated under these acts, as well
as state and local environmental regulations that have their foundation in the
foregoing United States environmental laws. As is the case with many
companies, Scout may face exposure to actual or potential claims and lawsuits
involving environmental matters with respect to its current inventory of real
estate as well as previously owned real estate. However, no such claims are
presently pending and Scout has not suffered, and does not anticipate that it
will suffer, a material adverse effect as a result of any past action by any
governmental agency or other party, or as a result of noncompliance with such
environmental laws and regulations.
RISK FACTORS
You should carefully consider the risks described below. The risks
and uncertainties described below are not the only ones facing our company. If
any of the following risks actually occur, our business, financial condition
or results of operations could be materially adversely affected. In that case,
the trading price of our common stock could decline, and you may lose all or
part of your investment in our common stock.
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RISKS RELATING TO OUR TECHNOLOGY
We might not successfully commercialize our technology, and
commercial-scale GTL plants based on the Syntroleum Process may never be
successfully constructed or operated.
To date, no commercial-scale GTL plant based on the Syntroleum
Process has been constructed. A commercial-scale GTL plant based on the
Syntroleum Process might never be successfully built either by us or by any of
our licensees. Our success depends on our ability, and the ability of our
licensees, to economically design, construct and operate GTL plants based on
the Syntroleum Process on a commercial scale. The successful commercial
construction and operation of a GTL plant based on the Syntroleum Process
depends on a variety of factors, many of which are outside our control.
Although we are currently developing the Sweetwater plant, our first
commercial-scale GTL plant, we do not know if we will be successful in
obtaining the necessary debt and equity financing for this plant. We do not
know when construction of this plant will begin or when it will become
operational. We do not have significant experience managing the financing,
design, construction or operation of commercial-scale GTL plants, and we may
not be successful in doing so.
Commercial-scale GTL plants based on the Syntroleum Process might not
produce results necessary for success, including results demonstrated on a
laboratory and pilot plant basis.
. A variety of results necessary for successful operation of the
Syntroleum Process could fail to occur at a commercial plant,
including reactions successfully tested on a laboratory and
pilot plant basis. Results that could cause commercial-scale
GTL plants to be unsuccessful include:
. lower reaction activity than that demonstrated in laboratory
and pilot plant operations, which would increase the amount of
catalyst or number of reactors required to convert synthesis
gas into liquid hydrocarbons and increase capital and
operating costs,
. shorter than anticipated catalyst life, which would require
more frequent catalyst regeneration, catalyst purchases, or
both, and increase operating costs,
. excessive production of gaseous light hydrocarbons from the
Fisher-Tropsch reaction compared to design conditions, which
would lower the anticipated amount of liquid hydrocarbons
produced and would lower revenues and margins from plant
operations,
. inability of the gas turbines or heaters integrated into the
Syntroleum Process to burn the low-heating-value tail gas
produced by the process, which would result in the need to
incorporate other methods to generate horsepower for the
compression process that may increase capital and operating
costs, and
. higher than anticipated capital and operating costs to
design, construct and operate a GTL plant.
In addition, these plants could experience mechanical difficulties,
either related or unrelated to elements of the Syntroleum Process.
Many of our competitors have significantly more financial and other
resources than our company, and GTL technologies developed by our competitors
could become more commercially successful than our technology or render our
technology obsolete.
The development of GTL technology is highly competitive, and other
GTL technologies could become more commercially successful than our
technology. The Syntroleum Process is based on chemistry that has been used by
several companies in synthetic fuel projects over the past 60 years. Our
competitors include major integrated oil companies that have developed or are
developing competing GTL technologies, including BP, Conoco, Exxon, Sasol
(including through its participation in a joint venture with Chevron) and
Shell. Each of these companies has significantly more financial and other
resources than us to spend for research and development of their technologies
and for funding construction and operation of commercial-scale GTL plants. In
addition to using their own GTL technologies in competition with us, these
competitors could also offer to license their technology to others. In
addition, several small companies have developed, and are continuing to
develop, competing GTL technologies. The Department of Energy has also
sponsored a number of research programs relating to GTL technology that, in
many cases, could potentially lower the cost of competitive processes.
19
As GTL technologies continue to be developed by our competitors, one
or more of our current technologies may become obsolete. Our ability to create
and maintain technological advantages is critical to our future success. As
new technologies develop, we may be placed at a competitive disadvantage, and
competitive pressures may force us to implement new technologies at a
substantial cost. We may not be able to successfully develop or expend the
financial resources necessary to acquire new technology.
