SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
Annual Report Pursuant to section 13 or 15(d)
of the Securities Exchange Act of 1934
(Mark One)
[ ] Annual report pursuant to section 13 or 15(d) of the Securities Exchange
Act of 1934 for the fiscal year ended ______________ or
[X] Transition report pursuant to section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from June 1, 2002 to
December 31, 2002
Commission file number 0-6814
U.S. ENERGY CORP.
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(Exact Name of Registrant as Specified in its Charter)
Wyoming 83-0205516
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
877 North 8th West
Riverton, WY 82501
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(Address of principal executive offices) (Zip Code)
Registrant's Telephone Number, including area code: (307) 856-9271
Securities registered pursuant to Section 12(b) of the Act:
NONE
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Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $0.01 PAR VALUE
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(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
The aggregate market value of the shares of voting stock held by
non-affiliates of the Registrant as of March 21, 2003, computed by reference to
the average of the bid and asked prices of the Registrant's common stock as
reported by the National Market System of NASDAQ on that date, was approximately
$30,284,400.
Class Outstanding at March 21, 2003
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Common Stock, $0.01 par value 12,209,776 shares
Documents incorporated by reference: Portions of the documents listed below have
been incorporated by reference into the indicated parts of this report as
specified in the responses to the referenced sections of this filing.
Proxy Statement for the Meeting of Shareholders to be held June 2003, into
Part III of the filing.
Indicate by check mark if disclosure of delinquent filers, pursuant to Item 405
of Regulation S-K is not contained herein and will not be contained, to the best
of the Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K includes "forward-looking statements"
within the meaning of Section 21E of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"). All statements other than statements of historical
fact included in this Report, are forward-looking statements, including without
limitation the statements under Management's Discussion and Analysis of
Financial Condition and Results of Operations and the disclosures about Rocky
Mountain Gas, Inc. and plans for developing its coalbed methane acreage. In
addition, whenever words like "expect," "anticipate" or "believe" are used, we
are making forward-looking statements.
Although we believe that our forward-looking statements are reasonable, we
don't know if our expectations will prove to be correct. Important future
factors that could cause actual results to differ materially from expectations
include: domestic consumption rates for natural gas; domestic market prices for
natural gas, uranium, gold, and molybdenum; the amounts of gas we will be able
to produce from our coalbed methane properties; the availability of permits to
drill and operate coalbed methane wells; whether and when gas transmission lines
will be built in reasonable proximity to our coalbed methane properties and
whether and on what terms the capital necessary to develop our properties can be
obtained. The forward-looking statements should be carefully considered in the
context of all the information set forth in this Annual Report.
The Company has changed its fiscal year from May 31 to December 31.
Therefore, this is a "transition" Annual Report, presenting information as of
December 31, 2002 and for the seven months then ended. PART I
ITEM 1 AND ITEM 2. BUSINESS AND PROPERTIES.
(A) GENERAL.
U.S. Energy Corp. is a Wyoming corporation (formed in 1966) in the business
of acquiring, exploring, developing and/or selling or leasing mineral
properties. In this Annual Report, "we", "Company" or "USE" refers to U.S.
Energy Corp. including subsidiaries unless otherwise specifically noted. Our new
year ends December 31.
During the seven months ended December 31, 2002, most of our business
activity was devoted to the coalbed methane ("CBM") area , i.e., acquiring
acreage, drilling exploratory wells, testing the wells, and closing the purchase
of the Bobcat Field (a CBM producing field) in Wyoming. CBM activities are
conducted through Rocky Mountain Gas, Inc ("RMG"), a Wyoming corporation owned
51.1% by USE and 40.4% by Crested Corp. ("Crested"). At December 31, 2002,
Crested was a 70.5% majority-owned subsidiary of USE, see below. Properties of
RMG are held in Wyoming and southeastern Montana. As of the filing date of this
Annual Report, RMG holds approximately 281,886 gross mineral acres of CBM
properties.
We also hold commercial properties, most of which are located in Utah that
were acquired as part of a uranium property and mill acquisition. In the new
fiscal year ended December 31, 2002 (i.e., the seven months then ended),
revenues were generated from CBM sales and commercial operations.
For financial statement presentation purposes, the Company has two segments
of business; minerals and commercial operations (motel, real estate and
airport), see note I to the financial statements. However, presently the
Company's business priority is focused mainly on CBM.
2
Ryder Scott Company, independent petroleum consultants of Houston, Texas,
have estimated the net proved gas reserves and the discounted 10% present value
of the reserves, in our Bobcat Field in Wyoming. See "Gas Reserves" below. We
have been selling CBM from the Bobcat field since June 2002.
We have conducted exploratory drilling and testing on other CBM properties,
but in general, additional work (dewatering of completed wells, and drilling and
dewatering more wells) is needed before we can determine if we have proved
reserves on those properties. Specifically, we expect to make a determination
whether there are proved reserves on the Clearmont property (not now in
production) in the third or fourth quarter 2003. Such determinations on the
other properties are not expected to be made until 2004 or later.
For detailed information about our coalbed methane properties and business
strategy, please see "Minerals - Coalbed Methane" below.
Except for in the Bobcat field, only a limited number of exploratory wells
have been drilled, and there is not yet enough information from these wells to
determine if they contain proved reserves. Gas prices during the seven months
ended December 31, 2002 were lower in the Powder River Basin (our area of
activity) relative to national prices, and continued low prices will affect not
only the economics of the producing Bobcat property, but also the economics of
the exploration projects as they move into production in the future. In
addition, we could encounter delays in obtaining permits for continued
exploration, and more funding may be needed but may not be available.
USE and Crested originally were independent companies, with two common
affiliates (John L. Larsen and Max T. Evans; Mr. Evans died in February 2002).
In 1980, USE and Crested formed a joint venture ("USECC") to do business
together (unless one or the other elected not to pursue an individual project).
As a result of USE funding certain of Crested's obligations from time to time
(due to Crested's lack of cash on hand), and Crested subsequently paying a
portion of this debt by issuing common stock to USE, Crested became a
majority-owned subsidiary of USE in fiscal 1993. In fiscal 2001, Crested issued
another 6,666,666 shares of its common stock to reduce Crested's debt owed to
USE by $3.0 million, which increased USE's ownership of Crested to 70.5%. All
the operations of USE (and Crested) are in the United States. Principal
executive offices of USE are located in the Glen L. Larsen building at 877 North
8th Street West, Riverton, Wyoming 82501, telephone 307.856.9271.
Most of the USE's operations are conducted through subsidiaries, the USECC
Joint Venture with Crested, and jointly-owned subsidiaries of USE and Crested.
The Company's subsidiaries are:
Percent Primary
Subsidiary Owned by USE* Business Conducted
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Plateau Resources Ltd. 100.0% Uranium (Utah) - Inactive - shut down;
Motel/real estate - Active
Northwest Gold, Inc. 96.0% Gold (Montana) - Inactive - shut down
Rocky Mountain Gas, Inc. 91.5% Coalbed methane exploration - active
Energx, Ltd. 90.0% Gas - Inactive - shut down
Crested Corp. 70.5% Uranium, gold and molybdenum properties
(all inactive and shut down), and exploration
activities on coalbed methane properties
Sutter Gold Mining Company 66.3% Gold (California) - Inactive - shut down
Four Nines Gold, Inc. 50.9% Contract Drilling/Construction - Inactive
(since 2001)
3
USECC Joint Venture 50.0% Uranium (Wyoming, Utah), gold and
molybdenum,** all inactive and shut down;
real estate management and coalbed methane
exploration
Yellowstone Fuels Corp. 35.9% Uranium (Wyoming) - Inactive - shut down
*Includes ownership of Crested Corp. in RMG and Sutter.
**There are no plans to put the molybdenum property into production in the
foreseeable future. See "Inactive Mining Properties - Molybdenum.
Until September 11, 2000, USE, USECC and Kennecott Uranium Company
("Kennecott") owned the Green Mountain Mining Venture ("GMMV"), which held a
large uranium deposit and uranium mill in Wyoming. On September 11, 2000, USE
and Crested settled litigation with Kennecott involving the GMMV by selling
their interest in the GMMV and its properties back to Kennecott for $3,250,000,
receiving a royalty interest in the uranium properties and miscellaneous
equipment . The GMMV properties are shut down. Kennecott also assumed all
reclamation obligations on the GMMV properties; reclamation obligations for an
ion exchange facility located on properties outside the GMMV were not assumed by
Kennecott, see "Sheep Mountain Partners - Properties" below. Other uranium
properties and a uranium mill in southeast Utah are held by Plateau Resources
Ltd., a wholly-owned subsidiary of USE. The Utah uranium properties are shut
down.
The mineral properties held by Sutter Gold Mining Company ("SGMC", a
majority-owned subsidiary of USE), are shut down because the historical market
price of gold has not permitted raising the capital necessary to put the
properties into production. During the first quarter of 2003, gold prices
increased to a level which allowed the Company to begin marketing the SGMC
property.
In coalbed methane, we compete against many companies, some of which are
much larger and better financed than the Company. The principal area of
competition is encountered in the financial ability to acquire good acreage
positions and drill wells to explore coalbed methane potential, then, if
warranted, drill production wells and install production equipment (gathering
systems, compressors, etc.).
We own a royalty interest in a molybdenum property in Colorado; the
property is owned by Phelps Dodge Corporation, a worldwide integrated minerals
company with inventories of exploration, development stage, and producing
properties, involving numerous metals and other minerals. We believe, at the
present time, Phelps Dodge does not have a plan to place the molybdenum property
into production.
In the motel, real estate and airport operations area (significant in terms
of revenues for fiscal 2002 and the seven months ended December 31, 2002, but
not our primary business focus), we own and manage an office building (where our
headquarters are located), and small parcels of land, all in Riverton, Wyoming,
and a small amount of additional acreage elsewhere in Wyoming and Colorado. We
also own a townsite, a motel and convenience store, and other commercial
facilities in Utah. There is no significant competition in this area; although
parcels are sold from time to time, we are not in the land development business.
(B) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS.
During the seven months ended December 31, 2002 and the two former fiscal
years ended May 31, 2002 and 2001, for technical financial presentation
purposes, we operated in three business segments: (i) coalbed methane gas
exploration (and holding shut down mines and mineral properties), (ii) motel,
real estate, and airport operations, and (iii) contract drilling/ construction
(the first quarter of former fiscal year 2001). Contract drilling/construction
operations were shut down as an operating segment in fiscal 2001. While we
4
technically had three segments in this 31 month period, most activities in
minerals, motel/real estate/airport, and contract drilling/construction have
ceased or have been severely curtailed. The only current activities of a
material and recurring nature are in coalbed methane, and motel operations and
management services.
The principal products of the operating units within each of the reportable
industry segments for the seven months ended December 31, 2002 and the two
former fiscal years ended May 31, 2002 are shown in the narrative table below.
For more information, see note I to the financial statements.
INDUSTRY SEGMENTS PRINCIPAL PRODUCTS
Coalbed Methane Gas Exploration Acquisition of coalbed methane
and Production (and holding of properties, production of coalbed
mineral properties which are methane, and exploration and
shut development of properties for coalbed
methane. This activity is down)
materialand recurring, and is our
principal business focus. Sales and
leases of mineral-bearing properties and,
from time to time, the production and/or
marketing of uranium, gold and receipt of
advance royalties on molybdenum.
Activities in uranium, gold and
molybdenum are shut down as recurring
activities.
Motel and Real Estate Operation of a motel and rental of real
estate, operation of an aircraft fixed
base operation (fuel sales, flight
instruction and aircraft maintenance,
which was shut down in the former fiscal
year 2002), and various contract
services, including managerial services
for subsidiary companies. Only the motel
and real estate, and management services
activities remain active now. Though
significant in terms of contributions to
revenues on a historical basis, these
operations are auxiliary to the principal
business focus of the company (coalbed
methane).
