Attached files
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
———————
FORM
10-K
———————
þ
ANNUAL REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For
the fiscal year ended December 31, 2009
OR
o
TRANSITION REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For the
transition period from: _____________ to _____________
001-34525
(Commission
File Number)
PACIFIC ASIA PETROLEUM, INC. |
(Exact name of registrant as specified in its charter) |
Delaware
|
30-0349798
|
|
(State
or Other Jurisdiction
|
(I.R.S.
Employer
|
|
of
Incorporation or Organization)
|
Identification
No.)
|
250 East Hartsdale Ave., Suite 47, Hartsdale, New York 10530 |
(Address of Principal Executive Office) (Zip Code) |
(914) 472-6070 |
(Registrant’s telephone number, including area code) |
Securities
registered pursuant to Section 12(b) of the Act:
None
Securities
registered pursuant to Section 12(g) of the Act:
Common
Stock, $0.001 par value.
———————
Indicate by check mark if the
registrant is a well-known seasoned issuer, as defined in Rule 405 of the
Securities Act. Yes ¨ No þ
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act. Yes ¨ No þ
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 þ
No ¨
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (§229.405 of this chapter) is not contained herein, and will not
be contained, to the best of registrant’s knowledge, in definitive proxy
or information statements incorporated by reference in Part III of
this Form 10-K or any amendment to this Form 10-K. ¨
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every
Interactive Data File required to be submitted and posted pursuant to Rule 405
of Regulation S-T (§ 232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post
such files). Yes o
No ¨
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
definition of “large accelerated filer”, “accelerated filer”, “non-accelerated
filer” and ”smaller reporting company” in Rule 12b-2 of the Exchange Act.
(Check one):
Large accelerated filer o | Accelerated filer þ | Non-accelerated filer þ | Small reporting company o |
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes ¨
No þ
The
aggregate market value of the voting and non-voting common equity held by
non-affiliates of the registrant as of the last business day of the registrant’s
most recently completed second fiscal quarter (June 30, 2009) was approximately
$53,900,873 (based on $1.98 per share, the last price of the common stock as
reported on the OTC Bulletin Board on such date). For purposes of the
foregoing calculation only, all directors, executive officers and 10% beneficial
owners have been deemed affiliates. As of March 1,
2010, there were 48,257,896 shares of Common Stock
outstanding.
DOCUMENTS
INCORPORATED BY REFERENCE
Portions
of the definitive Proxy Statement relating to the Company’s Annual Meeting of
Stockholders to be held on June 9, 2010 are incorporated by reference in Part
III of this report.
CAUTIONARY STATEMENT RELEVANT TO FORWARD-LOOKING INFORMATION
All
statements, other than statements of historical fact, included in this Form
10-K, including without limitation the statements under “Management’s Discussion
and Analysis of Financial Condition and Results of Operations” and “Description
of Business,” are, or may be deemed to be, forward-looking statements. Such
forward-looking statements involve assumptions, known and unknown risks,
uncertainties and other factors, which may cause the actual results, performance
or achievements of Pacific Asia Petroleum, Inc. and its subsidiaries and
joint-ventures, (i) Pacific Asia Petroleum, Limited, (ii) Inner Mongolia
Production Company (HK) Limited, (iii) Pacific Asia Petroleum (HK) Limited, (iv)
Inner Mongolia Sunrise Petroleum Co. Ltd., (v) Pacific
Asia Petroleum Energy Limited, (vi) Beijing Dong Fang Ya Zhou Petroleum
Technology Service Company Limited, and (vii) CAMAC Petroleum Limited
(collectively, the “Company”), to be materially different from any future
results, performance or achievements expressed or implied by such
forward-looking statements contained in this Form 10-K.
In our
capacity as Company management, we may from time to time make written or oral
forward-looking statements with respect to our long-term objectives or
expectations which may be included in our filings with the Securities and
Exchange Commission (the “SEC”), reports to stockholders and information
provided in our web site.
The words
or phrases “will likely,” “are expected to,” “is anticipated,” “is predicted,”
“forecast,” “estimate,” “project,” “plans to continue,” “believes,” or similar
expressions identify “forward-looking statements.” Such
forward-looking statements are subject to certain risks and uncertainties that
could cause actual results to differ materially from historical earnings and
those presently anticipated or projected. We wish to caution you not
to place undue reliance on any such forward-looking statements, which speak only
as of the date made. We are calling to your attention important
factors that could affect our financial performance and could cause actual
results for future periods to differ materially from any opinions or statements
expressed with respect to future periods in any current statements.
The
following list of important factors may not be all-inclusive, and we
specifically decline to undertake an obligation to publicly revise any
forward-looking statements that have been made to reflect events or
circumstances after the date of such statements or to reflect the occurrence of
anticipated or unanticipated events. Among the factors that could
have an impact on our ability to achieve expected operating results and growth
plan goals and/or affect the market price of our stock are:
·
|
Lack
of meaningful operating history, operating revenue or earnings
history.
|
·
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Dependence
on key personnel.
|
·
|
Fluctuation
in quarterly operating results and seasonality in certain of our
markets.
|
·
|
Possible
significant influence over corporate affairs by significant
shareholders.
|
·
|
Our
ability to enter into definitive agreements to formalize foreign energy
ventures and secure necessary exploitation
rights.
|
·
|
Our
ability to raise capital to fund our
operations.
|
·
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Our
ability to successfully integrate and operate acquired or newly formed
entities and multiple foreign energy ventures and
subsidiaries.
|
·
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Competition
from large petroleum and other energy
interests.
|
·
|
Changes
in laws and regulations that affect our operations and the energy industry
in general.
|
·
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Risks
and uncertainties associated with exploration, development and production
of oil and gas, drilling and production
risks.
|
·
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Expropriation
and other risks associated with foreign
operations.
|
·
|
Risks
associated with anticipated and ongoing third party pipeline construction
and transportation of oil and gas.
|
·
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The
lack of availability of oil and gas field goods and
services.
|
·
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Environmental
risks, economic conditions.
|
CERTAIN
DEFINED TERMS
Throughout
this Annual Report on Form 10-K, the terms “we,” “us,” “our,” ” Company,” and
“our Company” refer to Pacific Asia Petroleum, Inc. (“PAP”), a Delaware
corporation, and its present and former subsidiaries, including Pacific Asia
Petroleum, Limited (“PAPL”), Pacific Asia Petroleum Energy Limited (“PAPE”),
Inner Mongolia Production Co (HK) Limited (“IMPCO HK”), Pacific Asia Petroleum
(HK) Limited (“PAP HK”), Inner Mongolia Sunrise Petroleum Co.