Our ability to protect our intellectual property rights involves many
complexities and uncertainties, and commercialization of the Syntroleum
Process could give rise to claims that our technology infringes upon the
rights of others.
Our success depends on our ability to protect our intellectual
property rights, which involves complex legal, scientific and factual
questions and uncertainties. We rely on a combination of patents, copyrights,
trademarks, trade secrets and contractual restrictions to protect our
proprietary rights. We cannot assure you that additional patents will be
granted, and our existing patents might not provide us with commercial benefit
or might be infringed upon, invalidated or circumvented by others. In
addition, the availability of patents in foreign markets, and the nature of
any protection against competition that may be afforded by those patents, are
often difficult to predict and vary significantly from country to country. We
or our licensors may choose not to seek, or may be unable to obtain, patent
protection in a country that could potentially be an important market for our
GTL technology. The confidentiality agreements that are designed to protect
our trade secrets could be breached, and we might not have adequate remedies
for the breach. In addition, our trade secrets and proprietary know-how might
otherwise become known or be independently discovered by others.
Commercialization of the Syntroleum Process may give rise to claims
that our technologies infringe upon the patents or other proprietary rights of
others. Although it is our policy to regularly review patents that may have
applicability in the GTL industry, we may not become aware of these patents or
rights until after we have made a substantial investment in the development
and commercialization of those technologies. We cannot assure you that third
parties will not claim infringement by us with respect to past, present or
future GTL technologies. Legal actions could be brought against us, our
partners or our licensees claiming damages and seeking an injunction that
would prevent us, our partners or our licensees from testing, marketing or
commercializing the affected technologies. If an infringement action were
successful, in addition to potential liability for damages, our partners, our
licensees or we could be required to obtain a license in order to continue to
test, market or commercialize the affected technologies. Any required license
might not be made available or, if available, might not be available on
acceptable terms, and we could be prevented entirely from testing, marketing
or commercializing the affected technology. We may have to expend substantial
resources in litigation, either in enforcing our patents, defending against
the infringement claims of others, or both. Many possible claimants, like the
major energy companies that have or may be developing proprietary GTL
technologies competitive with the Syntroleum Process, have significantly more
resources to spend on litigation.
We could have potential indemnification liabilities to licensees
relating to the operation of GTL plants based on the Syntroleum Process or
intellectual property disputes.
Our license agreements require us to indemnify the licensee, subject
to a cap of 50% of the license fees we receive, against specified losses
relating to, among other things:
. the use of patent rights and technical information relating
to the Syntroleum Process,
. acts or omissions by us in connection with our preparation
of process design packages for plants, and
. performance guarantees that may be provided by us.
Our indemnification obligations could result in substantial expenses
and liabilities to us in the event that intellectual property rights claims
are made against us or our licensees, or GTL plants based on the Syntroleum
Process fail to operate as designed.
If improvements to the Syntroleum Process are not commercially
viable, the design and construction of lower-cost GTL plants based on the
Syntroleum Process could be delayed or prevented.
20
A number of improvements to the Syntroleum Process are in various
early stages of development. These improvements will require substantial
additional investment, development and testing prior to their
commercialization. We might not be successful in developing these improvements
and, if developed, they may not be capable of being utilized on a commercial
basis. If improvements to the Syntroleum Process currently under development do
not become commercially viable on a timely basis, the total potential market
for GTL plants that could be built by us and our partners and by our licensees
could be significantly limited.
For example, we are seeking to develop improvements to the heat
integration of the Syntroleum Process designed to lower capital and operating
costs. These improvements may not occur because further integration of the gas
turbine into the process might not be technically feasible due to the operating
tolerances of the materials in the gas turbine.
Industry rejection of our technology would make the construction of
GTL plants based on the Syntroleum Process more difficult or impossible and
adversely affect our ability to receive future license fees.
As is typical in the case of any evolving technology, demand and
industry acceptance for our GTL technology is subject to a high level of
uncertainty. Failure by the industry to accept our technology would make our
construction of GTL plants more difficult or impossible and adversely affect
our ability to receive future license fees and to generate other revenue.
Should a high profile industry participant adopt the Syntroleum Process and
fail to achieve success or should any commercial GTL plant based on the
Syntroleum Process fail to achieve success, other industry participants'
perception of the Syntroleum Process could be adversely affected. In addition,
some oil companies may be motivated to seek to prevent industry acceptance of
GTL technology based on their belief that widespread adoption of GTL technology
might negatively impact their competitive position.
RISKS RELATING TO OUR BUSINESS
We will need to obtain funds from additional financings or other
sources for the Sweetwater project and our other business activities. If we do
not receive these funds, we would need to reduce, delay or eliminate some of
our expenditures, including those for the Sweetwater project.
