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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 [FEE REQUIRED] FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998.
[_] TRANSITION REPORTING PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED] FOR THE TRANSITION PERIOD FROM
______ TO ______.
COMMISSION FILE NO. 0-21911
SYNTROLEUM CORPORATION
(Exact name of registrant as specified in its charter)
KANSAS 43-1764632
(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 25, 1999, the aggregate market value of the registrant's common stock
held by non-affiliates of the registrant was approximately $89,087.932 million
based on the closing price of such stock on such date of $5.63 per share
(assuming solely for this purpose that all of the registrant's directors,
executive officers and 10% stockholders are its affiliates).
At March 25, 1999, the number of outstanding shares of the registrant's common
stock was 26,900,052.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive proxy statement for the registrant's 1999 Annual
Meeting of Stockholders are incorporated by reference in Part III of this Form
10-K. Such definitive proxy statement will be filed with the Securities and
Exchange Commission not later than 120 days subsequent to December 31, 1998.
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TABLE OF CONTENTS
Page
PART I
Item 1. Business.................................................................................................... 1
Item 2. Properties.................................................................................................. 31
Item 3. Legal Proceedings........................................................................................... 31
Item 4. Submission of Matters to a Vote of Security Holders......................................................... 32
Executive Officers of the Registrant.................................................................................. 32
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters....................................... 35
Item 6. Selected Financial Data..................................................................................... 37
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations....................... 38
Item 7A. Quantitative and Qualitative Disclosures about Market Risk.................................................. 49
Item 8. Financial Statements and Supplementary Data................................................................. 49
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure........................ 49
PART III
Item 10. Directors and Executive Officers of the Registrant.......................................................... 49
Item 11. Executive Compensation...................................................................................... 49
Item 12. Security Ownership of Certain Beneficial Owners and Management.............................................. 50
Item 13. Certain Relationships and Related Party Transactions........................................................ 50
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K............................................ 50
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, anticipated costs to design, construct
and operate such plants, the timing of commencement and completion of the design
and construction of such plants, obtaining required financing for such plants,
the economic construction and operation of GTL plants, including the value and
markets for products produced by such plants, the continued development of the
Syntroleum Process (alone or with partners), anticipated capital expenditures,
anticipated revenues, the sale of Syntroleum's real estate inventory and any
other statements regarding future growth, cash needs, operations, business plans
and financial results. When used in this document the words "anticipate,"
"believe," "estimate," "expect," "intend," "may," "plans," "project," "should"
and similar expressions are intended to be among the statements that identify
forward-looking statements. Although Syntroleum believes that the expectations
reflected in these forward-looking statements are reasonable, such statements
involve risks and uncertainties and 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 potential
that the cost of designing and constructing commercial-scale GTL plants will
exceed current estimates, commercial-scale GTL plants will not achieve the same
results as those demonstrated on a laboratory or pilot basis or that such plants
will experience technological and mechanical problems, the potential that
improvements to the Syntroleum Process currently under development may not be
successful, the impact on plant economics of operating conditions (including
energy prices), competition, intellectual property risks, Syntroleum's ability
to obtain financing and other risks described in this Annual Report on Form 10K.
-ii-
MERGER TRANSACTION
Pursuant to an Agreement and Plan of Merger dated as of March 30, 1998 by
and between Syntroleum Corporation, an Oklahoma corporation ("Old Syntroleum"),
and SLH Corporation, a Kansas corporation ("SLH"), effective August 7, 1998, (1)
Old Syntroleum merged (the "Merger") with and into SLH, with SLH being the
surviving corporation (the survivor of the Merger, together with its
subsidiaries and predecessors, is referred to as "Syntroleum" or the "Company"),
(2) SLH changed its name to "Syntroleum Corporation" and (3) the other
transactions relating to the Merger were effected. The Merger and related
transactions are more fully described in the Joint Proxy Statement/Prospectus
filed with the Securities and Exchange Commission on July 6, 1998.
-iii-
PART I
Item 1. Business
Overview
Syntroleum is the developer and owner of a proprietary process (the
"Syntroleum Process") designed to catalytically convert natural gas into
synthetic liquid hydrocarbons ("gas to liquids" or "GTL"). The Syntroleum
Process is a simplification of traditional GTL technologies aimed at
substantially reducing both the capital cost and the minimum economical size of
a GTL plant, as well as plant operating costs. A unique characteristic and
primary advantage of the Syntroleum Process over competing processes is its use
of air, rather than pure oxygen, in the conversion process. Syntroleum believes
that the Syntroleum Process can, in some circumstances, be cost effective in GTL
plants with throughput levels ranging from 2,000 to 50,000 barrels per day and
larger. Due to their relatively small footprint, Syntroleum believes that GTL
plants based on the Syntroleum Process can be placed on skids, barges and ocean-
going vessels, allowing these mobile plants to be used at a variety of
locations, including isolated and offshore areas. Although no commercial-scale
GTL plant based on the Syntroleum Process has yet been built, Syntroleum owns
and operates a nominal two barrel per day pilot plant in Tulsa, Oklahoma, where
it has successfully demonstrated certain elements and variations of the
Syntroleum Process.
GTL plants can be designed to refine the synthetic liquid hydrocarbons
(also known as "synthetic crude oil") produced by the Syntroleum Process into
higher margin liquid fuels such as diesel, kerosene and naphtha, or specialty
products such as synthetic lubricants, synthetic drilling fluid, waxes, liquid
normal paraffins and certain chemical feedstocks. Synthetic crude oil produced
by the Syntroleum Process has certain performance and environmental benefits and
is substantially free of contaminants normally found in crude oil, such as
sulphur, aromatics and heavy metals.
Syntroleum believes that a significant opportunity exists for the use
of cost-effective GTL plants due to the large resource base of natural gas
worldwide and the large volume of natural gas that is currently stranded.
Stranded gas exists in reservoirs that have been discovered but for which no
economical market has been found. The United States Department of Energy has
reported worldwide identified natural gas reserves of 5,011 trillion cubic feet
as of January 1, 1996. Wood MacKenzie Consultants Limited ("Wood MacKenzie") and
others have estimated that of the world's identified natural gas reserves,
approximately one-half, or 2,500 trillion cubic feet, are stranded. This
stranded gas would generally be convertible into approximately 250 billion
barrels of synthetic crude oil using GTL technology. According to industry
sources, approximately 15.5 trillion cubic feet of stranded natural gas was
flared, vented or reinjected in 1996. This gas would generally be convertible
into approximately 1.5 billion barrels of synthetic crude oil per year (4.1
million barrels per day) using GTL technology.
Business Strategy
Syntroleum's objective is to be a leading GTL technology provider to
the oil and gas industry. Its business strategy to achieve this objective
involves the following key elements.
Broadly License the Syntroleum Process. Syntroleum intends to continue
offering licenses to the Syntroleum Process and related proprietary catalysts to
the oil and gas industry for the production of synthetic crude oil and liquid
fuels primarily outside of North America. To date, Syntroleum has entered into
license agreements with Texaco Inc. ("Texaco"), Atlantic Richfield Company
("ARCO"), Marathon Oil Company ("Marathon"), YPF International, Ltd., an
affiliate of Argentina-based Yacimientos Petroliferos Fiscales, S.A. ("YPF"),
Enron Capital & Trade Resources Corp. ("Enron") and Kerr-McGee Corporation
("Kerr McGee"). Syntroleum believes that substantial long-term revenues can be
derived from license fees and catalyst sales to licensees.
To support its licensing efforts and facilitate the design and
construction of GTL plants by licensees, Syntroleum intends to continue to
establish relationships with engineering companies and manufacturers of critical
-1-
components. Syntroleum has established strategic relationships with the
engineering firms of Bateman Engineering, Inc. ("Bateman"), Kellogg Brown &
Root, Inc. ("Kellogg Brown & Root") and AMEC Process and Energy Limited
("AMEC"). In addition, Syntroleum has established strategic relationships with
critical component and process vendors, including Criterion Catalyst Company,
L.P. ("Criterion") (a catalyst manufacturer whose owners are Royal Dutch Shell
Petroleum Company ("Shell") and Cytec Industries), Catalytica Combustion
Systems, Inc. ("Catalytica Combustion Systems"), GE Power Systems ("GE Power
Systems") and Lyondell Chemical Company ("Lyondell"). Syntroleum is actively
pursuing similar relationships with other engineering companies and component
vendors.
Syntroleum generally obtains title or exclusive rights to inventions
or improvements that result from its joint development activities with others.
Under its license agreements, Syntroleum obtains royalty-free license rights,
including sublicense rights, to all inventions or improvements relating to the
Syntroleum Process that are commercially used by its licensees. As a result of
these rights, Syntroleum believes that widespread licensing, combined with
Syntroleum's research and development activities to further improve the
Syntroleum Process, will enhance Syntroleum's ability to gain an advantage over
competing technologies and allow Syntroleum to strengthen its relationships with
existing licensees and attract new licensees.
Own Specialty Product GTL Plants. Syntroleum intends to establish
joint ventures with its licensees and other oil and gas industry partners and/or
financial partners to design, construct and operate GTL plants designed to
produce fuels and high margin specialty products. Syntroleum's license
agreements do not permit licensees to use the Syntroleum Process for the
production of specialty products due to Syntroleum's desire to retain these
markets for its own commercial development. Syntroleum has formed a joint
venture with Enron with respect to the development of a proposed 8,000 barrel
per day GTL plant and is currently in discussions with several other potential
participants in this joint venture. Specialty product plants would enable
Syntroleum to gain experience with the commercial operation of plants based on
the Syntroleum Process and, if successful, would provide more consistent
revenues than license fees.
Provide Mobile GTL Plants on a Contract Basis. Syntroleum intends to
make available mobile GTL plants to customers on a contract basis through
efforts with industry partners and others. Syntroleum believes that significant
market potential exists for these mobile GTL plants in various applications,
including: (1) extended well testing in areas with stringent flaring
regulations; (2) conversion of small associated gas fields that are not large
enough to justify the capital investment of a permanent GTL plant; and (3)
short-term use of a GTL plant on large fields in order to generate cash flow
while a permanent GTL plant is being built or while awaiting pipeline
connection.