Ltd.(“IMPCO Sunrise”), Beijing Dong Fang Ya Zhou Petroleum Technology Service
Company Limited (”Dong Fang”), and CAMAC Petroleum Limited (“CPL,”
and collectively, the “Company”). References to “PAP” refer to Pacific Asia
Petroleum, Inc. prior to the mergers of Inner Mongolia Production Company LLC
(“IMPCO”) and Advanced Drilling Services, LLC (“ADS”) into wholly-owned
subsidiaries thereof, effective May 7, 2007. Historical financial
results presented herein are the results of IMPCO from inception on August 25,
2005 to May 6, 2007 and the consolidated entity Pacific Asia Petroleum, Inc.
from May 7, 2007 forward, which is considered to be the continuation of IMPCO as
Pacific Asia Petroleum, Inc.
2
PART
I
ITEM
1. DESCRIPTION OF BUSINESS
General
Pacific
Asia Petroleum, Inc. is a development stage company formed to develop new energy
ventures, directly and through joint ventures and other partnerships in which it
may participate. Members of the Company’s senior management team have experience
in the fields of petroleum engineering, geology, field development and
production, operations, international business development and
finance. Members of the Company’s management team have held
management and executive positions with Texaco Inc. and other international
energy companies and have managed energy projects in the People’s Republic of
China (the “PRC” or “China”) and elsewhere. Members of the Company’s management
team also have experience in oil drilling, operations, geology, engineering,
government relations and sales in China’s energy sector. The Company
considers itself currently to be engaged in a single business segment--oil and
gas exploration, development and production.
The
Zijinshan Production Sharing Contract
On
October 26, 2007, Pacific Asia Petroleum, Limited (“PAPL”), a wholly-owned
subsidiary of the Company, entered into a Production Sharing Contract (“ PSC”)
with China United Coalbed Methane Co., Ltd. (“CUCBM”) (the Chinese
Government-designated company holding exclusive rights to negotiate with foreign
companies with respect to coalbed methane (“CBM”) production in
China) exclusive rights to a large contract area located in the
Shanxi Province of China ( the “CUCBM Contract Area”), for the exploitation of
CBM resources (the "Zijinshan PSC"). The Zijinshan PSC provides, among other
things, that PAPL, following approval of the Zijinshan PSC by the Ministry of
Commerce of China, has a minimum commitment for the first three years
to drill three exploration wells and to carry out 50 km of 2-D seismic data
acquisition (an estimated expenditure of $2.8 million), and in the fourth and
fifth years PAPL will drill four pilot development wells at an
estimated cost of $2 million (in each case subject to PAPL’s right to terminate
the Zijinshan PSC). That five year period constitutes the exploration period,
which is subject to extension. After the exploration period, but
before commencement of the development and production period, CUCBM will have
the right to acquire a 40% participating interest and to work jointly
and pay its participating share of costs to develop and produce CBM
under the Zijinshan PSC. Pursuant to the Zijinshan PSC, all CBM resources
(including all other hydrocarbon resources) produced from the CUCBM Contract
Area are shared as follows: (i) 70% of production is provided to PAPL
and CUCBM for recovery of all costs incurred; (ii) PAPL has the first right to
recover all of its exploration costs from such 70% and then development costs
are recovered by PAPL and CUCBM pursuant to their respective participating
interests; and (iii) the remainder of the production is split with
CUCBM and PAPL collectively receiving between 99% and 90% of such remainder
depending on the actual producing rates (a sliding scale) and the balance of the
remainder (between 1% and 10%) is provided to the Government of
China.
The
Zijinshan PSC has a term of 30 years and was approved in April 2008 by the
Ministry of Commerce of China. In December 2008, the Company and CUCBM finalized
a mutually agreed work program pursuant to which the Company has now commenced
exploration operations under the Zijinshan PSC. The Zijinshan PSC is in close
proximity to the major West-East and the Ordos-Beijing gas pipelines which link
the gas reserves in China’s western provinces to the markets of Beijing and the
Yangtze River Delta, including Shanghai. The Zijinshan PSC covers an area of
approximately 175,000 acres.
3
During
2009, the Company completed seismic data acquisition operations on the Zijinshan
Block and spent approximately $1.5 million to shoot 162 kilometers of seismic
under the work program. Based on the seismic interpretation, four
potential well locations were identified. A regional environmental
impact assessment study (“EIA”) has also been completed. Following
completion of a site-specific EIA study, the Company spudded well ZJS 001 on
September 30, 2009. This well intersected 4/5 coal seams in the
Shanxi formation and 8/9 coal seams in the Taiyuan formation as
anticipated. The well reached total depth in mid-November
2009. Core samples have undergone laboratory testing, including tests
for gas content, gas saturation and coal characteristics. Based on
the results of these tests, at the latest Zijinshan PSC Joint
Management Committee (JMC) meeting, the Company agreed to a 2010 work program
which includes undertaking further technical studies related to the CUCBM
Contract Area and drilling at least two additional wells there.