We have expended and will continue to expend a substantial amount of
funds to continue the research and development of our technologies, to market
the Syntroleum Process and to design and construct GTL plants. We intend to
finance the Sweetwater plant primarily through non-recourse debt financing at
the project level, as well as equity financing, and plan to obtain additional
funds for our GTL plant projects primarily through a combination of equity and
debt project financing. We also intend to obtain additional funds through
collaborative or other arrangements with strategic partners and others and debt
and equity financing in the capital markets. Financing may not be available
when needed or on terms acceptable or favorable to us. In addition, we expect
that definitive agreements with equity and debt participants in the Sweetwater
project and our other capital projects will include conditions to funding, many
of which could be outside of our control. If adequate funds are not available,
we would be required to delay or to eliminate expenditures for the Sweetwater
project and may be required to reduce, delay or eliminate expenditures for our
other capital projects, research and development, and other activities. We
could also be forced to license to third parties the rights to commercialize
additional products or technologies that we would otherwise seek to develop
ourselves. If we obtain additional funds by issuing equity securities, dilution
to stockholders may occur. In addition, preferred stock could be issued in the
future without stockholder approval and the terms of our preferred stock could
include dividend, liquidation, conversion, voting and other rights that are
more favorable than the rights of the holders of our common stock.
Assuming the commercial success of the plants based on the Syntroleum
Process, we expect that license fees, catalyst sales and sales of specialty
products from GTL plants in which we own an interest will be a source of funds
for operations. However, we may not receive any of these revenues, and these
revenues may not be sufficient for capital expenditures or operations and may
not be received within expected time frames. If we are unable to generate funds
from operations, our need to obtain funds through financing activities will be
increased.
The construction of the Sweetwater plant and other GTL plants based on
the Syntroleum Process will be subject to the risks of delay and cost overruns
inherent in any large construction project.
The construction of GTL plants based on the Syntroleum Process,
including the Sweetwater plant currently under development in Western
Australia, will be subject to the risks of delay or cost overruns inherent in
any large construction project resulting from numerous factors, including the
following:
21
. shortages of equipment, materials or skilled labor,
. unscheduled delays in the delivery of ordered materials and
equipment,
. engineering problems, including those relating to the
commissioning of newly designed equipment,
. work stoppages,
. weather interference,
. unanticipated cost increases, and
. difficulty in obtaining necessary permits or approvals.
We have incurred losses and anticipate continued losses.
As of December 31, 2001, we had an accumulated deficit of $99 million.
We have not yet achieved profitability and expect to continue to incur net
losses until we recognize sufficient revenues from licensing activities, GTL
plants or other sources. Because we do not have an operating history upon which
an evaluation of our prospects can be based, our prospects must be considered
in light of the risks, expenses and difficulties frequently encountered by
small companies seeking to develop new and rapidly evolving technologies. To
address these risks, we must, among other things, continue to attract
investment capital, respond to competitive factors, continue to attract, retain
and motivate qualified personnel and commercialize and continue to upgrade our
GTL technologies. We may not be successful in addressing these risks. We cannot
assure you that we will achieve or sustain profitability.
Our anticipated expense levels are based in part on our expectations
as to future operating activities and not on historical financial data. We plan
to continue to fund research and development and project development
activities. Capital expenditures will depend on the progress we make in
developing various GTL projects on which we are currently working. Increased
revenues or cash flows may not result from these expenses.
The economic application of GTL plants based on the Syntroleum Process
depends on favorable crude oil prices and other commodity prices.
Our belief that the Syntroleum Process can be cost effective at GTL
plants with throughput levels under 10,000 to over 100,000 barrels per day is
based on our assumption that oil prices in the range of at least $15 to $20 per
barrel will prevail. However, the markets for oil and natural gas have
historically been very volatile and are likely to continue to be very volatile
in the future. Although world crude oil prices were approximately $18 per
barrel in December 2001, during 1998 crude oil prices fell to historically low
levels of below $10 per barrel for a period of time and could return to low
levels in the future.
Because the synthetic crude oil, liquid fuels and specialty products
that GTL plants based on the Syntroleum Process are expected to produce will
compete in markets with oil and refined petroleum products, and because natural
gas will be used as the feedstock at these GTL plants, an increase in natural
gas prices relative to prices for oil and refined products, or a decrease in
prices for oil and refined products, could adversely affect the operating
results of these plants. Higher than anticipated costs for the catalysts and
other materials used in these plants could also adversely affect operating
results. Factors that could cause changes in the prices and availability of
oil, natural gas and refined products include:
. the level of consumer product demand,
. weather conditions,
. domestic and foreign government regulation,
. the actions of the Organization of Petroleum Exporting
Countries,
. political conditions in oil and natural gas producing
countries,
22
. the supply of foreign crude oil and natural gas,
. the location of GTL plants relative to natural gas reserves
and pipelines,
. the capacities of pipelines,
. fluctuations in seasonal demand, and
. the price and availability of alternative fuels and overall
economic conditions.