Further Reduce Costs Through Research and Development Activities and
Acquisitions. Syntroleum intends to continue its research and development
activities with a focus on developing further improvements to the Syntroleum
Process and further reducing the capital and operating costs of GTL plants based
on the Syntroleum Process. Syntroleum conducts its research and development
activities utilizing its own resources and through joint development
arrangements with its licensees and other industry partners. Texaco, ARCO,
Marathon, Bateman, GE Power Systems, DaimlerChrysler AG ("DaimlerChrysler") and
AGC Manufacturing Services, Inc. ("AGC") have participated or are currently
participating in specific joint development projects with Syntroleum. In
addition, Syntroleum has a catalyst research and development relationship with
Catalytica Advanced Technologies, Inc. ("Catalytica Advanced Technologies").
Syntroleum is actively pursuing similar relationships with other oil and gas
companies, engineering companies and technology providers as potential joint
development partners or providers of complementary technologies that might
enhance or improve the Syntroleum Process.
Syntroleum also reviews technological advances made by others and
actively seeks to acquire technologies that enhance the Syntroleum Process.
Through its license and joint development agreements, Syntroleum has acquired
various proprietary technologies, patents and patent applications relating to
several improvements to the Syntroleum Process.
-2-
Syntroleum believes that the network created through its license and
joint development agreements, along with its strategic alliances with
engineering companies and critical component vendors, will allow Syntroleum to
more rapidly commercialize and improve the Syntroleum Process. Syntroleum also
believes that this network will provide Syntroleum and its licensees with an
important competitive advantage and enhance Syntroleum's ability to attract
additional licensees and joint development partners.
Syntroleum's major customers for licensing and contract GTL plants are
expected to be energy companies worldwide with significant stranded natural gas
reserves that cannot be economically marketed and are therefore generally shut-
in, flared or reinjected. Syntroleum believes that these energy companies could
significantly enhance the value of their reserves by using the Syntroleum
Process to convert such natural gas into liquids that could be economically
marketed. Syntroleum's major customers for specialty products are expected to
include many of these energy companies, as well as a variety of manufacturing,
chemical, refining and oil field service companies.
Industry Overview
Syntroleum believes that significant opportunity exists for the use of
cost-effective GTL plants due to (1) the large volume of natural gas that is
currently stranded and (2) the significant liquid hydrocarbon markets available
to absorb the production from GTL plants.
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. Syntroleum compiled these estimates
of identified reserves from the referenced industry publications and other
publicly available reports to identify the order of magnitude of the oil and gas
resource base and does not purport to have independently verified this
information. Accordingly, no assurance can be given 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 convertibility 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 such variance may be material.
Natural Gas Resource Base
The world's natural gas resource base is very large. The United States
Department of Energy has reported worldwide identified natural gas reserves of
approximately 5,011 trillion cubic feet as of January 1, 1996. This gas would
generally be convertible into approximately 500 billion barrels of synthetic
crude oil using GTL technology.
The following table presents the 1996 worldwide identified natural gas
reserves, consumption and ratio of reserves to consumption (i.e., reserve life)
by region.
-3-
1996 Worldwide Natural Gas Reserves, Consumption and Reserve Life
Reserves to
Consumption
1996 Ratio
Region Reserves Consumption (Reserve Life)
------ -------- ----------- --------------
(trillion (trillion (years)
cubic feet) cubic feet)
Central and South America........................................... 214 3.0 71
Africa and the Middle East.......................................... 1,960 6.0 327
Asia................................................................ 363 8.0 45
Europe.............................................................. 169 12.3 14
North America....................................................... 299 26.0 11
Russia and other former Soviet Union regions........................ 2,006 22.0 91
----- ---- ---
Total.......................................................... 5,011 77.3 65
===== ==== ===
- --------------------
Source: Oil & Gas Journal, August 11, 1997
Additionally, according to the August 11, 1997 edition of the Oil &
Gas Journal, identified natural gas reserves have been growing at a rapid rate,
almost doubling in size from 2,540 trillion cubic feet in 1976 to 5,011 trillion
cubic feet in 1996. This has extended the reserve life for worldwide identified
reserves from 53 years in 1976 to 65 years in 1996. This increase occurred
despite the fact that, over the same time frame, demand for natural gas
increased 60%. Syntroleum believes these statistics demonstrate the need for a
cost-effective market for this growing resource.
Natural Gas Field Size Distribution
The table below lists an estimate of the distribution by field size of
natural gas fields located outside North America. Only 86 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 liquid natural
gas plant. Syntroleum believes that fields with natural gas reserves as low as
.01 trillion cubic feet will be able to economically support a GTL plant based
on the Syntroleum Process. As a result, Syntroleum believes that, based on
field size and portability, GTL plants based on the Syntroleum Process can
potentially access over 2,000 of these fields, holding approximately 95% of the
reserves held in such fields.
The World's Natural Gas Fields
Reserves Number of Fields
-------- ----------------
(Trillion cubic feet)
Between 50 and 500......................... 15
Between 5 and 50........................... 71
Between 1 and 5............................ 234
Between .5 and 1........................... 269
Between .25 and .5......................... 276
Between .1 and .25......................... 475
Between .01 and .1.........................1,195
Less than .01..............................1,913
-----
4,448
=====
- --------------------
Source: Oil & Gas Journal, February 15, 1993
-4-
Stranded Natural Gas Reserves
Wood MacKenzie and others have estimated that of the world's
identified natural gas reserves, approximately one-half, or 2,500 trillion cubic
feet, are stranded. This stranded gas would generally be convertible into
approximately 250 billion barrels of synthetic crude oil using GTL technology.
The term "stranded gas" generally refers to gas which exists in
reservoirs that have been discovered, but no economical market can be found for
the production or production would be too prolific for the limited markets
available. Natural gas that is stranded can be managed in the following ways.
Shut-in Natural Gas. When stranded natural gas reserves have no
associated oil reserves, the natural gas is typically not produced. Based on a
resource study prepared for Syntroleum by Petroconsultants, Inc.
("Petroconsultants"), there are at least 394 fields of at least .5 trillion
cubic feet located outside North America that are not associated with oil
reserves and hold approximately 1,488 trillion cubic feet of currently
unmarketable natural gas reserves. This gas would generally be convertible into
approximately 149 billion barrels of synthetic crude oil using GTL technology.
Flared and Vented Natural Gas. When stranded natural gas reserves are
associated with oil reserves, the natural gas produced is typically flared or
vented if allowed by applicable law. According to industry sources, an aggregate
of approximately 4.1 trillion cubic feet of natural gas was flared or vented
worldwide in 1996. This gas would generally be convertible into approximately
one million barrels per day of synthetic crude oil using GTL technology.
Re-injected Natural Gas. When flaring is not permitted by law and the
nature of the geologic formation permits, stranded natural gas is often
reinjected when associated with oil reserves. According to industry sources,
approximately 11.4 trillion cubic feet of natural gas was reinjected worldwide
in 1996. This gas would generally be convertible into approximately three
million barrels per day of synthetic crude oil using GTL technology.
Shut-in Oil. The presence of natural gas in association with oil
reserves often results in the oil and gas not being produced if flaring is not
permitted by law and reinjection of the natural gas is not a practical
alternative due to the nature of the geologic formation or the economics of the
project. Syntroleum is not aware of any published estimates of shut-in oil
reserves.
The large amount of stranded natural gas is caused by four primary
factors: the overall size of the gas resource base and the relatively small size
of many fields (as discussed above), the location of the gas relative to its
markets, the cost to transport the gas to those markets and the relatively small
size of the markets for products such as ammonia and methanol that can be made
from the gas.
Location of Gas Relative to Markets. Much of the world's stranded
natural gas is located in areas where there is no local market and the distance
to large consuming areas is great. This makes transportation costs high and
often renders development projects uneconomic. As shown in the table under "--
Industry Overview-Natural Gas Resource Base", the Africa and the Middle East and
Russia and other former Soviet Union regions have a large percentage of
reserves, low levels of production and reserves that are long distances from gas
markets. This situation creates stranded gas which is manifested in the high
reserve to production ratios shown.
Transportation Costs. 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. For example, according to published pipeline tariffs, the cost
to transport natural gas approximately 1,600 miles via pipeline from Houston to
Boston is approximately $.80 per million British thermal units, equal to $4.80
per barrel of oil equivalent (assuming 6 million British thermal units per
barrel), while the cost to transport crude oil from the Middle East via tanker
to Boston, a distance of approximately 6,500 miles, is less than $1.00 per
barrel.
-5-
Natural gas can also be transported as liquefied natural gas. In an
article published in the July 3, 1995 edition of the Oil & Gas Journal, Mobil
Oil Corporation estimated that a five million ton per year liquefied natural gas
plant would incur capital costs of between $9 and $13 billion (including
conversion plant, dedicated liquefied natural gas tankers and regasification
facilities). On the other hand, Syntroleum estimates that a GTL plant producing
the same energy output would cost substantially less than this amount and would
not require dedicated shipping or unloading facilities.
Small Alternative Natural Gas Markets. Syntroleum estimates that the
worldwide liquefied natural gas market is approximately 1.2 million equivalent
barrels per day, which is relatively small compared to the approximately 57
million barrels per day transportation fuels markets. Natural gas can also be
converted to products such as ammonia and methanol. Syntroleum currently
estimates that the market for ammonia on a barrel of oil equivalent basis is
approximately 780,000 barrels per day and the market for methanol on a barrel of
oil equivalent basis is approximately 280,000 barrels per day. These markets are
small relative to the size of the worldwide natural gas resource base and
relative to the approximately 74 million barrels per day market for crude oil
and related products.
Markets for Synthetic Crude Oil Products
The markets for many of the products that can be produced using the
Syntroleum Process and conventional refining techniques are very large. As a
result, Syntroleum believes that even if substantial volumes of synthetic crude
oil created from natural gas were to flow into these markets, these additional
volumes would not cause a significant degradation of price. The following table
presents the worldwide consumption of refined petroleum products for the years
1986, 1991 and 1996.