The
Chifeng Oil Opportunity
Through
Inner Mongolia Sunrise Petroleum Co. Ltd. (“IMPCO Sunrise”), the Company in 2006
commenced operational activities in China and successfully drilled its first
well in a prospective area in Inner Mongolia in cooperation with Chifeng
Zhongtong Oil and Natural Gas Co. (“Chifeng”) pursuant to a Contract for
Cooperation and Joint Development (the “Chifeng Agreement”) (described in
greater detail under “Principal Business Strategy” of this
section). The Company’s drilling operations in this area have been
suspended pending receipt of a production license from the Chinese
government. The Company is pursuing a combination of strategies to
have such production license awarded, including a possible renegotiation of the
Chifeng Agreement with the goal of increasing the financial incentives to all
the parties involved, and the Company is also pursuing a strategy focused on
entering into negotiations with respect to an opportunity to participate in the
existing production from the 22 sq. km. Kerqing Oilfield. Participation in the
Kerqing Oilfield could significantly enhance the Chifeng Agreement in scale and
value. As of December 31, 2009, there was no certainty that any of
these strategies will ultimately succeed in obtaining a production license for
the Chifeng area, but the Company intends to continue in these
efforts.
Handan
Gas Distribution Venture
The
Company entered into a Letter of Intent in November 2008, to potentially acquire
a 51% ownership interest in Handan Chang Yuan Natural Gas Co., Ltd. (“HGC”) from
the Beijing Tai He Sheng Ye Investment Company Limited. HGC owns and
operates gas distribution assets in and around Handan City, China. HGC was
founded in May 2001, and is the primary gas distributer in Handan City, which is
located 250 miles south of Beijing, in the Hebei Province of the People’s
Republic of China. HGC has over 300,000 customers and owns 35 miles of a main
gas pipeline, and more than 450 miles of delivery gas pipelines, with a delivery
capacity of 300 million cubic meters per day. HGC also owns an 80,000
sq. ft. field distribution facility. Gas is being supplied by Sinopec and
PetroChina from two separate sources. On July 7, 2009, the
Company entered into a revised Letter of Intent with Handan Hua Ying
Company Limited (“Handan”) relating to the possible acquisition of a 49%
interest in HGC. The Company will continue its evaluation of this potential
acquisition including the possibility of bringing in partners.
Enhanced
Oil Recovery and Production (“EORP”)
On May
13, 2009, PAP and its wholly-owned Hong Kong subsidiary, PAPE, entered into a
Letter of Understanding (“LOU”), which was amended and further detailed in
various other associated agreements that were executed on June 7, 2009, with Mr.
Li Xiangdong (“LXD”) and Mr. Ho Chi Kong (“HCK”), pursuant to which the parties
agreed to form Beijing Dong Fang Ya Zhou Petroleum Technology Service Company
Limited(“Dong Fang”) as a new Chinese joint venture company, to be 75.5% owned
by PAPE and 24.5% owned by LXD, into which LXD would assign certain
pending patent rights related to chemical enhanced oil recovery (the “LXD
Patents”). Dong Fang was officially incorporated under Chinese law on
September 24, 2009. As required by the LOU, and pursuant to that certain
Agreement on Cooperation, dated June 7, 2009, and as amended on June 25, 2009
(the “AOC”), entered into by and between PAPE and LXD, upon the effectiveness of
the assignment of the LXD Patents to Dong Fong by LXD on November 27, 2009, (i)
the Company paid LXD and HCK $100,000 each, (ii) PAP has issued shares of PAPE
to Best Source Group Holdings Limited, a Hong Kong company designated by HCK
(“BSG”), to provide BSG with a 30% ownership interest in PAPE, with the Company
retaining the balance 70% ownership interest in PAPE, and (iii) the Company has
issued to HCK’s designee 100,000 shares of Common Stock of the Company and
options to purchase up to 400,000 additional shares of Common Stock of the
Company. These options were approved for issuance by the Board of Directors at
an exercise price of $4.62 per share, which was the closing sale price of the
Company’s Common Stock at that date the Company’s issuance obligation was
triggered upon achievement of the applicable milestone under the LOU on November
27, 2009 as reported by NYSE Amex. The Company has also agreed to issue 300,000
more shares of Company Common Stock to HCK or his designee upon the signing of
certain contracts by Dong Fang with respect to the Fulaerjiqu
oilfield. All the options granted to HCK do not vest
immediately; vesting will be contingent upon the achievement of certain
milestones related to the entry by Dong Fang into certain EORP-related
development contracts pertaining to oilfield projects in the Fulaerjiqu
Oilfield. These contracts are anticipated to each deliver to Dong Fang a
significant percentage of the incremental oil production and/or fixed fees per
ton for the incremental production which results from using the technology
covered by the LXD Patents.
4
In
addition, LXD has been engaged as a consultant by Dong Fang to provide research
and development services, training, and assistance in promoting certain other
opportunities developed by him that target the application of the technology
embodied in the LXD Patents, including assistance with entering into a contract
with respect to the Liaohe Oilfield (the “Liaohe Contract”), and helping to
develop projects in both the Shandong Province and the Xinjiang autonomous
region of the People’s Republic of China for the provision and application of
technology and chemicals developed by LXD.
The
Company has agreed to loan up to $5 million to PAPE, which may then invest up to
RMB 30,000,000 (approximately $4.4 million) into Dong Fang, with a portion of
this being a requirement to invest RMB 22,650,000 as PAPE’s share of the
registered capital of Dong Fang, when and to the extent required under
applicable law. PAPE’s capital investment will be used by Dong Fang
to carry out work projects, fund operations, and to make, together with PAPE,
aggregate payments of up to $1.5 million in cash to LXD and HCK. The payments of
up to $1.5 million in cash to LXD and HCK are subject to the
achievement of certain milestones pursuant to the LOU, including the formation
of Dong Fang, the transfer of the LXD Patents to Dong Fang, and the signing of
the contracts with respect to the Fularjiqu Oilfield and the Liaohe Contract by
Dong Fang, as well as certain production-based milestones resulting from the
implementation of these contracts. As of December 31, 2009, $500,000 of
milestone payments had been paid or accrued by PAPE. The loan from the Company
to PAPE will be repaid from funds distributed to PAPE by way of dividends or
other appropriate payments from Dong Fang. As of December 31, 2009,
the Company has loaned a total of $1.3 million to PAPE, and PAPE has invested a
total of RMB 4.8 million (approximately US$700,000) into Dong Fang.