We cannot predict the future markets and prices for oil, natural gas,
or other materials used in the Syntroleum Process or refined products.
The economic application of GTL plants based on the Syntroleum Process
depends on favorable plant operating conditions.
The economic application of GTL technology depends on favorable plant
operating conditions. Among the operating conditions that impact plant
economics are the site location, infrastructure, weather conditions, the size
of the equipment, the quality of the natural gas feedstock, the type of plant
products and whether the natural gas converted by the plant is associated with
oil reserves. For example, if a plant were located in an area that requires the
construction of substantial infrastructure, plant economics would be adversely
affected. In addition, plants that are not designed to produce specialty
products or other high margin products and plants that are not used to convert
natural gas that is associated with oil reserves will be more dependent on
favorable natural gas and oil prices than plants designed for those uses. We do
not expect these plants to be cost-effective at price levels below the range of
at least $15 to $20 per barrel for oil.
GTL plants will depend on the availability of natural gas at economic
prices, and alternative uses of natural gas could be preferred in many
circumstances.
The construction and operation of GTL plants will depend on the
availability of natural gas at economic prices. The market for natural gas is
highly competitive in many areas of the world, and in many circumstances, the
sale of natural gas for use as a feedstock in a GTL plant will not be the
highest value market for the owner of the natural gas. The cryogenic conversion
of natural gas to liquefied natural gas may compete with our GTL plants for use
of natural gas as feedstocks in many locations. Local commercial, residential
and industrial consumer markets, power generation, ammonia, methanol and
petrochemicals are also alternative markets for natural gas. Unlike us, many of
our competitors also produce or have access to large volumes of natural gas,
which may be used in connection with their GTL operations. The availability of
natural gas at economic prices for use as a feedstock for GTL plants may also
depend on the production costs for the gas and whether natural gas pipelines
are located in the areas where these plants are located. New pipelines may be
built in, or existing pipelines may be expanded into, areas where GTL plants
are built, and this may affect the operating margins of these plants as other
markets compete for the available natural gas. The United States and Western
Europe have well-developed natural gas markets. In these markets, the
relationship between natural gas prices and liquid hydrocarbon prices would
likely make investments in GTL plants that produce fuels uneconomic based upon
current natural gas and refined product prices, as well as other market,
environmental and regulatory conditions. Other areas around the world that have
developed local markets for natural gas may also have higher valued uses for
natural gas than as feedstocks for GTL plants. In addition, the
commercialization of GTL technologies may have an adverse effect on the
availability of natural gas at economic prices.
Our receipt of license fees depends on substantial efforts by our
licensees, and our licensees could choose not to construct a GTL plant based on
the Syntroleum Process or to pursue alternative GTL technologies.
Our licensees will control whether we issue any plant site licenses
and, as a result, whether we receive any additional license fees under our
license agreements. To date, no licensee of the Syntroleum Process has
exercised its right to obtain a site license. Under most circumstances, a
licensee will need to undertake substantial activities and investments before
we issue any plant site licenses and receive license fees. These activities may
include performing feasibility studies, obtaining regulatory approvals and
permits, obtaining preliminary cost estimates and final design and engineering
for the plant, obtaining a sufficient dedicated supply of natural gas,
obtaining adequate commitments for the purchase of the plant's products and
obtaining financing for construction of the plant. A licensee will control the
amount and timing of resources devoted to these activities. Whether licensees
are willing to expend the resources
23
necessary to construct GTL plants will depend on a variety of factors outside
our control, including the prevailing view of prices for crude oil, natural gas
and refined products. In addition, our license agreements may be terminated by
the licensee, with or without cause, upon 90 days' notice to us. If we do not
receive payments under our license agreements, we may not have sufficient
resources to implement our business strategy. Our licensees are not restricted
from pursuing alternative GTL technologies on their own or in collaboration
with others, including our competitors.
Our success depends on the performance of our executive officers, the
loss of whom would disrupt our business operations.