Contract Drilling/Construction Contract drilling of coalbed methane
wells, construction of drill sites, gas
pipe lines, reservoirs and reclamation of
locations. This activity has been shut
down.
(C) NARRATIVE DESCRIPTION OF BUSINESS (INCLUDING ITEM 2 - PROPERTIES).
COALBED METHANE (AND INACTIVE MINING PROPERTIES)
ROCKY MOUNTAIN GAS, INC. ("RMG") was incorporated in Wyoming on November 1,
1999 for business in the coalbed methane industry in Wyoming and Montana. RMG is
a subsidiary of the Company (owned 51.1% by the Company and 40.4% by Crested as
of December 31, 2002).
As of the filing date of this Annual Report, RMG holds leases and options
on approximately 281,886 gross mineral acres of federal, state and private (fee)
land in the Powder River Basin ("PRB") of Wyoming and Montana and the Green
River Basin of Wyoming. As of the filing date of this Annual Report, there are
24 producing CBM wells on the acreage, all located in the Bobcat Field (1,940
gross acres in the Bobcat Field which was acquired in June 2002). RMG holds a
27.6% working (22% net revenue) interest in the Bobcat Field.
5
Through December 31, 2002, 70 CBM wells have been drilled, almost all with
funds provided by industry partner CCBM, Inc. ("CCBM") ( a wholly owned
subsidiary of Carrizo Oil and Gas, Inc. of Houston, Texas) and former industry
partner SENGAI (see below). Seven of these wells were drilled in the Bobcat
Field. Except for the wells in the Bobcat Field, reserves have not been
established for any of the properties on which these wells were drilled.
Subject to production of coalbed methane gas by July 2003, an independent
reserve evaluation for the Clearmont prospect is expected to be completed in the
third or fourth quarter 2003. This prospect was acquired as unexplored acreage
in former fiscal year 2001; drilling started there in former fiscal year 2002.
The dewatering process at Clearmont is underway. See "Acquisition and
Exploration Capital Expenditures" below.
RMG's Castle Rock and Kirby properties in southeast Montana contain large
acreage prospects will require the drilling of numerous exploratory wells and
extended dewatering periods for each group or "pod" of wells (from 6 to 18
months after drilling and completion) before an assessment of reserves can be
made. In areas where no other wells on adjacent properties are dewatering the
coal seam, the dewatering process could take as long as 24 months.
Among the uncertainties we face in determining if our coalbed methane
investments will yield value are the following: Prices for gas sold in the
Powder River Basin are currently the lowest in the United States due to the
current lack of take-away capacity in the Basin, and may not improve enough,
over a sustained time period, to make many properties economic. To continue
exploration efforts, additional capital (in addition to RMG's one half of
remaining balance under the CCBM $5.0 million drilling commitment which was
$893,300 at December 31, 2002) may be needed. Permitting issues for new wells
may further delay work. An unfavorable confluence of these uncertainties, if
realized, could result in a write-down of the carrying value of those properties
which don't produce enough gas at low prices to be economic. This could result
in the write-down of the carrying value of other properties which need more
wells drilled and dewatered to improve the economics of production; and/or the
delay (whether from lack of capital or permitting problems) in establishing
reserves for the larger prospects where many wells will have to be drilled to
assess their value.
GAS RESERVES
The following table sets forth estimated net proved gas reserves for RMG's
producing properties and the present value (discounted 10%, referred to as the
"PV10") of such reserves as of December 31, 2002. The reserve data and the
present value as of that date were prepared by Ryder Scott Company, independent
petroleum engineers. For further information, see Ryder Scott's reserve report
included as an exhibit to this Annual Report.
The PV10 value was prepared using constant prices as of the calculation
date, discounted at 10% per annum on a pre-income tax basis, and is not intended
to represent the current market value of the estimated gas reserves owned by the
Company. Note that the PV10 discount factor has been calculated net of ad
valorem and production taxes, but before income taxes. The PV10 discount factor
is not the same as the standardized measure of present value calculations which
are determined on an after-income tax basis.
Proved Reserves Proved Reserves
Developed Undeveloped Total
--------- ----------- -----
Coalbed methane gas (Mmcf)* 489.7 95.9 585.6
PV10 Value $ 793,482 $ 94,947 $ 888,429
*Million cubic feet
6
For further information concerning the present value of future net revenue
from these proved reserves, see Note M to the financial statements in this
Annual Report.
These estimates of proved reserves have been filed with the Securities and
Exchange Commission, and have not been included in reports to other federal
agencies.
Note that there are numerous uncertainties inherent in estimating gas
reserves and their estimated values, including many factors beyond the control
of the Company. The reserve data in this Annual Report are only estimates.
Reservoir engineering is a subjective process of estimating underground
accumulations of gas that cannot be measured exactly. Estimates of economically
recoverable gas, and the future net cash flows which may be realized from the
reserves, necessarily depend on a number of variable factors and assumptions,
such as historical production from the area compared with production from other
areas, the assumed effects of regulations by government agencies, assumptions
about future gas prices and operating costs, severance and excise taxes,
development costs, and work-over and remedial costs. The outcomes in fact may
vary considerably from the assumptions.
Estimates of the economically recoverable quantities of gas attributable to
any particular property, the classification of reserves as to proved developed
and proved undeveloped based on risk of recovery, and estimates of the future
net cash flows expected from the properties, as prepared by different engineers
or by the same engineers but at different times, may vary substantially, and the
estimates may be revised up or down as assumptions change.
It is likely that actual production volumes, revenues from production, and
the amount of money spent on the properties, will vary from the estimates. These
variances could be material.
The PV10 discount factor, which is required by the Securities and Exchange
Commission for use in calculating discounted future net cash flows for reporting
purposes, is not necessarily the most appropriate discount factor, based on
interest rates in effect in the financial markets, and risks associated with the
gas business.
Generally, the volume of gas production declines as reserves are depleted,
with the rate of decline depending on reservoir characteristics. Except to the
extent we conduct successful exploration and development activities, or acquire
properties with proved reserves, or both, our proved reserves will decline with
production. Therefore, our future production depends on finding or acquiring
more reserves.
The business of exploring for, developing, or acquiring reserves is capital
intensive. To the extent operating cash flow is reduced and external capital
becomes unavailable or limited, our ability to make the necessary capital
investment to maintain or expand our gas reserves asset base would be impaired.
There is no assurance future exploration, development, and acquisition
activities will result in additional proved reserves. Even if revenues increase
because of higher gas prices, increased exploration and development costs could
neutralize cash flows from the increased revenues.
VOLUMES, PRICES AND GAS OPERATING EXPENSE
This table shows RMG's 27.6% working (22% net revenue) sales volumes of gas
produced, average sales prices received for gas sold, and average production
costs associated with the Company's gas sales for the seven months ended
December 31, 2002, all from the Bobcat Field.
7
Seven Months Ended
December 31, 2002
-----------------
Sales volumes (Mcf) 64,314
Average sales price per Mcf(1) $1.86
Average cost (per Mcf)(2) $1.91
(1) The Bobcat Field gas (the only property in production at the filing date of
this Annual Report) has an energy content of .96 to .98 MMBtu per 1 Mcf.
From time to time, we have sold some of the production at a set price and
the balance at daily market prices. During the seven months ended December
31, 2002, we sold 22.6% of our share of production at contract prices and
77.4% of our share at the market.
(2) Includes direct lifting costs (labor, repairs and maintenance, materials
and supplies, workover costs, insurance and property, gathering,
compression, marketing and severance taxes).
ACQUISITION AND EXPLORATION CAPITAL EXPENDITURES
From inception on November 1, 1999 through December 31, 2002, RMG incurred
net acquisition (purchase price and holding costs) and exploration costs
(drilling and completion) on CBM properties of approximately $4,904,000, which
does not include approximately $1,606,700 funded by CCBM on RMG's behalf for
lease hold, drilling and completion costs. Unproved CBM properties on the
balance sheet have been reduced by $2,500,000 to reflect the reduction of the
full cost price as a result of principal payments made by CCBM under its
agreement with RMG and by payments from other industry partners.
The following table shows certain information regarding the gross costs
incurred by RMG.
Seven Months Ended Year Ended May 31,
December 31, -------------------------------
2002 2002 2001
------------ ----------- ------------
Acquisition costs $ 936,200 $ 192,600 $ 870,600
Exploration 97,200 87,400 283,900
------------ ----------- ------------
$ 1,033,400 $ 280,000 $ 1,154,500
============ =========== ============
The acquisition costs included amounts paid for properties, delay rentals,
lease option payments, and general and administrative costs directly
attributable to the acquisitions.
The recorded amounts for acquisition and exploration of $1,033,400,
$280,000 and $1,154,500 represent 3.0%, 1.5% and 3.8% of total assets at
December 31, 2002, and May 31, 2002 and 2001, respectively.
We use the full-cost method of accounting for gas properties. Under this
method, all acquisition and exploration costs are capitalized in a "full-cost
pool" as incurred. Depletion of the pool will be recorded using the
unit-of-production method. To the extent capitalized costs in the full-cost pool
(net of depreciation, depletion and amortization and related deferred taxes)
exceed the present value (using a 10% discount rate) of estimated future net
pre-tax cash flows from proved gas reserves as established by reserve reports,
the excess costs will be charged to operations.
If it is determined that there are no reserves on the Clearmont or other
CBM properties, all acquisition and exploration costs previously capitalized for
those properties will be written-down and charged to operations. To the extent
reserves are established to be less than such costs, the costs will be
written-down
8
to the amount of present value of the reserves. In this event, assets would
decrease and expenses would increase. Once incurred, a write-down of gas
properties can't later be reversed.
In addition, if future exploration work (in particular the larger
prospects) is delayed because of lack of capital or permitting delays, or both,
with the result that it cannot be established whether or not proved reserves
exist on the properties, the exploration costs for those properties would be
written-off.
When updated reserve reports are obtained on our properties, any resulting
impact on the financial statements will be reported in the next periodic filing
with the SEC.
As of the filing of this Annual Report, we hold leases and options to
develop approximately 281,886 gross mineral acres (including 43,711 acres we
have options on - see "Oyster Ridge below) under leases from the United States
Bureau of Land Management, the states of Wyoming and Montana, and private
landowners. Table 1 shows the total gross and net lease acres held in each
prospect, and the amount of such acreage held by RMG and by companies with which
RMG has agreements (CCBM, Inc. and Quaneco, L.L.C.). These agreements are
summarized under "Carrizo - Purchase and Sale Agreement" and "Quaneco -
Agreement." Acreage data assumes CCBM completes its obligations; CCBM will own
its 50% working interest in wells drilled under CCBM's drilling fund commitment,
but if CCBM does not complete its purchase obligations, CCBM would be entitled
to a reduced working interest in the remaining undrilled acreage.
The 281,886 gross acres does not include approximately 50,600 acres RMG has
options to purchase. See "New Options Acreage."
CCBM currently has purchase rights to acquire a 6.25% working interest in
the Castle Rock prospect, and owns a 6.25% working interest in eight wells in
Castle Rock, which were drilled by Suncor Energy Natural Gas America, Inc.
("SENGAI"). RMG's and CCBM's interests in the Castle Rock prospect, as shown in
Table 1, reflect the completion of SENGAI's drilling program in late calendar
2001. SENGAI elected not to exercise its option under an Option and Farmin
Agreement on February 8, 2002.
