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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_________________
FORM 10-K
_________________
[X] Annual
For the fiscal year ended December 31, 1998
[_] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from ___________ to ___________
Commission file number: 0--24027
PINNACLE OIL INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
NEVADA 61-1126904
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
SUITE 750 PHOENIX PLACE, 840-7TH AVENUE, S.W., CALGARY, ALBERTA, CANADA T2P 3G2
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (403) 264-7020
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 $0.001 PER SHARE
(Title of Class)
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 (Section 229.405 of this Chapter) 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. [_]
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of March 20, 1999 was approximately $32,352,OOO based upon the
closing price per share of the Common Stock of $12.50 on that date.
The number of shares outstanding of the registrant's Common Stock as of March
20, 1999: 12,431,983 shares
DOCUMENTS INCORPORATED BY REFERENCE
Information required by Part III (Items 10, 11, 12 and 13) is incorporated by
reference to the Company's definitive proxy statement for its 1999 Annual
Meeting of Stockholders.
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PINNACLE OIL INTERNATIONAL, INC.
ANNUAL REPORT ON FORM 10 REGISTRATION STATEMENT
TABLE OF CONTENTS
PAGE
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ITEM 1. BUSINESS.................................................................................. 1
Overview.................................................................................. 1
Corporate Structure And Development....................................................... 8
Description Of SFD Technology And SFD Survey System....................................... 9
Timing Of SFD Survey And Interpretation................................................... 10
Timing Of Drilling And Production......................................................... 11
Use Of SFD Survey System As Inferential Exploration Tool To Detect Geologic
Structures Associated With Hydrocarbon Accumulations...................................... 12
Use Of SFD Survey System As Direct Hydrocarbon Detection Tool............................. 13
Competitive Advantages Of SFD Technology As Wide-area Reconnaissance Tool................. 14
Competition............................................................................... 15
Theoretical Basis Of Stress Fields........................................................ 15
Geology And Traditional Exploration....................................................... 18
Third Party Field Evaluations Of The SFD Survey System.................................... 22
Field Evaluation By Rod Morris, Geologist................................................. 23
Field Evaluation By Encal Energy Ltd...................................................... 30
Field Evaluation By Camwest Limited Partnership........................................... 33
Review By Gilbert Laustsen Jung Associates Ltd............................................ 33
Joint Venture And Survey Agreements....................................................... 37
Momentum SFD Technology License Agreement................................................. 42
Intercompany Agreements................................................................... 44
ITEM 2. PROPERTIES................................................................................ 44
ITEM 3. LEGAL PROCEEDINGS......................................................................... 45
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS..................................... 45
ITEM 5. MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS....................................................................... 45
Dividend Policy........................................................................... 46
ITEM 6. SELECTED CONSOLIDATED FINANCIAL INFORMATION............................................... 46
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS................................................................................ 47
General................................................................................... 47
Overview.................................................................................. 47
Results Of Consolidated Operations........................................................ 48
Liquidity And Capital Resources........................................................... 50
Outlook And Prospective Capital Requirements.............................................. 51
Other Matters............................................................................. 51
Uncertainties And Risk Factors............................................................ 52
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK................................. 55
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA............................................... 59
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE................................................................................ 59
ITEMS 10., 11., 12. AND 13.................................................................................. 59
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8--K........................ 59
-i-
GLOSSARY OF TERMS
"RECOMMENDED SFD LEAD" means an SFD Lead for which the Company has received
sufficient SFD Data and other information to complete its interpretation, and
which the Company believes has sufficient hydrocarbon accumulation potential to
warrant recommendation to the Company's strategic partners for geological and
geophysical evaluation.*
"SFD ANOMALY" means a waveform (or change in waveform) derived from SFD Data
which varies from the norm and may or may not be associated with hydrocarbon
deposits.
"SFD DATA" means certain proprietary information provided exclusively to the
Company for petroleum and natural gas exploration purposes by Momentum Resources
Corporation.
"SFD LEAD" means an SFD Anomaly which the Company believes, based upon its
initial review of SFD Data, to warrant further investigation as a potential
hydrocarbon accumulation. As a practical matter, only a small portion of SFD
Leads will ultimately be determined to be Recommended SFD Leads. *
"SFD PROSPECT" means a Recommended SFD Lead for which a strategic partner has
completed its geological, geophysical, and economic evaluation, and has accepted
for exploratory drilling or other hydrocarbon exploitation. *
"SFD SURVEY SYSTEM" means the proprietary system composed of the Stress Field
Detector and the Company's data acquisition and global positioning systems.
"SFD TECHNOLOGY" refers to the Stress Field Detector and its underlying
scientific theories.
"SIGNATURE WAVEFORM" means the unique SFD Anomaly associated with or exhibited
by a particular type of stress-related subsurface condition.
"STRESS FIELD" means above ground, non-electromagnetic energy patterns caused by
apparent subsurface mechanical stresses in rocks and pressure differentials in
fluids.
"STRESS FIELD DETECTOR" or "SFD" means Momentum's proprietary system, whose
primary component is the "SFD SENSOR," a passive transducer which captures
stress fields through the interaction of energy patterns against the quantum
field generated by the SFD Sensor.
"WAVEFORM" means the resultant digitized data signal generated by the Stress
Field System in response to a stress field.
. The terminology used in the Company's various agreements with its strategic
partners varies. In order to avoid confusion and to provide conceptual
consistency in this Report, the Company has created certain defined terms
in this Glossary as denoted by an asterisk which differ from the actual
terminology used in one or more agreements with the Company's strategic
partners. For example, a "lead" which the Company recommends to a strategic
partner for further geologic and geophysical evaluation, but which such
strategic partner has not accepted, is defined in the Glossary as a
"Recommended SFD Lead." Such lead is actually called an "SFD Anomaly" under
the Company's joint venture agreement with Encal Energy Ltd., and an "SFD
Prospect" under the Company's agreements with Renaissance Energy Ltd. and
CamWest Exploration LLC. For a description of the actual terminology, see
that section in Part I, Item 1, of this Report captioned "Business--Joint
Venture and Survey Agreements."
THE FOLLOWING TERMS ARE COMMONLY USED WITHIN THE CONTEXT OF THE COMPANY'S
INDUSTRY:
"Anticline" is an arch or dome shaped structure of rock strata.
"BARREL" or "BBL" means 42 U.S. gallons.
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"CRETACEOUS" refers to a geologic period from about 135 million B.C. to 63
million B.C.
"DEVONIAN" refers to a geologic period from about 405 million B.C. to 345
million B.C.
"DRY HOLE" means a well that fails to produce commercial volumes of hydrocarbons
and is subsequently abandoned by the owner.
"FAULT" means a linear break in the continuity of rock strata which may involve
movement of the strata on one or the other side.
"FOLDS" means a buckling of the earth's strata caused by movement.
"GEOLOGIC DEFORMITIES" refers to abrupt variations in subsurface geology, such
as anticlines, faults, fractures and unconformities, such as reefs and salt dome
structures.
"HYDROCARBONS" refers to a mixture of organic compounds of which the principal
elements are carbon and hydrogen, and forming substances including crude oil,
condensate or natural gas.
"LOGGING" means the use of various types of instruments in well bores for the
purpose of recording data to determine lithology, porosity, permeability and
fluid content.
"MESOZOIC" refers to a geologic period from about 230 million B.C. to 63 million
B.C.
"MIGRATION" refers to the subsurface movement of hydrocarbons; primary migration
is from source bed through carrier beds into reservoirs.
"NATURAL GAS" means a gaseous form of petroleum.
"PERMEABILITY" refers to the capability of a reservoir to allow fluid flow.
"POROSITY" refers to the volume of pore space within a reservoir.
"RESERVOIR" means a volume of porous or permeable rock capable of holding an
accumulation of petroleum.
"SALT DOME" refers to a dome shaped salt plug which has been forced upward
through rock strata because of extreme pressure and differences in rock density.
"SEISMIC TECHNOLOGY" or "SEISMOLOGY" refers to survey methods based on creating
an explosion or artificial sound waves at the surface, observing how that sound
waves move through various subsurface layers, and recording how each layer of
rock reflects or attenuates the generated sound waves.
"SHALE" means rock composed of clay and fine-grain sediments.
"SPUDDING" means to begin the drilling a new well.
"STRATA" means a layer of rock.
"STRATIGRAPHIC TRAP" is a hydrocarbon trap where a reservoir bed is sealed by
impermeable strata that lies above, below or adjacent to it.
TRAP" is a hydrocarbon trap formed by deformation of rock layers, such as by
anticlines and faults.
"TRAP" means a geologic deformity or structure which confines the migration of
hydrocarbons.
"VISCOSITY" is a term used to describe the ability, or lack of ability, of a
fluid to flow.
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ADVISEMENT
CERTAIN STATEMENTS AND INFORMATION CONTAINED IN THIS REPORT, OTHER THAN
HISTORICAL INFORMATION, SHOULD BE CONSIDERED "FORWARD-LOOKING STATEMENTS" WITHIN
THE MEANING OF SECTION 21E OF THE UNITED STATES SECURITIES EXCHANGE ACT OF 1934,
AS AMENDED. ALL SUCH FORWARD-LOOKING STATEMENTS REFLECT MANAGEMENT'S CURRENT
VIEWS OF FUTURE EVENTS AND FINANCIAL PERFORMANCE BASED UPON CURRENTLY AVAILABLE
INFORMATION, AND INVOLVE A NUMBER OF RISKS AND UNCERTAINTIES THAT MAY CAUSE THE
COMPANY'S ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE EXPRESSED IN, OR
IMPLIED BY, SUCH FORWARD-LOOKING STATEMENTS. THE COMPANY HAS TRIED, WHEREVER
POSSIBLE, TO IDENTIFY THESE FORWARD LOOKING STATEMENTS BY, AMONG OTHER THINGS,
USING WORDS SUCH AS "ANTICIPATE," "BELIEVE," "ESTIMATE," "EXPECT" AND SIMILAR
EXPRESSIONS. FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY
INCLUDE, BUT ARE NOT LIMITED TO, DELAYS ON THE COMPANY'S PART IN CONDUCTING SFD
SURVEYS AND/OR INTERPRETING SFD DATA, AND DELAYS ON THE PART OF THE COMPANY'S
STRATEGIC PARTNERS IN PLANNING SURVEY ACTIVITIES, IN CONDUCTING GEOLOGIC AND
GEOPHYSICAL EVALUATIONS OF RECOMMENDED ANOMALIES, IN ACQUIRING DRILLING RIGHTS,
AND/OR IN CONDUCTING EXPLORATORY DRILLING ACTIVITIES, AS WELL AS OTHER
UNCERTAINTIES DETAILED IN THIS REPORT AND AS PARTICULARLY ENUMERATED IN ITEM 7
OF THIS REPORT CAPTIONED "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS--UNCERTAINTIES AND RISK FACTORS" AND ITEM 7A
OF THIS REPORT CAPTIONED "QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET
RISK." THE COMPANY IS NOT OBLIGATED TO UPDATE OR REVISE THESE FORWARD-LOOKING
STATEMENTS TO REFLECT NEW EVENTS OR CIRCUMSTANCES.