Worldwide Consumption of Refined Petroleum Products
Product 1986 1991 1996
- ------- ------ ------ ------
(millions of barrels)
Gasolines (1)......................... 5,022 5,609 6,431
Middle Distillates (2)................ 6,012 6,820 8,253
Others (3)............................ 6,600 7,216 7,790
------ ------ ------
Total............................. 17,634 19,645 22,474
====== ====== ======
- --------------------
(1) Consists of aviation and motor gasoline and light distillate feedstock.
(2) Consists of jet and heating kerosenes and gas and diesel oils.
(3) Consists of fuel oil, refinery gas, propane, solvents, petroleum coke,
lubricants, bitumen, wax and refinery fuel and loss.
Source: The British Petroleum Company p.c. Statistical Review of World Energy,
1997.
The Syntroleum Solution
Syntroleum expects that the Syntroleum Process will be an attractive
solution for oil and gas companies with stranded natural gas reserves based on
its belief that the Syntroleum Process can be:
. a relatively low cost process
. used in relatively small formats
. adaptable to feedstock quality, the location of the reserves and the
desired end products
-6-
. made portable in sizes up to 10,000 barrels per day
Low Cost. Historically, the most significant obstacle to widespread
commercial use of GTL technology has been cost. Because the Syntroleum Process
is less complex than traditional GTL technologies, Syntroleum believes that GTL
plants based on the Syntroleum Process will have lower capital and operating
costs than comparable-sized GTL plants based on traditional technology.
Small Formats. Given the large number of small fields containing
unmarketable natural gas, GTL plants that are economic only at high levels of
throughput have limited application. For example, of the 4,448 natural gas
fields located outside North America shown in the table under "Industry
Overview-Natural Gas Field Size Distribution," (1) approximately 86 contain
sufficient reserves to support a 50,000 barrel per day plant, (2) approximately
234 contain sufficient reserves to support a 10,000 to 50,000 barrel per day
plant, (3) approximately 269 contain sufficient reserves to support a 5,000 to
10,000 barrel per day plant, and (4) approximately 275 contain sufficient
reserves to support a 2,500 to 5,000 barrel per day plant, in each case for a
typical 30-year plant life. In addition, approximately 1,670 of these 4,448
fields contain sufficient reserves to support a 2,000-barrel-per-day plant for
less than a 30-year plant life. Syntroleum believes that GTL plants based on
the Syntroleum Process can be cost-effective at throughput levels as low as
2,000 barrels per day and consequently could potentially be used at over 50% of
these 4,448 fields, representing over 95% of the total reserves held in all of
such fields.
Adaptable. Syntroleum also believes that GTL plants based on the
Syntroleum Process can be adapted to use lower quality feedstock and can be
located in isolated and remote locations. For example, Syntroleum believes that
impurities such as nitrogen and carbon dioxide will not need to be completely
removed in order for natural gas to be used as a feedstock in GTL plants based
on the Syntroleum Process. However, other impurities, such as sulfur compounds
or trace metals, must be removed from natural gas prior to processing. Due to
their relatively small footprint, Syntroleum believes GTL plants based on the
Syntroleum Process can be placed on skids, barges and ocean-going vessels,
allowing these plants to be used at a variety of locations, including isolated
and offshore areas where Syntroleum believes a majority of natural gas fields
are located. Moreover, because the Syntroleum Process is a net energy
generator, Syntroleum believes that these plants can be located in remote areas
without the need for any additional power supply.
Portable. Because of their high capital costs, gas pipelines and other
traditional methods for commercialization of natural gas resources require
significant reserves and established local markets to be economically feasible.
However, due to the potential portability of smaller-sized GTL plants based on
the Syntroleum Process, Syntroleum believes that these plants may in some
circumstances be used to convert smaller quantities of in-place reserves than
would be necessary to support a traditional project. Syntroleum also believes
that this portability, together with the global nature of the markets for liquid
hydrocarbons, will reduce the risk involved in GTL projects as compared to
traditional methods of commercialization.
Implementation of Syntroleum's Business Strategy
The following sets forth Syntroleum's progress to date in implementing
its business strategy. Although, Syntroleum has made significant progress
towards commercializing the Syntroleum Process, no assurance can be given that
licensees will construct any plants under their license agreements, that
financing for specialty product or mobile GTL plants will be obtained by
Syntroleum, 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 "Risks Relating to the Syntroleum Process" and "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Additional Financing Requirements and Access to Capital Funding."
-7-
Licensing Arrangements
Syntroleum currently markets four types of license agreements:
. Master license agreements, which generally grant 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, except in North America (due to
Syntroleum's desire to retain this region for its own commercial
development) and China and India (in each case due to intellectual
property protection concerns).
. Volume license agreements, which generally grant 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 in areas outside of North America, China and India, subject
to specified aggregate production capacity limits.
. Regional license agreements, which generally grant 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 (generally not expected to
include North America, China or India).
. Site license agreements, which generally grant 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 and may be
granted under Syntroleum's 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.
By entering into a master, volume or regional license agreement, a
licensee obtains the right to use the Syntroleum Process and to acquire
catalysts from Syntroleum, secures pricing terms for site licenses and obtains
rights to future improvements in Syntroleum's GTL technology. Syntroleum's first
license agreement was a master license agreement entered into with Texaco in
September 1996. To date, Syntroleum has also entered into master license
agreements with ARCO and Marathon, and has entered into volume license
agreements with YPF, Enron and Kerr-McGee. Syntroleum intends to continue to
market the Syntroleum Process for license primarily to major oil and gas
companies with significant stranded natural gas reserves.
The following description summarizes the principal terms and
conditions of the forms of Syntroleum's license agreements, does not purport to
be complete and is qualified in its entirety by reference to the form of
Syntroleum's master license agreement, a copy of which has been filed as an
exhibit to this Annual Report on Form 10-K. Agreements entered into with
specific licensees may differ in material respects from the current forms of
Syntroleum's license agreements.
Initial Deposits and License Fees. At the inception of a master,
volume or regional license agreement, the licensee is generally required to make
an initial deposit to Syntroleum, the amount of 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 location of the region covered. Syntroleum
has received an aggregate of $11 million in cash as initial deposits and option
fees under its existing license agreements. In some cases, Syntroleum has
acquired technologies or commitments to provide funding for future development
activities in lieu of initial cash deposits in cases where Syntroleum viewed
these technologies or commitments as being more valuable than the initial cash
deposit.
Generally, the amount of the license fee for site licenses under
Syntroleum's master, volume and regional license agreements is determined
pursuant to a formula based on the discounted present value of the product of
(1) the annual maximum design capacity of the plant, (2) an assumed life of the
plant and (3) Syntroleum's per barrel
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rate, which currently is approximately $.50 per barrel of daily capacity.
Syntroleum's license fees for new plants may change from time to time based on
the size of the plant, improvements that reduce plant capital cost and
competitive market conditions. Syntroleum's existing master and volume license
agreements allow for the adjustment of fees for new site licenses under certain
circumstances. Syntroleum expects that license fees under existing agreements
will be paid in increments when certain milestones during the plant design and
construction process are achieved.
Licensee Support. Syntroleum believes that support of its licensees
both before and after they have executed a license agreement is critical to
facilitate the development and construction of multiple GTL plants based on the
Syntroleum Process. Syntroleum intends to provide this support directly through
its internal engineering department and through its relationships with Bateman,
Kellogg Brown & Root, AMEC and other engineering companies and component
manufacturers. Syntroleum's engineers and business development managers seek to
establish support relationships with its licensees as they move through the
process of developing and constructing plants. Syntroleum has held and intends
to continue to hold educational seminars for its licensees and prospective
licensees that cover a variety of GTL topics, such as project evaluation, data
requirements for feasibility studies and different process designs.
Catalyst Sales and Process Design Packages. Syntroleum's license
agreements grant the licensee the right to acquire from Syntroleum or vendors
designated by Syntroleum any proprietary catalyst used in either the synthesis
gas reaction or the Fischer-Tropsch reaction, in each case at prices based on
Syntroleum's cost plus a margin. Syntroleum's license agreements require
Syntroleum's catalyst to be used in the initial fill for the licensee to receive
Syntroleum's process guarantee. After the initial fill, the licensee may use
other catalyst vendors if appropriate catalysts are available. Syntroleum
currently estimates that these catalysts will be required to be replaced every
three to five years. Licensees also have the right to acquire proprietary
reactors used in the Syntroleum Process from vendors approved by Syntroleum. In
addition, under Syntroleum's license agreements, licensees are required to
purchase a process design package for plants covered by the license from
Syntroleum at a fee based on Syntroleum's costs plus a specified margin.
Syntroleum may, however, develop the process design package with the assistance
of a third party. Syntroleum is also required to provide certain technical
support to licensees at specified fees.
Other License Terms. The term of a master, volume or regional license
agreement is generally the later of 15 years following its effective date or
five years following the effective date of the last site license issued under
the agreement. Rights of a licensee to acquire site licenses under Syntroleum's
master, volume and regional license agreements would survive a change of control
of Syntroleum.
Under its license agreements, Syntroleum acquires a royalty-free
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 certain of its other licensees). Licensees also acquire the right
to use subsequent inventions or improvements to the Syntroleum Process that have
been placed in commercial use or are suitable for commercial use for which
Syntroleum has royalty-free licensing rights and is offering to license to
others. Due to Syntroleum's desire to retain the rights to produce specialty
products for its own commercial development, each license agreement with non-
affiliates of Syntroleum currently provides that the licensee is entitled only
to produce synthetic crude oil and liquid fuels at plants based on the
Syntroleum Process and is not entitled to produce specialty products.