Prospects are evaluated for coal potential using available public and
industry data, taking into account proximity to other positions held by RMG and
existing or planned gas transmission lines, and whether drilling and production
permits can be obtained and the costs thereof. The final decision to acquire a
prospect is made by the president of RMG. Well drilling and testing is done by
outside contract drilling companies. Drilling results (cores, gas and water flow
rates, and other data) are evaluated by RMG staff, using customary technical
methods, to determine if any coal zones encountered in the well should be
completed for production. Completion requires setting casing pipe down to the
zone(s), installing pumps, and installing and setting up the necessary surface
equipment (for example, water disposal lines and water holding tanks for
evaluation wells in Montana, pending production permitting approval and water
holding ponds in Wyoming), and dewatering the well sufficiently so production
can start. The decision whether to complete the well is made by RMG's president.
Table 1 reflects RMG's, Quaneco's and CCBM's acreage position as of the
filing of this Report. Table 1 does not reflect the reduction in net acreage
held by RMG if Anadarko Petroleum, Inc. exercises its option to back-in for a
25% working interest on 43,711 gross acres within the Oyster Ridge prospect.
Also, 43,711 of the acres shown as held in Oyster Ridge assume we continue to
earn acreage under the drill-to-earn-acreage provisions of the option agreement
with Anadarko. See "Description of Prospects - Oyster Ridge" below.
9
TABLE 1
- ---------------------------------------------------------------------------------------------------------
Project
and Date Gross Lease Net Lease RMG Net Quaneco Net CCBM Net
Acquired Acres Acres Acres Acres Acres
- ---------------------------------------------------------------------------------------------------------
Castle Rock 123,840 111,567 48,811 55,784 6,973
Jan. 2000
Kirby 81,494 75,122 18,933 37,256 18,933
Jan. 2000
Bobcat June 1,940 1,940 530 0 530
2002
Oyster Ridge 65,247 65,247 25,729 0 25,729
Dec. 1999
Clearmont 6,465 3,905 1,953 0 1,953
Jan. 2000
Sussex 640 640 320 0 320
Jan. 2000
Finley 160 160 80 0 80
Jan. 2000
Baggs North 120 120 60 0 60
Jan. 2000
Gillette North 80 80 40 0 40
Jan. 2000
Arvada 1,900 1,700 850 0 850
Jan. 2000
- ---------------------------------------------------------------------------------------------------------
TOTAL 281,886 260,481 97,306 93,040 55,468
- ---------------------------------------------------------------------------------------------------------
We own a 25% working interest (20% net revenue interest) in 81,494 gross
and 75,122 net acres in the Kirby prospect (southeast Montana) and a 50% working
interest (from 30% to 50% net revenue interest) in 73,792 net acres in other
prospects (all in Wyoming), and a 27.6% working (22% net revenue) interest in
Bobcat Field. We own a 43.75% working interest (35% net revenue interest) in the
Castle Rock prospect on 123,840 gross and 111,567 net acres in southeast
Montana. CCBM can purchase a 6.25% working interest in our acreage (6,973 net
acres) of the Castle Rock prospect if they meet certain payment obligations. In
July 2001, we sold a 50% working interest in all our coalbed methane leases,
except at Castle Rock, to CCBM for $7,500,000, plus other considerations, and
CCBM purchased a 27.6% working (22% net revenue) interest in Bobcat at the same
time we purchased our interest in Bobcat. The acreage data above reflects these
transactions.
CCBM agreed to pay up to $5,000,000 for drilling and completing CBM wells
on the properties owned by RMG and CCBM. Drilling started on the Clearmont
prospect in Wyoming in August 2001. This drilling program should be sufficient
to drill a total of approximately 60 coalbed methane wells to completion or
abandonment stage. We have a carried working interest in all of the wells
drilled in these programs.
As of the filing of this Report, we have set casing on 33 wells (80 acre
spacing units) and have plugged and abandoned one of those wells at the
Clearmont prospect. No reserves have been established to date on the Clearmont
property. Drilling permits for 61 additional wells have been issued for
Clearmont.
A total of 70 wells have been drilled on RMG acreage through December 31,
2002: 5 in former fiscal year 2001 and 53 in former fiscal year 2002 and 12 in
the seven months ended December 31, 2002. Nineteen of the wells were drilled by
SENGAI in Castle Rock under the terms of a option and farmin agreement. Eleven
of those 19 wells were stratigraphic wells and will be reclaimed by SENGAI; 8 of
those 19 wells were completed and are owned by RMG (93.75% working interest) and
CCBM (6.25% working interest), as
10
Quaneco opted out of maintaining a working interest in the 8 wells. Other than
the Castle Rock and Bobcat wells, RMG and CCBM both have a 50% working interest
in all of these wells (see Table 2 below). For information on the 19 wells
drilled by SENGAI in Castle Rock, see "SENGAI - Option and Farmin Agreement"
below.
As of December 31, 2002, CCBM and RMG have spent approximately $3,171,900
of the $5,000,000 drilling fund. We are relying on the $1,828,100 balance to pay
for continued drilling and completion work on the RMG properties. Like previous
wells drilled with the CCBM drilling fund, RMG will have a 50% carried working
interest with no financial obligation of RMG for drilling and completion costs
until after CCBM has spent $5,000,000. Work would be delayed if CCBM were not
able to fund these costs. Presently, we do not have the capital resources to
fund these costs, and would have to obtain the necessary capital from other
industry partners or from sale of equity in RMG.
Future annual financial obligations for our coalbed methane properties
consist of approximately $323,200 gross in rental fees to the lessors for the
new calendar fiscal year 2003 ($109,600 net to RMG).
Table 2 shows the wells drilled on RMG's prospects from June 1, 2000
through December 31, 2002. Under the agreement with CCBM, RMG has a carried
working interest in all these wells (with the exception of a $156,600 payment
that was made by RMG to cover 50% of a non-consent cost for 12 wells). CCBM also
paid $156,600 to cover 50% of their cost in acquiring a non-consent working
interest in those 12 wells. RMG had a carried working interest in the 8 Castle
Rock wells which were completed (out of the 19 drilled in that prospect), as
SENGAI paid all costs under their drilling program completed in December 2001.
RMG owns a 93.75% working interest and CCBM owns a 6.25% working interest in the
8 Castle Rock wells.
With the exceptions noted above, RMG has had a carried interest in all the
wells on the Oyster Ridge, Clearmont and Arvada prospects. Table 2 lists the
number of wells drilled, the total exploration costs and the remaining number of
wells currently permitted for drilling as of December 31, 2002.
TABLE 2
ROCKY MOUNTAIN GAS, INC.
Prospect FY 2001 FY 2002 New Year 2002 TOTAL Remaining
(6/1/00-5/31/01) (6/1/01-5/31/02) (6/1/02-12/31/02) Permits
Wells $ Wells $ Wells $ Wells $
- --------------------------------------------------------------------------------------------------------------------------
Castle Rock 3 $ 283,900 19 $ 2,500,000 0 $ 4,300 22 $ 2,788,200 16
- --------------------------------------------------------------------------------------------------------------------------
Kirby 0 -0- 0 -0- 0 -0- 0 -0- 8
- --------------------------------------------------------------------------------------------------------------------------
Oyster Ridge 2 150,500 5 464,200 0 3,400 7 618,100 0
- --------------------------------------------------------------------------------------------------------------------------
Clearmont 0 -0- 28 1,470,400 5 474,700 33*** 1,945,100 61
- --------------------------------------------------------------------------------------------------------------------------
Arvada 0 -0- 1 64,800 0 -0- 1 64,800 6
- --------------------------------------------------------------------------------------------------------------------------
Bobcat 0 -0- ** 7 528,500 7 528,500 14
- --------------------------------------------------------------------------------------------------------------------------
TOTAL 5 $ 434,400 53 $ 4,499,400 12 $ 1,010,900 70 $ 5,944,700 105
- --------------------------------------------------------------------------------------------------------------------------
* 19 of these wells were drilled by SENGAI
** 18 wells had been drilled by previous owner
*** one well plugged and abandoned
11
CARRIZO - PURCHASE AND SALE AGREEMENT. On July 10, 2001, RMG closed a
Purchase and Sale Agreement with CCBM, Inc., a Delaware corporation which is
wholly-owned by Carrizo Oil & Gas, Inc., Houston, Texas (NMS "CRZO"). The
agreement between CCBM and RMG is intended to finance the further exploration of
the acreage prospective for coalbed methane currently owned by RMG in Montana
and Wyoming, and to acquire and develop more acreage in Wyoming and the Powder
River Basin of Montana.
RMG has assigned CCBM an undivided 50% interest in all of RMG's existing
coalbed methane properties (with the exception of Castle Rock of which only a
6.25% working interest was assigned) for a purchase price of $7,500,000 by a
promissory note payable in principal amounts of $125,000 per month plus interest
at an annual rate of 8%, over 41 months (starting July 31, 2001) with a balloon
payment due on the forty-second month. These properties consisted of the Kirby,
Oyster Ridge, Clearmont, Sussex, Finley, Baggs North, and Gillette North
properties. The 50% undivided interest is pledged back to RMG to secure the
purchase price, and will be released 25% when 33.3% of the principal amount
($2,500,000) of the purchase price is paid, another 25% when total principal
payments reach 66.6% of the principal amount ($5,000,000) of the purchase price,
and the balance of the total 50% undivided interest when all of the principal
amount ($7,500,000) of the purchase price, has been paid.
CCBM has the right to participate in other properties RMG may acquire (like
the Bobcat property) under the area of mutual interest ("AMI"), see "Agreement
for Purchase of the Bobcat Property" above, and "Carrizo - Purchase and Sale
Agreement" in the Annual Report (Form 10-K/A1) for the former fiscal year ended
May 31, 2002.
In addition to its one-half share of revenues in proportion to its one-half
share of the working interest, CCBM will be entitled to a credit (applied as a
prepayment of the purchase price for the undivided 50% interest in RMG's
acreage), equal to 20% of RMG's net revenue interest from wells drilled with the
$5,000,000 drilling budget, until the amount of that credit in favor of CCBM
equals $1,250,000.
RMG is the designated operator under a Joint Operating Agreement between
RMG and CCBM, which governs all operations on the properties subject to the
Purchase and Sale Agreement between RMG and CCBM subject to pre-existing JOA's
with other entities, and operations or properties in the area of mutual interest
("AMI"). The AMI four-year term ends June 30, 2005. It covers the entire state
of Wyoming, and the Powder River Basin of Montana, but will be reduced if CCBM
does not obtain at least $20 million for future property acquisitions (see
below).
Under the Purchase and Sale agreement with CCBM, CCBM will use its best
efforts to obtain financing to raise no less than $20,000,000 to be used by RMG
to acquire more properties in the AMI. CCBM would have a 50% working interest in
properties so acquired. If CCBM's efforts were not successful by June 30, 2002,
the AMI was to be reduced to a 6-mile radius from all existing properties held
jointly by RMG and CCBM. As of December 31, 2002, CCBM has not been successful
in its efforts to raise the $20,000,000 land acquisition fund. RMG has agreed
verbally not to invoke this provision of the contract, which CCBM has agreed to
continue to pursue sources of capital to fund the $20,000,000 commitment.
A management committee oversees all operations subject to the Purchase and
Sale Agreement, with two members each from CCBM and RMG, however, RMG shall have
a tie-breaking vote until the $5,000,000 drilling commitment has been expended
and until the purchase price has been paid. Once the $5,000,000 drilling
commitment has been expended and the full purchase price is paid, RMG will
allocate (with Quaneco's consent) to CCBM one of RMG's managing member positions
with Powder River Gas LLC, which is the operative entity for the Montana acreage
RMG holds with Quaneco L.L.C.