The observations, beliefs and opinions expressed in this Report relating to the
scientific basis and principles of the SFD Technology, and the ability of the
SFD Technology to detect geologic features, structures and hydrocarbons, are
those of the Company and its management, and should not be construed as
representing the observations, beliefs and/or opinions of any third party,
including the Company's strategic partners and professional geologists and
engineers engaged by the Company, except to the extent expressly stated in this
Report to represent the observations, beliefs and/or opinions of any such third
parties. The Company maintains the scientific and operating principles and
mechanics of the SFD Technology in strict confidence. While the Company's
strategic partners and professional geologists and engineers engaged by the
Company have observed the operations of SFD Technology while on survey
assignment, and are given access to the results of selected interpreted SFD Data
in connection with the Company's predictions, they have not been given any
information relating to the scientific and operating principles and mechanics of
the SFD Technology other than general information consistent with the general
observations, beliefs and opinions of the Company expressed in this Report, and
such parties are not, and do not hold themselves out as being, experts in or
otherwise having specific knowledge as to the SFD Technology and its scientific
basis and principles.
The information set forth in Part I, Item 1, of this Report, captioned
"Business," is current as of March 20, 1999, unless an earlier or later date is
indicated in such section. The information set forth in the sections of this
Report other than Part I, Item 1, is current as of December 31, 1998, unless an
earlier or later date is indicated in such sections.
PART I
ITEM 1. BUSINESS
OVERVIEW
INTRODUCTION
Pinnacle Oil International, Inc. ("Pinnacle International"), together with its
subsidiaries, Pinnacle Oil Inc. and Pinnacle Oil Canada, Inc. ("Pinnacle U.S."
and "Pinnacle Canada," respectively, and collectively with Pinnacle
International, the "Company"), is a remote-sensing technology company engaged in
the business of wide-area hydrocarbon (oil and natural gas) reconnaissance
exploration. Pinnacle International is a publicly traded company whose common
stock, par value $0.001 ("Common Stock"), trades over-the-counter on the NASD
Electronic Bulletin Board under the symbol "PSFD." The principal executive
offices of the Company are located at Suite 750, Phoenix Place, 840-7th Avenue
S.W., Calgary, Alberta, Canada T2P 3G2, and its telephone number is (403) 264-
7020.
The Company uses Stress Field Detector or "SFD" technology to survey or
reconnoiter large exploration areas from the Company's survey aircraft at speeds
in excess of 150 mph to identify and "high-grade" potential SFD Leads for
further evaluation and drilling by the Company's strategic partners, United
States-based CamWest Exploration LLC ("CamWest Exploration"), and Canada-based
Encal Energy Ltd. ("Encal Energy") and Renaissance Energy Ltd. ("Renaissance
Energy"). (See "Business--Strategic Partners"). The SFD is a recently developed
technology which the Company adapted for airborne survey operations and field
tested for independent geologists and the Company's strategic partners in 1996
and 1997, and commenced SFD survey activities on a full commercial basis for its
strategic partners in early 1999. No wells have been drilled to date using the
SFD Technology, although the Company has tendered 37 Recommended SFD Leads to
its strategic partners for geological and geophysical evaluation since mid 1998,
and one strategic partner has since spudded one well with drilling results
anticipated by mid-1998, and a second strategic partner anticipates it will
commence initial drilling activities in June 1999. (See "Business--Status of
Commercial Activities").
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The SFD captures non-electromagnetic energy patterns (which the Company refers
to as "stress fields") which the Company believes result from subsurface
mechanical stress in rocks and subsurface fluid pressures. The Company processes
and interprets the waveforms associated with these energy patterns through
several different modes of operation and analysis wherein the Company uses the
SFD as both an inferential detection tool to identify geologic structures and
features and porosity levels from which the presence of hydrocarbons may be
deduced, as well as a direct detection tool which identifies the actual presence
of oil, gas and water and the relative amount of these accumulations. The
interpretation process involves, among other interpretative functions, a
"templating" process whereby the Company matches the waveform of the structural
and hydrocarbon signals of the prospect being surveyed to those of known oil and
gas pools in the same area (the Company has determined that each type of
geologic structure/feature and hydrocarbon accumulation bears a unique or
signature waveform that it shares in common with similar geologic structures and
hydrocarbon accumulations). The Company has, to date, successfully used the SFD
to identify known hydrocarbons over land at depths of up to 15,000 feet below
the surface. The SFD has also indicated an ability to identify potential off-
shore hydrocarbon accumulations at unknown depths based upon survey activities
conducted recently in the Gulf of St. Lawrence (Canada) water depths of up to
500 feet.
The SFD affords the Company with the relatively inexpensive ability to obtain
near real-time analysis and interpretation of potential hydrocarbon
accumulations in a matter of days or weeks, as compared to months, and in some
cases years, in the case of the seismic methods currently employed by the oil
and gas exploration industry for wide area exploration or reconnaissance. These
cost and time advantages may ultimately enable the Company's strategic partners
to effectuate potentially significant reductions in their "finding costs," i.e.,
the cost of wide-area seismic, the cost to acquire land for exploration, and the
cost to drill and complete exploratory wells. The ability to reduce finding
costs is an extremely important financial factor in the oil and gas industry,
insofar as low finding costs represent a measure of an oil and gas company's
ability to effectively and efficiently find new reserves, as well as generate
cash flow. For example, in its 1998 Finding, Development & Acquisition Analyst,
First Energy Capital Corp, a Canadian energy analyst ("First Energy"), made the
following statements relating to reserve replacements:..."We believe, next to
the strength and ability of the management teams, that the full cycle, economic
impact of reserve additions costs is the most important variable in judging the
direction of the stock prices for oil and gas companies"..."However they are
analyzed, reserve additions costs and production replacement ratios will be the
major drivers to a company's success, or lack thereof"..."Essentially, each Boe
of cash flow that is being currently generated must be replaced, with the key
being the relative Boe additions cost. The bottom line is that, if the new Boe
costs more than the Boe flowing through the financial statements, the company is
eroding value and on the course for bankruptcy."
As tracked by Arthur Andersen and John S. Herold, the average finding and
development costs in the United States for the 1995 to 1997 period was $6.83 per
barrel of oil or oil equivalent, as compared to average production costs of
$3.96 per barrel of oil or oil equivalent. One significant element of finding
costs is the cost of wide-area seismic, which is approximately $5,000 to $25,000
per linear mile for 2D seismic, and $15,000 to $100,000 per square mile for 3D
seismic, depending upon the terrain and geologic features and characteristics.
The cost of the SFD, on the other hand, is only $5 to $12 1/2 per linear mile,
which is a fraction of the cost of conducting seismic. The other elements in
finding costs are, as noted above, costs incurred to acquire drilling rights,
and to drill and complete exploratory wells. Use of the SFD Technology may
potentially result in significant savings with respect to these other finding
costs, since the ability of the SFD Technology to "high grade" potential
prospects allows oil and gas companies to otherwise avoid expenditures on
prospects which will ultimately be determined to be marginal or non-productive.
In summary, the potential ability of the SFD Technology to significantly reduce
the cost of wide area seismic for an oil and gas company, and to enable such
company to minimize its other finding costs with respect to marginal or non-
productive exploration areas, may ultimately enable such oil and gas company to
significantly reduce its overall finding costs and focus its exploration
expenditures on prospects with the most commercial potential.
The Company believes that the SFD Technology has demonstrated that it has the
minimum ability to inferentially detect hydrocarbon accumulations by
identifying, through their unique stress fields, structural traps, strata types,
and other geologic features and characteristics commonly associated with
hydrocarbon reservoirs and which features and characteristics are otherwise
identifiable with seismic (collectively, "seismically-detectable geologic
structures and features"). This belief is based upon a seismic confirmation rate
over the past several years by the Company's strategic partners in the range of
85%--90% with respect to more than 30 SFD Leads containing material seismically-
detectable geologic features and characteristics. (See "Business--Use of SFD
Survey System As Inferential Exploration Tool To Detect Geologic Structures
Associated With Hydrocarbon Accumulations"). As such the SFD Technology is a
functional equivalent to seismic for wide-area exploration or reconnaissance
purposes, in that both methods identify seismically-detectable geologic
structures and features from which a trained geologist can make an educated
inference whether an oil and gas reservoir is present.
The Company also believes that the SFD Technology has the potential ability to
directly detect substantial hydrocarbon accumulations, although this belief will
not be proven until a statistically meaningful number of wells have been
drilled. The Company's belief that the SFD Technology is a hydrocarbon detection
tool is principally supported by the results of three sets of blind field tests
of known oil and gas pools and fields conducted by an independent geologist and
the Company's strategic partners over the past several years. (See "Business--
Use of SFD Survey System as Direct Hydrocarbon Detection Tool"). (The only other
technique to the knowledge of the Company which can potentially detect
hydrocarbons is "AVO" {amplitude versus offset}, a seismic "bright spot"
analysis technique which may, under limited circumstances, indicate natural gas
and, less commonly, oil accumulations. However, the AVO seismic technique
remains subject to the other time and costs limitations inherent in seismic).
The potential ability of the SFD Technology to directly detect hydrocarbons is
particularly important for the following reasons.
. First, the historical industry success rate in drilling commercially-
productive exploratory wells on structural-based prospects indirectly
identified using seismic methods is only 10% to 50% (although there
have been recent reports of a success rate of up to 75% with respect
to Gulf Coast sedimentary basins where AVO processing of 3D seismic is
used). The Company's approximate 85% "across the board" field
confirmation success rate to date in directly detecting known oil and
gas reservoirs (including both structural traps and stratigraphic
traps) means that its strategic partners will (i) potentially have a
higher overall success rate in drilling commercially-productive
exploratory wells, and (ii) as a result of such higher success rate,
will potentially incur lower finding costs.
. Second, oil and gas reservoirs known as "stratigraphic" traps may be
less susceptible to detection by seismic (although there are a number
of stratigraphic traps which contain certain types of strata or
"subtle" reservoir characteristics which seismic can detect). The SFD
gives the Company's strategic partners the potential ability to detect
and exploit these otherwise difficult to find oil and gas reservoirs.
Since it is likely that there are abundant undiscovered stratigraphic
traps, the potential ability to detect and exploit these reservoirs
has significant economic implications.
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. Finally, the SFD registers a greater response to larger accumulations
of oil and gas than smaller accumulations, therefore allowing the
Company's strategic partners to focus their efforts on drilling those
SFD Leads which exhibit maximum production and revenue generation
potential (and conversely, enabling such strategic partners to
eliminate or cull potentially non-productive or marginal leads, such
as structural-based leads which otherwise look favorable based upon
their seismically-detectable structures and features, from acquisition
and drilling consideration).
Business Strategy and Evolution of Business
The Company's initial business strategy was to enter into joint venture and
other strategic arrangements through its subsidiaries with a small and select
number of reputable, experienced, well-capitalized oil and gas companies
pursuant to which:
. The Company would generally use the SFD Technology to focus on
exploration activities to identify SFD Leads for these strategic
partners in exploration areas potentially containing larger oil and
gas fields (which the Company believes represents the best utilization
of the SFD Technology).
. The strategic partner would geologically and geophysically evaluate
Recommended SFD Leads at their sole cost.
. The strategic partner would finance the acquisition and development of
Recommended SFD Prospects they select to drill.
. The strategic partner would pay the Company a royalty based on
revenues with respect to production (as opposed to a fixed fee),
unless the Company elects to participate on a working interest basis.
(For any SFD Prospect for which the Company is paid a royalty, the
strategic partner would be responsible, at its own cost and risk, to
acquire the necessary drilling rights for such prospect, and to
conduct all drilling, production and marketing activities necessary to
exploit such prospect).