License agreements generally provide that Syntroleum is required to
indemnify the licensee against certain losses arising out of (1) the use of
patent rights and technical information relating to the Syntroleum Process and
(2) acts or omissions in the preparation and content of the process design
packages and certain other matters. Syntroleum anticipates that licensees may
require Syntroleum or an engineering firm to provide a process guarantee with
respect to certain elements of the Syntroleum Process as a condition to entering
into site license agreements. Under its existing license agreements,
Syntroleum's obligations under these indemnity provisions and any separate
process guarantees are, however, limited to 50% of the total fees received with
respect to each license.
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Specialty Product GTL Plants
Syntroleum intends to design and construct GTL plants that produce
specialty products, such as synthetic lubricants, synthetic drilling fluids,
waxes, liquid normal paraffins and certain chemical feedstocks. Syntroleum
intends to own these plants through joint ventures and retain significant equity
interests in these joint ventures. In most cases, these specialty plants will
require additional refining technologies and expertise to convert and separate
synthetic crude oil into the desired products.
Initial Specialty Product GTL Plant. In May 1997, Syntroleum formed a
joint venture through which Syntroleum intends to develop an 8,000 barrel per
day specialty product plant. The plant was initially planned to be constructed
in Sweetwater County, Wyoming. In addition to the Wyoming site, several
alternative sites at which lower cost natural gas could be obtained are
currently under consideration. Syntroleum has issued a site license and
contributed a total of $2 million to this joint venture. Syntroleum intends to
contribute an additional $15 million at the closing of the financing for the
plant and, based on current plans, would retain a majority interest in this
joint venture. However, if Syntroleum obtains additional capital, it may
increase such contribution and retain an additional interest. ENRON has
contributed $1 million in exchange for a four percent interest in the joint
venture and agreed to contribute an additional $14 million for an additional
seven percent interest upon closing of the financing for the plant. The capital
costs of this plant are currently expected to be funded by a combination of
project senior and subordinated debt and additional equity financing. Actual
ownership percentages may vary from current estimates depending on the terms of
subsequent financings.
Syntroleum currently expects that Bateman and another major
engineering firm will design and construct the plant. Syntroleum is the managing
member of this joint venture, but it may subcontract with a third party that
would manage the operations of the plant. Syntroleum currently anticipates that
this plant will produce lube oil, normal paraffins, drilling fluid, naphtha and
electricity.
Syntroleum is currently reviewing preliminary design and cost
estimates for the plant and exploring sources of debt and equity capital to fund
final design and construction. However, there can be no assurance that the
necessary capital for this project will be obtained. The schedule for
construction of this plant has not yet been finally determined. See "Item 7.
Management's Discussion and Analysis of Financial Condition and Result of
Operations."
The Joint Venture GTL Plant. In November 1997, Syntroleum, Texaco and
Kellogg Brown & Root entered into a project development agreement for the
development of a small GTL plant based on the Syntroleum Process. In July 1998,
the parties extended the term of the agreement to July 15, 1999. During the
third quarter of 1998, Kellogg Brown & Root informed Syntroleum of its decision
not to participate in the project as an equity holder while expressing an
interest in continuing to provide engineering and construction services to the
project. The project development agreement provides that Syntroleum and Texaco
will initially contribute up to $1.5 million to the project in cash and that
additional contributions may be made by the parties at or after the formation of
the joint venture. To date, the parties have spent approximately $1.3 million
on the project.
The first phase of the project, which involved preparation of a
feasibility study, has been completed. Because of the difficulty in attracting
the necessary capital for the project in the current climate of low oil and gas
prices, the project has been suspended. Syntroleum is currently reviewing
smaller plant designs capable of achieving similar objectives of the original
project and which Syntroleum believes would be capable of attracting the
necessary equity and/or debt capital for design and construction. Several of
Syntroleum's licensees have expressed interest in such a revised project.
However, there can be no assurance that this project will be resumed or that the
necessary capital will be obtained.
Additional Specialty Product GTL Plants. Pursuant to an agreement with
Texaco, Syntroleum granted to Texaco the right to participate with Syntroleum in
up to three specialty product GTL plants. Syntroleum is also in discussions with
several oil and gas companies and anticipates forming additional joint ventures
in order to finance,
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construct and operate additional specialty product GTL plants worldwide.
Syntroleum's plans for these plants will focus on partnering with companies who
have low-cost gas reserves in strategic locations and/or have distribution
networks in place for the specialty products to be produced in these plants.
Contract GTL Plants
Syntroleum believes that GTL plants based on the Syntroleum Process
can be placed on skids, barges and ocean-going vessels. Through efforts with
industry partners and others, Syntroleum intends to make available these mobile
GTL plants for use by oil and gas companies on a contract basis. Syntroleum
plans to make available contract services to customers that do not desire to
enter into a license agreement and build a licensed plant because (1) the
customer needs to conduct extended well testing in areas with stringent flaring
regulations, (2) the customer needs to use a GTL plant in small associated gas
fields that are not large enough to justify the capital investment of a
permanent GTL plant, (3) the customer needs to use a GTL plant on a short-term
basis on a large field in order to generate cash flow while a permanent GTL
plant is being built or while awaiting pipeline hookup, or (4) for other
reasons. Syntroleum anticipates that these plants would be designed so that they
would be operational at a variety of locations, which would enable the plants to
be relocated to new fields with minimal modifications.
Research and Development
One of Syntroleum's key strategies is to continue to lower the cost of
its GTL technology through research and development. Syntroleum's current
laboratory has 13 fixed tubular reactors, one HMX reactor, two moving bed slurry
reactors and three continuous stirred tank reactors in which automated tests are
run and catalyst systems are evaluated and developed. As of March 1, 1999,
Syntroleum had 38 employees in its laboratory, pilot plant and engineering
departments, 24 of which are chemists, engineers or other degreed professionals
(12 with masters or Ph.D. degrees) devoted to research and development
activities. A number of other chemists, engineers and professionals that are
employed by Syntroleum's licensees and joint development partners are also
contributing efforts to the further development of the Syntroleum Process.
Syntroleum has recently acquired an additional laboratory facility that contains
approximately 16,500 square feet and is located on approximately 100 acres of
land and plans to expand its research and pilot plant capabilities further at
this facility.
Syntroleum also has access to laboratory and test facilities through
its joint development partners. For example, both Texaco and ARCO have performed
catalyst tests at their own or contract facilities, and testing with Catalytica
and Marathon regarding low heating value gas combustion has been conducted at
Catalytica's and AGC's test facilities. Additionally, Syntroleum has its own
technical experts as well as access to the technical experts of its joint
development partners. Several of Syntroleum's joint development partners have
employees working on research and development activities related to improving
the Syntroleum Process.
Syntroleum's 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 Syntroleum's efforts in these
areas, see "The Syntroleum Process."
Strategic Relationships
Syntroleum has sought to rapidly improve and commercialize the
Syntroleum Process by entering into relationships with engineering companies,
component manufacturers and other companies that provide complementary expertise
and technology. Syntroleum believes that these relationships
. result in significant contributions toward the development and
commercialization of the Syntroleum Process
. contribute to Syntroleum's marketing program
. facilitate GTL market growth
. reduce competitive risks that smaller companies often face
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Syntroleum intends to continue to seek additional strategic partners with
expertise and technologies from which Syntroleum could benefit.
Although Syntroleum has entered into agreements with the following
strategic partners, no assurance can be given that these agreements will not be
terminated, that these relationships will continue, or that the anticipated
benefits of the relationships will be obtained. See "Risks Relating to the
Syntroleum Process."
Bateman
Bateman has been an important strategic partner of Syntroleum. Since
1993, Bateman has provided engineering services in connection with Syntroleum's
pilot plant and other aspects of Syntroleum's development of its GTL technology.
Pursuant to a project development agreement entered into between Bateman and
Syntroleum in March 1997, Syntroleum has agreed to utilize Bateman to assist in
the development of Syntroleum-owned specialty product GTL plants in North and
South America. Bateman is entitled to provide all process design packages, as
well as engineering, procurement, construction and project management services,
for the construction of such plants, provided that Bateman satisfies the
financial or performance criteria required by the parties providing equity and
debt financing for the plant. Under its agreement with Bateman, Syntroleum
acquires title to all inventions and improvements to the Syntroleum Process that
result from the collaborative efforts of Bateman and Syntroleum.
Kellogg Brown & Root
Kellogg Brown & Root has also been an important strategic partner of
Syntroleum. Since 1996, Kellogg Brown & Root has provided engineering services
in connection with Syntroleum's pilot plant and other aspects of Syntroleum's
development of its GTL technology. Syntroleum and Kellogg Brown & Root are
parties to an agreement under which Kellogg Brown & Root is authorized to
provide engineering services to Syntroleum and its licensees. Under an
intellectual property agreement with Kellogg Brown & Root, Syntroleum acquires
title to all inventions and improvements to the Syntroleum Process created by
Kellogg Brown & Root that result from the collaborative efforts of the parties.
Texaco
Syntroleum first began discussions with Texaco in 1993 to evaluate
Syntroleum's GTL technologies. In February 1995, Syntroleum entered into a
research and development agreement with Texaco to support the initial
development of Syntroleum's chain limiting catalyst. Texaco provided
approximately $265,000 for development activities under this agreement over a
two-year period. Under this agreement, Syntroleum also acquired from Texaco
certain data relating to the Hydrocol plant formerly located in Brownsville,
Texas and operated by Texaco in the early 1950s.
In connection with entering into a master license agreement with
Syntroleum in September 1996, Texaco entered into a joint development agreement
with Syntroleum pursuant to which Texaco agreed to fund additional joint
research and development activities. Under this agreement, Texaco contributed
certain reactor technology and agreed to fund all activities of the parties
under the agreement. Based on this technology, the parties have engaged in the
joint development of the HMX reactor and related catalyst system. As of March 1,
1999, Texaco had spent approximately $3.5 million for joint development
activities under this agreement, including approximately $1.4 million during
1998 which represents approximately 31% of Syntroleum's revenue for 1998. Under
its joint development agreement with Texaco, Syntroleum retains title to all
inventions and improvements to the Syntroleum Process that result from
collaborative activities. In addition, for its commitment of research and
development funds, Texaco receives a limited discount on future license fees
which may be otherwise due under its master license agreement.