12
QUANECO - AGREEMENT. On January 3, 2000, RMG purchased a 50% working
interest and 40% net revenue interest in the Castle Rock and Kirby prospects in
the Powder River Basin of southeast Montana consisting of approximately 185,000
net mineral acres from Quaneco, L.L.C. (formerly Quantum Energy, L.L.C.,
Cleveland, Ohio and Oklahoma City, Oklahoma). The acreage includes 88,409 net
acres of Bureau of Land Management ("BLM") land, 14,916 net acres of state land
(Montana), and 82,775 net acres of fee land. In fiscal 2000 and 2001, RMG paid
Quaneco the cash purchase price of $5,500,000 for the acreage plus a drilling
commitment of $2,500,000.
For information on the Quaneco agreement, see "Quaneco Agreement" in the
Annual Report (Form 10-K/A1) for the former fiscal year ended May 31, 2002.
SENGAI - OPTION AND FARMIN AGREEMENT.
For information on the Quaneco agreement, see "SENGAI Option and Farmin
Agreement" in the Annual Report (Form 10-K/A1) for the former fiscal year ended
May 31, 2002.
NEW OPTIONS ACREAGE
In December 2002, we signed an option to acquire producing, proven and
undeveloped CBM properties from an undisclosed party. The optioned properties
are reported to be producing CBM from 184 wells producing from various coal
seams ranging in depth from 400 to 500 feet. Working interest in these wells
range from 27% to 100% and net revenue interest ranges from 21% to 98%. Deeper
coals could be prospective for development, and operational and infrastructure
improvements. Drilling more wells could enhance current production. The
properties include various gas gathering contracts, gas purchasing contracts and
additional drilling permits. This option expires April 15, 2003.
In February 2003, we signed a separate option with the same party to
acquire additional gross acres of undeveloped acreage. There are reported to be
10 completed shut-in wells on the properties. A portion of the acreage under
option, offsets production from adjoining properties belonging to other parties.
Pipelines traverse a portion of the acreage. This option expires May 1, 2003.
As of the filing of this Annual Report, RMG is conducting due diligence
review of the acreage under the options. Ryder Scott Company, independent
petroleum engineers, is preparing reserve evaluations of the producing
properties under option. Results of the reserve reports will determine whether,
and at what price, RMG will negotiate the purchase of one or both properties.
Closing is subject to RMG raising sufficient capital. CCBM will have the right
to purchase one-half the interests RMG purchases in the acreage.
DESCRIPTION OF PROSPECTS
Leases of federal mineral rights are obtained from the United States Bureau
of Land Management and expire from 2004 to 2009, unless RMG establishes
production on the lease, in which event the lease is held so long as coalbed
methane or other gas or oil is produced. A royalty interest of 12.5% on the
production is paid to the BLM. State leases expire from 2003 to 2004 in Wyoming
and Montana, unless RMG establishes production on the lease, in which event the
lease is held so long as coalbed methane or other gas or oil is produced. The
royalty paid to the State of Wyoming is from 12.5 % to 16.67%, and 12.5% to the
State of Montana. Annual renewal fees for non-producing Federal leases is $1.50
to $2.00 per acre, and $1.00 and $1.50 for non-producing Wyoming and Montana
leases.
13
An environmental group has filed a lawsuit against the BLM, RMG and others,
challenging the validity of numerous BLM leases in the Powder River Basin of
Montana. See Item 3, Legal Proceedings ("Rocky Mountain Gas Litigation").
Leases on private (fee) land for coalbed methane and conventional gas
expire at various times from 2003 to 2011, unless production is established, in
which event the lease is held so long as there is production. The landowner is
paid a royalty from production of 12.5% to 20.0% , depending on the lease terms.
Table 3 presents total acreage, both developed and undeveloped held by RMG
at December 31, 2002.
TABLE 3
ROCKY MOUNTAIN GAS, INC.
- ------------------------------------------------------------------------------------------------------------------------
Gross Leased Net Leased Net Leased Net Leased Net Leased from Net Leased
Prospect Acres Acres from BLM from State of State of from Private
Wyoming Montana Owners
- ------------------------------------------------------------------------------------------------------------------------
Castle Rock 123,840 111,567 55,104 0 10,860 45,603
- ------------------------------------------------------------------------------------------------------------------------
Kirby 81,494 75,122 33,305 0 4,056 37,761
- ------------------------------------------------------------------------------------------------------------------------
Oyster Ridge* 21,536 21,536 17,107 1,229 0 3,200
- ------------------------------------------------------------------------------------------------------------------------
Clearmont 6,465 3,905 0 640 0 3,265
- ------------------------------------------------------------------------------------------------------------------------
Sussex 640 640 0 640 0 0
- ------------------------------------------------------------------------------------------------------------------------
Finley 160 160 0 160 0 0
- ------------------------------------------------------------------------------------------------------------------------
Baggs North 120 120 0 120 0 0
- ------------------------------------------------------------------------------------------------------------------------
Gillette North 80 80 0 80 0 0
- ------------------------------------------------------------------------------------------------------------------------
Arvada 1,900 1,700 1,200 0 0 500
- ------------------------------------------------------------------------------------------------------------------------
Bobcat - Undeveloped 180 180 0 0 0 180
- ------------------------------------------------------------------------------------------------------------------------
Total Undeveloped Acres 236,415 215,010 106,716 2,869 14,916 90,509
- ------------------------------------------------------------------------------------------------------------------------
Bobcat - Developed 1,760 1,760 0 0 0 1,760
- ------------------------------------------------------------------------------------------------------------------------
Total Acres 238,175 216,770 106,716 2,869 14,916 92,269
- ------------------------------------------------------------------------------------------------------------------------
*Does not include 43,711 acres under option from Anadarko Petroleum. See
"Description of Properties - Oyster Ridge."
BOBCAT FIELD. On April 12, 2002, the Company and RMG signed an agreement to
purchase working interests in approximately 1,940 gross acres of coalbed methane
properties in the Powder River Basin of Wyoming. The contract closed on June 4,
2002. The Company paid the seller $500,000 cash and another $150,000 by issuing
37,500 shares of its restricted common stock to the seller; CCBM paid $500,000
cash to the seller and Carrizo Oil & Gas, Inc. issued its restricted shares of
common stock valued at $150,000. The properties are located approximately 25
miles north of Gillette, Wyoming, in Campbell County.
As of the filing of this Annual Report, 24 CBM wells have been drilled (22
completed in the Cook coal at 650 feet, 2 completed in the Canyon coal at 450
feet), and are producing. Produced and sold gas (net of gas used as fuel for the
compressors) averaged approximately 1,829 Mcf or 1,796 MMBtu per day in
14
January 2003 (422 Mcf or 414 MMBtu per day net to RMG). All gas sales during
January 2003 were sold at market prices, which averaged $3.03 per MMBtu.
In February 2003, RMG received a guaranteed contract price of $3.07 per
MMBtu for its share of the first 1,000 MMBtu of gas sold each day, with the
balance at market prices (an average of $4.25/MMBtu). 500 MMBtu per day will be
sold at a guaranteed contract price of $3.52 per MMBtu from March 1, 2003 to
October 31, 2003. Reserves have been established for the Bobcat Field, see "Gas
Reserves" above.
CASTLE ROCK: The Castle Rock project consists of 123,840 gross and 111,567
net acres located in the northeastern portion of the Powder River Basin of
Montana, west of Broadus, Montana. Coals present are in the Tongue River member
of the Fort Union formation and appear comparable to coals currently being
developed by other operators south of the Castle Rock acreage near the
Montana/Wyoming border. Currently, there are no pipelines in this area.
KIRBY: The Kirby project consists of 81,494 gross and 75,122 net acres
located in the northwestern portion of the Powder River Basin in Montana located
in Big Horn and Rosebud Counties, Montana, north of Sheridan, Wyoming. Coals are
in the lower portion of the tertiary Fort Union formation and are similar to
productive coals in the Wyoming portion of the Powder River Basin to the south.
Redstone (recently acquired by Montana Dakota Utilities) has established
significant coalbed methane production 12 miles south of Kirby at the CX field.
At least two other operators are currently planning to drill and develop nearby
acreage. CMS's Bighorn Gas Gathering recently extended a new 20" pipeline to
within 10 miles of the Kirby project.
In the seven months ended December 31, 2002, a 3 well exploration program
was started; 2 wells have been drilled and were completed in January 2003 at the
southern end of the acreage, with encouraging initial gas shows and an
individual coal thickness of over 50 feet. Complete results from the exploration
program will dictate the extent of follow-up pilot programs tentatively
scheduled for later in 2003.
OYSTER RIDGE: The Oyster Ridge project consists of 65,247 gross and net
acres located in southwestern Wyoming in the Ham's Fork Coal Field adjacent to
the Green River Basin. RMG and CCBM have a 100% working interest (50% each) in
21,536 acres within Oyster Ridge.
Anadarko Petroleum, Inc. is successor to Union Pacific Land Resources
Corporation, which sold the acreage subject to UPLRC's back-in option to third
parties, from whom RMG acquired the acreage in December 1999.
The agreement with Anadarko is a drill-to-earn-acreage agreement: we must
drill at least four wells each year, each on a new section (640 acres), to earn
a lease on each drilled section , and also to keep in force previously earned
leases in the 43,711 acres areas. Wells drilled by our seller, and by us (with
CCBM), have earned 3,200 acres, which are included in the 21,536 acres leased
presently. Under the terms of the agreement, we must drill 4 additional wells by
March 31, 2003 to keep our agreement in force. As a result of a 60 day extension
of time granted by Anadarko, RMG expects to meet this drilling commitment.
Within this prospect, 43,711 gross acres are subject to an option held by
Anadarko Petroleum, Inc. to participate as a 25% working interest owner on all
wells drilled each year. Anadarko has not yet elected to participate, and has no
working interest in the seven wells drilled to date on this prospect. If
Anadarko elects to participate in the future, working interest ownership in
affected wells would be 37.5% RMG, 37.5% CCBM, and 25% Anadarko.
15
The area is prospective for coalbed methane production from two primary
Cretaceous age coals, the Frontier and the Adaville. The Kern River pipeline,
which services southern California, crosses the property. Exploratory drilling
and completion operations on previously drilled wells resumed at Oyster Ridge in
June, 2001. Through December 31, 2002, $618,100 has been spent on drilling and
completion at Oyster Ridge.
CLEARMONT: The Clearmont project consists of approximately 6,465 gross and
3,905 net acres located in the western Powder River Basin of Wyoming. RMG (and
now CCBM jointly) owns working interests ranging from 25% to 100%. The area is
characterized by several shallow Fort Union coalbeds (most notable the Roland
and Anderson coals) as well as several deeper coals that hold significant
exploration potential. Substantial coalbed methane production and development is
ongoing in the immediate area including Federated's Box Elder Creek project 12
miles to the west and the Penneco/CMS Wild Horse Creek project 15 miles to the
east. The Clearmont project is located at the convergence of the WBI Bitter
Creek and the Bighorn Sheridan Lateral pipelines. An exploration drilling
program began at Clearmont in August 2001 and could be in production fourth
quarter 2003 depending on drilling results and gas prices. Through December 31,
2002, $1,945,100 has been spent on drilling and completion at Clearmont.
Nineteen of the existing 32 wells at Clearmont have been on full-scale
dewatering since June 2002. These 19 wells are hooked up to a gas gathering
system but as of December 31, 2002, no gas production had occurred. The other 13
wells were not being dewatered as of December 31, 2002. Dewatering of these
wells will commence once the gathering system is installed. During 2003, RMG
expects to begin selling gas produced from the Clearmont wells to CMS Field
Services, Inc. pursuant to a gas contract. However, production could be delayed
if dewatering hasn't progressed sufficiently to allow production of commercial
amounts of gas. In the third calendar quarter 2002, RMG completed construction
of a field gathering system (for delivery and initial compression of the gas) to
Bighorn Gas Gathering, LLC. Bighorn has signed a gas gathering agreement with
RMG to deliver gas collected from RMG's system to CMS.