. The strategic partner would grant the Company a working interest in a
project if elected by the Company. (In any case where the Company
elects a working interest in a project, the Company would generally be
responsible for its share of the costs to develop the SFD Prospect,
but the strategic partner would be responsible for managing the
acquisition of all drilling rights, and all drilling, production and
marketing activities. Although a working interest option requires an
investment by the Company and bears greater financial risks than a
royalty option, a working interest carries the potential of
significantly greater financial returns if the project is successful).
. The strategic partner would agree to a relatively short-term joint-
venture agreement of 3 to 4 years, which joint venture is timed to
correspond to the anticipated evolution of the Company's business plan
as addressed below.
. The strategic partner would agree to maximum inventory obligations of
the Company to induce drilling performance by a joint venture partner
on an SFD Prospect.
Since the commencement of full commercial applications of the SFD Technology in
1998 under the Company's strategic arrangements, the Company has focused its
operational efforts on improving the speed and accuracy of its SFD Data
acquisition systems, and has made substantial strides in this objective, which
has lead to significant improvements in the quality of the SFD Data and
reductions in interpretation time. During this period the Company has also made
significant strides in organizing its SFD survey and interpretation operations,
including developing and implementing survey and interpretation procedures. The
Company has also acquired a survey aircraft which the Company has outfitted to
meet its unique SFD survey requirements, and has also hired additional
professional staff to provide support and assistance to further develop the
Company's operational abilities. The Company is still in the process of
organizing and developing its operational abilities, and intends to hire
additional professional staff and flight personnel in the near future to
-3-
provide additional support and assistance developing the Company's operational
abilities (including a vice president of operations to manage overall
exploration operations), as well as assisting in further SFD Survey System
research and development.
One of the Company's principal operational objectives is to shorten its survey
and interpretation time to as close to real-time as possible, and the Company
foresees having two "survey teams" for each survey assignment in order to
accomplish this objective, as well as office-based professional and technical
support personnel. One survey team will conduct survey flights in morning
weather windows, while the second team interprets SFD Data in conjunction with
office-based professional and technical support personnel. The survey teams will
then switch job duties in the afternoon weather window.
The Company's longer-term strategy and objective, once it has fully developed
its SFD survey and interpretation operational abilities, is to directly acquire
drilling rights and evolve into more active exploration and working interest
activities. Specifically, at this stage of its development the Company will have
the ability to expeditiously and inexpensively qualify land for the acquisition
of drilling rights, and to finance land acquisition initiatives with the
Company's available cash flow or through financings funded, in part, through the
Company's anticipated base of proven reserves. The Company would, at that point
in time, establish a land department to acquire drilling rights and manage its
properties. The Company's strategic partners would most likely continue drilling
their SFD Prospect inventories, and may continue their association with the
Company through other royalty, working interest and/or fixed fee arrangements.
(The Company intentionally limited the terms of its joint venture agreements
with its strategic partners to a three or four year term to facilitate this
evolutionary step, and to also qualify the resources, skills and level of
commitment of each strategic partner to potentially continue their participation
after the expiration of their respective agreements).
It should be noted that prospects which may be confirmed through exploratory
drilling as containing commercial quantities of oil and gas may become
immediately marketable based on the size of their estimated reserves. It is
therefore not necessary to actually place production wells on-line to recognize
the value of these reserves, and the Company and/or its strategic partners may
instead consider selling the reserves and associated drilling rights to third
parties based upon a discounted cash flow formula derived from estimated
reserves and other production and/or market factors. The Company and its
strategic partners anticipate they will have the similar ability, once the SFD
Technology is proven, to sell SFD Prospects on the market, even if exploratory
wells have not been drilled. The Company and certain of its joint venture
partners have, in fact, set up a mechanism under their joint venture agreements
wherein they may dispose of smaller SFD Prospects which may have commercial
value.
STRATEGIC PARTNERS
Pinnacle U.S. and Pinnacle Canada have, to date, entered into joint venture
agreements with two strategic partners, United States-based CamWest Exploration
and Canadian-based Encal Energy. Pinnacle Canada has also entered into two SFD
survey agreements with a third such strategic partner, Canadian-based
Renaissance Energy.
. CamWest Exploration is a privately held oil and gas exploration
company, and an affiliate of SFD Investment LLC, which invested $6
million into the Company in April 1998 concurrently with CamWest
Limited Partnership, CamWest Exploration's predecessor and affiliate,
entering into the joint venture agreement. Each of CamWest Exploration,
CamWest Limited Partnership and SFD Investment LLC are affiliates of
Stephens Group, Inc., a private company headquartered in Little Rock
Arkansas which invests primarily in media, telecommunications, energy
and investment banking companies.
. Encal Energy is an intermediate Canadian exploration company listed on
the Toronto and New York Stock Exchanges. As of December 31, 1998,
Encal Energy had total assets of Cdn. $630 million, 34 million barrels
of total proven oil and natural gas liquid reserves, and 481 billion
cubic feet of proven natural gas. For fiscal 1998 Encal Energy averaged
12,384 barrels per day in oil and natural gas liquid production, and
143 million cubic feet per day in natural gas production.
Renaissance Energy is a major Canadian exploration company listed on
the Toronto and Montreal Stock Exchanges. As of December 31, 1998,
Renaissance Energy had total assets of Cdn. $4.691 billion, 426 million
barrels of total proven oil reserves, and 2,197 billion cubic feet of
proven natural gas reserves as of December 31, 1998. For fiscal 1998
Renaissance Energy averaged 87,891 barrels per day in oil production,
and 468 million cubic feet per day in natural gas production.
The strategic partners have evaluated the SFD Technology for periods ranging
from one to two years. Each of the strategic agreements provide for the payment
of a royalty to Pinnacle Canada or Pinnacle U.S. by the respective strategic
partner, currently in the range of 5% to 8%, based upon revenues attributable to
the strategic partner's interest in production and resulting from the sale of
hydrocarbons produced by wells drilled on SFD Prospects identified by such
subsidiary. In any situation where Pinnacle Canada or Pinnacle U.S. is being
paid a royalty with respect to an SFD Prospect identified by such subsidiary,
each strategic partner will be responsible, at its own cost and risk, to acquire
the necessary drilling rights for such prospect (if it has not already done so),
and to conduct all drilling, production and marketing activities necessary to
exploit such prospect. Each of these agreements also provides for the strategic
partner to pay all (in the case of CamWest Exploration and Renaissance Energy),
or one-half of all (in the case of Encal Energy), of the SFD survey costs
incurred by Pinnacle Canada or Pinnacle U.S.. The joint venture agreement with
CamWest Exploration is for a four year term, which will expire on March 15,
2003. The joint venture agreement with Encal Energy is for a three year term
which will expire on September 15, 2000. The survey agreements with Renaissance
Energy will expire on June 30, 1999. For a more complete description of the
terms of these agreements, see "Business--Joint venture and Survey Agreements."
The joint venture agreements with CamWest Exploration and Encal Energy each also
permit Pinnacle U.S. or Pinnacle Canada to elect to participate on a higher
working interest basis (in percentage terms relative to a royalty interest) with
-4-
respect to each SFD Prospect identified by such subsidiary, in which case such
subsidiary must bear its share of the acquisition (if necessary), drilling and
production costs incurred with respect to such prospect based upon such
subsidiary's working interest for such prospect. Notwithstanding that Pinnacle
U.S. or Pinnacle Canada bear a share of the costs in such circumstances, the
strategic partner will nevertheless remain responsible for conducting and
managing all drilling, production and marketing activities to exploit the SFD
Prospect.
Although Pinnacle U.S. and Pinnacle Canada have retained the noted working-
interest rights with CamWest Exploration and Encal Energy, and although the
Company and its subsidiaries have the right to explore and exploit hydrocarbon
accumulations for their own accounts and, subject to certain limitations under
the joint venture agreements, for additional strategic partners, the Company's
current near-term intentions (subject to future developments) are: (i) to limit
its exploration efforts to the Company's current strategic partners subject to
their financial and operational ability to develop all SFD Prospects tendered to
each such partner, and (ii) for each of the Company's subsidiaries to elect to
receive a royalty interest (in lieu of a working interest) on all SFD Prospects
developed by their strategic partners unless and until such time as the Company
and/or such subsidiaries have accrued substantial working capital from the
receipt of royalties or other income or other sources of capital as will enable
them to elect to participate on a working interest basis with respect to
selected SFD Prospects should management determine it advisable to do so.
MOMENTUM SFD TECHNOLOGY LICENSE
Pinnacle International holds the exclusive world-wide rights to exploit the SFD
for hydrocarbons under a ten-year renewable SFD Technology License from a
related company, Momentum Resources Corporation ("Momentum). Momentum is a
Bahamas corporation indirectly owned and controlled by the two principal
founders of Pinnacle International, Mr. George Liszicasz (the inventor of the
SFD and presently the Chief Executive Officer, Chairman and a significant
stockholder of the Company), and Mr. R. Dirk Stinson (presently the President
and a director and significant stockholder of the Company) (See "Business--
Corporate Structure and Development"). Under the terms of the SFD Technology
License, Pinnacle International will pay Momentum a fee equal to 1% of "Prospect
Profits" (as such term is defined under the SFD Technology License) received by
Pinnacle International and its subsidiaries on or before December 31, 2000, and
5% of Prospect Profits received after December 31, 2000. Prospect Profits is
defined as the aggregate of all gross revenues actually received by the Pinnacle
International and its subsidiaries with respect to the commercial exploitation
of all SFD Prospects, less all project expenses actually paid by Pinnacle
International and its subsidiaries with respect to the commercial exploitation
of such SFD Prospects. The SFD Technology License also provides for the grant of
"Performance Options" on Pinnacle International's Common Stock for each month in
which SFD Prospect production exceeds 20,000 barrels of oil or oil equivalents.
For a more complete description of the SFD Technology License, see "Business--
Momentum SFD Technology License Agreement"
STATUS OF COMMERCIAL ACTIVITIES
The Company completed the last of the field evaluations designed by its
strategic partners to evaluate and test the SFD Survey System in early 1998, and
Pinnacle U.S. and Pinnacle Canada are now actively engaged in SFD Prospect
survey and interpretation activities intended to lead to royalty or working
interest income under the Company's various strategic arrangements. The Company
has tendered 37 Recommended SFD Leads to its strategic partners for further
evaluation and ultimate drilling (as discussed below). The Company believes the
Recommended SFD Prospects have the potential to contain commercial oil and gas
accumulations. The Company also has an active inventory of over 175 SFD Leads
which the Company is in the process of evaluating for its three strategic
partners (although the majority of these leads will probably not become SFD
Prospects for various reasons).
The current status of the Recommended SFD Leads tendered by the Company to its
strategic partners are as follows:
. CAMWEST EXPLORATION--The Company has tendered 25 Recommended SFD Leads
to CamWest Exploration for further geologic and geophysic evaluation
to date, and CamWest Exploration has successfully completed its
geological and geophysical evaluation with respect to 12 of these
leads and
-5-
accepted eight as SFD Prospects, and is completing its evaluation with
respect to the balance. CamWest Exploration is currently in the
process of obtaining drilling rights for a number of these Recommended
SFD Leads, and has informed the Company that it anticipates that
initial drilling operations may commence in June 1999, subject to
unexpected delays or complications, including acquiring drilling
rights. It should be noted that a number of the Recommended SFD Leads
which CamWest Exploration may accept as SFD Prospects for drilling
would, (assuming such prospects are successfully drilled and
production tested), constitute potential "fields" which would support
multiple producing wells.