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ARCO
ARCO has worked with Syntroleum since 1993 in the evaluation of
certain variations on the Syntroleum Process for designs applicable to certain
of ARCO's natural gas properties. In March 1994, ARCO and Syntroleum entered
into two research and development agreements relating to Syntroleum Process
design and Syntroleum's chain limiting catalyst, respectively.
Pursuant to the terms of its joint development agreement entered into
with Syntroleum in April 1997, Syntroleum also has acquired from ARCO certain
patent applications relating to gas turbine integration and Fischer-Tropsch
reactor designs. ARCO is currently constructing a 70 barrel per day pilot plant
at ARCO's Cherry Point Refinery near Bellingham, Washington. This pilot plant
will test a moving bed slurry reactor configuration and associated catalyst and
a high pressure autothermal reformer design. During the fourth quarter of 1998,
major modules for the plant were shipped to the plant site. Construction of this
pilot plant is expected to be completed during the second quarter or early third
quarter of 1999. Under its development agreements with ARCO, Syntroleum retains
title to all inventions and improvements to the Syntroleum Process that result
from collaborative activities. In addition, for its commitment of research and
development funds, ARCO receives a limited discount on future license fees which
may be otherwise due under its master license agreement.
Marathon
Syntroleum first began discussions with Marathon in 1994 to evaluate
Syntroleum's GTL technologies. In connection with Syntroleum's master license
agreement with Marathon, Syntroleum entered into a separate agreement with
Marathon pursuant to which Syntroleum acquired certain exclusive rights
(including the right to sublicense) in the GTL field under a newly issued United
States patent and a pending United States patent application relating to gas
turbine technology and non-exclusive rights to use such technology outside the
GTL field. Under its agreement with Marathon, Syntroleum retains title to all
inventions and improvements to the Syntroleum Process that result from
collaborative activities.
Marathon also participated in and partially funded a joint testing and
development program conducted by Syntroleum and AGC described below.
Criterion
One of Syntroleum's principal strategic relationships is with
Criterion, a catalyst company jointly owned by Shell and Cytec Industries. In
August 1996, Syntroleum entered into an agreement with Criterion that provides
Criterion with the non-exclusive right to manufacture Syntroleum's proprietary
high alpha catalyst for sale by Criterion to Syntroleum for its own use and for
resale to others and, with approval of Syntroleum, directly to approved
licensees of the Syntroleum Process. The agreement provides for a fixed margin
to be paid to Syntroleum for any sales of catalyst to approved licensees and
that any ideas, developments or improvements related to such catalyst, other
than manufacturing techniques, are the property of Syntroleum. In addition,
Syntroleum is required to purchase all such catalysts for its own use from
Criterion, subject to certain price and delivery requirements. Criterion also
agrees to provide Syntroleum with other catalysts made by Criterion, including
the catalyst used in the lube oil isomerization and dewaxing process licensed by
Syntroleum from Lyondell.
Catalytica Combustion Systems
In July 1997, Syntroleum entered into a joint testing agreement with
Catalytica Combustion Systems, a manufacturer of low emission catalytic
combustion products, relating to the development of a catalytic combustion
system for use in the Syntroleum Process. Catalytica Combustion Systems has
developed a proprietary combustion system for the catalytic combustion of
gaseous and liquid hydrocarbons which significantly reduces emission of nitrous
oxide compounds. Under the agreement, the parties have conducted tests to
determine whether Catalytica Combustion Systems' combustion system design can be
adapted to efficiently combust low heating value fuel with
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low emissions. The combustion systems being tested include those that are fueled
only by low heating value fuel and those that are initially fueled by natural
gas and later fueled by low heating value fuel. The agreement calls for
additional development to create a special combustor that can be fitted for use
on a wide variety of available gas turbines allowing them to utilize the low
heating value residue gases created by the Syntroleum Process. Syntroleum will
have the exclusive right to utilize such combustors supplied by Catalytica
Combustion Systems in GTL applications.
Catalytica Advanced Technologies
In April 1998, Syntroleum entered into a technical catalyst services
and development agreement with Catalytica Advanced Technologies. Under this
agreement, Syntroleum may engage, on a project by project basis, the technical,
research and development services of Catalytica Advanced Technologies to assist
Syntroleum in its ongoing catalyst research, development and manufacturing
activities.
AGC
In July 1997, Syntroleum entered into a joint testing agreement with
AGC, which is a packager of gas turbines and systems incorporating gas turbines.
In 1998, the parties completed a series of tests demonstrating that AGC's gas
turbine and related combustion systems can be modified to use low heating value
gas as fuel. Based on these tests, Syntroleum believes that the technology can
be migrated to various size turbines from various manufacturers, potentially
allowing for the application of a broader range of gas turbines in the
Syntroleum Process. The technology that allows a gas turbine to use low heating
value gas is based on technology acquired by Syntroleum from Marathon.
Syntroleum and AGC may elect to conduct additional joint development work or
proceed to commercial design and production of the technology for use in plants
based on the Syntroleum Process.
GE Power Systems
In December 1998, Syntroleum entered into an agreement with GE Power
Systems to certify GE heavy-duty gas turbines for use in the Syntroleum Process.
Under the agreement, the parties are to cooperate to verify GE's low heating
value gas combustion technology for use in the Syntroleum Process. GE Power
Systems has begun verification testing which is currently expected to be
completed by the end of 1999. Verification would allow Syntroleum and its
licensees immediate access to GE turbines for projects under development and
allow for the application of a broader range of turbine sizes in the Syntroleum
Process. In addition, Syntroleum believes that joint development activities to
be conducted under the agreement will enhance its efforts to continue to lower
the cost of GTL plants based on the Syntroleum Process and to provide more
flexible plant designs.
DaimlerChrysler
In October 1998, Syntroleum entered into an agreement with
DaimlerChrysler to develop automobile fuels produced using the Syntroleum
Process. The agreement calls for DaimlerChrysler to test several fuel
formulations made by Syntroleum on various engines to determine the optimum
physical and chemical characteristics desired for each fuel. The agreement also
allows for joint testing of lubricants and automatic transmission fluids made
with the Syntroleum Process. Syntroleum believes that fuels designed from the
Syntroleum Process will be able to run in current diesel vehicles without
modification and should be suitable for future technologies such as advanced
clean-burning diesel engines, fuel cells and hybrid electric vehicles.
AMEC
In September 1997, Syntroleum entered into an engineering
representation and intellectual property agreement with AMEC, one of Europe's
leading engineering and construction contractors. The agreement designates AMEC
as an approved engineering contractor for Syntroleum and its licensees. In
addition, the agreement entitles AMEC to market the Syntroleum Process to
certain third parties, subject to Syntroleum's prior
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approval with respect to proposed licensees. The agreement provides for AMEC to
complete, at its expense, a reference design and associated design support
systems for one type and size of GTL plant identified by Syntroleum and AMEC.
Under the agreement, Syntroleum retains title to all inventions and improvements
to the Syntroleum Process that result from the collaborative efforts of the
parties.
Lyondell
In October 1996, Syntroleum entered into an agreement with Lyondell, a
major petrochemical company, whereby Syntroleum acquired an exclusive, royalty-
bearing license to utilize Lyondell's wax isomerization process in the
Syntroleum Process to produce certain synthetic lubricants through at least the
year 2000 and thereafter, provided that Syntroleum meets certain performance
criteria. Given the current uncertain schedule for construction of GTL plants
using the Syntroleum Process, Syntroleum may seek to extend the term of this
agreement. The process, which is based on Lyondell's catalytic dewaxing
process, was developed to make synthetic lube base stocks from the waxy
synthetic crude oil produced by the high alpha catalyst in the Syntroleum
Process. Under this agreement, Lyondell has agreed to provide Syntroleum with
certain technical information and assistance (including training) related to its
wax isomerization process.
Sales and Marketing
Syntroleum intends to maintain an active marketing and sales effort to
develop and promote the Syntroleum Process through several channels. Syntroleum
has been and will continue to be an active participant at industry conferences
relating to GTL processes. During 1998, representatives of Syntroleum spoke at
24 different conferences on four continents. Syntroleum also intends to
continue to write and publish papers on topics regarding the implications of GTL
technology to the industry. Additionally, Syntroleum will continue to educate
and inform its customers through the use of multi-media and print presentations.
Syntroleum also intends to establish brand recognition for specialty products to
be produced by its specialty plants. Syntroleum has received trademark and
service mark rights to the name "Syntroleum" in the United States and has
applications pending to register the trademark in various foreign countries.
In addition, Bateman, Kellogg Brown & Root, AMEC and other engineering
companies are familiar with Syntroleum's GTL technology and have assisted
Syntroleum in marketing the Syntroleum Process. Syntroleum's agreements with
engineering firms generally provide such firms with the right to market the
Syntroleum Process. Syntroleum believes that these relationships will expand its
marketing effort in a cost-effective manner. Syntroleum currently has five
employees in its business development and marketing departments, three of which
hold advanced degrees, and retains a full-time sales representative in London,
England.
Historical Development of the Technology
The Chemistry
The basis for most GTL technologies, including the Syntroleum Process,
originated in 1923 when two German chemists, Franz Fischer and Hans Tropsch,
discovered that synthesis gas (carbon monoxide and hydrogen) could be
catalytically converted into synthetic hydrocarbons using a precipitated cobalt
catalyst. In the Fischer-Tropsch reaction, the synthesis gas in contact with
the catalyst surface at certain temperatures and pressures causes a chemical
reaction that produces hydrocarbons and byproducts consisting primarily of water
and carbon dioxide.
The length and distribution of the hydrocarbon molecules produced by
the reaction vary significantly depending on the choice of catalysts, reactors
and other operating conditions of the process, but range from methane (CH\4\)
to hydrocarbons containing as many as 100 carbon atoms that tend to be very
linear or parrafinic. Hydrocarbons with one to four carbon atoms tend to be
gaseous at room temperature and atmospheric pressure. Hydrocarbons with a
molecular range of 5 to 20 carbon atoms tend to be liquid under the same
conditions. Above 20 carbon atoms, these molecules tend to form solids (wax) at
room temperature.