SUSSEX: RMG and CCBM hold 640 gross and net acres in this project area
located in Johnson County, Wyoming. This State lease lies 3 miles south of
Sussex, Wyoming. RMG has a 50% working interest. To date, RMG has not conducted
any significant exploration on the property.
FINLEY: RMG and CCBM hold 160 gross and net acres in this project area
located in Converse County, Wyoming. This prospect is a State lease 12 miles
east of Edgerton, Wyoming. To date, RMG has not conducted any significant
exploration on the property.
BAGGS NORTH: This prospect contains 120 gross and net acres located in
Carbon County, Wyoming. This State lease is located 7 miles north of Baggs,
Wyoming. RMG holds a 50% working interest in this prospect. To date, RMG has not
conducted any significant exploration on the property.
GILLETTE NORTH: RMG holds a 50% working interest in 80 gross and net acres
in this project area located in Campbell County, Wyoming. This State lease lies
at the north end of the City of Gillette. Existing coalbed methane wells lay in
the section immediately north. To date, RMG has not conducted any significant
exploration on the property.
ARVADA: This prospect contains 1,900 gross acres, 1,700 net acres, located
in Sheridan County, Wyoming adjacent to the Clearmont prospect. RMG holds a 50%
working interest, and a 31% to 40.75% net revenue interest. To date, RMG and
CCBM have spent $64,800 on the drilling of one 1,471' deep test well and are
analyzing the drilling results. Gas gathering and production sales are covered
by agreements with Bighorn Gas Gathering, LLC and CMS Field Services, Inc.
16
GENERAL INFORMATION ABOUT COALBED METHANE.
Methane is the primary commercial component of natural gas produced from
conventional gas wells. Methane also exists in its natural state in coal seams.
Natural gas produced from conventional wells generally contains other
hydrocarbons in varying amounts which require the natural gas to be processed.
Methane gas produced from coalbeds generally contains only methane and is
pipeline-quality gas after simple water dehydration.
Coalbed methane ("CBM")production is similar to conventional natural gas
production in terms of the physical producing facilities. However, the
subsurface mechanisms that allow gas movement to the wellbore are very
different. Conventional natural gas wells require a porous and permeable
reservoir, hydrocarbon migration and a natural structural or stratigraphic trap.
Coalbed methane gas is trapped (adsorbed) in the coal itself and in the water
contained in the pore space, until released by pressure changes when the water
in the coal is removed. In contrast to conventional gas wells, new coalbed
methane wells initially produce water for several months. As the formation water
pressure decreases, methane gas is released from the structure.
Methane production is a direct result of reducing the hydrostatic (water)
pressure in the coal formation. Three principal stages are involved:
o Drill wells (typically eight or more in a 'pod') down to the same coal
formation, in contiguous 80 acre spacing per well; test the water in
the formation and test coal samples taken from the formation. Water
testing determines if the geochemical environment of the coal seam is
conducive to the formation of CBM.
o Install gathering lines to hook up and put wells on pump to 'dewater'
the coal formation. Hydrostatic pressure must be reduced to about 50%
of initial pressure before enough data is obtained (water flow rates,
CBM gas flows) to determine how much CBM the wells may produce. This
dewatering stage may take 6 to 18 months, and in some instances 24
months (where there is no dewatering of the coal seam occurring from
wells drilled by others on adjacent properties).
o Installing (or have a transmission company install) a compressor and
transport line to carry produced gas to a gas transmission line for
sale to end users. Gas production starts gradually then continues to
grow in volume as hydrostatic pressure is reduced; optimal production
won't occur until hydrostatic pressure is reduced approximately 90%
from initial levels.
COALBED METHANE WELL PERMITTING
Operators drilling for coalbed methane are subject to many rules and
regulations and must obtain drilling, water discharge and other permits from
various governmental agencies depending on the type of mineral ownership and
location of the property. Intermittent delays in the permitting process can
reasonably be expected throughout the development of all RMG projects. For
example, there is currently a temporary moratorium for drilling coalbed methane
wells on fee and state lands in Montana (although, RMG negotiated the right to
receive 116 drilling permits to drill in Montana during the moratorium). We may
shift our exploration and development strategy as needed to accommodate the
permitting process. As with all governmental permit processes, there is no
assurance that permits will be issued in a timely fashion or in a form
consistent with the plan of operations.
Drilling and production operations on our Powder River Basin leases in
Wyoming and Montana are subject to environmental rules, requirements and permits
issued by various federal authorities for drilling and
17
operating on all land, regardless of ownership, and state and local regulatory
agencies for land owned by the state or in fee by private interests. The primary
U.S. federal agency with related responsibilities is the Bureau of Land
Management of the U.S. Department of the Interior ("BLM") which has imposed
environmental limitations and conditions on coalbed methane drilling, production
and related construction activities on federal leases in the PRB. These
conditions and requirements are imposed through Records of Decision ("ROD")
issued pursuant to Environmental Impact Statements ("EIS"). The BLM may also
impose site- specific conditions on development activities, such as drilling and
the construction of rights-of-way, before it approves required applications for
permits to drill and plans of development. The BLM is currently developing an
updated Supplemental EIS ("SEIS") for 51,000 CBM wells in the Powder River Basin
of Wyoming. Additionally, the BLM is conducting a SEIS for 39,000 CBM wells in
Montana. Both of these PRB SEISs are expected to be completed, with RODs issued,
by mid 2003. While the BLM SEIS has been underway, there has been a moratorium
on the issuing of new drilling permits on federal leases in both Wyoming and
Montana; however, RMG currently holds previously issued BLM permits and Montana
state permits to drill 16 wells on the Castle Rock project and 8 wells on the
Kirby project and can therefore drill these wells prior to completion of the
SEISs and issuance of additional permits.
The state-based environmental agencies primarily concern themselves with
the issuance of permits related to drilling, land, air quality and water
discharge. The primary state-based agencies for which coalbed methane operators
are subject to include:
o Wyoming Department of Environmental Quality ("WDEQ")
o Wyoming Oil and Gas Conservation Commission ("WOGCC")
o Montana Department of Environmental Quality ("MDEQ")
o Montana Board of Oil and Gas Conservation ("MBOGC")
While the BLM is primarily responsible for issuing broadly based EISs for
each state, its jurisdiction over related matters and the actual issuance of
drilling permits is primarily reserved for federal leases. Permits for drilling
on state or fee owned land are issued by the WOGCC and MBOGC following their
review of the BLM EIS and the formulation of their own local EIS's.
The WOGCC has historically undertaken environmental studies and its history
in issuing drilling permits for the Powder River Basin is as follows:
o 90 wells approved on three small pilot projects from 1992 to 1995.
o 250 wells approved in areas north of Gillette in 1996.
o 640 wells approved in areas south of Gillette in 1997.
o 5,890 wells approved in 1999, (in conjunction with the 1998 Wyoming EIS)
in the Wyodak area. (The Wyodak area of the Powder River Basin runs
south of Gillette and was the initial development area of the Basin).
o 2,500 wells approved in early 2001 in the Wyodak area, primarily on
federal lands.
To date, a total of 28,000 CBM drilling permits have been issued statewide,
(including permits for other coalbed methane basins) on federal, state and fee
leases, although 6,700 were unused and are now expired.
In conjunction with the BLM EIS, WOGCC has also been formulating its own
updated SEIS since June 2000 related to future permits for 51,000 CBM wells in
the PRB of Wyoming covering 8,000,000 acres in Campbell, Sheridan, Johnson and
Converse counties. The related minerals are on land which is 54% federal, 37%
fee and 9% state. Surface rights are on land which is 14% federal, 77% fee and
9% state. The related ROD is expected by mid 2003, which should lead to a large
number of new drilling permits being
18
issued in 2003. The WOGCC has estimated that approximately 5,000 new CBM wells
will be drilled annually for at least the next five years.
In contrast to Wyoming, Montana authorities have been very slow in
undertaking CBM environmental studies and granting permits to drill wells. In
fact, to date, only the Redstone (Fidelity) project just south of RMG's Kirby
project is producing CBM gas in Montana. With the exception of a relatively
small number of drilling permits available from earlier issuance (including
those held by RMG which have allowed some recent drilling on the Kirby and
Castle Rock projects), a drilling moratorium has been in effect during the last
two years. In recent months, however, the MBOGC has drafted a SEIS, as an
amendment to the Powder River and Billings Resources Management Plans, for
coalbed methane gas development in Montana. This new SEIS, in conjunction with
the similar EIS carried out by the BLM, is expected to address a comprehensive
statewide CBM development program to allow permitting for 39,000 wells. A draft
of the SEIS has been completed and a ROD is expected by mid 2003. Additionally,
despite the current moratorium on CBM drilling permits in Montana, RMG received
one of only two Environmental Assessments and a Finding of No Significant Impact
("FONSI")which will allow it to drill 56 wells on federal leases held in
Montana. These wells would evaluate potential CBM production as well as
conventional gas. The ROD in Montana is expected by mid 2003 and drilling
permits should then be issued on federal, state and fee leases.
The DEQs are primarily responsible for issuing air quality and water
discharge permits, among other things. Water disposal has been and is expected
to continue to be a significant issue, particularly with respect to coalbed
methane gas production, which typically entails substantial water production at
least during the dewatering phase of completion of a new well. The primary issue
of concern is the salinity content in the produced water, which is measured by
the sodium absorption ratio ("SAR"), which, depending upon a location, can range
from slightly less than that in surface water to a substantially greater amount.
Due to the discrepancies of the SAR content found in water from coalbed methane
wells, the disposal of this water is tightly regulated. If the SAR content is
low, the water can be used for irrigation, livestock drinking water or even as a
water supply for cities. If the SAR content is higher, the water quality does
not merit use for drinking water or irrigation and, under these measures, the
DEQ has outlined various other methods of water disposal. Man-made ponds may
also be built right beside the wells, enabling the wells to drain their water
into the ponds (called surface discharge). Additionally, there might be
drainages which the produced water can flow into. Finally, the water might be
reinjected through wells into the ground below levels from which the water was
produced. Thus far, the vast majority of associated water produced has been
discharged on the surface, primarily captured in reservoirs and ponds and
allowed to evaporate.
Overall, RMG has not experienced any difficulty in obtaining air quality
and water discharge permits from the WDEQ and has yet to apply for such permits
in Montana. It has two WDEQ National Point Discharge Elimination System
("NPDES") Program permits to dispose of all anticipated water production into
reservoirs at the Bobcat and Clearmont projects. The State of Wyoming recently
streamlined the process and time required to obtain these permits and RMG
anticipates that it will be able to obtain the necessary permits for its other
properties in Wyoming and Montana.
The following summarizes permits now in place.
19
Table 4
Expiration
Prospect Remaining Permits or Renewal Date
- --------------------------------------------------------------------------------
Castle Rock 16 05/13/03 and 07/03/03
- --------------------------------------------------------------------------------
Kirby 8 07/03/03 and 07/15/03
- --------------------------------------------------------------------------------
07/15/03; 08/01/03; 08/02/03; 08/09/03;
Clearmont 61 09/11/03; 10/28/03; 11/20/03;
12/19/03; 12/20/03 and 02/17/04
- --------------------------------------------------------------------------------
Arvada 6 10/28/03 and 12/05/03
- --------------------------------------------------------------------------------
Bobcat 14 09/11/03; 09/18/03 and 12/19/03
- --------------------------------------------------------------------------------
Total 105
- --------------------------------------------------------------------------------
Drilling permits issued by the State of Wyoming allow one year for drilling
completion; permits issued by the State of Montana allow six months. Expired
permits for undrilled locations are usually renewed by the agencies without
difficulty.
