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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000.
[ ] TRANSITION REPORTING PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______ TO ______.
COMMISSION FILE NO. 0-21911
SYNTROLEUM CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 73-1565725
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
------------------------------ -------------------
1350 South Boulder, Suite 1100
Tulsa, Oklahoma 74119-3295
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (918) 592-7900
Securities registered pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
and
Preferred Share Purchase Rights
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. YES X NO __
-
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. __
At March 1, 2001, the aggregate market value of the registrant's common stock
held by non-affiliates of the registrant was approximately $277 million based on
the closing price of such stock on such date of $12.438 per share (assuming
solely for this purpose that all of the registrant's directors, executive
officers and 10% stockholders are its affiliates).
At March 1, 2001, the number of outstanding shares of the registrant's common
stock was 33,154,001.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive proxy statement to be filed with the
Securities and Exchange Commission within 120 days of December 31, 2000 for its
2001 annual meeting of stockholders are incorporated by reference into Part III
of this Form 10-K.
TABLE OF CONTENTS
Part I
Item 1. Business 3
Item 2 Properties 30
Item 3 Legal Proceedings 30
Item 4. Submission of Matters to a Vote of Security Holders 30
Executive Officers of the Registrant 30
Part II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 32
Item 6. Selected Financial Data 33
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 34
Item 7A.Quantitative and Qualitative Disclosures about Market Risk 42
Item 8. Financial Statements and Supplementary Data 43
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 43
Part III
Item 10.Directors and Executive Officers of the Registrant 43
Item 11.Executive Compensation 43
Item 12.Security Ownership of Certain Beneficial Owners and Management 43
Item 13.Certain Relationships and Related Party Transactions 43
Part IV
Item 14.Exhibits, Financial Statement Schedules, and Reports on Form 8-K 44
FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K includes forward-looking statements as well as
historical facts. These forward-looking statements include statements relating
to the Syntroleum Process and related technologies, gas-to-liquids plants based
on the Syntroleum Process, including the Sweetwater plant, anticipated costs to
design, construct and operate these plants, anticipated costs to make products
from these plants, the timing of commencement and completion of the design and
construction of these plants, obtaining required financing for these plants, the
economic construction and operation of gas-to-liquids plants, the value and
markets for plant products, testing, certification, characteristics and use of
plant products, the continued development of the Syntroleum Process (alone or
with partners), anticipated capital expenditures, anticipated revenues, the sale
of and costs associated with our real estate inventory and any other statements
regarding future growth, cash needs, operations, business plans and financial
results. When used in this document, the words "anticipate," "believe,"
"estimate," "expect," "intend," "may," "plan," "project," "should" and similar
expressions are intended to be among the statements that identify
forward-looking statements. Although we believe that the expectations reflected
in these forward-looking statements are reasonable, these kinds of statements
involve risks and uncertainties. Actual results may not be consistent with these
forward-looking statements. Important factors that could cause actual results to
differ from these forward-looking statements include the risks that the cost of
designing, constructing and operating commercial-scale gas-to-liquids plants
will exceed current estimates, the schedule for construction of commercial-scale
gas-to-liquids plants will extend beyond current estimated schedules, financing
for design and construction of commercial-scale gas-to-liquids plants and our
other activities may not be available, commercial-scale gas-to-liquids plants
will not achieve the same results as those demonstrated on a laboratory or pilot
basis, gas-to-liquids plants may experience technological and mechanical
problems, improvements to the Syntroleum Process currently under development may
not be successful, markets for gas-to-liquids plant products may not develop,
plant economics may be adversely impacted by operating conditions, including
energy prices, construction risks and risks associated with investments and
operations in foreign countries, our ability to implement corporate strategies,
competition, intellectual property risks, our ability to obtain financing and
other risks described under "Risk Factors" and elsewhere in this Annual Report
on Form 10-K.
As used in this Annual Report on Form 10-K, the terms "we," "our" or "us" mean
Syntroleum Corporation, a Delaware corporation, and its predecessors and
subsidiaries, unless the context indicates otherwise.
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PART I
ITEM 1. BUSINESS
OVERVIEW
We are a leading developer, owner and licensor of a proprietary catalytic
process for converting natural gas to synthetic liquid hydrocarbons, generally
known as gas-to-liquids, or GTL, technology. We sell licenses to use our GTL
technology, the Syntroleum Process, for the production of fuels, and we plan to
develop and own GTL plants based on the Syntroleum Process that produce refined
specialty products and fuels. We believe that the costs to produce many products
from natural gas using the Syntroleum Process, including diesel fuel, gasoline
and lubricants, can be competitive with the costs to produce comparable quality
products from crude oil using conventional refining processes. The key
advantages of our technology over traditional GTL technologies are the use of
air in the conversion process (in contrast to the requirement for pure oxygen in
alternative technologies) and the use of our proprietary catalysts, which
enhance the conversion efficiency of the catalytic reaction. We believe these
advantages will reduce the capital and operating costs of GTL plants based on
the Syntroleum Process, while also permitting smaller unit sizes, including
mobile plants that could be placed on skids, barges and ocean-going vessels.
Based on our demonstrated research, we believe that the Syntroleum Process can
be economically applied in GTL plants with throughput levels from as low as
2,000 to over 100,000 barrels per day. The advantages of our technology combined
with the large worldwide resource base of stranded natural gas provide what we
believe is a significant market opportunity for the use of the Syntroleum
Process by our company and our licensees to develop cost-effective GTL plants.
The Syntroleum Process produces synthetic liquid hydrocarbons, also known
as synthetic crude oil, which can be further processed into higher margin
products through conventional refining processes. These products include:
- - Premium, ultra-clean liquid fuels, such as diesel, kerosene, gasoline,
naphtha and fuel for fuel cells, and
- - Specialty products, such as synthetic lubricants, process oils, high
melting point waxes, liquid normal paraffins, drilling fluids and chemical
feedstocks.
We have successfully demonstrated many elements and variations of the
Syntroleum Process in pilot plant operations and laboratory tests, including our
joint participation in a 70 barrel per day GTL demonstration plant with one of
our licensees, ARCO. While we have not yet built a commercial-scale GTL plant
based on the Syntroleum Process, we are currently developing a 10,000 barrel per
day specialty product GTL plant based on the Syntroleum Process known as the
Sweetwater plant to be constructed in Western Australia. We are also evaluating
the potential development of additional GTL plants, including facilities that
will produce synthetic liquid fuels.
BUSINESS STRATEGY
Our objectives are to rapidly establish the Syntroleum Process as an
industry standard and maximize our market share relative to alternative GTL
technologies. Our business strategy to achieve these objectives involves the
following key elements:
BROADLY LICENSE THE SYNTROLEUM PROCESS. We intend to continue offering
licenses to use the Syntroleum Process for the production of synthetic crude oil
and liquid fuels. To date, we have entered into license agreements with the
following companies or their affiliates: ARCO (a subsidiary of BP), the
Commonwealth of Australia, Enron Corp., Ivanhoe Energy Inc., Kerr-McGee
Corporation, Marathon Oil Company, Repsol-YPF, S.A. and Texaco Inc. (which has
announced a proposed merger with Chevron). We believe that widespread licensing,
combined with research and development activities to further improve the
Syntroleum Process, will provide an advantage over competing technologies,
strengthen our relationships with our existing licensees and attract new
licensees.
DEVELOP AND OWN GTL PLANTS. We intend to own significant equity interests
in joint ventures with our licensees and other energy industry and financial
partners to develop and own GTL plants for the production of specialty products
and fuels. For example, we are currently developing the 10,000 barrel per day
Sweetwater plant to be constructed in Western Australia, in which we will own a
significant equity interest. We retain the exclusive right to manufacture
specialty products under our license agreements. We believe that our proprietary
reactor designs and catalysts, combined with our improvements to existing
refining methods, will enable us to produce relatively high margin, high quality
specialty products on a more economic basis than conventional refining
techniques.
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FURTHER EXPAND AND DEVELOP PRODUCT MARKETS. We intend to continue to
develop new markets for Syntroleum synthetic fuels and specialty products in
order to promote the construction of plants by our licensees and to establish
markets for the products of GTL plants developed and owned by us. We believe
that our technology can cost-effectively provide environmentally superior
ultra-clean fuels for use in diesel, gasoline and jet engines. We are in the
process of applying for certification that Syntroleum diesel fuels qualify as
alternative fuels under the Energy Policy Act. We also believe that the
availability of our fuels will enhance the successful development of fuel cells
and other clean combustion technologies.
FURTHER REDUCE COSTS THROUGH NETWORKED RESEARCH AND DEVELOPMENT ACTIVITIES.
We intend to continue research and development activities with a focus on
improving the efficiency of the Syntroleum Process, further reducing the capital
and operating costs of GTL plants based on the Syntroleum Process, and better
understanding the unique qualities of and markets for the synthetic products
produced by the Syntroleum process. We conduct research and development
activities using our own resources and through our network of joint development
arrangements with licensees and other industry partners. We believe that this
network will provide us and our licensees with an important competitive
advantage and enhance our ability to attract additional licensees and joint
development partners. We generally obtain title or exclusive rights to
inventions or improvements that result from our joint development activities
with others. We regularly review technological advances of others in related
fields and actively seek to acquire rights to technologies that may enhance the
Syntroleum Process.
To date, we have joint development, testing, marketing or strategic
relationships with the following companies:
- - AMEC Process and Energy Ltd. - General Motors Corporation
- - ARCO (a subsidiary of BP) - IdaTech (formerly Northwest Power Systems)
- - Argonne National Laboratories - Ivanhoe Energy
- - Bateman Engineering Inc. - The Lubrizol Corporation
- - Catalytica Combustion Systems, Inc - Lyondell Petrochemical Company
- - Criterion Catalyst Company L.P. - Marathon
- - DaimlerChrysler AG - Tessag Industrie-Anlagen GmbH
- - FuelCell Energy - Texaco
- - GE Power Systems - Volkswagen of America
COMPLETE DISPOSAL OF OUR REAL ESTATE INVENTORY. We intend to complete the
disposition of our real estate inventory in a manner that maximizes the sale
value. Our real estate inventory was owned by SLH Corporation prior to the
merger of Syntroleum Corporation and SLH Corporation and reflects the remaining
inventory of a real estate development business that was conducted by SLH's
former parent corporation. We have used the proceeds from the sale of our real
estate inventory to fund our operations.
THE SYNTROLEUM ADVANTAGE
We expect that products of the Syntroleum Process will become a competitive
source of supply for the anticipated demand for ultra-clean synthetic
transportation fuels and specialty products, based on our belief that these
products can be:
- - produced at costs that can be competitive with costs to produce many
comparable quality products from crude oil using conventional refining
processes, including diesel fuel, gasoline and lubricants, assuming crude oil
prices of at least $15 per barrel and natural gas prices lower than $1 per
million British thermal units (price levels that are available for the purchase
of stranded natural gas in many parts of the world),
- - produced substantially free of contaminants normally found in fuels and
specialty products made from crude oil,
- - used as blending stock to upgrade conventional fuels and specialty
products made from crude oil,
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- - used unblended in traditional combustion engines to significantly reduce
emissions,
- - used in advanced combustion and fuel-cell engines that require sulfur and
aromatic-free fuels, and
- - transported using the existing infrastructure for crude oil and refined
products.