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Initial Development in Germany, the United States and South Africa
Prior to and during World War II, development of the Fischer-Tropsch
process occurred primarily in Germany. Due to Germany's significant coal
resources and limited oil and gas resources, these development activities
focused exclusively on the conversion of coal into fuels and chemicals. Between
1934 and 1945, nine government-funded coal to liquids plants were built in
Germany using coal as the feedstock. The synthesis gas was generated by high-
temperature gasification of coal with oxygen and steam. An iron-based catalyst
was used to manufacture synthetic hydrocarbons, primarily motor fuels. Maximum
combined production from these nine plants reached approximately 16,000 barrels
per day in 1944.
Between 1943 and 1950, the United States Bureau of Mines, prompted by
fears of an oil shortage, extensively researched coal-to-oil processes. However,
no commercial plants were built in the United States during that period. In
1950, Texaco participated in the Hydrocol plant, which was an 8,000 barrel per
day synthetic fuel plant that was built in Brownsville, Texas and used natural
gas as the feedstock. The plant's design was based, in part, on the work done by
the United States Bureau of Mines. Although the plant was a technical success,
it was not economic to operate because a new gas pipeline and changes in the
price of oil created a more economic market for the natural gas, which resulted
in the shutdown of the plant in 1953.
In 1950, the South African government formed a predecessor of Sasol
(which was later privatized) to develop synthetic fuels using coal as the
feedstock. The first South African plant, a 2,500 barrel per day facility
located in Sasolburg, South Africa, became operational in 1955 and is still in
operation today. This plant, known as Sasol One, produces liquid fuels, pipeline
gas, waxes and chemicals. Following the Middle East oil crisis of 1973, an
approximately 50,000 barrel per day Fischer-Tropsch plant, Sasol Two, was built
in Secunda, South Africa, and has been operating since 1980. Sasol Three, which
was designed to be identical to Sasol Two, has been operating since 1982. In
1989, the South African government established Mossgas (Pty) Limited, a separate
government-supported company, to build a natural gas-based GTL plant. A 23,000
barrel per day plant utilizing Sasol technology began production in 1993.
Modern Development by Major Oil Companies
Following the oil embargo of 1973, further development efforts focused
on utilizing both coal and natural gas to produce synthesis gas for the Fischer-
Tropsch process. Several major oil companies and several governments funded
research into synthetic fuels. The worldwide recession of 1982 and the related
drop in oil prices resulted in the termination of most coal-related development
activities. However, development activities related to the conversion of natural
gas continued.
In 1985, Mobil commissioned a 14,500 barrels per day plant located in
Montuni, New Zealand. The plant, which was not based on Fischer-Tropsch
chemistry, was designed to convert natural gas to methanol and then to gasoline.
In 1990, the plant was sold and was later converted into a methanol-only
facility. In 1993, Shell commissioned a 12,500 barrels per day plant located
in Bintulu, Malaysia. The plant is based on Shell's version of GTL technology,
known as SMDS (Shell Middle Distillate Synthesis) and is not currently
operational. In October 1996, Exxon reported that it was in discussions with
the government of Qatar to construct a GTL plant utilizing its GTL process
(which Exxon calls the AGC-21 process). Reports on Exxon's technology have
suggested that costs associated with its technology are lower than historic
levels and that a plant based on Exxon technology would be economical at a size
of between 50,000 and 100,000 barrels per day. Exxon currently operates a 200
barrel per day pilot plant located in Baton Rouge, Louisiana.
The generally accepted capital cost target for a GTL plant to be cost
effective for the production of transportation fuel given oil prices in the
range of $15 to $20 per barrel is $30,000 per barrel of daily plant capacity or
less. Syntroleum believes that to date no company has built a commercial-scale
GTL plant that has broken this
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cost barrier. In addition, Syntroleum believes that each of the current
competitive GTL technologies has taken in excess of ten years to develop.
The Syntroleum Process
The Syntroleum Process involves two catalytic reactions. The first
reaction converts natural gas into synthesis gas, and the second reaction
converts the synthesis gas into hydrocarbons through the Fischer-Tropsch
reaction over a proprietary catalyst. Syntroleum's goal in developing this
process has been to substantially reduce both the capital cost and the minimum
economical size of a GTL plant, as well as plant operating costs. Syntroleum
believes that by reducing the complexity of the process it has achieved this
goal. Syntroleum has developed and continues to develop variations of its 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.
Syntroleum completed construction of its first pilot plant in 1990,
and the plant was successfully operated in 1990 and 1991. Between 1991 and 1995,
Syntroleum focused the majority of its research and development efforts on
catalyst development for the Fischer-Tropsch reaction. The pilot plant was
extensively modified in 1995 to test new catalysts and again in 1997 to test new
reactor designs. Syntroleum's nominal two barrel per day pilot plant has
successfully demonstrated certain elements and variations of the Syntroleum
Process. However, no commercial-scale GTL plant based on the Syntroleum Process
has yet been constructed.
Although Syntroleum believes that the Syntroleum Process can be
utilized in commercial-scale GTL plants, no assurance can be given that such
commercial-scale GTL plants will be successfully constructed and operated or
that such plants will yield the same economics and results as those demonstrated
on a pilot plant basis. In addition, certain improvements to the Syntroleum
Process are under development and may not prove to be commercially applicable.
See "Risks Relating to the Syntroleum Process."
The Synthesis Gas Reaction
The first reaction in the Syntroleum Process--converting natural gas
into synthesis gas--involves the use of Syntroleum's proprietary auto thermal
reformer reactor. In this reaction, natural gas (consisting primarily of
methane), compressed air (consisting primarily of oxygen and nitrogen) and minor
amounts of steam are combined in the auto thermal reformer reactor at a
specified temperature, pressure and ratio to produce synthesis gas (which
consists of hydrogen and carbon monoxide) diluted with nitrogen. The auto
thermal reformer reactor is a refractory-lined carbon steel vessel utilizing a
nickel-based catalyst and is similar to the secondary reformer in an ammonia
plant. The production of synthesis gas in the auto thermal reformer reactor is a
combination of exothermic and endothermic reactions that generate a large amount
of heat, a portion of which may be captured as steam for other internal and
external uses.
The following diagram illustrates the net reaction in the ATR:
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\O [RIGHT ARROW] CO + H\2\ + N\2\ + H\2\O
The Fischer-Tropsch Reaction
The second reaction in the Syntroleum Process is the Fischer-Tropsch
synthesis reaction. In a one-pass process, synthesis gas diluted with nitrogen
flows into one or more reactors containing Syntroleum's proprietary
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catalyst. As the synthesis gas passes over the catalyst, it is converted into
hydrocarbons of various molecular weights, with byproducts consisting of water
and minor amounts of carbon dioxide also being produced. This reaction is also
very exothermic. The synthetic liquid hydrocarbons and water drain from the
reactor vessel and are subsequently separated. The nitrogen, carbon dioxide and
gaseous hydrocarbons also leave the reactor vessel and are subsequently burned
in a heater to generate steam or process heat or in a turbine to generate
horsepower or electricity.
The following diagram illustrates the Fischer-Tropsch reaction:
Step 2
Fischer - Tropsch Synthesis
Synthesis Gas
(diluted with Nitrogen) Hydrocarbons Nitrogen Water
Catalyst
H\2\ + CO + N\2\ [RIGHT ARROW] C\n\H(\2n\+\2\) + N\2\ + H\2\O
Fischer-Tropsch Catalyst Systems
Syntroleum has 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 applications.
Based upon pilot tests of catalysts manufactured by Syntroleum,
Syntroleum believes that it has a number of proprietary catalyst systems that
meet or exceed the activity and selectivity targets necessary for commercial
application in certain current Syntroleum Process designs, including the
catalysts associated with the hybrid multi-phase reactor known as "HMX" under
development with Texaco, and the moving bed slurry reactor to be pilot-tested
with ARCO at its 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. Syntroleum's proprietary "high alpha" catalyst produces a
very waxy synthetic crude oil which can also be further processed through
hydrocracking to make liquid fuels, or with other refining processes, the waxy
portion can be converted into higher value specialty products such as synthetic
lubricants. Syntroleum's proprietary "chain-limiting" catalyst currently under
development is designed to produce hydrocarbons primarily in the liquid fuels
range, without producing wax. Use of this catalyst should further lower the
capital cost of a plant by permitting the use of high-capacity fluidized-bed
reactors and eliminating the need for hydrocracking equipment. Further
development of Syntroleum's chain limiting catalyst is required before it will
be available for commercial use.
Under Syntroleum's agreement with Criterion, Criterion has
manufactured, in its commercial facilities, batches of certain catalyst in
quantities sufficient to confirm that such catalyst performance is comparable to
the same catalyst produced by Syntroleum and such catalysts can be produced in
commercial quantities at targeted cost levels. Syntroleum estimates that the
useful life of its Fischer-Tropsch catalysts will be three to five years under
normal operating conditions.
Syntroleum plans to refine existing catalysts and continue to develop
additional catalyst formulations for use in the Syntroleum Process. Catalyst
development is a complex process requiring significant scientific skills and
resources. Syntroleum has in the past and intends 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, Syntroleum intends to enhance
its catalyst development activities
-18-
through catalyst joint development programs with certain of its joint
development partners. From time to time, Syntroleum also retains catalysis
experts on a consulting basis to assist in catalyst development.
Fischer-Tropsch Reactor Designs
Syntroleum has tested at its pilot plant three different proprietary
Fischer-Tropsch reactor designs and associated catalysts for use in the
Syntroleum Process. These include a fixed bed vertical tubular reactor, a
fluidized bed reactor for use with Syntroleum's chain-limiting catalyst and the
proprietary hybrid multi-phase HMX reactor developed under Syntroleum's joint
development agreement with Texaco. In addition, Syntroleum has tested a large
bench scale moving bed slurry reactor developed under Syntroleum's agreement
with ARCO. ARCO is currently constructing a 70 barrel per day pilot plant that
will further test the moving bed slurry reactor on a larger scale. A horizontal
reactor design is also being developed by Syntroleum and may be preferred in GTL
plants on ships operating in rough water conditions, where its low center of
gravity may be an important feature. Syntroleum has several pending United
States and foreign patent applications related to its Fischer-Tropsch reactors.