In
accordance with the terms of the LOU, as amended on June 7, 2009, PAPE, LXD and
the Company’s existing Chinese joint venture company, Inner Mongolia Sunrise
Petroleum Co. Ltd. (“IMPCO Sunrise”), entered into an Assignment Agreement of
Application Right for Patent, Consulting Engagement Agreement, and an Interest
Assignment Agreement. Upon formation of Dong Fang on September 24,
2009, all these and other agreements entered into by IMPCO Sunrise on behalf of
Dong Fang were assigned by IMPCO Sunrise to Dong Fang.
With
these EORP-related agreements signed and in place, the Company through Dong Fang
has commenced operations in various oil fields located in the Liaoning,
Shandong, and Xinjiang Provinces in China. In the year ended December
31, 2009, the Company recorded initial revenues, cost of sales and expenses from
the EORP business activities.
Oyo
Field Production Sharing Contract Interest
On
November 18, 2009, the Company entered into the Purchase and Sale Agreement (the
“Purchase and Sale Agreement”) with CAMAC Energy Holdings Limited and certain of
its affiliates (“CAMAC”) pursuant to which the Company agreed to acquire all of
CAMAC’s 60% interest in production sharing contract rights with respect to that
certain oilfield asset known as the Oyo Field (the “Contract Rights”) and the
transactions contemplated thereby, including the election of directors of the
Company (the “Transaction”). The Purchase Agreement, provides that,
among other things: (i) CAMAC will transfer the Contract Rights to CAMAC
Petroleum Limited, a newly-formed Nigerian entity wholly-owned by the Company,
in consideration for the Company’s payment of $38.84 million in cash
(subject to possible reduction pursuant to the agreement in principle
between CAMAC and the Company which will reduce such payment amount
by a portion of CAMAC’s net cash flow generated by production from the Oyo Field
through the closing of the Transaction) and the issuance of the Company’s Common
Stock, par value $0.001 per share, equal to 62.74% of the Company’s issued and
outstanding Common Stock, after giving effect to the Transaction; and (ii) for a
period commencing on the closing of the transactions contemplated by the
Purchase and Sale Agreement (the “Closing”) and ending the date that is one year
following the Closing, the Company’s Board of Directors will consist of seven
members, four of whom will be nominated by CAMAC.
5
The
Transaction is expected to close during the first quarter of 2010, and is
subject to the satisfaction of customary and other conditions to Closing,
including, without limitation: (i) the negotiation and entry by the
parties into certain other agreements as set forth in the Purchase and Sale
Agreement in forms reasonably satisfactory to the parties; (ii) the Company’s
consummation of a financing on terms reasonably acceptable to CAMAC resulting in
gross proceeds of at least $45 million to the Company; and (iii) the approval of
the Company’s stockholders of the Purchase and Sale Agreement and the
transactions contemplated thereby. The Purchase and Sale Agreement also
contains other customary terms, including, but not limited to, representations
and warranties, indemnification and limitation of liability provisions,
termination rights, and break-up fees if either party terminates under
certain circumstances. The Company has already raised $20
million in a financing (disclosed below) and plans to raise an additional $25
million in connection with its obligation under the Purchase and Sale
Agreement. However, if the Company is unable to consummate such
additional financing, agree upon the terms of the other required agreements
between the parties or satisfy any of the other closing conditions set forth in
the Purchase and Sale Agreement, the Company may be unable to consummate the
Purchase and Sale Agreement.
At the
Closing of the Transaction, and subject to stockholder approval prior to
Closing, the Company’s name will be changed to CAMAC Energy Inc. The
Transaction, if consummated, will result in a change of control of the
Company.
Registered
Direct Offering
On
February 16, 2010, the Company consummated the offer and sale of 5,000,000
shares (the "Shares") of its common stock, par value $0.001 per share ("Common
Stock"), for an aggregate purchase price of $20 million, or $4.00 per share (the
"Purchase Price"), pursuant to a Securities Purchase Agreement, dated February
10, 2010, among the Company and certain purchasers signatory thereto (the
“Purchasers”). In addition, the Company issued to the Purchasers (1)
warrants to purchase up to an additional 2,000,000 shares of Common Stock of the
Company, in the aggregate, at an exercise price of $4.50 (subject to
customary adjustments), exercisable commencing 6 months following the closing
for a period of 36 months after such commencement date (the “Series A
Warrants”); and (2) warrants to purchase up to an additional
2,000,000 shares of Common Stock of the Company, in the aggregate, at an
exercise price $4.00 per share (subject to customary adjustments), exercisable
immediately at the closing until November 1, 2010 (the “Series B Warrants” and
together with the Series A Warrants, the “Warrants”). If all the
Warrants are exercised, the Company would receive additional gross proceeds of
$17 million. The Shares and the Warrant Shares are to be sold pursuant to a
shelf registration statement on Form S-3 declared effective by the SEC on
February 3, 2010 (File No. 333-163869), as amended by the prospectus supplement
filed with the SEC on February 12, 2010 and delivered to the
Purchasers.
Rodman
& Renshaw, LLC (“Rodman”) served as the Company’s exclusive placement agent
in connection with the offering. As consideration for its services as
placement agent, Rodman received a cash fee equal to 6.0% of the gross proceeds
of the offering ($1,200,000), as well as a 5-year warrant to purchase shares of
Common Stock of the Company equal to 3.0% of the aggregate number of shares sold
in the offering (150,000 shares of Common Stock), plus any shares underlying the
Warrants. Rodman’s warrant has the same terms as the Warrants issued to the
Purchasers in the offering except that the warrant is not exercisable until the
6-month anniversary of the closing and the exercise price is 125% of the per
share purchase price of the shares issued in the offering ($5.00 per
share). In addition, subject to compliance with Financial Industry
Regulatory Authority ("FINRA") Rule 5110(f)(2)(D), the Company reimbursed
Rodman’s out-of-pocket accountable expenses actually incurred in the amount of
$25,000.
Net
proceeds from the offering are planned to be used by the Company for working
capital purposes, and also may be used by the Company to fund the Company’s
acquisition from CAMAC of the Contract Rights with respect to the Oyo Field,
which began production in December 2009.