Once drilled, all wells in Wyoming are subject to a National Pollution
Discharge Elimination System ("NPDES") permit relating to water testing and
discharge. All wells in the Castle Rock and Kirby prospects remain subject to
the Montana Board of Oil and Gas Commission approval. Upon completion of
drilling, wells are subject to monthly reporting regarding status and production
to the respective state agencies in which they are located.
GATHERING AND TRANSMISSION OF CBM GAS
Due to the low pressure characteristics of the coalbeds, the production of
coalbed methane is dependent on the installation of multi-stage compression
facilities. Gas gathering will be similar among RMG's fields. Components include
the wellhead and two pipelines. One pipeline transports gas to a low level
compression station, then on to a high level compression station and finally to
the transmission pipeline. The water is commonly collected through another
pipeline from each of the wells and pumped into a surface reservoir.
Companies involved in coalbed methane production generally outsource gas
gathering, compression and transmission. RMG and industry partners have and will
likely continue to outsource their compression and gathering to third parties at
fixed charges per Mcf transported.
GAS MARKETS
Current production from the PRB, having grown from virtually nothing in the
early 1990s, is now approximately 900 Mmcfd. Since this area is sparsely
populated, most of this gas must be exported from Montana and Wyoming to distant
markets. The existing Wyoming pipeline infrastructure is already substantial and
continues to expand with gathering systems and intrastate lines, yet is
ultimately dependent on large interstate pipelines. With the exception of a
portion of the gathering systems, this pipeline system is typically owned and
operated by independent mid-stream energy companies, rather than oil and gas
operators. The pipelines generally will not be financed and constructed until
appropriate amounts of gas have been proven and committed for transport on the
new lines. While the total current take away capacity from the PRB is
approximately 1.25 billion cubic feet per day (Bcfd), excess capacity over
current production rates does not exist in all locations and not all producers
have a ready market for the sale of their gas at all times. Some major producers
in the region reserve portions of pipeline capacity beyond their current
requirements, resulting in less than stated maximum capacity being available for
other producers. In addition, total stated
20
capacity is unavailable at times, as was the case during this past summer when
two major pipelines were curtailed or shut down for maintenance or construction
activities.
Based on the existing pipeline systems and the gas sales markets in its
area of operations in Wyoming, RMG expects that, at least for the next few
years, the markets in which it sells its gas, and the spot prices to which it
will be subject, will be dependent upon three major sales points:
o The Colorado Interstate Gas ("CIG") station near Cheyenne in
southeastern Wyoming, which primarily feeds regional markets or
markets in the Midwest.
o The Ventura market ("Ventura") located in Ventura, Iowa, which
prices gas on the Northern Border pipeline where it interconnects
with Northern Natural Gas and feeds markets in the Northern
Plains and Midwest.
o The Opal market ("Opal") in southwestern Wyoming, which delivers
to the Kern River pipeline for delivery to Utah, Nevada, Arizona
and California.
PIPELINES THAT SERVE THE CIG MARKET
Following early PRB development, two large diameter intrastate pipelines,
the Fort Union and the Thunder Creek, were constructed in the Basin in 1999, and
gathering system infrastructure has continued to grow significantly since that
time. These two major intrastate pipelines currently provide almost 1.1 Bcfd
capacity, flowing south out of the Basin to the CIG Hub in Southeast Wyoming.
Descriptions are as follows:
o Fort Union. The Fort Union Gas Gathering pipeline consists of a
106 mile, 24 inch, 434 Mmcfd capacity line completed in August
1999 and a 20" pipeline with a capacity of 200 Mmcfd completed in
September 2001. It is believed that capacity could be increased
by another 200 Mmcfd by adding additional compression to this
line.
o Thunder Creek. Thunder Creek Gas Services pipeline is a 126-mile,
24 inch pipeline which commenced operations on September 1, 1999
with a capacity of 450 Mmcfd.
The RMG Bobcat Field currently delivers its gas to the Thunder Creek
pipeline where it is carried south and delivered to the CIG market. As an
alternative, the Bobcat gas could be sold in the Ventura market through an
interconnection of the Thunder Creek pipeline to other lines flowing north out
of the Basin.
The Clearmont and Arvada projects will utilize the Big Horn pipeline, a 110
mile gathering line originating on the Montana/Wyoming border north of Sheridan,
flowing generally east and bisecting the Clearmont and Arvada projects before
connecting with the Fort Union pipeline. The Big Horn pipeline was completed in
December 2000 with an initial capacity of 250 Mmcfd and is readily up-gradable
through additional compression to 500 Mmcfd. While the Big Horn pipeline can
currently deliver gas only to the south into the CIG market, anticipated future
pipeline construction may enable this gas to be delivered to the Ventura market
at a later date.
When the Kirby project is prepared to commence gas sales in the future, it
is expected that this property will be hooked up with an approximate 10 mile
extension of the Big Horn pipeline. However, Kirby is still largely unexplored,
so any production from this acreage may be several years into the future.
21
PIPELINES THAT SERVE THE VENTURA MARKET
There is currently only a single significant pipeline capable of
transporting gas out of the Basin to the north, the Bitter Creek pipeline, which
connects with the Northern Border interstate pipeline. However, two additional
lines that are well along in their planning stages, would also deliver gas to
the Northern Border pipeline. Descriptions are as follows:
o Bitter Creek. The Bitter Creek pipeline is owned by Williston
Basin Interstate Pipeline Company ("WBI"), a subsidiary of MDU
Resources Group, Inc. It was completed in 2001 with initial
capacity of 150 Mmcfd.
o Grasslands. In response to the need for expandable access to the
Ventura market, the Grasslands pipeline, also owned by WBI, is
expected to be completed and in service by November 2003. It is
anticipated to be a 245 mile, 16 inch line with an initial
capacity of 80 Mmcfd and expandable to 200 Mmcfd.
o Bison. Northern Border Partners, L.P. is currently holding an
open season to solicit interest in firm transportation on the
proposed Bison 20 inch interstate pipeline project which would
connect PRB gas supplies to a proposed interconnection to its own
Northern Border pipeline. Currently, the project is anticipated
to be in service in November 2005 with a capacity of 240 Mmcfd.
The pipeline is proposed to start near Gillette, Wyoming and
extend north into Montana. Interconnections for receipt of gas
are proposed with Big Horn, Fort Union, Thunder Creek and other
lines through the eastern corridor of the Castle Rock project.
THE OPAL MARKET
The Opal market, in southwestern Wyoming, is a major pipeline connection
point, with several intrastate and interstate lines connecting to the major
interstate line, Kern River, which transports gas to the southwest and is
described as follows:
o Kern River. The Opal market is served by the Kern River pipeline
which has a capacity of 824 Mmcfd, and delivers to markets in
Utah, Nevada, Arizona and California. Kern River Gas Transmission
has started construction of a $1.2 billion expansion project to
more than double the capacity of its 926 mile interstate
pipeline. When completed in May 2003, this line will have
capacity of 1.73 Bcfd.
GAS PRICES
Historically, spot gas prices received by producers at the Ventura, CIG and
Opal markets have generally been at discounts to the NYMEX front month contract
and Henry Hub spot cash prices, although with lesser discounts during the winter
months. Prices at CIG almost always trade at a further discount to the Ventura
prices, and again with an even higher discount during the second and third
quarters, because CIG is partially based on local demand which drops
approximately 50% outside the heating season, whereas Ventura serves larger
national markets and is highly correlated to Chicago market prices.
Opal has generally traded in price ranges close to those at CIG. This
larger than normal negative spread has resulted from a combination of (i)
rapidly growing CBM and conventional gas production volumes in this region, (ii)
the curtailment of both of the primary lines taking gas south out of the PRB due
to maintenance and/or construction (Fort Union and Thunder Creek), (iii) weak
western U.S. demand during most of 2002, (iv) large amounts of current pipeline
capacity controlled by the larger producers, and (v)
22
restraint in new pipeline construction from both regulatory delays and hesitancy
to construct new lines by the pipeline companies. RMG management believes that
this situation is temporary and that new pipelines currently under construction
should bring the price differentials back to normal historic levels in 2003 and
2004. Furthermore, commencing with cooler weather in late October 2002, realized
prices in the CIG market have returned to differentials more in line with the
historical norm. However, there is no guarantee that the increased capacity will
eliminate the negative price differential or even significantly reduce it.
INACTIVE MINING PROPERTIES - URANIUM
GENERAL. We have interests in several uranium-bearing properties in Wyoming
and Utah and in a uranium processing mill in southeastern Utah (the "Shootaring
Mill" in Garfield County). All the uranium- bearing properties are in areas
which produced significant amounts of uranium in the 1970s and 1980s. At some
future date, we could sell or develop and operate these properties (directly or
through a subsidiary company or a joint venture) with companies having the
necessary capital to mine and mill the uranium bearing material to produce
uranium concentrates ("U3O8") for sale to public utilities that operate nuclear
powered electricity generating plants. Currently there is no uranium mill
available in Wyoming and it would take a substantial increase in the market
price of uranium concentrate over a period of time before a company with the
financial wherewithal would build a mill and place the deposits in production.
Therefore, until uranium oxide prices improve significantly, the uranium
properties will remain shut down.
At the dates of the consolidated balance sheets in this report, there are
no values carried on the balance sheets for uranium properties.
SHEEP MOUNTAIN - WYOMING
Unpatented lode mining claims, underground and open pit uranium mines and
mining equipment in the Crooks Gap area are located on Sheep Mountain in Fremont
County, Wyoming. From December 21, 1988 to June 1, 1998, these properties were
held by Sheep Mountain Partners ("SMP"). On June 1, 1998, the Company received
back from SMP all of the Sheep Mountain mineral properties and equipment, in
partial settlement of disputes with Nukem, Inc. ("Nukem") and its subsidiary
Cycle Resource Investment Corp. ("CRIC"). The judgment against Nukem impressing
the CIS uranium supply contracts in constructive trust with SMP remains
unresolved. See "Legal Proceedings." The Sheep Mountain Mines 1 and 2 were first
operated by Western Nuclear, Inc., a subsidiary of Phelps Dodge Corporation, in
the late 1970s.
We have recorded reclamation liabilities for the SMP properties (see note K
to the consolidated financial statements in this report). All historical costs
in the SMP properties were offset against a monetary award which was received
from Nukem during fiscal 1999.
THE PROPERTY INTERESTS OF USE IN UTAH THROUGH PLATEAU RESOURCES LIMITED
("PLATEAU") ARE:
Plateau Resources Limited is a wholly-owned subsidiary of USE. See "Plateau
Shootaring Canyon Mill" below.
The Tony M property contains underground uranium deposits in San Juan
County, Utah.
Plateau is the lessee of the Tony M property and has posted a bond securing
Plateau's obligations to reclaim these properties. The Tony M property was
originally developed by Plateau at the time Plateau was owned by Consumers Power
Company ("CPC"), a Michigan public utility. Significant areas of uranium
mineralization have been accessed and delineated by the prior owner's
underground workings. When the Tony M property was in production (while Plateau
was owned by CPC), it produced ore containing from three to
23
eight pounds of uranium concentrates per ton. Some of this ore was processed at
the Shootaring Mill. In addition, low grade uranium mineralization was
stockpiled at the Tony M property and at the Shootaring Mill.
Plateau also acquired the Velvet property and the nearby Woods Complex in
the Lisbon Valley area in southeastern Utah. The Velvet Mine was developed and
permitted by its prior owner and is located approximately 178 miles by road from
the Shootaring Mill. The prior owner drove several miles of access tunnels
(adits) and drifts (access tunnels) and mined material from the workings.