. ENCAL ENERGY--The Company has tendered 6 Recommended SFD Leads to
Encal Energy for further geological and geophysic evaluation to date,
and Encal Energy has completed its geological and geophysical
evaluation with respect to five of these Recommended SFD Leads and
accepted them as SFD Prospects, and is completing its evaluation with
respect to the remaining Recommended SFD Lead. These six SFD Prospects
include the Shoal Point prospect which, as noted below, was spudded
earlier in 1999 and for which the Company is entitled to a potential
2.1% gross overriding royalty. Encal Energy is not in a position to
drill the other five SFD Prospects until the 1999-2000 winter drilling
program (a winter drilling window generally starts with freeze-up,
which usually occurs in November, and ends with break-up, which
usually occurs in March or April). All five remaining SFD Prospects
were previously evaluated by Encal for drilling by the end of 1998 as
part of its 1998-1999 winter drilling program, however, Encal Energy
decided in early 1999 to delay drilling these prospects until the next
winter drilling program (subject to the Company's continued
recommendation and request) as the result of delays in resurveying
several prospects, as well Encal Energy's inability to obtain drilling
rights for certain of these prospects for the 1998-1999 winter
drilling program and reconsideration of drilling economics. (Encal
Energy has indicated that it reserves the right to reconsider drilling
these SFD Prospects based upon future developments in the oil market
and/or better alternatives afforded in the interim arising from the
Company's pending survey activities for Encal Energy.)
An exploratory well was spudded on Encal Energy's Shoal Point SFD
Prospect, located on the Port au Port Peninsula in western
Newfoundland, Canada, on February 8, 1999 (drilling was delayed for
over six weeks due to unforeseen complications and costs in building
an access road over a swampy area to the drilling site). The Shoal
Point exploratory well will test a major seismically defined
structural feature located approximately 15 miles northeast of the
Hunt-PCP Port au Port #1 well, which was drilled in 1995, and which
tested light oil at flow rates up to 1,742 barrels per day. The Shoal
Point exploratory well is scheduled for drilling to a total depth of
2,440 meters.
The Shoal Point exploratory well, which is estimated to cost Cdn. $10
million, is being drilled directionally from an onshore drilling site
to an offshore target area for economic considerations (an off-shore
exploration well would be considerably more expensive to drill). Due
to the long lead times attendant to drilling the directional
exploration well, the Company does not anticipate that drilling and
production results will be completed, and results obtained, until late
spring or mid-summer
-6-
1999 at the earliest. Even if Shoal Point is successfully drilled and
production tested, it will take several years for Shoal Point to
generate revenues due to the long lead time to place necessary
infrastructure in place.
Should production commence at the Shoal Point location, the Company
will be entitled to a potential 2.1% of overall revenues. The Company
is entitled to this interest as a result of providing SFD Data
relating to the Shoal Point area to Encal Energy in mid-1998. Encal
Energy negotiated a farm-in agreement pursuant to which it agreed to
contribute an undivided 37 1/2% share of well costs in order to
participate in approximately 200,000 gross acres upon completion or
abandonment of the test well. The Company is under no obligation to
contribute toward any of Encal Energy's development costs for Shoal
Point.
No assurance can be given that the Shoal Point SFD Prospect will be
successfully drilled, or proven to have commercial quantities of
hydrocarbons. It should be noted that there have been six previous
unsuccessful attempts to find commercially viable hydrocarbon pools in
areas surrounding the Shoal Point SFD Prospect.
RENAISSANCE ENERGY--The Company has tendered six Recommended SFD Leads
to Renaissance Energy for further geologic and geophysic evaluation to
date (including two new SFD Leads identified by the Company in
December 1998 while resurveying certain of the first Recommended SFD
Leads), and Renaissance Energy successfully completed its geological
and geophysical evaluation with respect to four of these Recommended
SFD Leads, and is completing its evaluation with respect to the
remaining Recommended SFD Leads. The four Recommended SFD Leads which
Renaissance Energy seismically confirmed were all previously targeted
for drilling by Renaissance Energy by the end of 1998, however, due to
developments in the oil market, Renaissance Energy decided in early
1999 not to drill two of these leads for economic reasons, and also
decided to delay drilling the remaining two leads pending completion
of its evaluation of the two new Recommended SFD Leads, due to
Renaissance Energy's preference to drill all prospects it has
initially selected at one time. The Company does not anticipate that
Renaissance Energy would spud any exploratory well before the end of
the second to third quarter of 1999 at the earliest, assuming there
are no delays or complications in obtaining drilling rights. Although
the two Recommended SFD Leads currently under evaluation appear to be
promising based upon early information, no assurance can be given they
Renaissance Energy will drill these or any of the previously
seismically confirmed Recommended SFD Leads, or that any exploratory
wells Renaissance Energy does drill will not be a dry hole or will be
commercially productive.
Insofar as the Company has fully performed its obligations in
recommending SFD Leads to Renaissance Energy under its Survey
Agreement, the Company and Renaissance Energy anticipate they will
enter into negotiations in mid-1999 with respect to entering into a
longer term exploration agreement similar to those the Company has
entered into with its other strategic partners. In the meantime, the
Company and Renaissance Energy have extended the term of the Survey
Agreement through June 30, 1999.
No assurance can be given that the Recommended SFD Leads tendered to the
Company's strategic partners will be drilled at all or by projected drilling
dates due to, among other things, factors such as the perceived economics of
drilling at such time, the ability of the strategic partner to obtain drilling
rights (where necessary) on favorable terms or at all, and the ability of the
strategic partner to timely schedule a drilling rig and other drilling services.
Even if an SFD Prospect is drilled, no assurance can be given that the well will
produce commercially viable quantities of hydrocarbons. See "Management's
Discussion And Analysis Of Financial Condition And Results Of Operations--
Uncertainties and Risk Factors--Risks Relating to the Company and its Business,"
generally, and "Management's Discussion And Analysis Of Financial Condition And
Results Of Operations--Uncertainties and Risk Factors----Reliance on Joint
Venture Partners;Non-Operator Status" and "Management's Discussion And Analysis
Of Financial Condition And Results Of Operations--Uncertainties and Risk
Factors----Risk of Exploratory Drilling Activities" particularly.
-7-
CORPORATE STRUCTURE AND DEVELOPMENT
Pinnacle International was initially incorporated in Nevada on September 27,
1994 under the name "Auric Mining Corporation" ("Auric"). Auric was formed by
Mega-Mart, Inc. ("Mega-Mart"), a Delaware corporation formed on January 28,
1987, for the purpose of facilitating the change of Mega-Mart's corporate
domicile from Delaware to Nevada. On September 28, 1994, Auric and Mega-Mart
entered into a Plan Of Reorganization pursuant to which the shareholders of
Mega-Mart received 1,096,500 shares of the common stock of Auric, constituting
100% of its outstanding capital stock, in exchange for 100% of their outstanding
shares of common stock in Mega-Mart. The Plan Of Reorganization also
contemplated a subsequent merger of Mega-Mart into Auric, however, the parties
subsequently determined not to merge the companies, thereby retaining Mega-Mart
as a wholly-owned subsidiary of Auric. Auric subsequently determined that its
investment in Mega-Mart was without value, and abandoned this investment.
On March 21, 1995, Auric entered into a Plan Of Reorganization with Fiero Mining
Corporation, a Nevada corporation ("Fiero"), whereby Auric agreed to issue
3,833,357 shares of common stock (constituting approximately 16.8% of its
outstanding shares of common stock) in exchange for 100% of the outstanding
shares of the common stock of Fiero. Fiero was retained as a wholly-owned
subsidiary of Auric until December 16, 1995, at which time Fiero was spun-off to
the shareholders of Auric on a one share for one share basis.
On December 12, 1995, Pinnacle U.S. and Auric entered into a letter of intent
pursuant to which: (i) Auric agreed to issue 10,090,675 shares of the common
stock, of Auric (constituting approximately 92% of its outstanding shares of
common stock) to the shareholders of Pinnacle U.S., in exchange for all of the
outstanding shares of common stock of Pinnacle U.S. (thereby making Pinnacle
U.S. a wholly-owned subsidiary of Auric); (ii) Auric agreed to solicit
shareholder consent to a 6:1 reverse stock split immediately prior to the share
exchange; and (iii) Auric agreed to change its name to "Pinnacle Oil
International, Inc." upon consummation of the reorganization.
Pinnacle U.S. is a Nevada corporation formed on October 20, 1995, by Mr. George
Liszicasz, the inventor of the Stress Field Technology (and presently the Chief
Executive Officer, Chairman and a significant stockholder of the Company), and
Mr. R. Dirk Stinson (presently the President and a director and a significant
stockholder of the Company), together with five other investors, for the purpose
of engaging in hydrocarbon exploration utilizing SFD Data generated by the SFD
Technology. Messrs. Liszicasz and Stinson formed Pinnacle U.S. pursuant to a
partnership agreement amongst themselves (the "Liszicasz-Stinson Agreement") to
exploit the SFD Technology. On January 1, 1996, pursuant to his obligations
under the Liszicasz-Stinson Agreement, Mr. Liszicasz and Pinnacle U.S. entered
into a license agreement (the "Original Technology Agreement," subsequently
superceded in August 1996 by the SFD Technology License) whereby Pinnacle U.S.
obtained its original license to utilize the data generated by the SFD
Technology. For a description of the SFD Technology License, see "Business--
Momentum SFD Technology License Agreement" below.
On January 12, 1996, the shareholders and directors of Auric approved the
transactions contemplated by the letter of intent, and consented to a 6:1
reverse stock split. A formal Plan Of Reorganization And Acquisition was
executed and effective as of January 20, 1996, and the change in Auric's name to
"Pinnacle Oil International, Inc." was effective on February 23, 1996.
Since the date of its formation and through the date of consummation of the
noted transactions with Pinnacle U.S., Auric was a holding company and never
(with the exception of Auric's subsidiary, Fiero) conducted an active business.
Auric's predecessor, Mega-Mart, was also a holding company which conducted no
active business from its date of formation through its date of abandonment by
Auric. Prior to its spin-off in December 1995, Fiero engaged in limited gold
exploration activities.
The founder of Mega-Mart was Mr. Claude Smith, and the founders of Fiero were
Messrs. Kurt James, Arnold Wyncoop and George White. Messrs. James, Wyncoop and
White were also the persons who, on behalf of Auric, founded Auric. None of the
officers, directors or stockholders of Pinnacle U.S. or Momentum, including
Messrs. Liszicasz and Stinson, were directly or indirectly affiliated with Auric
or any of its founders, officers, directors or stockholders during the course of
the transactions contemplated by the Plan Of Reorganization And Acquisition,
-8-
and such transactions were made on an arms' length negotiated basis. With the
exception of Mr. Terrence Dunne, the secretary and a director and nominal
shareholder of Auric, the officers and directors of Auric were replaced with
officers and directors designated by Pinnacle U.S., including Messrs. Liszicasz
(as Chief Executive Officer and Chairman) and Stinson (as President and a
director), immediately following the consummation of the noted transactions.
As a result of the noted transactions, Pinnacle U.S. became a wholly owned
subsidiary of Pinnacle International, and changed its corporate function to
performing United States-based survey and interpretation operations. Pinnacle
International formed Pinnacle Canada, a federal Canadian corporation, on April
1, 1997 to perform Canadian-based survey and interpretation operations.