6
Our History and Corporate
Structure
General
The
Company was incorporated in the State of Delaware in 1979 under the name “Gemini
Marketing Associates, Inc.” In 1994, the Company changed its name
from “Gemini Marketing Associates, Inc.” to “Big Smith Brands,
Inc.”; in 2006 it again changed its name to “Pacific East Advisors,
Inc.”; and in 2007 it again changed its name to “Pacific Asia
Petroleum, Inc.” As Big Smith Brands, Inc., the Company operated as an apparel
company engaged primarily in the manufacture and sale of work apparel, and was
listed on the Nasdaq Stock Market’s Small-Cap Market from 1995 until December 4,
1997, and the Pacific Stock Exchange from 1995 until April 1,
1999. In 1999, the Company sold all of its assets related to its
workwear business to Walls Industries, Inc., and in 1999 filed for voluntary
bankruptcy under Chapter 11 of the United States Bankruptcy Code. The final
bankruptcy decree was entered on August 8, 2001, and thereafter the Company
existed as a “shell company,” but not a “blank check” company, under regulations
promulgated by the SEC and had no business operations and only nominal assets
until May 2007, when it consummated the mergers of Inner Mongolia Production
Company LLC (“IMPCO”) and Advanced Drilling Services, LLC (“ADS”) into
wholly-owned subsidiaries of the Company. See “The Mergers”
below. In December 2007, the Company merged these wholly-owned
subsidiaries into the parent company, resulting in the cessation of the separate
corporate existence of each of IMPCO and ADS and the assumption by the Company
of the businesses of IMPCO and ADS. In connection with the mergers,
the Company changed its name from “Pacific East Advisors, Inc.” to “Pacific Asia
Petroleum, Inc.” In July 2008, the Company consummated the merger of
Navitas Corporation, a Nevada corporation whose sole assets were comprised of
Company Common Stock and certain deferred tax assets, with and into the Company,
and the separate corporate existence of Navitas Corporation ceased upon
effectiveness of the merger. On November 5, 2009, the Company’s
common stock became listed on the NYSE Amex under the symbol “PAP.”
Subsidiaries and Joint
Ventures
The
following summarizes the corporate structure of PAP and its subsidiaries (“we,”
“our,” “us,” or the “Company”), and its joint venture partner.
Inner Mongolia Production Company
(HK) Limited
– In December 2005, the
Company formed a Hong Kong corporation, Inner Mongolia Production Company (HK)
Limited, which is a wholly-owned subsidiary of the Company (“IMPCO HK”), for the
purpose of entering into certain business transactions in
China. IMPCO HK is a joint venture partner in Inner Mongolia Sunrise
Petroleum Co. Ltd., described in more detail below.
Inner Mongolia Sunrise Petroleum Co.
Ltd. and Beijing Jinrun Hongda Technology Co., Limited – In March 2006, the Company
formed Inner Mongolia Sunrise Petroleum Co. Ltd.(“IMPCO Sunrise”), a Chinese
joint venture company which is owned 97% by IMPCO HK and 3% by Beijing Jinrun
Hongda Technology Co., Ltd. (“BJHTC”), an unaffiliated Chinese
corporation. The Company formed IMPCO Sunrise as an indirect
subsidiary to engage in Chinese energy ventures. Under Chinese law, a
foreign-controlled Chinese joint venture company must have a Chinese partner.
BJHTC is IMPCO HK’s Chinese partner in IMPCO Sunrise. IMPCO Sunrise is governed
and managed by a Board of Directors comprised of three members, two of whom are
appointed by IMPCO HK and one by BJHTC. Through December 31, 2008
IMPCO HK advanced a total of $400,507 to BJHTC, which then invested that amount
in IMPCO Sunrise and issued notes to IMPCO HK for that amount. The notes a were
repayable in Chinese yuan (“RMB”). As of December 31, 2008, IMPCO HK
recorded an impairment adjustment of $273,618 on these notes to reduce the
carrying amount to $386,415. Based upon the delay in achieving net income in
IMPCO Sunrise, the impact of the significant decline in the price of oil in the
second half of 2008, the amount of uncollected interest on the note, and the
required date for repayment, it was determined in the fourth quarter of 2008
that the note was impaired. The impairment adjustment included the write-off of
accrued interest included in the principal balance. BJHTC is
obligated to apply any remittances received from IMPCO Sunrise directly to IMPCO
HK. IMPCO Sunrise is authorized to pay these remittances directly to IMPCO HK on
BJHTC’s behalf, until the debt is satisfied. On December 31, 2009 the total
recorded capital of IMPCO Sunrise was reduced by agreement among IMPCO Sunrise
and its owners, and the reduction (including the BJHTC share) was reclassified
as an intercompany loan from IMPCO HK to IMPCO Sunrise. The outside
note receivable of IMPCO HK from BJHTC was reduced as a result, without
recording any additional impairment adjustment. The recorded
balance for this note receivable was $33,015 at December 31,
2009. IMPCO Sunrise is a party to the Chifeng Agreement and is
pursuing the Chifeng
opportunity as described above.
7
Pacific Asia Petroleum, Limited –
In September 2007, the Company formed Pacific Asia Petroleum, Limited
(“PAPL”) as a wholly-owned Hong Kong corporate subsidiary of the Company for the
purpose of entering into certain business transactions in China. The
Company is the sole shareholder of PAPL.
Pacific Asia Petroleum (HK) Limited
– In May 2008, the Company formed a Hong Kong corporation, Pacific Asia
Petroleum (HK) Limited, which is a wholly-owned subsidiary of the Company (“PAP
HK”), for the purpose of entering into certain business transactions in
China. PAP HK has not entered into any transactions to
date.
Pacific Asia Petroleum Energy
Limited – In April 2009, the Company formed a Hong Kong corporation,
Pacific Asia Petroleum Energy Limited (“PAPE”), which, after the transfer of
PAPE shares to BSG, is 70% owned by PAP and 30% owned by BSG, in connection with
the establishment of the Company’s Enhanced Oil Recovery and Production program
and operations (“EORP”), as described in greater detail below.