However, we cannot ascertain the amount or grade of material previously mined,
nor have we ascertained by our own drilling the location and grade of remaining
mineralized material in the mine. The Woods Complex was formerly an operating
uranium mine with a remaining undeveloped resource. Access to this resource
would be by extending a drift approximately 2,500 feet from the former Woods
Mine. The Woods Mine property is not permitted, but we do not expect difficulty
in obtaining a new permit, should we seek one, because the surface facilities
would occupy the site that has been disturbed from previous operations.
PLATEAU'S SHOOTARING CANYON MILL AND PROPERTIES
ACQUISITION OF PLATEAU RESOURCES LIMITED ("PLATEAU"). In August 1993, USE
purchased from Consumers Power Company ("CPC"), all of the outstanding stock of
Plateau which owns the Shootaring Canyon uranium processing mill and support
facilities in southeastern Utah (the "Shootaring Mill") for a nominal cash
consideration. The Shootaring Mill holds a source materials license from the
NRC. In the purchase of the stock from CPC, we agreed to various obligations, as
disclosed in USE's 1998 Form 10-K at pages 15 and 16.
SHOOTARING MILL AND FACILITIES. The Shootaring Mill is located in
southeastern Utah and occupies 19 acres of a 265 acre plant site. The mill was
designed to process 750 tpd, but only operated on a trial basis for two months
in mid-summer of 1982. In 1984, Plateau placed the mill on standby because CPC
had canceled the construction of an additional nuclear energy plant.
For information on the Shootaring mill facility and related real estate
property at Ticaboo, please see "Plateau's Shootaring Canyon Mill and
Properties" in the annual report (Form 10-K/A1) for the former fiscal year ended
May 31, 2002.
THE GREEN MOUNTAIN MINING VENTURE ("GMMV") PROJECT
For information on the GMMV agreement, see "Green Mountain Mining Venture"
in the annual report (Form 10-K/A1) for the former fiscal year ended May 31,
2002.
SHEEP MOUNTAIN PARTNERS ("SMP")
SMP PARTNERSHIP. In February 1988, USE acquired uranium mines, mining
equipment and mineralized properties (Sheep Mountain Mines) at Crooks Gap in
south-central Fremont County, Wyoming, from Western Nuclear, Inc. These Crooks
Gap mining properties are adjacent to the Green Mountain uranium properties.
USECC mined and milled uranium ore from one of the underground Sheep Mines
during fiscal 1988 and 1989. In December 1988, USECC sold 50 percent of the
interests in the Crooks Gap properties to Nukem's subsidiary Cycle Resource
Investment Corporation ("CRIC") for cash. The parties thereafter contributed the
properties to and formed Sheep Mountain Partners ("SMP"), in which USECC
received an undivided 50 percent interest. SMP is a Colorado general partnership
formed on December 21, 1988, between USECC and Nukem, Inc. then of Stamford, CT
("Nukem") through its wholly-owned subsidiary CRIC.
24
SMP was directed by a management committee, with three members appointed by
USECC and three members appointed by Nukem/CRIC. The committee has not met since
1991 as a result of the SMP arbitration/litigation. During fiscal 1991, disputes
arose between the SMP partners which resulted in litigation. See Item 3, Legal
Proceedings.
PROPERTIES. USE, Crested and/or USECC own 98 unpatented lode mining claims
and a 644 acre Wyoming State Mineral Lease in the Crooks Gap area.
An ion exchange plant located on the properties (to remove natural soluble
uranium from mine water) was reclaimed and the plant disposed of at the
Sweetwater Mill impoundment facility in fiscal 2002.
Permits to operate existing mines (now shut down) on the Crooks Gap
properties have been issued by the State of Wyoming. Amendments are needed to
open new mines within the permit area. As a condition to issuance of the
permits, a NPDES water discharge permit under the Clean Water Act has been
obtained. Monitoring and treatment of water removed from the mines and
discharged in nearby Crooks Creek is generally required. During the past two
years, USECC did not discharge wastewater into Crooks Creek, and the mine water
is presently being discharged into the USECC McIntosh Pit.
INACTIVE MINING PROPERTIES - GOLD
SUTTER GOLD MINING COMPANY. In fiscal 1991, USE acquired an interest in
Sutter properties located in the Mother Lode Mining District of Amador County,
California. The entire Lincoln Project (which is the name we use for the
properties) is owned by Sutter Gold Mining Company, a Wyoming corporation
("SGMC"), and a majority-owned subsidiary of USE.
This property has never been in production. Persistent low prices for gold
have made financing difficult, and in fiscal 1999 resulted in a substantial
write down of the SGMC properties.
Due to the depressed gold prices in the past, litigation that has been
resolved and lack of available funding, SGMC has deferred the start of
construction of a gold mill complex and extension of existing underground
workings. A tourist visitors center has been set up (see below) and leased to a
third party for $1,500 per month plus a 4% gross royalty on revenues. There is
one caretaker employee at the Sutter operation. The exploration permits are
being kept current as necessary to allow for possible mining activities on the
properties in the future. With the increase in the gold spot market price, we
are currently marketing the SGMC properties.
In 1998 and 1999, the Company took impairments (write-downs) in the amounts
of $1,500,000 and $10,718,800, respectively, of the carrying value of the gold
properties. These two impairments wrote off almost 85% of our investment in
these properties. As a result of low market prices for gold, we determined that
we could not produce gold from these properties at a profit. The impairments
taken in 1998 and 1999 resulted in no value for mine exploration, and the
remaining assets relating to this property include raw land which is no longer
needed for mining activity, and buildings and equipment. A significant portion
of the raw land has been sold.
We have not obtained a final feasibility study to support a determination
that the Sutter property contains proven or probable reserves of gold.
PROPERTIES. SGMC holds approximately 216 acres of surface and mineral
rights (owned), 54 acres of surface rights (owned), 55 acres of surface rights
(leased), 154 acres of mineral rights (leased), and 366 acres of mineral rights
(owned), all on patented mining claims near Sutter Creek, Amador County,
California.
25
The properties are located in the western Sierra Nevada Mountains at from 1,000
to 1,500 feet in elevation; year round climate is temperate. Access is by
California State Highway 16 from Sacramento to California State Highway 49, then
by paved county road approximately .4 mile outside of Sutter Creek.
Surface and mineral rights holding costs will be approximately $113,000
from January 1, 2003 through December 31, 2003. Property taxes for fiscal 2003
are estimated to be $20,000.
The leases are for varying terms, and require rental fees, advance
production royalties, real property taxes and insurance.
PERMITS. The Amador County Board of Supervisors has issued a Conditional
Use Permit ("CUP") allowing mining of the SGM and milling of production, subject
to conditions relating to land use, environmental and public safety issues, road
construction and improvement, and site reclamation.
VISITORS CENTER. In fiscal 2000, SGMC spent approximately $298,000 for
surface infrastructure related to improving access to the mine site, and to a
lesser extent tourist related improvements. The visitors center is being
operated by a third party. The visitors center is an exhibit of the pictures and
memorabilia from mining operations on other properties in the Sutter district in
the nineteenth century, and a guided tour of the underground workings at the
Lincoln Project. Revenues from this tourist operation were $49,200 for the seven
months ended December 31, 2002 and $41,200 and $105,400 in former fiscal years
2002 and 2001, respectively, and are included in "motel, real estate and airport
operations" in the consolidated statements of operations included in this
report. These revenues offset a majority of costs for holding the Sutter
properties.
MOLYBDENUM
As a holder of royalty, reversionary and certain other interests in
properties located at Mt. Emmons near Crested Butte, Colorado, USE and Crested
are entitled to receive annual advance royalties of 50,000 pounds of molybdenum,
or cash equivalent. AMAX Inc. (which was acquired by Cyprus Minerals Company and
was renamed Cyprus Amax Minerals Company in November 1993 and was acquired later
by Phelps Dodge) delineated a deposit of molybdenum containing approximately
146,000,000 tons of mineralization averaging 0.43% molybdenum disulfide on the
properties of USE and Crested.
Advance royalties are paid in equal quarterly installments until: (i)
commencement of production; (ii) failure to obtain certain licenses, permits,
etc., that are required for production; or (iii) AMAX's return of the properties
to USE and Crested. The advance royalty payments reduce the operating royalties
(6% of gross production proceeds) which would otherwise be due out of
production. There is no obligation to repay the advance royalties if the
property is not placed in production. USE recognized $108,500 and $132,600 of
revenues in fiscal 2001 and 2000 related to this royalty interest. Phelps Dodge
ceased making the quarterly installments in July 2001.
The Agreement with AMAX also provides that USE and Crested receive
$2,000,000 if the Mt. Emmons properties are put into production and, in the
event AMAX sells its subsidiary, Mt. Emmons Mining Company, or its interest in
the molybdenum properties, USE and Crested are to receive 15% of the first
$25,000,000 received by AMAX.
AMAX Inc. and its successor companies have sought to put the Mt. Emmons
molybdenum property into production for 20 years. Due to local opposition to
mining (the property is close to the Crested Butte, Colorado recreational resort
area) and AMAX's successors' failure to diligently pursue obtaining the permits
needed to start mining, we know of no plans at this time to put the property
into production.
26
USE and Crested are in litigation with Phelps Dodge concerning the
Agreement and the properties, see "Item 3 - Legal Proceedings."
OIL AND GAS
FORT PECK LUSTRE FIELD (MONTANA). We operate a small oil production
facility (three wells) at the Lustre Oil Field on the Ft. Peck Indian
Reservation in northeastern Montana. We receive a fee based on oil produced.
This fee and other assets of the Company collateralize a $750,000 line of credit
from a bank.
MOTEL, REAL ESTATE AND AIRPORT OPERATIONS
WYOMING. We own varying interests, alone and with Crested, in affiliated
companies engaged in real estate, and other commercial businesses. Activities of
these and other subsidiaries include ownership and management of a commercial
office building, townsite, motel, convenience store and other commercial
facilities in Ticaboo, Utah.
The Company and Crested own a 14-acre tract in Riverton, Wyoming, with a
two-story 30,400 square foot office building (including underground parking).
The first floor is rented to nonaffiliates and government agencies; the second
floor is occupied by the Company and Crested. The property is mortgaged to the
WDEQ as security for future reclamation work on the Sheep Mountain Crooks Gap
uranium properties.
The Company and Crested also own a fixed base aircraft facility at the
Riverton Regional Airport, including a 10,000 square foot aircraft hangar and
7,000 square feet of associated offices and facilities. This facility is on land
leased from the City of Riverton for a term ending December 16, 2005, with an
option to renew on mutually agreeable terms for five years. The operation for
services to the public was shut down late in fiscal 2002.
The Company owns three mountain sites covering 16 acres in Fremont County,
Wyoming. In Riverton, Wyoming, the Company owns four city lots and improvements
including two smaller office buildings.
COLORADO. USECC owns 182 acres of undeveloped land in and near Gunnison,
Colorado.
UTAH. Canyon Homesteads, Inc. (a Plateau subsidiary) owns a majority
interest in a joint venture which holds the Ticaboo Townsite in Ticaboo, Utah
(see "Minerals - Uranium-Shootaring Canyon Mill - Ticaboo Townsite" above). In
fiscal 1995, USE acquired the minority interest in the joint venture from a
nonaffiliate.
The motel and real estate operations are not dependent upon a single
customer, or a few customers, the loss of which would have a materially adverse
effect on the Company.
RESEARCH AND DEVELOPMENT
No research and development expenditures have been incurred, either on the
Company's account or sponsored by customers, during the past three fiscal years.