DESCRIPTION OF SFD TECHNOLOGY AND SFD SURVEY SYSTEM
The SFD detects non-electromagnetic energy patterns or "stress fields"
apparently resulting from subsurface mechanical stress in rocks and subsurface
pressure differentials. Each type of subsurface condition generates a unique
energy pattern. The SFD captures these energy patterns through its "SFD
Sensor," a passive transducer that generates a quantum field which, in turn,
responds to the energy patterns. (See "Business--Theoretical Basis of Stress
Field Detector" below).
During an SFD survey assignment, the SFD is flown over a pre-selected survey
area (either land or water) from several different directions in the Company's
survey airplane at an altitude of approximately 1,000 feet. As the aircraft
crosses the survey area, the SFD sensor captures the constantly changing energy
patterns, and converts them into a distinct digitized signal which the Company
records on its integrated data acquisition and global positioning systems (the
Company refers to this integrated assembly as the "SFD Survey System"). The
waveforms from the SFD Survey System (which the Company calls "SFD Data") are
analyzed, interpreted and compared against the signatures of known viable oil
and gas pools or fields by the Company's personnel. Through this comparison, the
Company is able to determine the structural character (i.e., faults, fractures,
unconformities) of any geologic feature indicated by the SFD Data, as well as
certain reservoir characteristics (i.e., porosity and hydrocarbon content) and
size (i.e., large versus small) of any potential oil and gas accumulations
indicated by the SFD waveform. In addition, by tracking the beginning and ending
points of the SFD Anomalies on each flight line, the Company is also able to
extrapolate the areal (horizontal) extent or boundary of the geologic structure
or oil and gas accumulation indicated. The actual number of flights lines
required to obtain sufficient SFD Data varies based upon the type of geologic
feature, structure and hydrocarbon accumulation indicated, the operational mode
of the SFD, and the Company's experience. The Company has typically flown three
flight lines over Recommended SFD Leads, however, as a result of recent
advancements in the data acquisition and interpretation components of the SFD
Survey System, in many cases the Company and certain of its strategic partners
have found two flight lines to be sufficient. The following example provides an
illustration of this process based upon three SFD flight lines:
-9-
[CHART APPEARS HERE]
Legend:
SFD survey flight number and flight line direction
Extrapolated areal (horizontal) extent based upon SFD survey
flight lines
Actual areal (horizontal) extent of potential hydrocarbon
accumulation as determined through subsequent geological and
geophysical evaluation, including seismic (if warranted)
Best targeted drilling or pay zone, and targeted depth as
determined through subsequent geological and geophysical
evaluation, including seismic (if warranted)
As can be noted from the above illustration, the extrapolated areal extent of
the hydrocarbon accumulation does not necessarily correspond with the actual
areal extent as may be determined through subsequent geological and geophysical
evaluation. Therefore, the optimum drilling location or pay zone depth as
subsequently determined through such geological and geophysical evaluation may
not fall exactly under or sufficiently adjacent to an SFD flight line. Although
the SFD can identify geological structures and features and potentially
hydrocarbon accumulations, it is currently unable to indicate the depth of these
structures, features and/or accumulations. Also, once the Company is satisfied
that it has sufficient SFD Data with respect to a particular Recommended SFD
Lead, it is not productive to have the Company's aircraft fly numerous
additional flight lines over such lead for the sole purpose of further
delineating its areal extent. It therefore remains necessary with respect to
each Recommended SFD Lead to conduct further geological and geophysical
evaluations (including 2D or 3D seismic where warranted) in order to determine
the actual areal extent of the potential hydrocarbon accumulation and optimum
drilling location.
TIMING OF SFD SURVEY AND INTERPRETATION
Although the SFD can potentially give near real-time analysis and interpretation
of potential hydrocarbon accumulations, the actual time between initial
identification of an SFD Lead and the Company tendering a Recommended SFD Lead
can ordinarily take several days or weeks, and under certain circumstances can
take several months, depending upon a number of factors, including the
following:
. The Company may not have sufficient information to make a
recommendation based upon its initial SFD survey flights, either
because it has not had the opportunity to complete a sufficient number
of crossings over the SFD Anomaly, or the SFD Data is incomplete or
inconclusive, thereby necessitating the scheduling subsequent SFD
flights over the surveyed region.
-10-
. The Company may not have the opportunity to quickly complete its
interpretation and analysis of the SFD Data due to its pending
workload for SFD flights and interpretation obligations for its other
strategic partners.
. The strategic partner may request the Company make one or more
additional SFD survey flights over the SFD Anomaly to address
questions it may have upon its review of the Company's
recommendations, which may take several weeks or months to schedule
and interpret due to the Company's pending workload for SFD flights
and interpretation obligations for its other strategic partners.
TIMING OF DRILLING AND PRODUCTION
Once the Company tenders a Recommended SFD Lead to a strategic partner, the
actual time for such partner to drill an exploratory well on such location and
ultimately produce oil and gas from such well ordinarily takes several months
after the tender date, and potentially can take many months or even years in
certain cases, depending upon a number of factors, including the following:
. If the strategic partner does not already have drilling rights for the
site, the partner must obtain the rights to conduct geological and
geophysical evaluations on the site and to ultimately drill on the
site if warranted, either through direct acquisitions or farmin
arrangements where the drilling rights are currently held by other oil
gas exploration companies. (In many cases the strategic partner might
not be able to obtain such rights on reasonable terms or at all). In
cases where the site is located on government-owned property, the
strategic partner often must bid for the drilling rights pursuant to
an auction process, which in certain cases will only occur during
selected window periods throughout the year.
. The strategic partner must complete its geological and geophysical
evaluation, including obtaining commercial seismic (if available)
and/or conducting 2D or 3D seismic surveys where warranted, as well as
obtaining all permits necessary to conduct such surveys.
. Once the strategic partner completes its geological and geophysical
evaluation with respect to a Recommended SFD Lead, and provided such
evaluation is positive, the partner must next review the economics of
drilling and production operations before it proceeds. This evaluation
will be based upon a number of factors, including an evaluation of the
estimated reserves potentially contained in the prospect as indicated
by the results of the geological and geophysical evaluations, the cost
to drill an exploratory well, the anticipated production and marketing
costs, and current oil and gas prices. Variables the strategic partner
will consider include whether the site is on-shore versus off-shore
and shallow versus deep, and whether the site is accessible to drill-
rigs and pipelines.
. Once the strategic partner makes a decision to drill an exploratory
well, the partner must obtain the necessary drilling permits. Factors
that affect the timing of exploration drilling include the
availability of drilling rigs; whether the prospect can be drilled at
any time during the year or only in seasonal windows (such as in the
case of winter drilling); whether the site is on-shore versus off-
shore; and whether other permits must first be obtained or studies
conducted (such as environmental and archeological studies).
. Assuming the exploratory well results in the discovery of
hydrocarbons, the strategic partner must then production test the well
to determine the estimated sustainable rate of production and
estimated recoverable reserves, and make a determination as to whether
production will be cost justified.
. Assuming the exploratory well is successfully production tested, the
strategic partner must place the necessary infrastructure in place to
bring the hydrocarbons to market, including installing collection
tanks, and pipelines which connect such tanks to existing pipelines,
if necessary. (Longer lead-times are required to put these facilities
in place with respect to off-shore or remote locations).
-11-
USE OF SFD SURVEY SYSTEM AS INFERENTIAL EXPLORATION TOOL TO DETECT GEOLOGIC
STRUCTURES ASSOCIATED WITH HYDROCARBON ACCUMULATIONS
Industry geologists have determined based upon past experience that hydrocarbon
accumulations are commonly associated with certain types of structural-based
traps and geologic features and changes in geology (although the existence of
such structures or features does not guarantee that commercial quantities of
hydrocarbons, or any at all, will actually be present). Geologists geophysicists
use seismic as an inferential tool to detect geologic structures and features,
as well as changes in those structures and features, and then make an educated
guess or inference whether oil and gas may be present based upon their knowledge
and experience.
The Company believes that the SFD has demonstrated that it is, at the minimum,
an inferential wide-area exploration or reconnaissance geologic structure
detection tool analogous to the 2D (and in some cases the more expensive 3D)
reconnaissance seismic methods currently employed in wide-area exploration or
reconnaissance efforts to locate hydrocarbon accumulations, in that both the SFD
Technology and seismic identify geologic features and structures (and changes in
those features and structures) potentially associated with hydrocarbon
accumulations. The Company's belief is based upon a success rate in the range of
85%--90% to date with respect to over 30 seismic evaluations conducted by the
Company's strategic partners with respect to the Company's predictions as to the
existence of seismically-confirmable structural traps or geological changes (the
coincident rate is even greater for larger hydrocarbon bearing structures), as
follows:
. Since the Company commenced commercial survey operations in early 1998, the
Company's three strategic partners have seismically evaluated over 23 SFD
Leads which the Company reported as having geologic structures or changes.
In almost every case, the strategic partners confirmed the existence of the
predicted geologic structure or change. (The Company also reported that the
SFD technology directly detected the existence of hydrocarbons at each of
these locations, and also stated whether these deposits would be oil or
gas).
. In the latter half of 1997, the Company evaluated nine locations as part of
two sets of blind field tests conducted by Renaissance Energy. These nine
locations included five SFD Anomalies which the Company identified for
Renaissance Energy in an area selected by Renaissance, and four locations
which Renaissance Energy had previously decided to drill based upon
seismic. The Company reported the existence of structural traps or
geological changes with respect to seven of these locations, which
predictions were confirmed by Renaissance's seismic. During this same time
period Encal Energy also conducted a set of blind field tests, pursuant to
which the Company evaluated three locations which Encal Energy had
previously decided to drill based upon seismic. While Encal Energy reported
the existence of structure on one of these locations based upon its
seismic, the Company reported that no structure was apparent. The Company's
prediction was confirmed by drilling results, which found an absence of
structure. The remaining two Renaissance Energy locations and two Encal
Energy were stratigraphic prospects, and therefore not relevant for
purposes of confirming the ability of the SFD to detect geological
structures and features. (The Company also accurately predicted that none
of the twelve wells would produce commercial quantities of hydrocarbons).
To verify the results of the Company predictions, the Company engaged
Gilbert Laustsen Jung Associates Ltd. ("Gilbert Laustsen"), an independent
Canadian petroleum engineering firm, to observe and report the details of
the Company's survey activities for these blind field tests. The Company's
predictions were confirmed by Gilbert Laustsen's report, which concluded:
"The drill results of the twelve wells are consistent with the predictions
resulting from SFD surveys in the primary zone of interest. The critical
issue, of course, concerns the ability of SFD technology to continuously
identify undrilled exploration prospects that result in commercial
discoveries. Although the SFD predictions reported here are accurate with
respect to the primary zone of interest, they do not yet provide the
ultimate test of the technology because no highly ranked anomalies
identified by SFD technology have been drilled yet." It is important to
understand that Encal Energy and Renaissance Energy believed, based upon
their seismic, that a number of these wells would be productive, and that
the Company's prediction that the wells would not be productive
notwithstanding the Company's confirmation of structure was subsequently
confirmed by drilling results. For a more complete description of these
blind field tests and Gilbert Laustsen's report, see "Business--Third Party
Field Evaluations Of The SFD Survey System--Review By Gilbert Laustsen Jung
Associates Ltd."
Based upon these results and their experience with the SFD, the Company's
strategic partners have a high level of confidence that the SFD is, indeed, such
an inferential geologic structure detection tool analogous to seismic, and have
accepted the SFD as a wide-area exploration or reconnaissance tool.