Beijing Dong Fang Ya Zhou Petroleum
Technology Service Company Limited – In September 2009, the Company
formed Beijing Dong Fang Ya Zhou Petroleum Technology Service Company Limited
(“Dong Fang”), a Chinese joint venture company which is owned 75.5% by PAPE and
24.5% by LXD. Dong Fang was formed in connection with the Company’s
EORP program and operations, as described in greater detail below.
CAMAC Petroleum Limited – In
December 2009, the Company formed a Nigerian corporation, CAMAC Petroleum
Limited, which is a wholly-owned subsidiary of the Company, for the purpose of
acquiring the Oyo Field production sharing contract interest as described
elsewhere in this report.
8
The
following chart reflects our current corporate organizational
structure:
Our
executive offices are located at 250 East Hartsdale Ave., Suite 47, Hartsdale,
New York 10530 and our telephone number is (914) 472-6070. We also have an
office located in Beijing, China. We maintain a website at www.papetroleum.com
that contains information about us, but that information is not a part of this
report.
The
Company’s annual reports on Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K, and amendments to those reports filed or furnished pursuant
to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended
(the “Exchange Act”) are available on the Company’s website free of charge as
soon as practicable after such reports are electronically filed or furnished to
the SEC. Investors may also register on the Company’s website to
receive updates about the Company.
Our
Industry
China’s
Oil and Gas Industry
After
slowing in 2008 and early 2009, economic growth in China accelerated in recent
quarters and is expected to continue at a faster pace than in the countries of
the Organization of Economic Cooperation and Development (“OECD”) and most other
developing countries, as will China’s consumption of increasing amounts of
energy. Despite significant recent improvements in energy efficiency, China’s
economy is still less energy-efficient than the U.S.’s economy, requiring nearly
twice as many BTUs per dollar of Gross Domestic Product (“GDP”). As a
result, China's growth is expected to continue to amplify the country’s
increasing energy demand for some time (U.S. Department of Energy: International Energy Annual
& International
Petroleum Monthly). China’s GDP grew to
$4.33 trillion in 2008 at market exchange rates (World Bank data), making China
the 3rd
largest economy in the world, with output only 12% below that of
Japan. China passed Japan in late 2003 to become the world’s second
largest petroleum consumer. According to data from the U.S. Department of
Energy, between 2000 and 2008, oil use in China grew by an average of 6.3% per
year. In 2008, Chinese demand reached 7.8 million barrels per day, more than
one-third the level in the United States. At the same time, domestic crude oil
output in China has grown more slowly over the past five years, forcing imports
to expand rapidly to meet demand. Since 2000, China’s oil imports have more than
doubled, growing from 1.4 million barrels per day to 3.6 million barrels per day
in 2008, when they accounted for nearly half of Chinese oil demand.
9
According
to testimony by Jeffrey Logan, Senior Energy Analyst and China Program Manager
at the International Energy Agency, to the U.S. Senate Committee on Energy and
Natural Resources on February 3, 2005, China has become an economic superpower
and now plays a key role in the supply and demand of many global commodity
markets, including oil. He indicated that while China’s historical growth was
not dependent on energy, its growth was now very dependent on the development
and growth of oil and gas, with every one percent increase in GDP causing energy
demand to grow by over 1.5 percent. Although the Chinese government
has set a goal of reducing per-GDP energy consumption by 20% between 2005 and
2010, the strong linkage between energy and China’s economic growth is reflected
in the forecasts of the International Energy Agency (“IEA”). In its
2008 World Energy Outlook, the IEA projected that China’s petroleum demand would
continue to grow at 3.5% per year through 2030, increasing by 9 million barrels
per day and accounting for 43% of global oil demand growth over this period. Nor
is the energy impact of China’s growth confined to oil. In its latest
forecast, the IEA expects China and India together to account for more than half
of all incremental global energy demand through 2030, including over 1.3 million
MW of new power generation in China, along with a rapid increase in natural gas
consumption.
Natural
gas represents a particularly under-utilized energy source in China, supplying
only 3% of the country’s energy needs, compared with 23% globally and in the
U.S. We believe that its low emissions, combined with the low cost and high
efficiency of gas turbines, make gas an attractive fuel for meeting China’s
future electric power demand. This will be particularly important in light of
China's newly-announced goal of reducing the carbon-intensity of its economy by
40-45% by 2020, compared to 2005, in light of the much lower emissions from
gas-fired power plants relative to those burning coal. The Chinese government
has indicated that it would like to expand gas use significantly, and the
National Development and Reform Commission has set a goal of increasing gas’
share of the market to 5.3% by 2010 (U.S. Department of Energy: International Energy Annual & International Petroleum
Monthly). China’s
domestic natural gas production increased to 76 billion cubic meters (2.7
trillion cubic feet) in 2008 (China National Bureau of Statistics) and is
planned to double to 160 billion cubic meters (5.7 trillion cubic feet) by 2015
(China Daily, quoting
an official of the Ministry of Land and Resources). In spite of this
expansion, some sources foresee a gas supply shortfall as large at 90 billion
cubic meters per year by 2020.
The
government of China has taken a number of steps to encourage the exploitation of
oil and gas within its own borders to meet the growing demand for oil and to try
to reduce its dependency on foreign oil. Notably, the government has reduced
complicated restrictions on foreign ownership of oil exploitation projects and
has passed legislation encouraging foreign investment and exploitation of oil
and gas.
Through
successive “Five Year Plans,” China has undertaken a strategic reorganization in
the oil industry by means of market liberalization, internalization,
cost-effectiveness, scientific and technological breakthrough and sustainable
development. Changes were made in the structures of oil reservation and
exploration such as permitting more oil imports into the domestic market and
allocating a greater percentage of oil and gas in non-renewable energy
consumption. The reorganization was aimed at ensuring a smooth and sustainable
oil supply, at low cost and meeting a goal for sound economic growth. The
guiding principles of reform focused on developing the domestic market by
expanding exploration efforts while practicing conservation and building oil
reserves. These efforts focused on building key infrastructure for oil and gas
transportation and storage by targeting the development of oil and gas pipelines
to a target of 14,500 km in total length, and building storage facilities,
including a strategic petroleum reserve of approximately 100 million barrels and
facilities for 1.14 billion cubic meters of gas (40 billion cubic feet). In
order to further technical development and innovation, substantial resources
were devoted to oil and gas exploration.