The total cost to produce a barrel of fuel includes the amortized plant or
refinery capital costs, the operating costs and feedstock costs (cost of natural
gas in the case of the Syntroleum Process and cost of crude oil in the case of
conventional refineries). Based on our current technology, we expect the
combined capital and operating costs per installed barrel of capacity to be
higher for a GTL plant based on the Syntroleum Process when compared to a
conventional refinery. However, we believe lower prices for natural gas relative
to crude oil can result in a total cost per equivalent barrel of product from a
GTL plant based on the Syntroleum Process that is substantially less than the
equivalent total cost for conventional refineries. Specifically, we believe the
price of stranded natural gas can be generally in the range of approximately
$.25 to $1.25 per thousand cubic feet (approximately $2.50 to $12.50 per
equivalent barrel of synthetic crude) in many markets, as compared to crude oil
prices that have recently been in the range of $18.00 to $30.00 per equivalent
barrel.
In addition, we believe conventional refineries will face additional
capital and operating costs to meet the recently adopted EPA requirement to
reduce the sulfur content level of diesel fuel to 15 parts per million by 2006.
According to American Petroleum Institute estimates, a requirement to reduce
this sulfur content to 15 parts per million would add approximately $4.20 per
barrel of additional costs for conventional refining. In contrast, the
Syntroleum Process produces diesel fuel that already meets the expected low
sulfur requirement, providing an incremental relative cost advantage compared to
conventional refineries.
We anticipate that the Syntroleum Process will be an attractive solution
for companies with natural gas reserves that are not economic to produce using
traditional technology based on our belief that the Syntroleum Process can be
low cost, used in large or small formats, adaptable and portable.
Low Cost. Historically, the most significant obstacle to widespread
commercial use of GTL technology has been capital cost. Because the Syntroleum
Process is less complex than traditional GTL technologies, we believe that GTL
plants based on the Syntroleum Process will have lower capital and operating
costs than comparable-sized GTL plants based on traditional technology.
Small Formats. Given the large number of fields with small reserve
accumulations containing unmarketable natural gas, GTL plants that are economic
only at high levels of throughput have limited application. We believe that GTL
plants based on the Syntroleum Process can be cost- effective at throughput
levels as low as 2,000 barrels per day. Consequently, the Syntroleum Process
could potentially be used at over 59% of the total gas fields, representing over
95% of the total reserves held in identified natural gas fields worldwide.
Adaptable. We also believe that GTL plants based on the Syntroleum Process
can be adapted to use lower quality feedstock and can be located in isolated and
remote locations. While many impurities must be removed from natural gas
feedstock prior to processing using traditional GTL technology, some impurities
like nitrogen and carbon dioxide will not need to be completely removed from
natural gas feedstock for GTL plants based on the Syntroleum Process. Due to
their relatively small size and the use of air instead of pure oxygen, we
believe GTL plants based on the Syntroleum Process can be placed on skids,
barges and ocean-going vessels. We believe this reduces capital costs for
land-based plants by allowing for offsite fabrication and use of GTL plants at a
variety of locations, including isolated and offshore areas where we believe a
majority of natural gas fields are located. Moreover, because the Syntroleum
Process is a net energy generator, we believe that these plants can be located
in remote areas without the need for any additional power supply.
Portable. Because of their high capital costs, gas pipelines and other
traditional methods for commercialization of natural gas resources require
significant reserves and established local markets to be economically feasible.
However, due to the potential portability of smaller-sized GTL plants based on
the Syntroleum Process, we believe that these plants may in some circumstances
be used to convert smaller quantities of in-place reserves than would be
necessary to support a traditional project. We also believe that this
portability, together with the global nature of the markets for liquid
hydrocarbons, will reduce the risk involved in GTL projects as compared to
traditional methods of commercialization.
5
MARKET POTENTIAL
We believe that significant market potential exists for the Syntroleum
Process and its products due to the large existing demand for refined fuels and
specialty products, including lubricants and chemical feedstocks, the
anticipated demand for ultra-clean synthetic fuels and fuels for fuel cells, and
the large supply of stranded natural gas worldwide.
Demand for Products
We expect demand for products created through the Syntroleum Process to be
driven by the following.
Refined Fuels. The existing market for transportation fuels is large,
comprising 64% of the approximately 64.4 million barrels per day of refined
petroleum products produced worldwide in 1998, as derived from information in
the BP Statistical Review of World Energy, 1999. Moreover, according to the
Energy Information Administration, estimates show that diesel fuel demand is
growing at a faster rate than the total demand for refined products due to the
superior fuel efficiency of a diesel engine. We believe that a significant
portion of the growing demand for transportation fuels can be satisfied through
the conversion of natural gas into ultra-clean Syntroleum fuels. We also believe
that even if substantial volumes of Syntroleum fuels were to flow into these
markets, these additional volumes would not cause a significant price
degradation based on the large size of the market. Worldwide consumption of
refined petroleum products is estimated as follows:
WORLDWIDE CONSUMPTION OF REFINED PETROLEUM PRODUCTS
PRODUCT 1988 1993 1998
------- ---- ---- ----
VOLUME % VOLUME % VOLUME %
------ ----- ------ ----- ------ -----
(MILLIONS OF BARRELS PER DAY)
Gasolines (1) 14.88 28.26% 16.32 28.43% 18.53 28.80%
Middle Distillates (2) 17.95 34.07 20.26 35.28 23.53 36.57
Others (3) 19.84 37.67 20.84 36.29 22.29 34.63
----- ------ ----- ------ ----- ------
Total 52.67 100.0% 57.42 100.0% 64.35 100.0%
===== ====== ===== ====== ===== ======
- ---------------------
(1) Consists of aviation and motor gasoline and light distillate feedstock.
(2) Consists of jet and heating kerosenes, gas oils and diesel oils.
(3) Consists of fuel oil, refinery gas, propane, solvents, petroleum coke,
lubricants, bitumen, wax and refinery fuel and loss.
Source: Derived from information in the BP Statistical Review of World
Energy, 1999.
Traditionally, United States consumers have relied on the less efficient
but more popular gasoline engines for automobiles. However, as economic and
environmental pressures come into play, the United States is expected to see
major growth in the replacement of gasoline engines with the more efficient
diesel engines.
Existing crude oil refineries are expected to require additional capital
investment due to the increasingly stringent specifications regarding sulfur and
aromatics content in fuels. These investments are expected to be uneconomic for
many smaller, less sophisticated refineries. As a result, we believe that
Syntroleum fuels can be a source of the fuel necessary to displace the fuel
supplied by these refineries.
Specialty Products, including Lubricants and Chemical Feedstock. The
synthetic crude oil produced by the Syntroleum Process can be further refined
into specialty products using conventional refining processes that can be
simplified to take advantage of the ultra-clean nature of the synthetic
feedstock. We retain the exclusive right to manufacture these products using the
Syntroleum Process under our license agreements and intend to develop and own
significant equity interests in GTL plants designed to produce these specialty
products. We believe that Syntroleum specialty products have environmental and
performance characteristics that are superior to comparable conventional crude
oil products. For example, we expect our synthetic lube-base oil will meet or
exceed new high performance and emissions standards established by the United
States federal government and the automobile industry for lubricants in new
vehicles beginning in 2003. Our targeted specialty product markets include the
following.
- - Lube-Base Oils. We have developed with others a proprietary process and
catalyst system for use in the production of high quality synthetic lube oils.
These products have a variety of industrial applications, including use as
transformer oil, passenger car motor oil, heavy-duty lubricants and synthetic
basestock. Worldwide demand for all lubricants is approximately 800,000 barrels
per day. Historically, lube oil prices have varied from approximately $40 per
barrel for the lowest quality grades to over $200 per barrel for the highest
quality synthetic grades.
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Beginning in 2003, lubricants initially supplied with new vehicles in the United
States will be required to possess very high performance and emissions
characteristics, such as those produced by the Syntroleum Process. The National
Petroleum Refining Association has estimated that 60% of the current volume of
lubricants produced will not meet these specifications. We believe that this
requirement will cause a substantial increase in demand for high quality
lubricants.
- - Process Oils. Process oils are used in a number of industries involved in
the production of chemicals, textiles, rubber and plastics. These products have
a wide variety of applications, from mold release agents to ingredients in
personal care products. Process oils can also be used in electrical transformers
as a cooling and insulation agent. According to a study prepared for us in 1999,
prices for these products have historically ranged from $35 per barrel to over
$200 per barrel.
- - Waxes. Waxes are longer linear chain hydrocarbon molecules that are solid
at room temperature and have a variety of applications, including adhesives,
coatings and other products. United States demand for waxes is approximately
21,000 barrels per day. These markets have primarily been supplied with
petroleum-derived waxes. Historically, prices have varied between $30 per barrel
for the lowest quality wax to over $150 per barrel for high melting point
synthetic wax.
- - Normal Paraffins. Normal paraffins are saturated linear hydrocarbons with
molecular ranges between ten and 15 carbon atoms. These products must be 98%
pure, have low odor levels and be of water clear quality. They are primarily
used in the production of laundry detergent, cosmetics, pharmaceuticals, paints,
stains, aluminum rolling oils and other products. Prices for normal paraffins
historically have averaged between $60 and $85 per barrel.
- - Drilling Fluids. Drilling fluids are used in the drilling of oil and gas
wells as a coolant and lubricant for the drill bit and to enhance safety during
drilling operations by maintaining well pressure. Drilling fluids mixed with
well cuttings can accumulate under offshore platforms. Crude oil-based fluids,
which have been used historically, degrade slowly and can suffocate aquatic
plant and animal life. In response to increased environmental pressures,
synthetic drilling fluids have been developed and used in the Gulf of Mexico and
other offshore locations, where prices have generally ranged between $250 and
$300 per barrel. With Amoco Production Company, we have developed a synthetic
drilling fluid product that we expect will meet or exceed all current applicable
environmental requirements for use in the drilling of oil and gas wells.
Ultra-Clean Synthetic Fuels. The market demand for ultra-clean fuels is
increasing according to a 1998 estimate by the Energy Information Administration
of alternatively fueled vehicles in use in the United States. This increase has
been driven by more stringent environmental and emission standards in most of
the world's industrialized countries and the need for vehicle manufacturers to
respond to the challenge of producing fuel-efficient engines that meet these
standards. The burden of producing cleaner fuels from conventional crude oil is
expected to substantially increase refining costs. We believe that these factors
will promote the creation of markets for premium ultra-clean synthetic fuels
produced by the Syntroleum Process.
Key domestic and international environmental regulations and initiatives
driving the demand for ultra-clean fuels include the following.