-12-
USE OF SFD SURVEY SYSTEM AS DIRECT HYDROCARBON DETECTION TOOL
As previously mentioned, the mere existence of subsurface structural traps or
features or changes in geology does not necessarily mean that there will be
commercially productive levels of oil and gas or, in fact, any at all. As a
result, oil and gas companies drill many dry or unproductive holes in areas that
otherwise appear to offer potential based upon seismic, particularly in
"exploration" or "non-developmental" areas (i.e., areas not within or adjacent
to known-producing areas). The current oil industry rate of success in drilling
productive wells in such exploration areas, for example, is 10% to 20% for high-
risk or "wildcat" exploration areas, and 30% to 50% for lesser risk exploration
areas. Accordingly, while seismic is a valuable tool for identifying potential
hydrocarbon bearing structures, its general inability to directly identify
hydrocarbons makes it an imperfect tool, particularly in view of the high
finding, acquisition and drilling costs invested in each dry hole.
To the knowledge of the Company no wide-area oil and gas exploration method to
date, including aeromagnetic, gravity, ground or surface radar, satellite
surveys, telemetrics, spectrum analyzers and conventional seismic, has
demonstrated the ability to directly detect and distinguish hydrocarbons
accumulations at their source with a high degree of accuracy. (The one exception
is certain seismic "amplitude" processing techniques which may, under limited
circumstances, directly identify natural gas and, less commonly, oil
accumulations, although this method remains subject to the other time and costs
limitations inherent in seismic).
The Company's belief that the SFD Technology is a hydrocarbon detection tool is
principally supported by the results of one set of blind field tests of known
oil and gas pools or fields conducted in 1996 by an independent geologist, and
two sets of blind field tests conducted in 1997 by the Company's strategic
partners (including one set conducted under the auspices of independent
petroleum engineers). Specifically, the Company believes that the SFD Technology
demonstrates the following characteristics based upon the results of the noted
blind field tests.
. The SFD Technology can not only directly identify hydrocarbons, but
can directly identify the presence of, and distinguish between,
various types of oil, gas and water accumulations and mixtures.
. The ability of the SFD Technology to directly detect hydrocarbons
allows it to identity oil and gas pools in "stratigraphic" pools which
are devoid of geologic structures and therefore often are not
susceptible to detection by seismic methods.
. The SFD Technology can distinguish large accumulations of hydrocarbons
with a field confirmation accuracy rate of approximately 85% to date
(as compared to the 10% to 50% success rate typically associated with
exploratory wells indirectly identified using seismic methods).
. The SFD Technology can indicate whether an identified hydrocarbon
accumulation which appears to contain commercially-developable
quantities of hydrocarbons has sufficient porosity to be exploitable.
The first blind field test was conducted in September 1996, in the early stages
of development of the SFD Technology, under the auspices of Rod Morris, a
Calgary-based independent professional geologist, in which the Company evaluated
a number of sites selected by Mr. Morris with the SFD technology, and informed
Mr. Morris whether or not hydrocarbons were present. The evaluation was
conducted in the southern portion of the Province of Alberta, Canada, and
involved over 1,000 linear miles covered by vehicle over a period of 7 days, and
27 hours of recordings of SFD Data. It should be noted that the principals of
the Company had no input in, or prior knowledge of, the areas to be traversed,
the known accumulations of the pools surveyed, or the trap types which would be
included. As reported by Mr. Morris, the SFD Technology had a 95% success rate
(19 of 20 pools) in accurately identifying oil and gas pools (including
stratigraphic pools), (2) the SFD could also differentiate between oil and gas,
and (3) and the SFD produced a stronger or more definitive signal in proportion
to the size and quality of the
-13-
hydrocarbon deposit. For a more complete description of these blind field tests,
see "Business--Third Party Field Evaluations Of The SFD Survey System--Field
Evaluation By Rod Morris, Geologist."
The second set of blind field tests were conducted for Encal Energy in August
and September 1997, when the Company acquired approximately 4,700 linear miles
of airborne SFD Data for Encal Energy during 9 flights over numerous known oil
and gas pools in Central Alberta. Encal Energy's analysis of the survey results
showed that larger reserve pools were more likely to produce SFD anomalies than
smaller reserve pools. The Company analyzed a portion of the survey, and
presented the results to Encal Energy. Encal Energy reviewed these results and
observed that the SFD identified 91% of pools with more than 5 million barrels
or 50 BCF in-place, and 63% of pools with less than 5 million barrels or 50 BCF
in-place. Encal Energy also noted the ability of the SFD Technology to identify
both structural and stratigraphic hydrocarbon signals, that oil and gas pools
had different SFD signals, and that larger oil and gas pools had more obvious
SFD signals. For a more complete description of these blind field tests, see
"Business--Third Party Field Evaluations Of The SFD Survey System--Field
Evaluation By Encal Energy Ltd."
The third and final set of field tests were those conducted in December 1997 for
CamWest Exploration's predecessor, CamWest Limited Partnership ("CamWest LP"),
in which the Company conducted "blind" airborne tests of the SFD Technology over
fourteen oil and gas fields, including eight stratigraphic fields, in
southeastern Alberta and the adjacent portion of northwestern Montana. CamWest
LP concluded that the SFD Technology had accurately identified 12 of 14 (or
approximately 85%) of the known oil and gas fields traversed; and that the
remaining 2 fields (or 15%) of the known fields not detected by the SFD
Technology involved fields with reserves of less than four million barrels. For
a more complete description of these blind field tests, see "Business--Third
Party Field Evaluations Of The SFD Survey System--Field Evaluation By Camwest
Limited Partnership."
Although these field tests support the Company's belief as to the potential
direct hydrocarbon detection ability and accuracy of the SFD Technology,
particularly with large fields, this belief will only be proven by drilling
results from previously unknown pools detected by the SFD Technology. The only
actual drilling results to date were the twelve wells drilled by Encal Energy
and Renaissance Energy mentioned above, in which the Company accurately
predicted with respect to each well that there would not be commercial levels of
hydrocarbons. Since a negative (the absence of hydrocarbons) cannot predict a
positive (the presence of hydrocarbons), these results are not the best
statistical evidence for verifying the potential direct hydrocarbon predictive
ability of the SFD Technology, although they did confirm its ability to identify
geologic structures.
This issue, however, may soon be statistically confirmed by the results of
exploratory wells which should be drilled on SFD Prospects by the Company's
strategic partners within 1999. When recommending these undrilled SFD Prospects
to its strategic partners, the Company reported that the SFD Technology detected
the existence of hydrocarbons at each of these prospects, and also generally
stated whether these deposits would be oil or gas. (As mentioned above, the
Company also reported that the SFD Technology also detected the existence of
geologic structures and changes.) The Company's belief that the SFD Technology
detected the existence of hydrocarbons at each of these SFD Prospects would be
statistically demonstrated by a high degree of drilling success (i.e., in excess
of the 10% to 50% rate ordinarily associated with seismic), as well as whether
the type of hydrocarbons produced (i.e., oil or gas) comport with the Company's
prediction when it originally recommended these prospects.
COMPETITIVE ADVANTAGES OF SFD TECHNOLOGY AS WIDE-AREA RECONNAISSANCE TOOL
The principal competitive advantage of the SFD Technology is its ability to
potentially effectuate significant reductions in the oil and gas "finding" costs
of its strategic partners in the following ways:
. The Company's strategic partners may substantially reduce their wide-
area seismic costs since they may use the SFD Survey System as their
wide-area exploration tool at a cost of approximately $12.50 per
linear mile, and may limit their 2-D and 3-D seismic costs to
confirming and delineating SFD Prospects that are first qualified by
the SFD Technology.
. The current success rate of oil and gas exploration companies in
drilling commercially productive wells is only 10% to 20% for high-
risk "wildcat" exploration wells, and 30% to 50% for lesser-risk
exploration wells. The Company believes that the SFD Technology will
have an extremely high level of accuracy as a hydrocarbon identifying
tool, estimated by the Company at approximately 85%
-14-
based upon the results of blind field tests of known oil and gas pools
or fields. As a result of this accuracy Pinnacle's strategic partners
should have fewer dry or commercially unproductive exploration wells
when using the SFD Technology.
. Oil and gas exploration companies who desire to exploit exploration
areas for which there is no available seismic data may obtain drilling
rights to these areas before they can conduct their seismic, which
often entails substantial expenditures. The SFD Technology will enable
the Company's strategic partners to limit their outlays for drilling
rights solely to areas which have been SFD qualified, thereby
resulting in significant savings in these acquisition costs.
. The ability of the Company's strategic partners to more productively
and profitably employ these cost savings will also have a significant
impact on their revenues and profits which extends far beyond the cost
savings in absolute terms. For example, if the strategic partner had a
10% to 20% success rate in higher risk wildcat exploration wells
without the SFD, and improves this success rate to 80% to 85% with the
SFD Technology, it would have the potential to increase its revenues
by 4 to 8 times as a result of such drilling successes alone. This
multiple is increased when the additional wells which may be drilled
due to the additional cash flow available as the result of the
substantial savings in seismic, drilling and land acquisition costs
are added to the equation.
. In addition to cost savings, the SFD technology can also potentially
accelerate the hydrocarbon identification process to near real-time.
Since the SFD Technology can be used in an airplane, the Company can
explore up to 1,000 miles per day per airplane. In contrast, seismic
acquisition teams can explore only 4-5 miles per day (unless they are
able to acquire commercially available seismic). Moreover, SFD Data
can be gathered within one or two days (although interpretative
activities typically take several days or weeks). In contrast, the
acquisition and interpretation of seismic may also take several weeks
or months or, in the case of large projects, years. These efficiencies
should permit the Company's strategic partners to more effectively and
efficiently use their resources.
. Also, the SFD Technology has the potential to locate major new
hydrocarbon deposits in areas never considered available to
exploration in the past, or only so at great expense, such as remote
and hostile locations and undersea locations.
Since exploration costs of the Company's strategic partners could be sharply
reduced, they have an economic advantage over oil and gas companies that do not
have access to the SFD Technology, which is particularly important in periods of
low or uncertain commodity prices.
COMPETITION
To the knowledge of the Company, there are no competitors in the oil and gas
exploration industry who use SFD Technology. Other "remote-sensing" competitors
in the oil and gas exploration industry include aeromagnetic, gravity, ground or
surface radar, satellite surveys, telemetrics and spectrum analyzers, as well as
general seismic. The Company does not believe that any of the noted remote
sensing technologies (other than general seismic) are accepted in the industry
as highly predictive general exploration tools.
THEORETICAL BASIS OF STRESS FIELDS
Momentum does not possess any patents or other registered intellectual property
rights with respect to the SFD Technology, and Momentum does not anticipate that
if it were to apply for and receive patent protection, that such patent
protection would necessarily protect Momentum and the Company from actual or
potential competition. In addition, patent counsel has advised Momentum and the
Company (i) that a patent application would inhere unwarranted disclosure risks;
and (ii) that the Company's present practices afford common law trade secret
protection. For these and other reasons, Momentum will not disclose a
comprehensive explanation of the SFD Technology. However, a brief description
of the theoretical basis and reasoning which support the SFD Technology are set
forth below.