10
Chinese
policymakers and state-owned oil companies have embarked on a multi-pronged
approach to improve oil security by diversifying suppliers, building strategic
oil reserves, purchasing equity oil stakes abroad, and enacting new policies to
lower demand. When it became a net oil importer in 1993, almost all of China’s
crude imports came from Indonesia, Oman and Yemen. After diversifying global oil
purchases over the past decade, Chinese crude imports now come from a much wider
range of suppliers. In 2008, Saudi Arabia was China’s largest supplier,
accounting for 20 percent of imports, followed by Angola, Iran, Oman and
Russia. 50% of China’s crude oil imports come from the Middle East,
and 30% from Africa (U.S. Department of Energy: China Country Analysis
Brief.) The
three major government-owned oil companies in China are (i) China Petroleum
& Chemical Company, or “Sinopec,” (ii) China National Offshore Oil
Corporation, or “CNOOC,” and (iii) PetroChina Company Limited, or “PetroChina”
(also sometimes referred to as “China National Petroleum Corporation” or “CNPC,”
which is the government company owning the majority of PetroChina). PetroChina
is China’s largest producer of crude oil and natural gas and has operations in
29 other countries. Sinopec is China’s largest refining, storage and
transmission company. CNOOC is China’s largest offshore oil and gas exploration
and development company. Each of these companies has been granted a charter by
the Chinese government to engage in various stages of oil and gas procurement,
transportation and production in China. Substantially all oil and gas
exploration, storage and transportation by foreign entities in China must be
conducted via joint ventures with one of these companies, or with another
Chinese company that has entered into an arrangement with one of these companies
and been authorized by the appropriate government authorities to engage in such
activities in China.
Unlike
the developed petroleum markets of the member countries of the OECD, the oil
market in China still includes important elements of central planning. Each
year, the National Development and Reform Commission publishes the projected
target for the production and sale of crude oil by the three state oil
companies, based on the domestic consumption estimates submitted by domestic
producers, including PetroChina, Sinopec and CNOOC, the production capacity of
these companies, and the forecast of international crude oil prices. The actual
production levels are determined by the producers themselves and may vary from
the submitted estimates. PetroChina and Sinopec set their crude oil median
prices each month based on the average Singapore market FOB prices for crude oil
of different grades in the previous month. In addition, PetroChina and Sinopec
negotiate a premium or discount to reflect transportation costs, the differences
in oil quality, and market supply and demand. The National Development and
Reform Commission will mediate if PetroChina and Sinopec cannot agree on the
amount of premium or discount.
While the
barriers to entry for foreign entities to engage in the development of oil and
gas resources in China have recently eased, we believe that many small companies
still face significant hurdles due to their lack of experience in the Chinese
petroleum industry. Development requires specialized grants and permits,
experience with operating in and China and dealing with challenging cultural and
political environments in remote regions and the ability to manage projects
efficiently during times of resource shortages. The Company hopes to take
advantage of the energy development opportunities that exist in China today by
leveraging its management team’s prior exploration experiences in China and
existing relationships with oil industry executives and government officials in
China. In addition, we believe that members of the Company’s production team
have the hands-on experience with projects in Asia that we believe is essential
to any successful petroleum project in China.
China’s
economic growth has been affected by the global financial crisis and recession,
declining to a year-on-year rate of 6.8% in the fourth quarter of
2008. However, by the third quarter of 2009 growth had rebounded to
8.9%, due in large part to a government fiscal stimulus amounting to 4 trillion
RMB ($586 billion), which included investment in energy infrastructure (World
Bank: China Quarterly Update,
December 2008 and November 2009). Estimates indicate growth
should average 8% for 2009 and continue at or above that level into 2010 (World
Bank website.) We believe China remains a very attractive investment opportunity
as the global economy begins to recover.
11
The
Nigerian Oil and Gas Industry
If the
closing occurs on our acquisition of the Contract Rights from CAMAC with respect
to the Oyo Field, we will also have an interest in the Nigerian oil and gas
industry. Nigeria is classified as an emerging market, and is rapidly
approaching middle income status, with its abundant supply of resources,
well-developed financial, legal, communications, transport sectors and stock
exchange (the Nigerian Stock Exchange), which is the second largest in Africa.
Nigeria is ranked 37th in the world in terms of GDP (PPP) as of 2007. Nigeria is
the United States' largest trading partner in sub-Saharan Africa and supplies a
fifth of the U.S.’s imported oil (11% of oil imports). It has the
seventh-largest trade surplus with the U.S. of any country worldwide. Nigeria is
currently the 50th-largest export market for U.S. goods and the 14th-largest
exporter of goods to the U.S. The United States is the country's largest foreign
investor. The bulk of economic activity is centered in four main cities: Lagos,
Kaduna, Port Harcourt, and Abuja. Beyond these four economic centers,
development is marginal.
According
to Oil and Gas Journal (“OGJ”), Nigeria had an estimated 36.2 billion barrels of
proven oil reserves as of January 2009. The majority of reserves are found along
the country’s Niger River Delta and offshore in the Bight of Benin, the Gulf of
Guinea and the Bight of Bonny. Current exploration activities are mostly focused
in the deep and ultra-deep offshore with some activities planned in the Chad
basin, located in the northeast of the country.
Nigeria
is an important oil supplier to the United States. Over half of the country’s
oil production is exported to the United States (see exports below) and the
light, sweet quality crude is a preferred gasoline feedstock. Consequently,
disruptions to Nigerian oil production impacts trading patterns and refinery
operations in North America and often affect world oil market
prices.
Since
December 2005, Nigeria has experienced increased pipeline vandalism, kidnappings
and militant takeovers of oil facilities in the Niger Delta. The Movement for
the Emancipation of the Niger Delta (“MEND”) is the main militant organization
attacking oil infrastructure for political objectives, claiming to seek a
redistribution of oil wealth and greater local control of the sector.