- - Clean Air Act. The Clean Air Act of 1970 set national goals for clean and
healthy air. It established specific responsibilities for government and private
industry to reduce emissions from vehicles, factories and other pollution
sources. In 1990, the Clean Air Act was amended and updated to include further
provisions regulating ground-level ozone (urban smog), carbon monoxide and
emissions from motor vehicles. Certain tailpipe (exhaust) standards were set for
all motor vehicles to be phased in by 1996 with provisions that would allow the
EPA to set even lower standards in 1999 if warranted. In December 1999, the EPA
made such a determination and has announced lower Tier 2 restrictions on
light-duty vehicle emissions. In order to reach these emission levels, the EPA
has mandated that Tier 2 sulfur levels in gasoline fuels be lowered from the
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current level of 500 parts per million to 30 parts per million beginning in
2004. Additionally, the EPA has adopted a Tier 2 reduction in the sulfur content
of highway diesel fuel from the current level of 500 parts per million to 15
parts per million beginning in 2006. The burden placed on the petroleum refining
and automobile industries to meet these new gasoline and diesel sulfur levels is
significant. In the last eight years, the sulfur content of crude oil refined in
the U.S. has increased by 20 percent as a result of shifts in the production mix
of the world's crude oil.
In 1998, the EPA implemented centrally fueled fleet and clean fuel fleet
requirements pursuant to the Clean Air Act Amendments of 1990. These
requirements affect owners and operators of fleets geographically located in
metropolitan areas with populations of 250,000 or more and designated by the
Environmental Protection Agency as being in serious, severe or extreme
noncompliance with ambient ozone standards or with specific carbon monoxide
standards. Owners of affected fleets must include in any new vehicle purchases
specified percentages of clean fuel vehicles certified to meet federal Clean Air
Act emission standards.
- - Energy Policy Act. The Energy Policy Act was passed in 1992 in order to
reduce the dependence by the United States on foreign oil imports. This act
mandates that, by the year 2001, 75% of all affected federal and state
government vehicle purchases, and 90% of all affected vehicle purchases by
private alternative fuel suppliers, must be alternative fuel vehicles. In
addition, the Energy Policy Act provides the Department of Energy with a goal of
displacing 10% of transportation fuel with non-petroleum replacement fuels,
including alternative fuels, by the year 2000, and 30% by 2010. During the
seven-year period from the passage of the Energy Policy Act in 1992 to 1999, the
total number of alternative fuel vehicles grew from 251,000 to an estimated
418,000. This represents a compounded annual growth rate of 7.6%. The use of
alternative fuels increased from 230,000 gasoline equivalent gallons in 1992 to
an estimated 341,000 gasoline equivalent gallons in 1999. This represents a
compounded annual growth rate of over 6.2% per year compared to a less than a 2%
annual growth rate for gasoline. Yet, with total United States highway gasoline
consumption currently over 125 billion gallons per year, alternative fuel use
only amounts to approximately 0.2% of the fuel used in the United States
transportation sector each year. For the goals set forth by the Energy Policy
Act to be successful, we believe an alternative fuel must be found that offers
consumers the convenience of using existing fuel distribution systems, while at
the same time meeting their expectations for vehicle power and range
performance. We believe our Syntroleum fuels could help meet these demands.
- - State Regulation. States are also looking for emission reductions. Many
ozone nonattainment areas are looking for reductions from mobile sources in
order to meet EPA's state implementation plan requirements. The Clean Air Act
requires states to develop state implementation plans demonstrating the emission
reductions and controls necessary for states to meet ozone attainment deadlines
under the Act. In response to this requirement, the California Air Resources
Board has announced plans to implement stringent new regulation on transit bus
emissions. The regulation, which begins to take effect in 2002, affects
approximately 8,500 buses at approximately 75 California transit agencies. Under
the new regulation, agencies electing to continue using older diesel buses will
be required to implement new emission controls to reduce exhaust emission and to
use low-sulfur fuels (containing a maximum of 15 parts per million) or to shift
to alternative fuels. The regulation also requires reduced exhaust particulate
matter and nitrogen oxides from new diesel engines. These reductions are
expected to be achieved only through the use of ultra-clean fuels.
- - Corporate Average Fuel Economy. Under the Corporate Average Fuel Economy
standards established under the 1975 Energy Policy and Conservation Act,
mandatory fleet fuel economy standards were imposed on all manufactures of
passenger cars and light trucks sold in the U.S. The continuing popularity of
larger family vehicles, including sport utility vehicles and pick-up trucks, has
challenged automakers to develop more fuel-efficient engines. According to the
U.S. Department of Energy 2000 Fuel Economy Guide, diesel engines in automobiles
can produce up to 63% better fuel economy than gasoline engines in automobiles.
As a result, automakers are turning to the use of diesel engines in their
attempts to supply the demand for these vehicles without violating these Federal
fuel-efficiency standards. While they do offer better fuel economy, traditional
diesel engines, when fueled by conventional diesel fuels, produce higher
emission levels of nitrous oxide and particulate matter. To comply with more
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stringent environmental standards, automakers have been partnering with oil
companies to develop ultra-clean fuels for conventional diesel engines. Further,
recommendations for a maximum allowable sulfur content of 10 parts per million
and aromatic content of 15% by volume for diesel fuels in markets with the most
stringent requirements for emission controls has been proposed by the Alliance
of Automobile Manufacturers pursuant to a Worldwide Fuel Charter. In addition,
DaimlerChrysler, Ford and General Motors are currently attempting to develop a
new generation of diesel and gasoline engines that use synthetic fuel and are
more fuel-efficient.
- - European Union. The European Union is also seeking sharp reductions in
engine emissions. Sulfur content from the current level of 350 parts per million
to below 50 parts per million is currently mandated for diesel fuel by 2005, and
further changes to other specifications, including reduction of aromatic
content, are under evaluation.
We believe that Syntroleum fuels are positioned to take advantage of the
demand for ultra-clean fuels that is anticipated to develop as a result of these
environmental and emission standards. Syntroleum fuels are substantially free of
contaminants, including sulfur, aromatics and heavy metals, and demonstrate high
operating efficiency. As a result, we believe that Syntroleum fuels, either
alone or blended with conventional fuels, can be used in existing and new
generation diesel and gasoline engines to cost-effectively meet or exceed
current and proposed emission standards. We are in the process of applying for
certification that Syntroleum diesel fuels qualify as alternative fuels under
the Energy Policy Act. By eliminating the need for specially equipped vehicles
or refueling stations, Syntroleum ultra-clean fuels can avoid the infrastructure
problems that have challenged the widespread use of other alternative fuels to
date.
Fuel cells. A fuel cell is a device that combines hydrogen, derived from a
fuel such as natural gas, propane, methanol, gasoline or diesel, and oxygen from
the air to produce electric power without combustion. Fuel-cell systems have
advantages over conventional power generation systems including low or no
pollution, higher fuel efficiency, greater flexibility in installation and
operation, quiet operation, low vibration and potentially lower maintenance and
capital costs. Fuel cells are being developed to support a variety of markets,
including transportation, continuous stationary (residential and commercial
power) and intermittent (recreational and emergency power).
Demand for fuel cells is expected to increase over the next several years.
Auto manufacturers and others are currently making significant investments in
fuel-cell technology. For example, DaimlerChrysler AG, one of our strategic
partners, and Ford Motor Company have invested approximately $750 million in a
partnership with Ballard Power Systems Inc., and DaimlerChrysler has indicated
that it expects this partnership to produce fuel-cell systems for 40,000
vehicles by 2004 and 100,000 vehicles by 2006. Traditional power generation
markets also represent a large opportunity for fuel-cell technology. According
to the Department of Energy, the total installed electricity generation capacity
in the U.S. in 1998 was estimated at approximately 775,885 megawatts and is
expected to double by 2015. In comparison, recent industry estimates prepared by
Kline & Company in June of 1998 have projected the demand for fuel cells to be
in the range of 2,500 to 6,000 megawatts by 2010. Allied Business Intelligence
stated in a 1999 market study that this growth in demand is expected to increase
the fuel cell market from $40 million in 1999 to over $10 billion by 2010.
We believe that Syntroleum fuels have the potential to become ideal fuels
for fuel cells and to significantly enhance commercial opportunities for many
fuel-cell applications. The absence of sulfur, aromatics and heavy metals from
Syntroleum fuels allows for simplified fuel cell processor design, construction
and operation. As the storage and processing of the fuel for a fuel cell are
simplified, the physical size of fuel-cell components can be reduced. Because
Syntroleum fuels have almost twice the hydrogen content of other fuels,
including compressed natural gas and methanol, Syntroleum fuels enable greater
utility and wider application of fuel-cell power for vehicles. Although methanol
initially emerged as the auto industry's favored fuel-cell fuel, it has
encountered setbacks due to its high toxicity and water solubility compared to
conventional fuels and the inability to use existing gasoline distribution
systems without major modifications. We believe that Syntroleum fuels can be
distributed using the existing conventional gasoline distribution
infrastructure, have lower toxicity and similar solubility compared to
conventional fuels.
Supply of Natural Gas
Natural Gas Resource Base. Set forth below and elsewhere in this Annual
Report on Form 10-K are estimates of identified reserves of oil and natural gas.
These estimates do not constitute proved reserves in accordance with the
9
regulations of the Securities and Exchange Commission. Under Securities and
Exchange Commission regulations, proved oil and gas reserves are the estimated
quantities of crude oil, natural gas and natural gas liquids which geological
and engineering data demonstrate with reasonable certainty to be recoverable in
future years from known reservoirs under existing economic and operating
conditions (i.e., prices and costs as of the date the estimate is made). We
compiled these estimates of identified reserves from the referenced industry
publications and other publicly available reports to identify the magnitude of
the oil and gas resource base. We have not independently verified this
information. Accordingly, we can give no assurance as to the existence or
recoverability of the estimates of identified reserves of oil and natural gas
set forth in this Annual Report on Form 10-K. References below and elsewhere in
this Annual Report on Form 10-K to the conversion of identified amounts of
natural gas into amounts of synthetic crude oil assume that all of the
referenced natural gas could be converted at anticipated conversion rates.
Actual amounts of synthetic crude oil produced will vary based on the ability of
the producer to extract the natural gas, the composition of the natural gas and
process conditions selected for the plant, and this variance may be material.
The world's large natural gas reserves provide an extensive resource base
from which Syntroleum fuels and specialty products can be produced. According to
information derived from the IHS Energy Group, BP Statistical Review of World
Energy, 1998, and the Department of Energy, worldwide identified natural gas
reserves are estimated to be approximately 5,429 trillion cubic feet.
The following table presents the 1998 worldwide identified natural gas
reserves, consumption and ratio of reserves to consumption (i.e., reserve life)
by region.
IDENTIFIED 1998 WORLDWIDE NATURAL GAS RESERVES, CONSUMPTION AND RESERVE LIFE
Region Reserves 1998 Consumption Identified Reserves
------- --------- ---------------- to Consumption
Ratio (Reserve Life)
----------------------
(trillion (trillion
cubic feet) cubic feet) (years)
Central and South America 235 3.0 77.3
Africa and the Middle East 1,791 7.8 230.2
Asia 402 9.1 44.0
Europe 279 15.1 18.5
North America 291 25.4 11.5
Russia and other former Soviet Union regions 2,431 18.7 130.1
Total 5,429 79.1 68.6
- ---------------------------
Source: Information derived from IHS Energy Group, BP Statistical Review of
World Energy, 1998, and the Department of Energy.