-15-
Abrupt variations in subsurface geology (called "geological deformities") cause
stresses to develop in the surrounding rock materials. It is generally known by
geologists that when certain materials in the earth's crust (such as single
crystals) rupture due to stress, they generate electromotive force as a release
mechanism. A premise of the SFD Technology is the theory that prior to such a
rupture and the release of electromotive force, there are constant sub-atomic
interactions that release non-electromagnetic energy. The SFD Technology is
based on the theory that: (i) both mechanical stress in rocks and the pressure
differentials in fluids produce non-electromagnetic energy patterns; (ii) that
the energy patterns reflect subsurface conditions which are geological and may
be hydraulic; and (iii) that the SFD Sensor, a passive transducer which
generates a quantum field, captures the interaction of these energy patterns
against the field. This interaction is registered by the SFD Sensor as it is
moved over a survey area, and these energy patterns are converted into
electrical signals that are forwarded to the data acquisition system.
Several observations support the theory that hydrocarbon accumulations produce
the observed energy patterns:
1. THE DETECTED ENERGY PATTERNS ARE NON-ELECTROMAGNETIC. Field tests were
conducted with the SFD Sensor both (i) while shielded from
electromagnetic forces, and (ii) without such shields. In both cases
the SFD Sensor registered no change. When the sensor was subjected to
high voltage static, alternating current and/or strong magnetic
fields, it did not indicate any changes in operation. In addition, the
amplitude of the signal captured by the SFD Sensor decreased as the
speed of traverse of the sensor was increased. This is essentially the
opposite of what would occur while measuring electromagnetic energy
with a conventional magnetometer.
2. THE DETECTED ENERGY PATTERNS ARE BOTH DYNAMIC AND DIRECTIONAL. In
field tests over known major faults the SFD Sensor captured energy
patterns which were dynamic while the sensor was stationary. In
addition, the "radiation" field vectors of the energy patterns showed
different magnitudes during the traverse of a known deposit.
3. THE DETECTED ENERGY PATTERNS REFLECTED KNOWN HYDROCARBON ACCUMULATIONS
WHERE TECTONIC OR MECHANICAL STRESS SHOULD NOT BE A MAJOR FACTOR. In
field tests the SFD Sensor was shown to react to the following known
geological and hydraulic phenomenon:
. Mechanical forces due to tectonic activity in areas prone to
earthquakes;
. Sediment loading resulting in faulting and dewatering of
sediments; and
. Pressure differentials in the subsurface that are caused by
different fluid densities.
SFD Sensor reactions were observed over faults caused by both tectonic and
sedimentary loading, in areas including the Texas and Louisiana Gulf Coast, the
San Andreas fault in California, the lower mainland of British Columbia, and the
foothills of Alberta. These observations tend to indicate that the SFD Sensor
reacts to mechanical stress in the subsurface. However, in field observations
the SFD Sensor was shown to react to known, significant accumulations of
hydrocarbons in the subsurface where mechanical and tectonic stress would not be
a major factor. In these instances it appears that the SFD Technology reacts to
energy patterns caused by pressure differentials in the hydrocarbon
accumulations themselves.
It has been suggested that a possible explanation for these reactions over
significant hydrocarbon pools can be obtained by examining the effect a column
of gas or oil has on the pressure within a reservoir, and the resulting stress
on the surrounding shales. The pressure vs. elevation graph below indicates the
effect changes in the relative density of subsurface fluids can have on the
pressure within a reservoir at any given depth.
-16-
[GRAPH OF PRESSURE VS. ELEVATION APPEARS HERE]
These pressure changes are due to buoyancy forces that develop whenever a fluid
of lower density (i.e., oil or gas) is emerged in a fluid of higher density
(water). As the column of oil or gas becomes higher, representing a thicker pay
zone, the pressure differential caused by the buoyancy forces of the
hydrocarbons vs. the normal hydrostatic pressure of the formation waters will
increase. This increase in pressure should cause a corresponding increase in
the stress exerted on the rock that contains and confines an oil or gas
accumulation, because immediately outside the boundaries of the oil or gas pool,
the pressure with the reservoir will be consistent with the normal hydrostatic
pressure for the reservoir. This known effect of buoyancy forces that develop
due to hydrocarbon columns lends strong support to the theory that pressure
differentials in hydrocarbon accumulations produce stress energy patterns which
are detected by the SFD Sensor.
Based on field evaluations by both Company personnel and third parties,
management of the Company believes that the SFD Technology can reliably:
. Detect, from an altitude of 1,000 feet, major oil and gas
accumulations, sandstone or limestone/dolomite deposits at depths from
1,000 to at least 15,000 feet.
. Detect and discriminate between a wide variety of subsurface
geological deformities, including anticlines, faults, fractures,
unconformities, reefs and dome structures. Major known faults
have been detected at an altitude of 10,000 feet.
. Detect structures, faults and, potentially, hydrocarbon accumulations,
in shallow waters up to 500 feet in depth. Tests have not yet been
conducted over deeper waters.
. Determine whether an identified geological structure or trap contains
gas, oil, water or no fluid at all.
. Indicate whether a basin is shallow or deep.
. Indicate the lateral extent and horizon of a reservoir, pool or field.
. Detect and identify large underground water beds, coal deposits and
hard rock mineral deposits.
. Indicate whether an identified but undrilled hydrocarbon accumulation
has sufficient porosity to be exploitable.
-17-
To appreciate the significance of these attributes of the technology, one must
first understand certain aspects of geology and traditional oil and gas
exploration.
GEOLOGY AND TRADITIONAL EXPLORATION
GEOLOGY AND OIL ORIGINATION
Scientists generally support the "organic theory" of oil origination--that
decaying plant and animal remains, when subjected to heat, pressure and a lack
of oxygen for long periods of time, become natural gas or oil. Under the organic
theory, hydrocarbons originate in decomposed prehistoric plant and animal life.
Decomposition takes place in an oxygen-free environment within layers of mud and
silt. Due to the extreme pressure of overlying beds, buried sediments
consolidate to form rock layers. Petroleum is squeezed out of source beds and
is accepted by a receiver bed in a process called "primary migration." Once
within a receiver bed, petroleum travels upward and laterally within the
receiver bed in "secondary migration" until either a suitable "geological
deformity" or "trap" is reached, or until the petroleum can find an exit from
the receiver bed. In extreme cases the petroleum may exit the receiver bed at
the earth's surface, resulting in oil or gas seepage at rock outcrops that reach
the surface. Thus oil creation occurs in three primary phases: (i)
decomposition and compaction; (ii) primary migration; and (iii) secondary
migration and accumulation.
DECOMPOSITION AND COMPACTION
Sedimentary rocks are formed by incremental particle deposition in an aqueous or
watery environment such as rivers, lakes and oceans. Water is almost always
intimately associated with petroleum deposits. As millennium of years pass, the
sediments become thicker and thicker; or if the depositional environment
changes, one type of sediment may be replaced by the deposition of another type
of sediment. This type of activity, coupled with the eons of time available for
the process, yields sequential layers, or strata of depositional sediments. When
sediments have been buried by enough other sediments, they become compacted rock
layers or strata that contain the microscopic remains of plants and animals.
Experts generally believe that most organic source beds are shales and
limestones. However, of all commercial petroleum deposits discovered to date,
about 60% have been located within sandstones and 40% have been found in rocks
such as limestone and dolomite. Because such a high percentage of petroleum has
been found in sandstone-type rocks, scientists believe that petroleum has
migrated, or moved, from the original shale and limestone source beds into new
receiver beds of sandstone, limestone, and dolomite. The process by which
petroleum is expelled, or squeezed out, from source beds and received by other
beds is called "primary migration."
Primary migration is dependent on porosity and permeability of surrounding rock.
Contrary to popular belief, oil and gas deposits do not exist as underground
pools or lakes. Oil and gas deposits actually occupy the infinitesimal void
spaces, or pores, between the individual grains of a rock. Porosity is the
amount of void space within a rock, expressed as a percent of the bulk volume
occupied by the rock. With respect to a reservoir, it is the volume of the non-
solid or fluid portion of the reservoir, divided by the volume, expressed as a
percentage. As the rock's porosity increases, its capacity to contain fluids
(including petroleum) increases. Hence high relative porosity is a requirement
for a commercial petroleum deposit to exist. Permeability, which determines how
difficult (or easy) it is for hydrocarbons to flow through the rock formation,
is based on several factors--the property of the fluid itself, or its viscosity;
the size and shape of the formation; the pressure, and the resulting flow.
GEOLOGICAL DEFORMITIES
As noted above, petroleum geologists believe that petroleum originates in source
rock (shale and limestone), and then moves to receiver beds of sandstone,
limestone and dolomite in primary migration. Such migration is caused by the
relative porosity and permeability of the source bed as compared to the porosity
and permeability of the receiver bed. Because oil and gas are lighter than
water, they tend to migrate upward and follow the line of least resistance,
until they either escape to the surface or are trapped by a geological deformity
or trap.
-18-
One basic assumption of geological studies is that all sedimentary beds were
originally deposited horizontally. If sedimentary rocks remained horizontal
throughout geologic time, younger rock layers or strata would always be on top
of older rock layers. However, the tectonic forces that alter the crust of the
earth--volcanoes, earthquakes, floods--also deform its interior. These forces
shift, twist and crack rock layers that were previously neat and horizontal.
Consequently, clean-cut horizontal rock layers seldom exist. More typically, a
cross section of the earth will appear wavy, erratic and deformed. Because of
tectonic forces, no rock layers in nature are ever perfectly horizontal. When
rock layers are not horizontal, they are said to be dipping. The severity of
dip, or angle, is expressed as degrees of deviation from a horizontal plane.
Petroleum, migrating through receiver beds, can become trapped inside the
geological deformities created by tectonic forces and dipping.
SECONDARY MIGRATION AND ACCUMULATION
As noted above, primary migration from a source bed to a receiver bed occurs
when the receiver bed is more permeable than a source bed. Once petroleum has
entered a receiver bed, it will migrate straight through until it is stopped by
an overlying impermeable layer. Then, because rock layers dip, the petroleum
will have to migrate laterally (secondary migration), following the general
upward incline of the rock layers. This lateral movement will continue until
the oil and gas reaches the highest point possible and begins to accumulate.
Geological deformities that become the points of accumulation are called
"traps." Some typical traps are anticlines, faults, unconformities and reefs.
By far the most common structural traps are anticlines, in which approximately
80% of the world's oil and gas has been discovered. Anticlines often (though not
always) have surface manifestations like hills, knobs or ridges. Ideally, an
anticline will form a dome or roof of impermeable strata above a permeable oil-
bearing stratum. Oil in secondary migration will move upward through various
permeable strata, and eventually become trapped under the roof. Typically such a
trap will have gas in the space directly under the impermeable rock, a layer of
oil, and beneath that salt water.
Another important structure to oil exploration is a fault trap. A fault is a
break in the continuity of stratified rocks. Forces on either side of the fault
move in different directions or at different magnitudes. Eventually, the force
becomes greater than the rock's resistance, and the rock breaks. The opposite
faces of the break slip against one another, and the related layers of the
strata are displaced from their original positions. To the petroleum geologist
faults are significant for two reasons. On the negative side, faults break open
other types of traps and prevent oil accumulations. However, by moving an
impervious stratum across an open-ended permeable one, a fault can form a trap
for oil and prevent further migration. An anticline nose can become an
effective reservoir if a fault blocks it before oil can escape.
The size of a given petroleum accumulation depends on the amount of petroleum
available from the source beds and the size of the trap. Thus in almost all
petroleum accumulations: (i) the source bed is different from the receiver bed
in porosity and permeability; (ii) the receiver bed is overlain by an
impermeable bed called a cap or cap rock; and (iii) a geological deformity is
necessary to form a trap for petroleum accumulation.