Heat Integration and Power Recovery
Compression energy is the primary energy consumer in the Syntroleum
Process. Engineering studies conducted by Bateman and Kellogg Brown & Root have
demonstrated that the heat generated by the two catalytic reactions in the
process can be captured in the form of mechanical and electrical energy
sufficient to supply all of the plant's needs plus a surplus for other uses if
desired. Syntroleum has developed several heat integration and power recovery
schemes 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 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 ATR and Fischer-Tropsch reactions to produce
energy for compression, electrical power and commercial sale. In addition,
Syntroleum has 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
Syntroleum's joint development efforts with others.
Advantages Over Competing Processes
Syntroleum believes that the method by which it 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 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 cryogenic 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
-19-
of reducing the size and complexity and lowering the energy requirement of GTL
plants based on the Syntroleum Process.
Syntroleum believes that another advantage of the Syntroleum Process
is the absence 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 one six
million British thermal unit barrel of liquid hydrocarbons from approximately 12
million British thermal units of natural gas feedstock, although conversion
efficiency may vary depending on gas composition and process conditions selected
for each plant. In general, for pipeline quality natural gas, ten thousand cubic
feet of natural gas is expected to produce one barrel of liquid hydrocarbons.
Syntroleum believes that production will decline when lower quality feedstocks
are used, and larger volumes of natural gas will be required to maintain
equivalent production levels. One of the benefits of the Syntroleum Process is
its ability to utilize natural gas containing nitrogen and carbon dioxide, up to
certain levels, without removing these impurities prior to consumption by the
plant. However, natural gas that contains sulphur, metals and certain 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.
Products: Synthetic Crude Oil, Naphtha and Distillates
The synthetic crude oil produced from GTL plants is widely compatible
with the existing crude oil-based energy infrastructure and can be either sold
as is or further refined to produce fuels, such as diesel, kerosene or naphtha.
Syntroleum believes that these products have certain environmental and
performance benefits when compared to similar products produced from
conventional crude oil.
Synthetic Crude Oil. Synthetic crude oil is high quality and has a
consistent composition, water-white color (clear) and high paraffin content.
Impurities commonly associated with crude oil, such as sulfur, metals, basic
sediment and water (BSandW) and salt, are not present in synthetic crude oil.
These properties make synthetic crude oil easier to refine into finished
products with superior environmental characteristics. Total worldwide demand
for crude oil is approximately 70 million barrels per day.
Naphtha. Naphtha is a light product generally in the molecular range
of five to nine carbon atoms. Naphtha is a common feedstock for the production
of ethylene. Refiners can also use naphtha as a component in gasoline. It is
often upgraded via catalytic reforming to improve its octane for the production
of gasoline. Syntroleum believes that synthetic naphtha will make an excellent
fuel for emerging fuel cell technology. It is non-toxic, contains approximately
twice the hydrogen content of other fuels being considered for fuel cells, and
can be distributed using existing infrastructure. Historically, naptha prices
have averaged between $15 and $25 per barrel.
Distillate/Synthetic Diesel Fuel. Distillate is a range of fuels from
ten to 20 carbon atoms and includes jet fuel, kerosene and diesel fuel. The
diesel product stream has significant benefits over conventional refinery
products because it is free of sulfur and, due to its high percentage of
straight chain molecules, has a very high cetane number. In California, current
regulatory requirements generally result in a cetane number of approximately 50
for diesel while the cetane number of diesel produced from synthetic crude oil
is between 70 and 75. As such, this product makes a superior blending stock for
upgrading conventional fuels. From 1996 to 1997, distillate prices have ranged
from a low of $23 to a high of $31 per barrel.
-20-
Synthetic diesel fuel produced using the Syntroleum Process contains
significantly reduced sulfur and aromatic content which reduces pollution levels
commonly associated with conventional diesel fuel, while maintaining a high
cetane rating which promotes high operating efficiency. Synthetic diesel fuel
can burn in conventional diesel engines, can be distributed using existing
infrastructure and will not require modification to existing diesel engines.
Southwest Research Institute has tested diesel fuels produced from three sources
of Fischer-Tropsch fuels to obtain environmental performance data. The study,
presented in 1997, found that engines that were run using Fischer-Tropsch diesel
fuel emitted 46% less carbon monoxide, 38% fewer hydrocarbons, 30% fewer
particulates and eight percent less NO\x\ when compared to emissions from
currently available diesel fuel that satisfies United States government
specifications. Syntroleum has entered into agreements with Southwest Research
Institute and the University of Kansas Center for Research, Inc. to test diesel
fuels produced using the Syntroleum Process. The objectives of these tests are
to determine the performance of these fuels compared to conventional diesel fuel
and identify those middle distillates produced using the Syntroleum Process that
are most suitable as fuels in diesel engines without the need for further
refining. In addition, Syntroleum intends to confirm that these fuels would
meet the most stringent United States environmental regulations and qualify as
alternate fuels under the guidelines set by the Environmental Protection Agency
and the Department of Energy. In addition, Syntroleum has entered into an
agreement with DaimlerChrysler to test and develop synthetic diesel fuel and is
also working with Argonne National Laboratories to develop a clean fuel for use
in emerging fuel cell technology. These testing programs are part of the
Company's efforts to develop a new family of high performance and
environmentally superior synthetic fuels for use in diesel engines.
Products: Specialty Products
Syntroleum intends to design, construct and own significant equity
interests in GTL plants designed to produce specialty products. These plants
will be designed to use Syntroleum's proprietary high alpha catalyst to produce
synthetic crude oil, which will then be further refined using conventional
refining equipment and proprietary processes licensed from others to convert a
portion of the synthetic crude oil into lubricants and drilling fluid.
Syntroleum has retained the exclusive right to manufacture these products using
the Syntroleum Process under its license agreements. The targeted specialty
products include the following.
Synthetic Lube Base Oil. Specifications for motor oil are anticipated
to become more stringent in the future as automobile manufacturers respond to
tightening emissions requirements. This could result in increased demand for
high quality base oils as blending stock. Syntroleum has licensed from Lyondell
a proprietary process and catalyst used in the production of a high quality lube
oil blending stock that could be blended with conventional lubricants to
increase overall quality of the finished product. According to industry
publications, 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.
Synthetic Drilling Fluid. Drilling fluids are used in the drilling of
oil and gas wells as a coolant and lubricant for the drill bit and to enhance
safety during offshore drilling operations by maintaining well pressure.
Drilling fluid can accumulate under platforms mixed with well cuttings. 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. In response to this market opportunity, Syntroleum, in
conjunction with Amoco Production Company, has developed a synthetic drilling
fluid product that it expects to meet all current applicable environmental
requirements.
Waxes. Waxes are longer linear chain hydrocarbon molecules that are
solids at room temperature and have a variety of applications including as
adhesives, candles and coatings. According to industry publications, United
States demand for waxes in 1995 was approximately 21,000 barrels per day. These
markets have primarily been supplied with petroleum derived waxes. Historically,
prices have varied between $30 per barrel for the lowest quality wax to over
$150 per barrel for high melting point synthetic wax.
-21-
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 and pharmaceuticals,
paints, stains, ink oils, aluminum rolling oils and lamp oils. Historically,
prices for normal paraffins have averaged between $60 and $85 per barrel.
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 on pilot
plant tests, Syntroleum believes that approximately 1.3 barrels 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 Syntroleum believes will generally be within
applicable emissions standards. Spent catalysts are expected to be processed by
a catalyst reclaimer who will recover useful metals and be responsible for
disposal of the nonreclaimed portion of the catalyst.
Risks Relating to the Syntroleum Process
No Assurance of Successful Commercial-Scale GTL Plants Based on the
Syntroleum Process
Syntroleum's future results of operations and financial condition are
highly dependent on its ability, and the ability of its 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 will be dependent on a
variety of factors, many of which are outside Syntroleum's control. To date, no
commercial-scale GTL plant based on the Syntroleum Process has been constructed.
Syntroleum is currently uncertain as to when any commercial-scale GTL plant
based on the Syntroleum Process is expected to become operational and does not
expect to receive any cash flows from GTL plants in which it owns an equity
interest until such a plant becomes operational. No assurance can be given that
GTL plants based on the Syntroleum Process will ever be successfully built
either by Syntroleum or by any of its licensees or that the Syntroleum Process
can be utilized in a full-scale commercial plant with the same economics and
results as those demonstrated on a laboratory and pilot basis.
Potential for Technological and Mechanical Problems in GTL Plants
based on the Syntroleum Process
A variety of results necessary for successful operation of the
Syntroleum Process could fail to occur at a commercial plant, including
operations and reactions successfully tested in Syntroleum's laboratory and
pilot plant. Results that could cause commercial GTL plants to be unsuccessful
include (1) lower reaction activity than 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 thereby
increase capital and operating costs, (2) shorter than anticipated catalyst
life, which would require more frequent catalyst purchases, (3) 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 thereby lower revenues and margins from plant
operations, and (4) inability of the gas turbine integrated into the Syntroleum
Process to burn the low heating value tail gas that is 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. Other factors may also impact commercial plants, including the size of
the equipment, the amount and quality of natural gas feedstock, local
construction conditions, operating conditions, the market for products produced
at such plants, and other
-22-
conditions that Syntroleum may not be able to anticipate. In addition, the
plants could experience mechanical difficulties, either related or unrelated to
elements of the Syntroleum Process.
No Assurance of Improvements to the Syntroleum Process
Syntroleum has a number of GTL technologies or improvements to the
Syntroleum Process in various early stages of development. These technologies
and improvements will require substantial additional investment, development and
testing prior to their commercialization. Syntroleum might not be successful in
developing such technologies and improvements, and such technologies and
improvements, if developed, may not be capable of being utilized on a commercial
basis. The failure of any of these technologies and improvements to become
commercially viable on a timely basis could adversely affect Syntroleum's
ability to continue to lower the cost of constructing GTL plants and delay the
schedule for completing the design and construction of GTL plants contemplated
by Syntroleum and its partners and by Syntroleum's licensees.