Additionally, identified natural gas reserves have grown at a rapid rate.
For example, identified natural gas reserves in 1988 were estimated to be
approximately 3,798 trillion cubic feet, according to Oil & Gas Journal Energy
Statistics Source Book, 13th Edition. In 1998, these reserves were estimated to
be approximately 5,429 trillion cubic feet, according to information derived
from the IHS Energy Group, BP Statistical Review of World Energy, 1998, and the
Department of Energy. This increase occurred despite the fact that, over the
same time frame, demand for natural gas increased 21%. We believe these
statistics demonstrate the need for an economic market for this resource.
Natural Gas Field Size Distribution. The table below lists an estimate of
the distribution, by field size, of the world's natural gas fields. Only 179 of
these fields are larger than five trillion cubic feet, which is generally
considered to be the minimum size necessary to support the development of a
full-scale liquid natural gas plant based on a typical 20-year plant life.
10
THE WORLD'S NATURAL GAS FIELDS
Reserves Number of Fields
-------- -----------------
(trillion cubic feet)
Between 50 and 500 16
Between 5 and 50 163
Between 1 and 5 641
Between .5 and 1 668
Between .25 and .5 940
Between .1 and .25 1,620
Between .01 and .1 5,085
Less than .01 6,243
------
Total 15,376
======
- ------------------
Source: IHS Energy Group, 1998.
Based on field size and portability, we believe GTL plants based on the
Syntroleum Process can potentially access over 9,133 of the world's natural gas
fields, representing approximately 95% of the total reserves held in these
fields. Assuming a typical 30-year plant life, of the 15,376 natural gas fields
shown above approximately:
- - 16 contain sufficient reserves to support ten or more 50,000 barrels per
day plants,
- - an additional 163 contain sufficient reserves to support one or more
50,000 barrels per day plants,
- - an additional 641 contain sufficient reserves to support one or more
10,000 to 50,000 barrels per day plants,
- - an additional 668 contain sufficient reserves to support one or more 5,000
to 10,000 barrels per day plants, and
- - an additional 940 contain sufficient reserves to support one or more 2,500
to 5,000 barrels per day plants.
An additional 6,705 of these 15,376 fields contain sufficient reserves to
support a portable 2,000 barrels per day plant for a shorter plant life.
Stranded Natural Gas Reserves. Wood MacKenzie Consultants Limited, an
international consulting firm, has estimated in its Energy Services Newsletter
that of the world's identified natural gas reserves, approximately one-half, or
2,500 trillion cubic feet, currently have no economic market. If converted using
GTL technology, this stranded gas could generally produce approximately 250
billion barrels of synthetic crude oil.
The term "stranded gas" generally refers to gas which exists in reservoirs
that have been discovered, but no economic market can be found for the
production, or production would be too prolific for the limited markets
available. Natural gas that is stranded is typically managed by either not
producing, or "shutting in," the gas, flaring or venting the gas, or reinjecting
the gas into the geologic formation from which it is produced.
The large amount of stranded natural gas throughout the world is caused by
a combination of four primary factors:
- - Relatively Small Size of Many Fields. Much of the world's stranded natural
gas is located in fields of less than five trillion cubic feet, which is
generally considered the minimum size necessary to support the development of a
full-scale liquid natural gas plant for a typical 20-year plant life. The small
size of many of these fields makes the production of natural gas from the fields
uneconomical.
- - Location of Gas Relative to Markets. Much of the world's stranded natural
gas is located in areas where there is no local market and the distance to large
natural gas consuming areas is great. This makes transportation costs high and
often renders development projects uneconomic. As shown in the "1998 Worldwide
Natural Gas Reserves, Consumption and Reserve Life" table above under "Market
Potential--Supply--Natural Gas Resource Base", Africa, the Middle East and
Russia and other former Soviet Union regions have a large percentage of the
identified reserves and low levels of production, combined with long distances
from developed gas markets. This situation creates stranded gas, which is
manifested in the high reserve-to-production ratios shown.
11
- - Transportation Costs. Even in circumstances where a transportation system
is available for natural gas, the cost of transporting natural gas in a gaseous
state is generally substantially higher, on an energy equivalent basis, than
that of oil. For example, according to published pipeline tariffs, the cost to
transport natural gas approximately 1,600 miles via pipeline from Houston to
Boston is approximately $1.00 per million British thermal units, equal to $6.00
per barrel of oil equivalent (assuming 6 million British thermal units per
barrel), while the cost to transport crude oil from the Middle East to the
United States Gulf Coast via tanker, a distance of approximately 6,500 miles, is
less than $2.00 per barrel.
Natural gas can also be transported as liquefied natural gas. In an article
published in the July 3, 1995 edition of the Oil & Gas Journal, Mobil Oil
Corporation estimated that a five million ton per year (approximately 123,000
equivalent barrels per day) liquefied natural gas plant would incur capital
costs of between $9 billion and $13 billion (including conversion plant,
dedicated liquefied natural gas tankers and regasification facilities). On the
other hand, we estimate that a GTL plant producing the same energy output would
cost substantially less and would not necessarily require dedicated shipping or
unloading facilities.
- - Small Alternative Natural Gas Markets. Based on industry publications, we
estimate that the worldwide liquefied natural gas market is approximately 1.8
million equivalent barrels per day, which is relatively small compared to the
approximately 57 million barrels per day transportation fuels markets. Natural
gas can also be converted to ammonia and methanol. Based on industry
publications, we currently estimate that the market for ammonia on a barrel of
oil equivalent basis is approximately 893,000 barrels per day and the market for
methanol on a barrel of oil equivalent basis is approximately 393,000 barrels
per day. These markets are small relative to the size of the worldwide natural
gas resource base and relative to the approximately 74 million barrels per day
market for crude oil and related products.
We believe that energy companies with stranded natural gas reserves will be
able to cost-effectively use our GTL technology to produce Syntroleum fuels and
products that can be sold in well-developed global markets. As a result, we
believe these companies would be able to generate a return on the exploration
and development expenditures associated with their stranded natural gas
reserves.
IMPLEMENTATION OF SYNTROLEUM'S BUSINESS STRATEGY
The following sets forth our progress to date in implementing our business
strategy. Although we have made significant progress towards commercializing the
Syntroleum Process, we can give no assurance that licensees will construct any
plants under their license agreements, that we will be able to obtain financing
for specialty product or mobile GTL plants, that design and construction of any
of these plants will be successfully completed, that any of these plants will be
commercially successful or that these plants will be constructed or utilized on
a cost-effective basis. See "Risk Factors."
Licensing Arrangements
We currently market four types of license agreements:
- - Master license agreements generally grant to the licensee the
non-exclusive right to enter into an unlimited number of site license agreements
to construct GTL plants based on the Syntroleum Process to produce fuels
worldwide. The licenses generally exclude the right to use the Syntroleum
Process in North America as well as in China and India due to intellectual
property protection concerns.
- - Volume license agreements generally grant to the licensee the
non-exclusive right to enter into an unlimited number of site license agreements
to construct GTL plants based on the Syntroleum Process in areas outside of
North America, China and India, subject to specified aggregate production
capacity limits.
- - Regional license agreements generally grant to the licensee the non-
exclusive right to enter into an unlimited number of site license agreements to
construct GTL plants based on the Syntroleum Process within a designated region.
The designated regions are not expected to include North America, China or
India.
12
- - Site license agreements generally grant to the licensee the non- exclusive
right to use the Syntroleum Process in a GTL plant at a single, specified
location for the life of the plant. This type of license may be granted under
our master, regional or volume license agreements or may be granted to licensees
for a specific site who have not otherwise entered into a master, regional or
volume license agreement.
By entering into a master, volume or regional license agreement, a licensee
secures pricing terms for site licenses and obtains the right to use the
Syntroleum Process, the right to acquire catalysts from us for which we charge a
fixed mark-up over our cost and the right to future improvements in our GTL
technology. To date, we have entered into master license agreements with ARCO,
Ivanhoe Energy, Marathon and Texaco, and we have entered into volume license
agreements with the Commonwealth of Australia, Enron, Kerr-McGee and Repsol-YPF.
We intend to continue to market the Syntroleum Process for license primarily to
major energy companies with significant stranded natural gas reserves.
The following description summarizes the principal terms and conditions of
the forms of our license agreements. This summary is not complete and is
qualified in its entirety by reference to the form of our master license
agreement, a copy of which has been filed as an exhibit to this Annual Report on
Form 10-K. Agreements entered into with specific licensees may differ in
material respects from the current forms of our various license agreements.
Initial Deposits and License Fees. At the inception of a master, volume or
regional license agreement, the licensee is generally required to make an
initial deposit to us, which is credited against future site-specific license
fees. The amount of the initial deposit depends on market conditions and, in the
case of volume and regional license agreements, the volume limitation and the
size and location of the region covered. We have received an aggregate of $38
million in cash as initial deposits and option fees under our existing license
agreements. In some cases, we have acquired technologies or commitments to
provide funding for future development activities in lieu of initial cash
deposits.
Generally, the amount of the license fee for site licenses under our
master, volume and regional license agreements is determined pursuant to a
formula based on the discounted present value of the product of (1) the annual
maximum design capacity of the plant, (2) an assumed life of the plant and (3)
our per barrel rate, which currently is approximately $.50 per barrel of daily
capacity. Our license fees for new plants may change from time to time based on
the size of the plant, improvements that reduce plant capital cost and
competitive market conditions. Our existing master and volume license agreements
allow for the adjustment of fees for new site licenses under certain
circumstances. We expect that license fees under existing agreements will be
paid in increments when certain milestones during the plant design and
construction process are achieved.
Catalyst Sales and Process Design Packages. Our license agreements grant
the licensee the right to acquire from us or vendors designated by us
proprietary catalysts for use in the synthesis gas reaction and the Fischer-
Tropsch reaction, in each case at prices based on our cost plus a margin. We
currently estimate that these catalysts will be required to be replaced every
three to five years. Licensees also have the right to acquire proprietary
reactors used in the Syntroleum Process from vendors approved by us. In
addition, under our license agreements, licensees are required to purchase a
process design package for plants covered by the license from us at a fee based
on our costs plus a specified margin. We may, however, develop the process
design package with the assistance of a third party. We are also required to
provide certain technical support to licensees at specified fees.
Other License Terms. As part of our network model for improving our GTL
technology, we acquire a royalty-free, non-exclusive license to any invention or
improvement to the Syntroleum Process that is developed by the licensee,
together with the right to grant corresponding sublicenses to our other
licensees who have granted us similar rights. Licensees also acquire the right
to use subsequent inventions or improvements to the Syntroleum Process that we
have acquired from other licensees. Our license agreements may be terminated by
the licensee, with or without cause, upon 90 days' notice to us.
13
Key Testing and Commercial Projects
In addition to our nominal two barrel per day pilot plant and laboratory
facilities located in Tulsa, Oklahoma, which are the primary sites for our
research and development activities, we have been or are currently involved in
several projects and initiatives, including the following.