The accumulation of petroleum within geologic deformities or traps is the target
of exploration activities of the petroleum industry, because a reasonably large
accumulation is necessary for a commercial deposit to exist. Therefore, a
geological deformity or trap becomes a requirement for commercial production.
REQUIREMENTS FOR A COMMERCIAL PETROLEUM DEPOSIT
Any oil and gas exploration company tries to locate and produce commercial
hydrocarbon deposits. That is, it tries to locate deposits that exist in
sufficient quantity and quality to yield revenues from petroleum sales in excess
of investment costs, operating costs and overhead expenses. For a viable
commercial hydrocarbon accumulation, all of the following must occur
simultaneously:
1. Hydrocarbons are contained within the pore spaces and cracks of a
rock, so the rock must have enough porosity to hold a commercial
quantity of oil or gas.
-19-
2. The permeability of a rock must be high enough to let the hydrocarbons
flow from one pore space to another, and then to a well, at a
commercial rate.
3. A sufficiently large hydrocarbon accumulation must exist within a
geological deformity or trap.
4. A reservoir must have enough stored energy or pressure, either
naturally or artificially induced, to force the hydrocarbon through
the pore spaces and into a well where it may be raised to the surface.
The absence of one or more of these four requirements is essentially responsible
for every dry hole, duster, or noncommercial well ever drilled. As a result,
most oil and gas exploration activity is focused on identifying geological
deformities, and determining the porosity and permeability within the deformity.
TRADITIONAL OIL AND GAS EXPLORATION
Traditional oil exploration may be divided very roughly into two risk
categories: "wildcatting" (extremely high risk) and developmental exploration
(low to moderate risk). While there are no specific definitions of these two
categories, wildcatting generally means prospecting in a new area many miles
distant from existing deposits. Developmental exploration means prospecting in
an area that is adjacent or relatively close to existing known deposits.
True wildcat exploration activity is without question the highest-risk venture
within the petroleum industry. Historically, only 1 well drilled out of 8-15
finds enough petroleum to pay for drilling the well. Only 1 well out of 50-66
drilled yields enough petroleum to economically justify drilling an adjacent
well. And only 1 well out of 700 will discover enough petroleum to justify
developing a field extensively.
It is generally recognized that geological deformities within the earth are
necessary for commercial accumulations of petroleum to exist. Hence most
exploratory techniques have been geared toward locating these geological
deformities. Techniques that obtain subsurface geological information by
physical measurements taken at the earth's surface are called geophysical
techniques. Since the 1920s, geophysicists have used several different surface
methods to locate subsurface traps. These methods have included aerial and
satellite surveys, gravimeter and torsion balance readings, and magnetometer
surveys.
TWO DIMENSIONAL AND THREE DIMENSIONAL SEISMIC TECHNOLOGY
Although the noted geophysical methods are still used, seismic technology and
surveys have become the preferred method for wide area exploration. Most
productive or potentially productive regions in the United States and Canada
have been or are being surveyed by seismic methods. Refractive and reflective
seismic techniques are based on creating an explosion or artificial sound wave
at the surface, observing how that sound wave moves through various subsurface
layers, and recording how each layer of rock reflects the created wave.
The seismic method is simple in concept. The subsurface is composed of layers
which vary in density and thickness. As the wave of the sound or vibration
strikes each of the layers, part of it is reflected back to the surface, where
it is detected and recorded by the seismograph. The process is comparable to a
child bouncing a rubber ball--if the ball strikes a concrete sidewalk it reacts
quite differently than it would if it landed in a pile of sand. Seismology is
really very similar. A small charge of dynamite is exploded, usually in a
shallow shot-hole. The resulting waves spread out through the ground
encountering different strata and formations. As with the bouncing ball, each
formation reflects the energy waves according to its own "bounce"
characteristics. The waves deflect upwards to the surface where they are picked
up by geophones, sensitive detection devices embedded in the ground at
predetermined locations. The geophones are attached to cables which carry their
signals to a seismic recording truck. There they are amplified and translated
onto permanent tapes, which are used to produce interpretations of the
subsurface. The data is gathered over a horizontal distance and compiled to
create a vertical cross section of the earth. By careful examination of seismic
surveys, the geophysicist is able to ascertain the possibility of the presence
of oil and gas.
-20-
In the past, the traditional land-based seismic crew consisted of a party chief
in overall charge of the crew; the geologists or geophysicists who decided where
the survey would be conducted, plotted the locations of the various pieces of
equipment, and decided on the "pattern" to be used; the surveyors who marked the
shot hole and geophone locations in the pattern desired; the drillers who
drilled the shot holes; the loaders who made up and loaded the explosive
charges; the shooters who connected the charges and fired them on command from
the party chief; and finally, the "jug hustlers" who pulled the cables from the
cable truck, arranged them in the desired patterns, and attached the geophones.
After the shot was fired, the crew had to pick everything up and quickly
transport it to the next location to repeat the process.
In the past 20 years, the use of high explosives by land-based seismic crews has
decreased greatly. While some soil and surface conditions still call for the
use of dynamite to get accurate data, today much information is garnered by the
use of vibrating or weight-dropping machines. Non-explosive seismic is
basically another method of creating man-made vibrations or waves for those
caused by an explosion. Specially designed equipment built into either wheeled
or tracked vehicles makes contact with the earth, and creates shock waves by
either dropping a heavy weight or using a vibrating device to create waves.
These penetrate the surface, strike underground formations, and are reflected
back to the seismograph in exactly the same manner as explosion-generated waves.
One of the biggest breakthroughs in oil and gas exploration has been the
evolution from two-dimensional ("2-D") to three-dimensional ("3-D") seismic
technology. 3-D seismic surveys were first proposed commercially in 1972.
Phillips Petroleum was one of the first exploration companies to use 3-D seismic
imaging, the most advanced--and expensive--of the new techniques. This involves
recording seismic data from several thousand locations, as compared with several
hundred with traditional 2-D methods. The 3-D process compiles the data and
feeds it into a super computer (in Phillips' case a Cray 1M 2800) which is
capable of millions of computations per second. In the most advanced systems,
the computer converts the data into a cube-like picture of the underground area
under study, in place of the older seismic strip charts.
By the mid-1980s, computer aided trace interpretation systems were starting to
appear that provided electronic storage and retrieval of seismic sections.
These interpretation systems included the ability to (i) auto-track horizons in
a data set, and (ii) display the resulting maps using color schemes to represent
the height and depth of a horizon.
However, despite the 3-D nature of seismic data, interpretation was often
performed in an essentially multi-2-D manner on sequential sections through the
data set. The resulting subsurface model was then built based on surfaces
(auto-tracked horizons, hand-picked faults and unconformities). Although this
type of model may be sufficient for a structural understanding, it is only a
skeleton of the possible 3-D seismic image. The multi-level 2-D model was
lacking in "muscle" and "sinew"--the seismo-stratigraphic and reservoir
character information and complex faulting that was available from the base
data, yet seldom used. This was due to the huge manual efforts required to
interpret and extract this information from the 3-D data by hand.
A number of technological developments contributed significantly to the wide
acceptance of 3-D seismic data during the past decade, including:
. Workstation technology
. Multi-streamer, multi-source, multi-vessel 3-D marine technology
. Onboard and real-time processing of navigation and seismic data
. Depth imaging (now utilized principally in the Gulf of Mexico)
The main contribution of these developments has been to make the 3-D product
much more available (through price and time) and impactive (through full three
dimensional visualization). With acceptance and use of 3-D technology growing,
the challenge has become computational as the industry advances beyond
conventional, but already data-intensive, 3-D processing into more comprehensive
techniques, such as depth imaging. Parallel seismic computing has been crucial
to this progress. It is parallel computer technology that has made 3-D prestack
depth imaging possible as an exploration and production tool.
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However, the processing of seismic data has significant limitations. As World
Oil has reported, industry participants have stated that "The biggest blessing
of 3-D is that you have a large volume of data that ties geology to seismic
signature. The biggest curse of 3-D is that you have a large volume of data,
and the time and money required to gather and process it is enormous."
According to World Oil, these enormous costs have resulted in projected
worldwide seismic spending (acquisition and processing) of $3.5 billion for
1997, and that amount is expected to reach almost $4.8 billion by 1999. 3-D
costs include the expense associated with using more sophisticated equipment and
computers, and covering a greater land surface area during the sweep, which
usually means increased expenses in arranging permission to use the land with
the property owners. Moreover, protracted timeframes are required for survey
design, set-up and execution, and computer processing. A seismographic crew,
covering only 25 to 50 square miles in a month, may cost $1,000,000 in salaries,
equipment and computer and geological analysis. At current prices, 3-D surveys
cost $50,000-$100,000 per square mile. In water of approximately 100 feet in
depth, 3-D surveys cost approximately $250,000 per square mile to complete.
THIRD PARTY FIELD EVALUATIONS OF THE SFD SURVEY SYSTEM
As noted earlier in this Report, Company management believes that the SFD Survey
System offers an alternative to traditional wide area of reconnaissance seismic
exploration, at a fraction of the time and cost. That belief is predicated on
extensive first-hand observation of the SFD Technology, and on the following
third party field evaluations:
. Field Evaluation Report dated September 30, 1996, by Rod Morris,
Geologist, Association of Professional Engineers, Geologists and
Geophysicists of Alberta
. Field Evaluation Report dated May 22, 1998, by Encal Energy Ltd.
. Report of Field Evaluation dated August 26, 1998, by CamWest Limited
Partnership
. Report dated February 27, 1998, of Gilbert Laustsen Jung Associates
Ltd., independent professional engineers
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A summary of each of the noted evaluations is provided below. The following
summaries are neither complete nor exact, and each summary is therefore
qualified in its entirety for reference to the complete report included as an
exhibit to this Report from which such summary is derived. Each report is also
subject to the qualifications and limitations contained therein. The field
evaluations summarized by the noted reports were prepared for the purpose of
comparing SFD survey predictions with known reserves or drilling or testing
results. The field evaluations do not address or evaluate the scientific basis
or principles of the underlying SFD Technology, and none of the noted third
parties are experts in the SFD Technology or its scientific basis or principles.
It should also be noted that these field evaluations have not been re-evaluated
or updated since the date of the initial report.
FIELD EVALUATION BY ROD MORRIS, GEOLOGIST
In September 1996 the Company retained Mr. Rod Morris, an independent geologist,
to design and conduct a field evaluation of the SFD Technology. Mr. Morris is a
geologist with over 15 years of multidisciplinary experience in hydrocarbon
exploration in western Canada. His experience includes oil and gas exploration
and development, as well as seismic data acquisition, interpretation and
research. Apart from his retention as a consultant, Mr. Morris had no
affiliation with the Company at the time of the evaluation or at any time
thereafter. Although principals of the Company were present and cooperated
during the actual field tests, the design and planning of trip routes, and the
selection of sites to be evaluated, the conclusions summarized below were
entirely those of Mr. Morris. The principals of the Company had no input in, or
prior knowledge of, the areas to be traversed, the known accumulations therein,
or the trap types which would be included. Mr. Morris' full report, from which
the following summary is derived, is included as an exhibit to this Report.
Mr. Morris' field evaluation of the SFD Technology was conducted in the southern
portion of the province of Alberta, Canada. The evaluation involved over 1,000
miles covered by vehicle over a period of 7 days, and 27 hours of recordings of
SFD Data. In his evaluation report, Mr. Morris indicated that he designed the
trip routes and pool targets to:
1. Assess the reliability of the SFD Technology in detecting significant
oil and gas accumulations;
2. Determine, on a "blind test" basis, whether the SF