ENVIRONMENTAL
GENERAL. Operations are subject to various federal, state and local laws
and regulations regarding the discharge of materials into the environment or
otherwise relating to the protection of the environment,
27
including the Clean Air Act, the Clean Water Act, the Resource Conservation and
Recovery Act ("RCRA"), and the Comprehensive Environmental Response Compensation
Liability Act ("CERCLA"). With respect to mining operations conducted in
Wyoming, Wyoming's mine permitting statutes, Abandoned Mine Reclamation Act and
industrial development and siting laws and regulations also impact us. Similar
laws and regulations in California affect SGMC operations and Utah laws and
regulations effect Plateau's operations.
Management believes the Company complies in all material respects with
existing environmental regulations.
As of December 31, 2002, we have recorded estimated reclamation obligations
of $8,906,800. We anticipate that the reclamation efforts may not be required to
be started for many years, and that when started, paying for those reclamation
efforts will occur over several years. For further information on the
approximate reclamation costs (decommissioning, decontamination and other
reclamation efforts for which we are primarily responsible or potentially
responsible), see note K to the consolidated financial statements included with
this report.
OTHER ENVIRONMENTAL COSTS. Actual costs for compliance with environmental
laws may vary considerably from estimates, depending upon such factors as
changes in environmental laws and regulation (e.g., the new Clean Air Act), and
conditions encountered in minerals exploration and mining. USE does not
anticipate that expenditures to comply with laws regulating the discharge of
materials into the environment, or which are otherwise designed to protect the
environment, will have any substantial adverse impact on the competitive
position of the Company.
EMPLOYEES
As of March 24, 2003, USE had 33 full-time employees. Crested uses
approximately 50 percent of the time of USE employees, and reimburses USE on a
cost reimbursement basis.
MINING CLAIM HOLDINGS
TITLE. Nearly all the uranium mining properties held by the Company, are on
federal unpatented claims. Unpatented claims are located upon federal public
land pursuant to procedure established by the General Mining Law. Requirements
for the location of a valid mining claim on public land depend on the type of
claim being staked, but generally include discovery of valuable minerals,
erecting a discovery monument and posting thereon a location notice, marking the
boundaries of the claim with monuments, and filing a certificate of location
with the county in which the claim is located and with the BLM. If the statutes
and regulations for the location of a mining claim are complied with, the
locator obtains a valid possessory right to the contained minerals. To preserve
an otherwise valid claim, a claimant must also pay certain rental fees annually
to the federal government (currently $100 per claim) and make certain additional
filings with the county and the BLM. Failure to pay such fees or make the
required filings may render the mining claim void or voidable. Because mining
claims are self-initiated and self-maintained, they possess some unique
vulnerabilities not associated with other types of property interests. It is
impossible to ascertain the validity of unpatented mining claims solely from
public real estate records and it can be difficult or impossible to confirm that
all of the requisite steps have been followed for location and maintenance of a
claim. If the validity of an unpatented mining claim is challenged by the
government, the claimant has the burden of proving the present economic
feasibility of mining minerals located thereon. Thus, it is conceivable that
during times of falling metal prices, claims which were valid when located could
become invalid if challenged.
28
RMG's properties and mineral leases of BLM, state and fee lands require
annual cash payments of approximately $323,200 during fiscal 2003. RMG is
obligated for $109,600 of this amount to keep the leases in effect.
PROPOSED FEDERAL LEGISLATION. The U.S. Congress has, in legislative
sessions in recent years, actively considered several proposals for major
revision of the General Mining Law, which governs mining claims and related
activities on federal public lands. If any of the recent proposals become law,
it could result in the imposition of a royalty upon production of minerals from
federal lands and new requirements for mined land reclamation and other
environmental control measures. It remains unclear whether the current Congress
will pass such legislation and, if passed, the extent such new legislation will
affect existing mining claims and operations. The effect of any revision of the
General Mining Law on operations cannot be determined conclusively until such
revision is enacted; however, such legislation could materially increase the
carrying costs of mineral properties which are located on federal unpatented
mining claims, and could increase both the capital and operating costs for such
projects and impair the ability to hold or develop such properties.
ITEM 3. LEGAL PROCEEDINGS
Material pending proceedings are summarized below. Other proceedings which
were pending in fiscal 2002 have been settled or otherwise finally resolved.
SHEEP MOUNTAIN PARTNERS ARBITRATION/LITIGATION
In 1991, disputes arose between USE/Crested, and Nukem, Inc. and its
subsidiary Cycle Resource Investment Corp. ("CRIC"), concerning the formation
and operation of the Sheep Mountain Partners partnership for uranium mining and
marketing, and activities of the parties outside SMP. Arbitration proceedings
were initiated by CRIC in June 1991 and in July 1991, USECC filed a lawsuit
against Nukem, CRIC and others in the U.S. District Court (District of Colorado)
in Civil No. 91B1153. Later, USECC filed another suit for the standby costs at
the SMP mines against SMP in the Colorado State Court. The Federal Court stayed
both the arbitration proceedings and the State Court case. In February 1994, all
of the parties agreed to exclusive and binding arbitration of the disputes
before the American Arbitration Association ("AAA"), for which the legal claims
made by both sides included fraud and misrepresentation, breach of contract,
breach of duties owed to the SMP partnership, and other claims.
The AAA panel (the "Panel") entered an Order and Award (the "Order") in
April 1996 and clarified the Order on July 3, 1996, finding generally in favor
of USE and Crested on certain of their claims (including the claims for
reimbursement for standby maintenance expenses and profits denied SMP in Nukem's
trading of uranium), and in favor of Nukem/CRIC and against USE and Crested on
certain other claims, and imposing a constructive trust in favor of Sheep
Mountain Partners on uranium contracts Nukem entered into to purchase uranium
from CIS republics. USECC filed a petition for confirmation of the Order and on
June 30, 1997, and the U.S. District Court confirmed the Order in its Second
Amended Judgment (the "Judgment"). Thereafter, Nukem/CRIC appealed the Judgment
to the 10th Circuit Court of Appeals ("CCA").
A three judge panel of the 10th CCA issued an Order and Judgment on October
22, 1998, which unanimously affirmed the Federal District Court's Second Amended
Judgment without modification. The ruling affirmed (i) the imposition of a
constructive trust in favor of SMP on Nukem's rights to purchase CIS uranium,
the uranium acquired pursuant to those rights, and the profits therefrom; and
(ii) the damage award against Nukem/CRIC. As a result of the ruling of the 10th
CCA, USE and Crested received an additional $6,077,264 (including interest and
court costs) from Nukem in February 1999 for a total net monetary award of
$15,468,625 in the arbitration/litigation, and equitable relief in the form of
USE's and Crested's interest in SMP, which holds the constructive trust over the
CIS contracts. Nukem/CRIC filed two motions for entry of final satisfaction of
Judgment. The U.S. District Court denied both motions, Nukem again appealed to
the 10th CCA, which again affirmed the District Court's ruling, and held that
Nukem/CRIC had not demonstrated that the Judgment had been satisfied because
they had not provided USECC with an accounting of the partnerships assets.
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In February 2001, the U.S. District Court appointed a Special Master to
determine the amounts, if any, owed by Nukem to SMP pursuant to the constructive
trust. The Special Master has ordered an accounting to identify all deliveries
of CIS uranium made directly or indirectly to Nukem and any Nukem affiliates; to
identify the ultimate disposition of all uranium purchased under the CIS
contracts; to identify the location, number of pounds, and associated cost of
uranium purchased under the CIS contracts at December 31, 2001, and to calculate
the profits realized from the sale of CIS uranium. At a status hearing held
before the U.S. District Court on August 23, 2002, the Court ordered the Special
Master to file his report on or before December 6, 2002 and a further hearing to
schedule arguments on December 13, 2002. Because Nukem and its affiliates failed
to furnish certain documentation and information, the Special Master filed a
motion for extension of time to file his report. The Court granted the motion
and ordered the Special Master to file the report by March 3, 2003. On February
9, 2003, the U.S. District Court granted a second motion of the Special Master
for an extension of time and ordered the report to be filed by April 4, 2003
with a hearing on the report to be held on April 11, 2003.
CONTOUR DEVELOPMENT LITIGATION
On July 28, 1998, USE filed a lawsuit in the United States District Court,
Denver, Colorado, Case No. 98WM1630, against Contour Development Company, L.L.C.
and entities and persons associated with Contour Development Company, L.L.C.
(together, "Contour") seeking compensatory and consequential damages of more
than $1.3 million from the defendants for dealings in real estate owned by USE
and Crested in Gunnison, Colorado. The Contour defendants asserted a
counterclaim asking for payment of attorneys fee and costs. The parties agreed
to settle the litigation, with the Company receiving $25,000 cash and
unencumbered title to two commercial real estate lots covering seven acres in
Gunnison, Colorado, and unencumbered title to five development lots covering 175
acres north of Gunnison, Colorado. There is a dispute as to the settlement terms
and the parties have submitted the issues for resolution by the Court.
See "Business - Commercial Operations - Real Estate and Other Commercial
Operations - Colorado Properties" above.
PHELPS DODGE LITIGATION
The Company and Crested, were served with a lawsuit on June 19, 2002, filed
in the U.S. District Court of Colorado (Case No. 02-B-0796(PAC)) by Phelps Dodge
Corporation and its subsidiary, Mt. Emmons Mining Company (MEMCO), over
contractual obligations from USECC's agreement with Phelps Dodge's predecessor
companies, concerning a mining property in Colorado.
The litigation stems from agreements that date back to 1974 when the
Company and Crested leased mining claims on Mt. Emmons near Crested Butte,
Colorado to AMAX Inc., Phelps Dodge's predecessor company. The claims cover one
of the world's largest and richest deposits of molybdenum. AMAX reportedly spent
over $200 million on the acquisition, exploration and mine planning activities
on the Mt. Emmons properties. In counter and cross-claims filed in the U.S.
District Court of Colorado, USECC contends that Phelps Dodge and its
subsidiaries committed several breaches of contracts related to the agreements,
including breach of fiduciary obligations and covenants of good faith and fair
dealing. USECC also contends Phelps Dodge is guilty of violating federal and
state antitrust laws when it purchased Cyprus Amax Minerals Company (Cyprus
Amax).
The complaint filed by Phelps Dodge and MEMCO seeks a determination that
Phelps Dodge's acquisition of Cyprus Amax was not a sale. Under a 1986 agreement
between USECC and AMAX, if AMAX sold MEMCO or its interest in the mining
properties, the Company and Crested would receive 15% (7.5% each) of the first
$25 million of the purchase price ($3.75 million). In November 1993, Cyprus
Minerals Company acquired AMAX to form Cyprus Amax Minerals Co. ("Cyprus Amax").
USECC's counter and cross-claims allege that in 1999, Phelps Dodge formed a
wholly-owned subsidiary CAV Corporation, for the purpose of purchasing the
controlling interest of Cyprus Amax and its subsidiaries (including MEMCO) at an
estimated value in cash and Phelps Dodge stock exceeding $1 billion and making
Cyprus Amax a subsidiary of Phelps Dodge. Therefore, USECC asserts the
acquisition of Cyprus Amax by Phelps Dodge
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was a sale of MEMCO and the properties that triggers the obligation of Cyprus
Amax to pay USECC the $3.75 million plus interest.
A second counterclaim by the Company and Crested rejects the claim by
Phelps Dodge that it and its predecessors, Cyprus Amax and AMAX Inc., had
mistakenly paid royalties to the Company and Crested since January 1991. In
1984, AMAX began paying the cash equivalent (half each to the Company and
Crested) of 700,000 pounds of molybdenum per year as an advance royalty prior to
the mine beginning production. In 1986, USECC agreed to assist financially
troubled AMAX and substantially reduced the annual advance royalty to 50,000
pounds of molybdenum, so that AMAX could continue to hold the properties and
eventually bring them into production. AMAX, Cyprus Amax and Phelps Dodge
continued paying the annual advance royalties to the Company and Crested until
the payment due in July 2001