Cherry Point Project. We were a joint participant with ARCO in a 70 barrel
per day GTL demonstration plant located at ARCO's Cherry Point refinery in the
State of Washington. The plant began operating in July 1999 and operated
successfully until it was shut down at the completion of testing shortly after
June 30, 2000. ARCO funded the construction and operation of this plant under
our joint development agreement. Plant operations exceeded our expectations and
successfully demonstrated a number of key aspects of our proprietary autothermal
reformer and moving bed reactor designs and related catalyst performance. The
data and experience generated from our participation in plant operations will be
useful in our efforts to apply these reactor designs on a commercial basis both
for fuels and specialty product plants. We are currently conducting
engineering studies with others for commercial-scale plants using these reactor
designs.
Sweetwater Project. We are developing a nominal 10,000 barrel per day
specialty product plant, which we call the Sweetwater plant. We currently
anticipate that this plant will produce synthetic lube oil, normal paraffins,
process oils and light paraffins. The plant is expected to use a fixed tube
reactor design which produces a high yield of the desired products with high wax
content and has lower scale-up risks than other reactor designs. The plant is
also expected to include additional refining equipment necessary to produce the
targeted specialty products. We plan to construct this plant through a joint
venture. In February 2000, we selected a site for the plant about four
kilometers from the North West Shelf liquid natural gas facility on the Burrup
Peninsula of Western Australia.
In November 1999, we signed a project development agreement with Tessag, a
wholly owned subsidiary of RWE AG, to provide us with a fixed price for the
design and construction of the Sweetwater plant. Tessag also agreed to pay
liquidated damages up to certain levels in the event certain process and product
specifications are not achieved. We currently expect that Tessag will complete
the plant design and, subject to completion of plant financing, begin
construction in 2001. We expect the plant to be operational in late 2003 or
early 2004, although construction of the plant will be subject to the risk of
delay inherent in any large construction project.
The State of Western Australia has announced its intention to assist the
Sweetwater project with an AUD $30 million (approximately U.S. $17 million)
common use infrastructure package, including a desalinization plant to which our
plant will supply steam and from which our plant will receive cooling water. In
addition, we have entered into a gas purchase agreement with the North West
Shelf Gas Partners, whose members include affiliates of BHP Petroleum, BP,
Chevron, Mitsui, Mitsubishi, Royal Dutch Shell and Woodside Energy Ltd. Subject
to certain conditions, North West Shelf Gas Partners have agreed to supply the
Sweetwater plant with the natural gas required to operate the plant at full
capacity for 20 years.
In August 2000, we entered into a license agreement and a separate loan
agreement with the Commonwealth of Australia. Under the loan agreement, the
Commonwealth will make a non-amortizing, interest-free loan to us in the amount
of AUD $40 million (approximately U.S. $22 million) with a 25-year maturity to
support the further development and commercialization of GTL technologies in
Australia. Under the loan agreement we have agreed to conduct a feasibility
study on constructing a large-scale GTL fuels plant in Australia. During 2000,
we entered into non-binding letters of intent with both Enron and Ivanhoe Energy
Inc. with respect to their equity participation in the Sweetwater project.
Consummation of the transactions contemplated by these letters of intent
requires the satisfaction of a number of conditions, some of which are not
within our control. For a discussion of these letters of intent and the license
and loan agreement with the Commonwealth of Australia, see "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operation -
Liquidity and Capital Resources - Initial Specialty Product GTL Plant."
Tessag recently completed front end engineering and design and has provided
us a price quote of $506 million for the engineering, procurement and
construction of the Sweetwater plant. The quote includes provision for expanded
refining capabilities that will give the plant greater flexibility for a wider
range of products than originally contemplated. The quote does not include
interest during construction and other owner's costs, which include proprietary
catalysts to be supplied by Syntroleum. These costs are yet to be finalized,
but could represent a substantial portion of total plant costs. Tessag's price
quote may change due to fluctuations in currency exchange rates, but will be
converted into a firm, lump sum, dollar denominated contract upon final closing
of the financing for the plant. With the quote completed, we are working with
Tessag toward finalizing the fixed price EPC contract. However, we can give no
assurance that the contract will be finalized. If finalized, the contract may
be on terms materially different than the terms currently anticipated. Upon
execution of the EPC contract, we can then proceed with completing the debt and
equity financing for the project.
14
We currently expect the capital costs of the Sweetwater project to be
funded primarily by non-recourse senior and subordinated debt at the project
level, as well as the equity financing discussed above, together with our own
equity contribution. We are currently seeking to finalize the equity investment
transactions discussed above and we are exploring sources of debt capital to
fund final design and construction. However, we can give no assurance that the
necessary capital for this project will be obtained.
Fuel Cell Testing. We have participated in tests performed by the Argonne
National Laboratory, Epyx Corporation and Northwest Power Systems in the
evaluation of our synthetic fuels for fuel-cell applications. Fuels produced by
the Syntroleum Process were determined to have physical properties similar to
conventional fuel equivalents and to yield more hydrogen per fuel equivalent
volume. Argonne tested Syntroleum fuels in its proprietary fuel-cell reformer,
and results indicated performance comparable to conventional gasoline, although
the equipment had not been optimized for the higher hydrogen content of our
fuels. Under a program sponsored by the Department of Energy, Epyx Corporation,
a leading fuel processing technology company, successfully demonstrated the high
efficiency and low emission operation of a fuel-cell power system using
synthetic fuel produced by the Syntroleum Process and a Plug Power fuel cell. In
addition, Northwest Power Systems, a leading manufacturer of patented fuel cell
systems, has demonstrated that synthetic fuels produced by the Syntroleum
Process are an effective on-board source of hydrogen to power fuel cells. Tests
conducted by Northwest Power also confirmed that Syntroleum fuels produced a
higher yield of hydrogen than comparable fuel produced from crude oil and
successfully powered their fuel cells.
RESEARCH AND DEVELOPMENT
One of our key strategies is to continue to lower the capital and operating
cost of our GTL technology through research and development. We have spent
approximately $4.2 million in 1998, $8.3 million in 1999 and $12.6 million in
2000 on pilot plant and research and development facilities and activities. Our
continued research and development efforts will take place in four primary
areas: process design, catalyst development, reactor design and heat
integration/power recovery. For a discussion of our efforts in these areas, see
"--The Syntroleum Process."
We lease a 4,500 square foot laboratory and own a 16,500 square foot
laboratory facility located on 100 acres of land where we are engaged in
extensive development and testing of Syntroleum products. These facilities also
house our product refining research and development activities, including
hydrogen saturation, hydroisomerization, hydrocracking and distillation
capabilities, as well as a fully automated dual train bench scale
hydroprocessing unit. We have recently completed construction of a large scale
hydroprocessing pilot unit and are in the pre-commissioning stage of start up
operations of this facility. We also have arrangements with a number of
companies for hydroprocessing larger quantities of our synthetic products. Our
laboratories currently have 21 fixed tube reactors, two fluidized bed reactors,
and six continuous stirred tank reactors in which automated tests are run and
catalyst systems are evaluated and developed. We also have arrangements with a
number of universities and companies for a full range of state-of-the-art
catalyst evaluation.
As of March 1, 2001, we had 59 employees in our laboratory, pilot plant and
engineering departments, 38 of whom are chemists, engineers or other degreed
professionals (15 with masters or Ph.D. degrees) devoted to research and
development activities. A number of other chemists, engineers and professionals
that are employed by our licensees and joint development partners are also
contributing efforts to the further development and commercialization of the
Syntroleum Process. We also have access to laboratory and test facilities
through our joint development partners. For example, both Texaco and ARCO have
performed catalyst tests at their own or contract facilities, and testing with
Catalytica and Marathon regarding low heating value gas combustion has been
conducted at Catalytica's and other test facilities.
SALES AND MARKETING
We intend to maintain an active marketing and sales effort to develop and
promote the Syntroleum Process through several channels. We have been and will
continue to be an active participant at industry conferences relating to GTL
processes. During 2000, representatives of our company spoke at 33 different
conferences at locations around the world. We also intend to continue to write
and publish papers on topics regarding the implications of GTL technology to the
energy and transportation industries. Additionally, we will continue to educate
and inform our customers through the use of multi-media and print presentations.
We also intend to establish brand recognition for specialty products to be
produced by our specialty plants. We have received trademark and service mark
rights to the name "Syntroleum" in the United States and have applications
pending to register the trademark in various foreign countries.
15
In addition, Tessag, Bateman, AMEC and other engineering companies are
familiar with our GTL technology and have assisted us in marketing the
Syntroleum Process. Our agreements with engineering firms generally provide
these firms with the right to market the Syntroleum Process. We believe that
these relationships will expand our marketing effort in a cost-effective manner.
We currently have 12 employees in our business development and marketing
departments, six of whom hold advanced degrees, and we also retain a full-time
sales representative in London, England.
HISTORICAL DEVELOPMENT OF GTL TECHNOLOGY
The basis for most GTL technologies, including the Syntroleum Process,
originated in 1923 when two German chemists, Franz Fischer and Hans Tropsch,
discovered that synthesis gas (carbon monoxide and hydrogen) could be
catalytically converted into synthetic hydrocarbons using a precipitated cobalt
catalyst. In the Fischer-Tropsch reaction, the synthesis gas in contact with the
catalyst surface at appropriate temperatures and pressures causes a chemical
reaction that produces hydrocarbons and byproducts consisting primarily of water
and carbon dioxide.
Prior to and during World War II, development of the Fischer-Tropsch
process occurred primarily in Germany. Due to Germany's significant coal
resources and limited oil and gas resources, these development activities
focused exclusively on the conversion of coal into fuels and chemicals. Between
1934 and 1945, nine government-funded, coal-to-liquids plants were built in
Germany using coal as the feedstock.
Following World War II, development efforts continued in the United States
and South Africa. In 1950, Texaco participated in the Hydrocol plant, which was
an 8,000 barrel per day synthetic fuel plant that was built in Brownsville,
Texas and used natural gas as the feedstock. Although the plant was a
technological success, it was not economic to operate because a new gas pipeline
and changes in the price of oil created a more economic market for the natural
gas, which resulted in the shutdown of the plant in 1953. In 1950, the South
African government formed a predecessor of Sasol (which was later privatized) to
develop synthetic fuels using coal as the feedstock. Three coal-to-liquids
plants were built in South Africa between 1955 and 1982, and a natural gas based
plant was built in 1993. Each of these plants is still in operation today.
Following the oil embargo of 1973, further development efforts focused on
utilizing both coal and natural gas to produce synthesis gas for the
Fischer-Tropsch process. Several major oil companies and several governments
funded research into synthetic fuels. The worldwide recession of 1982 and the
related drop in oil prices resulted in the termination of most coal-related
development activities. However, development activities in the conversion of
natural gas continued during the 1980's and 1990's. In 1985, Mobil built a GTL
plant in Montuni, New Zealand, and in 1993 Shell built a GTL plant in Bintulu,
Malaysia. Only the Malaysian plant remains operational as a GTL plant. Several
major oil companies, including BP, Chevron, Conoco, Exxon, Phillips and Shell,
have recently announced projects to construct gas-to-liquids plants.