We depend to a large extent on the performance of our executive
officers, including Kenneth L. Agee, our founder, Chief Executive Officer and
Chairman of the Board and inventor with respect to many of our patents and
patent applications, and Mark A. Agee, our President and Chief Operating
Officer. Given the technological nature of our business, we also depend on our
scientific and technical personnel. Our efforts to develop and commercialize
our technology have placed a significant strain on our scientific and technical
personnel, as well as our operational and administrative resources. Our ability
to implement our business strategy may be constrained, and the timing of
implementation may be impacted, if we are unable to attract and retain
sufficient personnel. At March 1, 2002, we had 125 full-time employees. Except
for a $500,000 life insurance policy held by us on the life of Kenneth L. Agee,
we do not maintain "key person" life insurance policies on any of our employees.
We depend on strategic relationships with manufacturing and
engineering companies. If these companies fail to provide necessary components
or services, this could negatively impact our business.
We intend to, and believe our licensees will, utilize third party
component manufacturers in the design and construction of GTL plants based on
the Syntroleum Process. If any third party manufacturer is unable to acquire
raw materials or to provide components of GTL plants based on the Syntroleum
Process in commercial quantities in a timely manner and within specifications,
we or our licensees could experience material delays, or construction plans
could be canceled, while alternative suppliers or manufacturers are identified
and prepare for production. We have no experience in manufacturing and do not
have any manufacturing facilities. Consequently, we will depend on third
parties to manufacture components of GTL plants based on the Syntroleum
Process. We have conducted development activities with third parties relating
to our proprietary catalysts and turbines that may be used in the Syntroleum
Process, and other manufacturing companies may not have the same expertise as
these companies.
We also intend to utilize third parties to provide engineering
services in connection with our efforts to commercialize the Syntroleum
Process. If these engineering firms are unable to provide requisite services or
performance guarantees, we or our licensees could experience material delays,
or construction plans could be canceled, while alternative engineering firms
are identified and become familiar with the Syntroleum Process. We have limited
experience in providing engineering services and have a limited engineering
staff. Consequently, we will depend on third parties to provide necessary
engineering services, and these firms may be asked by licensees or financial
participants in plants to provide performance guarantees in connection with the
design and construction of GTL plants based on the Syntroleum Process.
Our operating results may be volatile due to a variety of factors and
are not a meaningful indicator of future performance.
We expect to experience significant fluctuations in future annual and
quarterly operating results because of the unpredictability of many factors
that impact our business. These factors include:
. timing of any construction by us or our licensees of GTL
plants,
. demand for licenses of the Syntroleum Process and receipt
and revenue recognition of license fees,
. oil and gas prices,
. timing and amount of research and development expenditures,
. demand for synthetic fuels and specialty products,
. introduction or enhancement of GTL technologies by us and
our competitors,
24
. market acceptance of new technologies, and
. general economic conditions.
As a result, we believe that period-to-period comparisons of our
results of operations are not meaningful and should not be relied upon as any
indication of future performance. Due to all of the foregoing factors, it may
be that in some future year or quarter our operating results will be below the
expectations of public market analysts and investors. In that event, the price
of our common stock would likely be materially adversely affected.
We are subject to extensive laws relating to the protection of the
environment, and these laws may increase the cost of designing, constructing
and operating our GTL plants.
If we violate any of the laws and regulations relating to the
protection of the environment, we may be subject to substantial fines, criminal
sanctions or third party lawsuits and may be required to install costly
pollution control equipment or, in some extreme cases, curtail operations. Our
GTL plants will generally be required to obtain permits under applicable
environmental laws and various permits for industrial siting and construction.
Compliance with environmental laws and regulations, and any requisite
environmental or construction permits, may increase the costs of designing,
constructing and operating our GTL plants. We may also face exposure to actual
or potential claims and lawsuits involving environmental matters with respect
to our current real estate inventory as well as previously owned real estate.
We plan to construct GTL plants in foreign countries, where we would
be subject to risks of a political nature and other risks inherent in foreign
operations.
We plan to construct GTL plants in foreign countries, where we would
be subject to risks of a political nature and other risks inherent in foreign
operations. These risks include changes in domestic and foreign taxation,
currency exchange risks, labor disputes and uncertain political and economic
environments as well as risk of war, terrorism, civil disturbances or other
events that could limit or disrupt production and markets or result in the
deprivation of contract rights or the taking of property by nationalization or
appropriation without fair compensation. International operations and
investments may also be adversely affected by laws and policies of the United
States affecting foreign trade, investment and taxation, which could affect the
conduct or profitability of these operations.
Recent terrorist attacks and United States military action could
result in a material adverse effect on our business.
On September 11, 2001, the United States was the target of terrorist
attacks of unprecedented scope. In October 2001, the United States commenced
military action in Afghanistan in response