Among the possible improvements to the Syntroleum Process is
Syntroleum's chain limiting catalyst. This catalyst is designed to produce
hydrocarbons primarily in the liquid fuels range and may not become commercially
applicable because it may not produce sufficient product in the liquid fuels
range. Improvements to the heat integration of the Syntroleum Process 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. Syntroleum's horizontal reactor, which is designed to have a low
center of gravity for marine applications, may not be commercially applicable
due to operational difficulties. In addition, during 1998, Syntroleum pilot
tested a hybrid multi-phase (HMX) reactor and associated catalyst developed
under its joint development agreement with Texaco. During 1999, Syntroleum
intends to pilot test a new auto thermal reforming reactor design and a moving
bed slurry reactor and associated catalyst under a joint development program
with ARCO and these tests might not be successful.
Reliance on Technological Development and Possible Technological
Obsolescence
Syntroleum's business is dependent upon utilization of evolving
technology. As a result, Syntroleum's ability to create and maintain
technological advantages will be important to its future success. As new
technologies develop, Syntroleum may be placed at a competitive disadvantage,
and competitive pressures may force Syntroleum to implement such new
technologies at substantial cost or render the Syntroleum Process obsolete.
Syntroleum may not be able to successfully utilize, or expend the financial
resources necessary to acquire or develop, new technology. Others may be able to
achieve technological expertise comparable to or exceeding that of Syntroleum
and might implement new technologies before Syntroleum. One or more of the
technologies currently utilized by Syntroleum or implemented in the future may
become obsolete. In such case, Syntroleum's business, operating results and
financial condition could be materially adversely affected.
Effect of Crude Oil Prices and Other Energy and Product Prices on the
Economic Application of GTL Plants Based on the Syntroleum Process
Syntroleum's belief that the Syntroleum Process can, in some
circumstances, be cost effective at GTL plants with throughput levels ranging
from 2,000 to 50,000 barrels per day and larger is based on the assumption that
oil prices in the range of $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. During 1998, crude oil
prices fell to historically low levels of below $10 per barrel. Oil prices
continued at low levels in early 1999, but have increased recently. As of March
23, 1999, the West Texas Intermediate crude oil contract for May delivery was
$15.51 per barrel.
The effect of oil and natural gas prices on the cost effective
operation of a GTL plant depends significantly on the products produced at the
plant and whether the natural gas converted by the plant is associated with oil
reserves. Syntroleum anticipates that GTL plants designed to produce specialty
products, and GTL plants that are used to convert natural gas which is
associated with oil reserves, may continue to be cost effective at price levels
-23-
below the range of $15 to $20 per barrel for oil. However, GTL plants that are
used to convert natural gas that is not associated with oil reserves and are
designed to produce fuels (such as those Syntroleum's licensees are entitled to
construct) are generally not expected to be cost effective at price levels below
that range.
Because the synthetic crude oil, liquid fuels and specialty products
that GTL plants 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 GTL plants based on the Syntroleum Process, 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 such
plants. 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, the supply of foreign crude oil and natural
gas, the location of GTL plants vis-a-vis natural gas reserves and pipelines,
the capacities of such pipelines, fluctuations in seasonal demand, governmental
regulations, the price and availability of alternative fuels and overall
economic conditions. Syntroleum cannot predict the future markets and prices for
oil, natural gas or refined products. Adverse operating results at GTL plants
will adversely affect Syntroleum's business, operating results and financial
condition directly by impacting operating results at the GTL plants in which
Syntroleum retains equity interests and indirectly by reducing licensing fees
for both new license agreements and new plant construction.
Effect of Operating Conditions on the Economic Application of GTL
Plants Based on the Syntroleum Process
The economic application of GTL technology is highly dependent on a
number of factors, including site location, infrastructure, adverse weather and
a variety of other operating conditions. Syntroleum's belief in the economic
application of GTL plants based on the Syntroleum Process is based on certain
assumptions relating to the operating conditions of the plant and assumptions
regarding the capabilities of the Syntroleum Process based on data collected in
connection with the operation of Syntroleum's laboratory and pilot plant.
Numerous events could occur that would be inconsistent with these assumptions.
For example, the plants could be located in areas that require more
infrastructure than assumed by Syntroleum. In addition, GTL plant construction
cost estimates prepared for Syntroleum could be understated, necessary permits
may not be issued by regulatory authorities or may not be issued within the
expected time frames, the plants could take longer to construct than
anticipated, and the demand for the products produced by the plants may not
materialize or may materialize at lower price levels than Syntroleum currently
anticipates. The materialization of risks discussed above relating to the
commercial operation of GTL plants based on the Syntroleum Process would also
impact the economic application of such plants by increasing capital or
operating costs. The occurrence of any material event that is inconsistent with
the assumptions on which Syntroleum has based its belief in the economic use of
GTL plants based on the Syntroleum Process could materially adversely affect the
economic application of commercial GTL plants based on the Syntroleum Process
which, in turn, would materially adversely affect Syntroleum's business,
operating results and financial condition.
Reliance on Licensees
Syntroleum's licensees will control whether any site licenses are
issued and any resulting additional license fees are due under Syntroleum's
license agreements. Licensees may need to undertake substantial activities
before any site license is issued and license fees are due. These activities may
include performing feasibility studies, obtaining regulatory approvals and
permits, obtaining preliminary and final design and engineering for a plant,
obtaining a sufficient dedicated supply of natural gas, and obtaining adequate
commitments for the purchase of the plant's products. The amount and timing of
resources devoted to these activities will be controlled by the licensee.
Whether licensees are willing to expend the resources necessary to construct GTL
plants will depend on a variety of factors outside the control of Syntroleum,
including the prevailing view of prices for oil and natural gas, which have
historically been volatile and are likely to continue to be volatile in the
future. If Syntroleum does not receive payments under its license agreements, it
may not have sufficient resources to implement its business strategy.
Syntroleum's licensees are not restricted from pursuing alternative GTL
technologies on their own or in
-24-
collaboration with others, including Syntroleum's competitors. If licensees fail
to construct plants under the license agreements, or if Syntroleum is unable to
enter into additional license arrangements, Syntroleum's business, operating
results and financial condition would be adversely affected. See "--
Competition."
No Assurance of Industry Acceptance of the Syntroleum Process
As is typical in the case of a new and rapidly evolving technology,
demand and industry acceptance for Syntroleum's technology is subject to a high
level of uncertainty. If the industry fails to accept Syntroleum's technology
due to its novelty and continuous evolution or acceptance develops more slowly
than expected, Syntroleum's business, operating results and financial condition
will be materially adversely affected. 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. Any such event could reduce future license fees or
revenues from GTL plants on a contract basis and could make it more difficult or
impossible for Syntroleum to construct specialty product GTL plants. Likewise,
if a major oil and gas company were to either successfully develop or adopt a
GTL technology competing with the Syntroleum Process or should industry
participants adopt a strategy of disparaging the Syntroleum Process,
Syntroleum's reputation could be adversely affected. In addition, certain oil
and gas companies may be motivated to seek to prevent industry acceptance of GTL
technology based on their belief that widespread adoption of such technology
might negatively impact the competitive position of such companies without
access to GTL technology. Failure of Syntroleum's technology to achieve industry
acceptance could have a material adverse effect on Syntroleum's business,
operating results and financial condition. See "--Competition."
Dependence on Strategic Relationships with Manufacturing and
Engineering Companies
Syntroleum intends to, and believes its 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 provide
components of GTL plants based on the Syntroleum Process in commercial
quantities, in a timely manner and within specifications, Syntroleum or
Syntroleum's licensees could experience material delays, or construction plans
could be canceled, while alternative manufacturers are identified and prepare
for production. Syntroleum has no experience in manufacturing and does not have
any manufacturing facilities. Consequently, Syntroleum will be dependent on
third parties for the manufacture of components of GTL plants based on the
Syntroleum Process. Syntroleum has conducted development activities with third
parties relating to Syntroleum's 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. In addition, Syntroleum has entered into
an agreement with Criterion which provides that Syntroleum will purchase any
catalysts for its own use from Criterion. The failure of third party
manufacturers to adequately provide necessary components could have a material
adverse effect on Syntroleum's business, operating results and financial
condition.
Syntroleum also intends to utilize third parties to provide
engineering services in connection with Syntroleum's efforts to commercialize
the Syntroleum Process. If such engineering firms are unable to provide
requisite services or performance guarantees, Syntroleum or Syntroleum's
licensees could experience material delays, or construction plans could be
canceled, while alternative engineering firms are identified and become familiar
with the Syntroleum Process. Syntroleum has no experience in providing
engineering services and has a limited engineering staff. Consequently,
Syntroleum will be dependent on third parties to provide necessary engineering
services, and such 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. In addition,
Syntroleum has entered into an agreement with Bateman which provides that
Syntroleum will utilize Bateman to assist in the development of Syntroleum-owned
GTL plants in North and South America producing specialty products. The failure
of such engineering firms to provide necessary services in an adequate manner or
to provide such performance guarantees could have a material adverse effect on
Syntroleum's business, operating results and financial condition.
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Potential Indemnification Liabilities to Licensees
Syntroleum's license agreements require it to indemnify the licensee
against certain losses relating to, among other things, acts or omissions by
Syntroleum in connection with process design packages for plants and performance
guarantees that may be provided by Syntroleum. Syntroleum's indemnification
obligations could result in substantial expenses and liabilities to Syntroleum
in the event that GTL plants based on the Syntroleum Process do not operate as
currently anticipated.
Intellectual Property
Syntroleum pursues protection of the Syntroleum Process primarily
through a combination of trade secrets, patents and rights to the patents and
trade secrets of others relating to components critical to the Syntroleum
Process. Syntroleum's policy is to seek, when appropriate, protection for its
proprietary products and processes by filing patent ap