We believe the generally accepted capital cost target for a GTL plant to be
cost effective for the production of transportation fuel is $30,000 per barrel
of daily plant capacity or less. This cost target is determined by calculating
the capital cost necessary to achieve an expected return on an investment in a
GTL plant. Factors influencing the expected return include operating costs,
feedstock cost and product prices. Capital costs at or below $30,000 per barrel
of daily plant capacity generally result in an expected return on the
investment, assuming operating costs comparable to those for a conventional
refinery, natural gas feedstock prices below $1.00 per million British thermal
units and oil prices above $18 per barrel.
We believe that to date no company has built a commercial-scale GTL plant
that has broken this cost barrier. In addition, we believe that each of the
current competitive GTL technologies has taken in excess of ten years to
develop, resulting in significant barriers to entry for potential new
participants.
THE SYNTROLEUM PROCESS
The Syntroleum Process involves two catalytic reactions. The first reaction
converts natural gas into synthesis gas through our proprietary autothermal
reformer reactor, and the second reaction converts the synthesis gas into
hydrocarbons through the Fischer-Tropsch reaction over a proprietary catalyst.
The following diagrams illustrate the elements involved in these reactions, but
are not in exact proportions.
16
STEP 1
CONVERSION OF NATURAL GAS TO SYNTHESIS GAS
[GRAPHIC OMITED]
STEP 2
FISCHER - TROPSCH SYNTHESIS
[GRAPHIC OMITED]
Our goal in developing this process has been to substantially reduce both
the capital and operating costs and the minimum economic size of a GTL plant. We
believe that by reducing the complexity of the process we have achieved this
goal. We have developed and continue to develop variations of our basic process
design in an effort to further lower costs and increase the adaptability of the
Syntroleum Process to a wide variety of potential applications.
Although we believe that the Syntroleum Process can be utilized in
commercial-scale GTL plants, we can give no assurance that commercial-scale GTL
plants based on the Syntroleum Process will be successfully constructed and
operated or that these plants will yield the same economics and results as those
demonstrated on a pilot plant basis. In addition, improvements to the Syntroleum
Process currently under development may not prove to be commercially applicable.
See "Risk Factors--Risks Relating to our Technology."
Fischer-Tropsch Catalyst Systems
We have developed several different proprietary catalysts systems for use
in the Fischer-Tropsch reaction in order to allow for matching a catalyst system
to a particular reactor design and provide more flexibility in matching the
Syntroleum Process to the desired application.
Based upon pilot tests of catalysts that we have manufactured, we believe
that a number of proprietary catalyst systems meet or exceed the activity and
selectivity targets necessary for commercial application in some current
Syntroleum Process designs, including the catalysts associated with the moving
bed reactor recently operated at the pilot plant jointly developed with ARCO at
ARCO's Cherry Point refinery.
Most Fischer-Tropsch catalysts produce a very waxy synthetic crude oil.
Typically, more than 50% of a barrel of synthetic crude oil is solid at room
temperature due to the high wax content. These waxy hydrocarbons are typically
processed through a hydrocracker to convert them into liquid hydrocarbons at
room temperature that can be further processed into transportation fuels. Our
proprietary "high alpha" catalyst produces a very waxy synthetic crude oil which
can be further processed through hydrocracking to make liquid synthetic fuels,
or, with other refining processes, the waxy portion can be converted into higher
value specialty products such as synthetic lubricants.
17
Under our agreement with Criterion, Criterion has manufactured, in its
commercial facilities, batches of our catalysts in quantities sufficient to
confirm that the performance of these catalysts is comparable to the same
catalyst produced by us and that these catalysts can be produced in commercial
quantities at targeted cost levels. We estimate that the useful life of our
Fischer-Tropsch catalysts will be three to five years under normal operating
conditions.
We plan to improve existing catalysts and continue to develop additional
catalyst formulations for use in the Syntroleum Process. Catalyst development is
a complex process requiring significant scientific skill and resources. We have
in the past and intend to continue to devote substantial resources to research
and development activities to produce Fischer-Tropsch catalysts with improved
activity rates, selectivity and active life, all at reasonable manufacturing
cost. In addition, we intend to enhance our catalyst development activities
through catalyst joint development programs with our joint development partners.
From time to time, we also retain catalysis experts on a consulting basis to
assist in catalyst development.
Fischer-Tropsch Reactor Designs
We have tested at our pilot plant several different proprietary
Fischer-Tropsch reactor designs and associated catalysts for use in the
Syntroleum Process. These include multiple fixed bed vertical tubular reactors,
a fluidized bed reactor for use with our chain-limiting catalyst and a moving
bed reactor. In addition, under our agreement with ARCO, ARCO constructed and
operated a 70 barrel per day GTL pilot plant that tested the moving bed reactor
on a larger scale. We have several pending United States and foreign patent
applications related to our Fischer-Tropsch reactors.
Heat Integration and Power Recovery
Compression energy is the primary energy consumer in the Syntroleum
Process. Engineering studies conducted by Bateman and others have demonstrated
that the heat generated by the two catalytic reactions in the Syntroleum Process
can be captured in the form of mechanical and electrical energy sufficient to
supply all of a GTL plant's needs plus a surplus for other uses, if desired. We
have developed several heat integration and power recovery schemes with partners
such as GE Power Systems to broaden the flexibility of the Syntroleum Process
and, in some cases, lower the capital cost as well as the number of pieces of
major equipment necessary for operation of a GTL plant.
Different configurations of GTL plants based on the Syntroleum Process can
also change the energy sources within the plant and the excess energy produced.
For example, a steam turbine can be incorporated into the process and utilize
the steam produced by the auto-thermal reformer and Fischer-Tropsch reactions to
produce energy for compression, and electrical power for commercial sale. In
addition, we have developed a configuration that utilizes the low-heating-value
residue stream from the process as feedstock for a specially designed gas
turbine that can utilize very low-heating-value gas. Several of these heat
integration and power recovery schemes are the subject of United States patents
and patent applications and foreign patent applications and are a part of our
joint development efforts with others.
Product Upgrading
Synthetic liquid hydrocarbons made from the Syntroleum Process can be
refined into fuels using conventional refining processes such as hydrocracking.
However, we believe that because of the purity and uniform nature of the
synthetic hydrocarbon molecules, conventional process configurations and
conditions may not be optimum. We have developed new processes to further refine
synthetic liquid hydrocarbons made from the Syntroleum Process in a manner that
maximizes the value of the refined product streams, while minimizing the
processing cost. In August 2000, we began offering our licensees access to
proprietary hydrocracking technology optimized for converting synthetic crude
oil into ultra-clean, sulfur-free synthetic transportation fuels, primarily
diesel and jet fuels.
18
Advantages Over Competing Processes
We believe that the method by which our process uses air directly from the
atmosphere is a unique characteristic and a primary competitive advantage of the
Syntroleum Process. Competitive processes for the conversion of natural gas into
synthetic hydrocarbons generally utilize either steam reforming or a combination
of steam reforming and partial oxidation with pure oxygen in the conversion of
natural gas to synthesis gas. Steam reformers react steam with natural gas to
produce synthesis gas. A steam reformer is a relatively complex unit that
consists of a large fired heater with catalyst-filled tubes. Because the
reaction operates at high temperature and pressure, the tubes are made of exotic
alloys and are expensive. Operating costs are increased due to the endothermic
nature of the process, which requires a continuous input of heat. Processes that
utilize a combination of steam reforming and partial oxidation with pure oxygen
also require an air separation plant to produce pure oxygen. The air separation
plant must be constructed with expensive metals and materials, because its
operation involves very low temperatures and requires significant energy input,
as well as operating risks inherent in handling pure oxygen. Moreover, the use
of pure oxygen generates synthesis gas that is free of nitrogen. While the
Fischer-Tropsch reaction in competitive processes is designed to occur without
the presence of nitrogen, the Syntroleum Process is designed to utilize the
nitrogen in the Fischer-Tropsch process to remove a portion of the heat
generated by the process. Use of the auto thermal reformer reactor in the
Syntroleum Process also provides advantages over competitive processes because
of its relatively low capital and operating costs. In addition to lowering the
capital cost, the elimination of an air separation plant and steam reformer has
the additional advantage of reducing the size and complexity and lowering the
energy requirement of GTL plants based on the Syntroleum Process.
We believe that another advantage of the Syntroleum Process is the absence
of recycle loops necessary in some competitive processes, which also tends to
lower capital costs. In the Fischer-Tropsch stage of some competitive processes,
a recycle loop is utilized in order to maximize the output of hydrocarbons and
help control the heat generated by the reaction. As a result, these processes
are designed to avoid the introduction of inert gases (including nitrogen) into
the process, which would otherwise build up in the system and hinder the
reaction.
Feedstocks
The Syntroleum Process is designed to produce approximately six million
British thermal units of liquid hydrocarbons from between 9.5 and 13 million
British thermal units of natural gas feedstock. Conversion efficiency varies
depending on gas composition and process conditions selected for each plant. One
of the benefits of the Syntroleum Process is its ability to utilize natural gas
containing nitrogen and carbon dioxide, up to specified levels, without removing
these impurities prior to consumption by the plant. However, natural gas that
contains sulphur, metals and other materials that poison catalysts must be
processed in order to remove these contaminants prior to the use of the natural
gas in the first catalytic reaction.
Byproducts and Emissions
A byproduct of the Syntroleum Process is synthesized water that, with
treatment to remove organic materials, could be sold commercially as industrial
or irrigation water in areas where sufficient demand exists. Based on pilot
plant tests, we believe that approximately 1.3 barrels of synthesized water can
be produced for each barrel of synthetic crude oil produced.
Depending on the process configuration, emissions from the Syntroleum
Process are expected to include nitrous oxide, carbon monoxide, carbon dioxide
and light hydrocarbons, which we believe will generally be within applicable
emissions standards. Spent catalysts are expected to be processed by a catalyst
reclaimer who will recover useful metals and be responsible for disposal of the
nonreclaimed portion of the catalyst.
INTELLECTUAL PROPERTY
Our success depends on our ability to obtain, protect, and enforce our
intellectual property rights, to successfully avoid infringing the valid and
enforceable intellectual property rights of others and, if necessary, to defend
against any alleged infringements. We regard the protection of our proprietary
technologies as critical to our future success and we rely on a combination of
patent, copyright, trademark and trade secret law and contractual restrictions
to protect our proprietary rights. We pursue protection of the Syntroleum
Process primarily through patents and trade secrets. It is our policy to seek,
when appropriate, protection for our proprietary products and processes by
filing patent applications in the United States and selected foreign countries
and to encourage or further the efforts of others who have licensed technology
to us to file patent applications. Our ability to protect and enforce these
rights involves complex legal, scientific and factual questions and
uncertainties.
19
We currently own, or have licensed rights to more than 101 patents or
patent applications pending in the United States and various foreign countries
that relate in general to one or more embodiments of the Syntroleum Process.
We can give no assurance that additional patents will be granted with
respect to any patent applications filed by us or our licensors. Further, any
patents issued or licensed to us might not provide us with commercial benefit or
might be infringed, invalidated or circumvented by others. The approval or
rejection of our patent applications by the U.S. Patent Office may take several
years.
The availability of patents in foreign markets, and the nature of any
protection against competition that may be afforded by such patents, is often
difficult to predict and varies significantly from country to country. Moreover,
we or our licensors may choose not to seek, or may, for a variety of reasons, be
unable to obtain, patent protection in a country that might become an important
market for our GTL technology.
In addition to patent protection, we also rely significantly on trade
secrets, know-how and technological advances, which we seek to protect, in part,
through confidentiality agreements with our collaborators, licensees, employees
and consultants. If these agreements are breached, we might not have adequate
remedies for the breach. In addition, our trade secrets and proprietary know-how
might otherwise become known or be independently discovered by others.
It is our policy to honor the valid, enforceable intellectual property
rights of others. Our success depends on our ability to avoid infringing the
valid, enforceable intellectual property rights of others and, if need be,
defending ourselves against any claims of infringement. While we have made
efforts to avoid any such infringement, commercialization of our GTL
technologies may give rise to claims that the technologies infringe upon the
patents or other proprietary rights of others.
Although it is our policy to regularly review patents that may have
applicability in the GTL industry, we may not become aware of these patents or
rights until after we have made a substantial investment in the development and
commercialization of those technologies. Legal actions could be brought against
us, our partners or our licensees claiming damages and seeking an injunction
that would prevent us, our partners or our licensees from testing, marketing or
commercializing the affected technologies. Major energy companies seeking to
gain a competitive advantage may have an interest in bringing one of these
actions. If such an action was successful, in addition to potential liability
for damages, we, our partners or our licensees could be required to obtain a
license in order to continue to test, market or commercialize the affected
technologies. Any required license might not be made available or, if available,
might not be available on acceptable terms, and we could be prevented entirely
from testing, marketing or commercializing the affected technology. We may have
to expend substantial resources in litigation, either in enforcing our patents,
defending against the infringement claims of others, or both. Many possible
claimants, like the major energy companies that have or may be developing
proprietary GTL technologies competitive with the Syntroleum Process, have
significantly more resources to spend on litigation. We have conducted a review
of more than 600 existing patents applicable to the GTL field and believe that
we are not infringing on the valid, enforceable patents of others. To date, we
have not been notified of any claim that our GTL technology infringes the
proprietary rights of any third party. However, we can give no assurance that
third parties will not claim infringement by us with respect to past, present or
future GTL technologies.
In any potential intellectual property dispute involving us, our licensees
could also become the target of litigation. Our license agreements require us to
indemnify the licensees against specified losses, including the losses resulting
from patent and trade secret infringement claims, subject to a cap of 50% of the
license fees received. Our indemnification and support obligations could result
in substantial expenses and liabilities to us. These expenses or liabilities
could have a material adverse effect on our business, operating results and
financial condition. See "Risk Factors--Risks Relating to our Technology."
20
EMPLOYEES
We had 98 employees at March 1, 2001, including 47 employees involved in
research and development and pilot plant operations, 12 employees in business
development and marketing, 12 employees in engineering, and 27 employees in
finance, legal, information technology and administration. None of our employees
are represented by a labor union. We have experienced no work stoppages and
believe that our relations with our employees are excellent.
GOVERNMENT REGULATION
We will be subject to extensive federal, state and local laws and
regulations relating to the protection of the environment, including laws and
regulations relating to the release, emission, use, storage, handling, cleanup,
transportation and disposal of hazardous materials and employee health and
safety. In addition, our GTL plants will be subject to the environmental and
health and safety laws and regulations of any foreign countries in which these
plants are to be located. For example, our Sweetwater project will require us to
comply with extensive Australian environmental, health and safety laws.
Violators of these laws and regulations may be subject to substantial fines,
criminal sanctions or third party lawsuits and may be required to install costly
pollution control equipment or, in some extreme cases, curtail operations.
Further, these laws and regulations may limit or prohibit activities on lands
lying within wilderness areas, wetlands or other protected areas. Our operations
in the United States are also subject to the federal "Superfund" law, and
similar state laws, which can impose joint and several liability for site
cleanup, regardless of fault, upon statutory categories of parties, including
our company, that sent wastes offsite for disposal and current owners and
operators of property. Environmental laws and regulations often require the
acquisition of a permit or other authorization before activities may be
conducted and compliance with laws and regulations, and any requisite permits,
can increase the costs of designing, installing and operating our GTL plants.
For example, we are required to obtain numerous Australian environmental, health
and safety permits in connection with our Sweetwater project.
GTL plants will generally be required to obtain permits under applicable
state and federal clean air and water laws and various permits for industrial
siting and construction. Emissions from a GTL plant, primarily from the gas
turbine, will contain nitrous oxides and may require abatement equipment to be
installed in order to meet state and federal permit requirements. Additionally,
GTL plants will be required to adhere to state and federal laws applicable to
the disposal of byproducts produced, including waste water and spent catalyst.
Although we do not believe that compliance with environmental and health
and safety laws in connection with our current operations will have a material
adverse effect on us, the future costs of complying with environmental laws and
regulations and containing or remediating contamination cannot be predicted with
certainty. In the future, we could incur material liabilities or costs related
to environmental matters, and these environmental liabilities or costs
(including fines or other sanctions) could have a material adverse effect on our
business, operating results and financial condition. We do not currently carry
environmental impairment liability insurance to protect us against these
contingencies but may, in the future, seek to obtain insurance in connection
with our participation in the construction and operation of GTL plants if
coverage is available at reasonable cost and without unreasonably broad
exclusions.
OPERATING HAZARDS
Operations at our GTL plants will involve a risk of incidents involving
personal injury and property damage due to the operation of machinery in close
proximity to individuals and the highly flammable nature of natural gas and the
materials produced at these plants. The frequency and severity of personal
injury and property damage incidents will affect our operating costs,
insurability and relationships with customers, employees and regulators. Any
significant frequency or severity of these incidents, or the general level of
compensation awards, could affect our ability to obtain insurance and could have
a material adverse effect on our business, operating results and financial
condition.
MANAGEMENT AND DISPOSITION OF REAL ESTATE AND MISCELLANEOUS ASSETS
Our predecessor, SLH Corporation, acquired our real estate assets from Lab
Holdings, Inc. concurrent with the distribution by Lab Holdings to its
stockholders of all of SLH's outstanding common stock. These assets reflect the
remaining assets of a real estate development business that was conducted by Lab
Holdings in association with a previously owned life insurance company that was
sold in 1990. Real estate assets, as of December 31, 2000, consisted of land in
Houston, Texas comprised of 281 acres of undeveloped land and 108 residential
lots available for sale known as the "Houston Project." The total real estate
inventory had an aggregate carrying value at December 31, 2000 of approximately
$3.3 million.
21
Our real estate assets are owned by our subsidiary, Scout Development
Corporation. The Houston Project is owned by 529 Partners, Ltd., a Texas
limited partnership in which Scout holds a 75% interest. 529 Partners is
developing the property for residential and light commercial purposes. During
2000, 529 Partners sold 82 lots of the Houston Project for residential use for
approximately $1,663,000. We expect that the balance of the tract will be
developed by 529 Partners for residential use and ultimate sale.
Our other assets at December 31, 2000 included (1) an investment in a
privately owned developer of proprietary bone substitute technology, which had a
carrying value of approximately $565,000, (2) $87,069,000 million of cash,
government securities and current receivables, (3) an investment in a privately
held venture capital limited partnership, which had a carrying value of
$476,000, (4) a 49.9% interest in a community retail shopping center in
Gillette, Wyoming and (5) an equity investment in a recently renovated hotel in
Tulsa, Oklahoma. We plan to liquidate all of these investments other than the
cash, government securities and current receivables in an orderly manner to
maximize their value to stockholders.
The retail shopping center in which we have an interest contains
approximately 163,454 square feet of net leasable area and 7.5 acres of
partially undeveloped land. At the end of 2000, the center was 90% occupied.
Rental revenue totaled $878,000 for 2000. The average annual gross rental per
occupied square foot was $5.99. In addition to rental revenue, tenants are
responsible for their share of common area maintenance. During 2000, common
area maintenance collections from tenants totaled $106,000. The property is
subject to industrial revenue refunding bonds in the amount of $6 million that
are secured by a bank letter of credit and guaranteed by Scout. The letter of
credit is secured by a $3.2 million Treasury Note that is pledged by us to the
issuer of the letter of credit.
We believe that the real estate properties are adequately covered by
insurance with coverages for real and personal property, commercial general
liability, commercial crime, garage keepers legal liability, earthquake, flood,
windstorm and hail.
Our subsidiary, Scout, is subject to contingent obligations under leases
and other instruments incurred in connection with real estate activities and
other operations. We believe that adequate accruals have been made for the
contingent liabilities on our financial statements and that none of these are
deemed to be material, individually or in the aggregate.
Scout is subject to several United States environmental laws, including:
the Clean Air Act, the Comprehensive Environmental Response, Compensation, and
Liability Act, the Emergency Planning and Community Right-to-Know Act, the
Federal Water Pollution Control Act, the Oil Pollution Act of 1990, the Resource
Conservation and Recovery Act, the Safe Drinking Water Act and the Toxic
Substances Control Act. Scout is also subject to the United States
environmental regulations promulgated under these acts, as well as state and
local environmental regulations that have their foundation in the foregoing
United States environmental laws.
As is the case with many companies, Scout may face exposure to actual or
potential claims and lawsuits involving environmental matters with respect to
its current inventory of real estate as well as previously owned real estate.
However, no such claims are presently pending and Scout has not suffered, and
does not anticipate that it will suffer, a material adverse effect as a result
of any past action by any governmental agency or other party, or as a result of
noncompliance with such environmental laws and regulations.
RISK FACTORS
You should carefully consider the risks described below. The risks and
uncertainties described below are not the only ones facing our company. If any
of the following risks actually occur, our business, financial condition or
results of operations could be materially adversely affected. In that case, the
trading price of the common stock could decline, and you may lose all or part of
your investment in our common stock.
RISKS RELATING TO OUR TECHNOLOGY
We might not successfully commercialize our technology, and
commercial-scale GTL plants based on the Syntroleum Process may never be
successfully constructed or operated.
22
To date, no commercial-scale GTL plant based on the Syntroleum Process has
been constructed. A commercial-scale GTL plant based on the Syntroleum Process
might never be successfully built either by us or by any of our licensees. Our
success depends on our ability, and the ability of our licensees, to
economically design, construct and operate GTL plants based on the Syntroleum
Process on a commercial scale. The successful commercial construction and
operation of a GTL plant based on the Syntroleum Process depends on a variety of
factors, many of which are outside our control. Although we are currently
developing the Sweetwater plant, our first commercial-scale GTL plant, we do not
know if we will be successful in obtaining the necessary debt and equity
financing for this plant and we do not know for certain when construction of
this plant will begin or when it will become operational. We do not have any
experience managing the financing, design, construction or operation of
commercial-scale GTL plants, and we may not be successful in doing so.
Commercial-scale GTL plants based on the Syntroleum Process might not
produce results necessary for success, including results demonstrated on a
laboratory and pilot plant basis.
A variety of results necessary for successful operation of the Syntroleum
Process could fail to occur at a commercial plant, including reactions
successfully tested on a laboratory and pilot plant basis. Results that could
cause commercial-scale GTL plants to be unsuccessful include:
- - lower reaction activity than that demonstrated in laboratory and pilot
plant operations, which would increase the amount of catalyst or number of
reactors required to convert synthesis gas into liquid hydrocarbons and increase
capital and operating costs,
- - shorter than anticipated catalyst life, which would require more frequent
catalyst purchases and therefore increase operating costs,
- - excessive production of gaseous light hydrocarbons from the Fisher-Tropsch
reaction compared to design conditions, which would lower the anticipated amount
of liquid hydrocarbons produced and lower revenues and margins from plant
operations, and
- - inability of the gas turbines or heaters integrated into the Syntroleum
Process to burn the low-heating-value tail gas that is produced by the process,
which would result in the need to incorporate other methods to generate
horsepower for the compression process which may increase capital and operating
costs.
In addition, these plants could experience mechanical difficulties, either
related or unrelated to elements of the Syntroleum Process.
Many of our competitors have significantly more financial and other
resources than our company, and GTL technologies developed by our competitors
could become more commercially successful than our technology or render our
technology obsolete.
The development of GTL technology is highly competitive, and other GTL
technologies could become more commercially successful than our technology. The
Syntroleum Process is based on chemistry that has been used by several companies
in synthetic fuel projects over the past 60 years. Our competitors include major
integrated oil companies that have developed or are developing competing GTL
technologies, including BP, Conoco, Exxon, Sasol (including through its
participation in a joint venture with Chevron) and Shell. Each of these
companies has significantly more financial and other resources than us to spend
for research and development of their respective technologies and for funding
construction and operation of commercial-scale GTL plants. In addition to using
their own GTL technologies in competition with us, these competitors could also
offer to license their technology to others. In addition, several small
companies have developed, and are continuing to develop, competing GTL
technologies. The Department of Energy has also sponsored a number of research
programs relating to GTL technology that, in many cases, could potentially lower
the cost of competitive processes.
As GTL technologies continue to be developed by our competitors, one or
more of our current technologies may become obsolete. Our ability to create and
maintain technological advantages is critical to our future success. As new
technologies develop, we may be placed at a competitive disadvantage, and
competitive pressures may force us to implement new technologies at a
substantial cost. We may not be able to successfully develop, or expend the
financial resources necessary to acquire new technology.
23
Our ability to protect our intellectual property rights involves many
complexities and uncertainties, and commercialization of the Syntroleum Process
could give rise to claims that our technology infringes upon the rights of
others
.
Our success depends on our ability to protect our intellectual property
rights, which involves complex legal, scientific and factual questions and
uncertainties. We rely on a combination of patents, copyrights, trademarks,
trade secret law and contractual restrictions to protect our proprietary rights.
We cannot assure you that additional patents will be granted, and our existing
patents might not provide us with commercial benefit or might be infringed upon,
invalidated or circumvented by others. In addition, the availability of patents
in foreign markets, and the nature of any protection against competition that
may be afforded by those patents, are often difficult to predict and vary
significantly from country to country. We or our licensors may choose not to
seek, or may be unable to obtain, patent protection in a country that could
potentially be an important market for our GTL technology. The confidentiality
agreements that are designed to protect our trade secrets could be breached, and
we might not have adequate remedies for the breach. In addition, our trade
secrets and proprietary know-how might otherwise become known or be
independently discovered by others.
Commercialization of the Syntroleum Process may give rise to claims that
our technologies infringe upon the patents or other proprietary rights of
others. Although it is our policy to regularly review patents that may have
applicability in the GTL industry, we may not become aware of these patents or
rights until after we have made a substantial investment in the development and
commercialization of those technologies. Legal actions could be brought against
us, our partners or our licensees claiming damages and seeking an injunction
that would prevent us, our partners or our licensees from testing, marketing or
commercializing the affected technologies. Major energy
companies seeking to gain a competitive advantage may have an interest in
bringing one of these actions. If an infringement action was successful, in
addition to potential liability for damages, our partners, our licensees or we
could be required to obtain a license in order to continue to test, market or
commercialize the affected technologies. Any required license might not be made
available or, if available, might not be available on acceptable terms, and we
could be prevented entirely from testing, marketing or commercializing the
affected technology. We may have to expend substantial resources in litigation,
either in enforcing our patents, defending against the infringement claims of
others, or both. Many possible claimants, like the major energy companies that
have or may be developing proprietary GTL technologies competitive with the
Syntroleum Process, have significantly more resources to spend on litigation. We
can give no assurance that third parties will not claim infringement by us with
respect to past, present or future GTL technologies. In any potential
intellectual property dispute involving us, our licensees could also become the
target of litigation.
We could have potential indemnification liabilities to licensees relating
to the operation of GTL plants based on the Syntroleum Process or intellectual
property disputes.
Our license agreements require us to indemnify the licensee, subject to a
cap of 50% of the license fees received, against specified losses relating to,
among other things:
- - the use of patent rights and technical information relating to the
Syntroleum Process,
- - acts or omissions by us in connection with our preparation of process
design packages for plants, and
- - performance guarantees that may be provided by us.
Our indemnification obligations could result in substantial expenses and
liabilities to us in the event that intellectual property rights claims are made
against us or our licensees, or GTL plants based on the Syntroleum Process fail
to operate as designed.
If improvements to the Syntroleum Process are not commercially viable, the
design and construction of lower-cost GTL plants based on the Syntroleum Process
could be delayed or prevented.
A number of improvements to the Syntroleum Process are in various early
stages of development. These improvements will require substantial additional
investment, development and testing prior to their commercialization. We might
not be successful in developing these improvements and, if developed, they may
not be capable of being utilized on a commercial basis. If improvements to the
Syntroleum Process currently under development do not become commercially viable
on a timely basis, the total potential market for GTL plants that could be built
by us and our partners and by our licensees could be significantly limited.
24
For example, improvements to the heat integration of the Syntroleum Process
designed to lower capital and operating costs are currently under development.
These improvements may not occur because further integration of the gas turbine
into the process might not be technically feasible due to the operating
tolerances of the materials in the gas turbine. In addition, our horizontal
reactor, which is designed to have a low center of gravity for marine
applications, may not be capable of commercial application due to operational
difficulties that could limit the market for floating GTL plants.
The economic application of our technology depends on favorable plant
operating conditions.
The economic application of GTL technology depends on favorable plant
operating conditions. Among the operating conditions that impact plant economics
are the site location, infrastructure, weather conditions, the size of the
equipment, the quality of the natural gas feedstock, the type of plant products
and whether the natural gas converted by the plant is associated with oil
reserves. For example, if a plant were located in an area that requires the
construction of substantial infrastructure, plant economics would be adversely
affected. In addition, plants that are not designed to produce specialty
products or other high margin products and plants that are not used to convert
natural gas that is associated with oil reserves will be more dependent on
favorable natural gas and oil prices than plants designed for those uses and are
not expected to be cost-effective at price levels below the range of at least
$15 to $20 per barrel for oil.
Industry rejection of our technology would make the construction of GTL
plants based on the Syntroleum Process more difficult or impossible and
adversely affect our ability to receive future license fees.
As is typical in the case of a new and rapidly evolving technology, demand
and industry acceptance for our GTL technology is subject to a high level of
uncertainty. Failure by the industry to accept our technology would make our
construction of GTL plants more difficult or impossible and adversely affect our
ability to receive future license fees and to generate other revenue. Should a
high profile industry participant adopt the Syntroleum Process and fail to
achieve success or should any commercial GTL plant based on the Syntroleum
Process fail to achieve success, other industry participants' perception of the
Syntroleum Process could be adversely affected. In addition, some oil companies
may be motivated to seek to prevent industry acceptance of GTL technology based
on their belief that widespread adoption of GTL technology might negatively
impact their competitive position.
RISKS RELATING TO OUR BUSINESS
We will need to obtain funds from additional financings or other sources
for the Sweetwater project and other activities, and if we do not receive these
funds we might need to delay or eliminate our expenditures, including those for
the Sweetwater project.
We have expended and will continue to expend a substantial amount of funds
to continue the research and development of our technologies, to market the
Syntroleum Process and to design and construct GTL plants. We intend to finance
the Sweetwater plant primarily through non-recourse debt financing at the
project level, as well as equity financing, and plan to obtain additional funds
for our GTL plant projects primarily through a combination of equity and debt
project financing. We also intend to obtain additional funds through
collaborative or other arrangements with strategic partners and others and debt
and equity financing in the capital markets. Financing may not be available when
needed or on terms acceptable or favorable to us. Our letters of intent relating
to equity financing may not lead to definitive agreements. In addition,
definitive agreements with equity and debt participants in the Sweetwater
project and our other capital projects are expected to include conditions to
funding, many of which could be outside of our control. If adequate funds are
not available, we may be required to delay or to eliminate expenditures for the
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Sweetwater project and our other capital projects, as well as expenditures for
research and development and other activities. We could also be forced to
license to third parties the rights to commercialize additional products or
technologies that we would otherwise seek to develop ourselves. If we obtain
additional funds by issuing equity securities, dilution to stockholders may
occur. In addition, preferred stock could be issued in the future without
stockholder approval and the terms of our preferred stock could include
dividend, liquidation, conversion, voting and other rights that are more
favorable than the rights of the holders of our common stock.
Assuming the commercial success of the plants based on the Syntroleum
Process, we expect that license fees, catalyst sales and sales of specialty
products from GTL plants in which we own an interest will be a source of funds
for operations. However, we may not receive any of these revenues, and these
revenues may not be sufficient for capital expenditures or operations and may
not be received within the expected time frame. If we are unable to generate
funds from operations, our need to obtain funds through financing activities
will be increased.
The construction of the Sweetwater plant and other GTL plants based on the
Syntroleum Process will be subject to the risks of delay and cost overruns
inherent in any large construction project.
The construction of GTL plants based on the Syntroleum Process, including
the Sweetwater plant we are currently developing and plan to construct in
Western Australia, will be subject to the risks of delay or cost overruns
inherent in any large construction project resulting from numerous factors,
including the following:
- - shortages of equipment, materials or skilled labor,
- - unscheduled delays in the delivery of ordered materials and equipment,
- - engineering problems, including those relating to the commissioning of
newly designed equipment,
- - work stoppages,
- - weather interference,
- - unanticipated cost increases, and
- - difficulty in obtaining necessary permits or approvals.
We have incurred losses and anticipate continued losses.
As of December 31, 2001, we had an accumulated deficit of $69 million. We
have not yet achieved profitability and expect to continue to incur net losses
until we recognize sufficient revenues from licensing activities, GTL plants or
other sources. Because we do not have an operating history upon which an
evaluation of our prospects can be based, our prospects must be considered in
light of the risks, expenses and difficulties frequently encountered by small
companies seeking to develop new and rapidly evolving technologies. To address
these risks, we must, among other things, respond to competitive factors,
continue to attract, retain and motivate qualified personnel and commercialize
and continue to upgrade our GTL technologies. We may not be successful in
addressing these risks. We can give no assurance that we will achieve or sustain
profitability.
Our anticipated expense levels are based in part on our expectations as to
future operating activities and are not base