Additionally, kidnappings of oil workers for ransom are also common and security
concerns have led some oil services firms to pull out of the country and oil
workers unions threatening to strike over security issues for their
members.
The
instability in the Niger Delta has caused significant amounts of shut-in
production and several companies declaring force majeure on oil
shipments. The U.S. Energy Information Administration (“EIA”)
estimates Nigeria’s effective oil production capacity to be around 2.7 million
barrels per day (bbl/d) but as a result of attacks on oil infrastructure, 2008
monthly oil production ranged between 1.8 million bbl/d and 2.1 million bbl/d.
Additional supply disruptions for the year were the result of worker strikes
carried out by the Petroleum and Natural Gas Senior Staff Association of Nigeria
(“PENGASSAN”) that shut-in 800,000 bbl/d of ExxonMobil’s production for about 10
days in late April/early May.
In 2008,
Nigerian crude oil production averaged 1.94 million bbl/d, making it the largest
crude oil producer in Africa. If current shut-in capacity were to have been
online, EIA estimates that Nigerian production could have reached 2.7 million
bbl/d in 2008. As a member of the Organization of Petroleum Exporting Countries
(“OPEC”), Nigeria has agreed to abide by allotted crude production limits that
have varied over the years but do not appear to have an impact on production
volumes or investment decisions to the same degree as unrest in the Niger
Delta.
The major
foreign producers in Nigeria are Shell, Chevron, ExxonMobil, Total, and
Eni/Agip. Recent developments in the upstream sector include the start up of the
Chevron-operated Agbami field in September 2008, with expected peak production
of 250,000 bbl/d by the end of 2009.
12
Non-crude
petroleum production was about 230,000 bbl/d in 2008, bringing total oil
production to 2.17 million bbl/d for the year. This amount should increase in
the short-term with Total’s Akpo condensate field coming onstream in 2009 and
expected to peak at 180,000 bbl/d.
In 2008,
Nigerian exported most of its 2.17 million bbl/d of oil production
(approximately 1.9 million bbl/d were exported). Of this, 990,000 bbl/d (44
percent) was exported to the United States, making Nigeria the 5th largest
foreign oil supplier to the United States. Over the past year, volatility in
Nigerian oil supplies has led some U.S. refiners to stop purchasing Nigerian
crudes.
Additional
importers of Nigerian crude oil include Europe (25 percent), Brazil (7 percent),
India (11 percent) and South Africa (4 percent). Despite shut-in production,
Nigerian trade patterns appear to have remained stable over the past year, most
of which can be attributed to capacity additions from the Chevron-operated
Agbami oilfield in September 2008 combined with slightly decreasing domestic
consumption and declining world demand.
13
Nigeria
has six export terminals including Forcados and Bonny (operated by Shell);
Escravos and Pennington (Chevron); Qua Iboe (ExxonMobil) and Brass (Agip) with
deeper offshore production being exported directly from the Floating Production
Storage and Offloading (“FPSO”) vessels. According to the Energy Intelligence
Group’s International Crude Oil Market Handbook, Nigeria’s export blends are
light, sweet crudes, with gravities ranging from API 29 – 47 degrees and low
sulfur contents of 0.05 – 0.3 percent. Most Nigerian crudes trade at a premium
to Brent, the North Sea benchmark crude.
Principal
Business Strategy
The
Company is a development-stage company formed to develop new energy ventures,
directly and through joint ventures and other partnerships in which it may
participate.
China
Strategy
In 2006,
the Company commenced operations in China and is currently engaged in the
business of oil and gas exploration, development, production and distribution in
China. The Company has entered into a production sharing contract for CBM, an
oil development opportunity, letters of intent for joint cooperation on a gas
distribution venture, and agreements related to EORP activities in
China. The Company has also entered into a contract for the
acquisition of an interest in a production sharing contract on an oilfield in
Nigeria called the Oyo Oil Field, discussed elsewhere in this
report.
The
Zijinshan PSC
On
October 26, 2007, PAPL entered into the Zijinshan PSC with CUCBM, the Chinese
Government-designated company holding exclusive rights to negotiate with foreign
companies with respect to CBM production, covering an area in the Shanxi
Province of China referred to as the Zijinshan Block (the “CUCBM Contract
Area”). The CUCBM Contract Area is approximately 175,000 acres, and
is in proximity to the major West-East gas pipeline and the Ordos-Beijing gas
pipelines which link the gas reserves in China’s western provinces to the
markets of the Yangtze River Delta, including Shanghai. The PSC provides, among
other things, that PAPL, following approval of the PSC by the Ministry of
Commerce of China, has a minimum commitment for the first three years to drill
three exploration wells and to carry out 50 km of 2-D seismic data
acquisition (an estimated expenditure of $2.8 million), and in the
fourth and fifth years PAPL will drill four pilot development wells
at an estimated cost of $2 million (in each case subject to PAPL’s right to
terminate the Zijinshan PSC). That five year period constitutes the exploration
period, which is subject to extension. During the development and production
period, CUCBM will have the right to acquire a 40% participating interest and to
work jointly and pay its participating share of costs to develop and produce CBM
under the Zijinshan PSC. Pursuant to the Zijinshan PSC, all CBM
resources (including all other hydrocarbon resources) produced from the CUCBM
Contract Area are to be shared as follows: (i) 70% of production is
provided to PAPL and CUCBM for recovery of all costs incurred; (ii) PAPL has the
first right to recover all of its exploration costs from such 70% and then
development costs are recovered by PAPL and CUCBM pursuant to their respective
participating interests; and (iii) the remainder of the production is split by
CUCBM and PAPL receiving between 99% and 90% of such remainder depending on the
actual producing rates (a sliding scale) and the balance of the remainder
(between 1% and 10%) is provided to the government of China. The
Zijinshan PSC has a term of 30 years and was approved by the Ministry of
Commerce of China in April 2008. In December 2008, the Company and
CUCBM finalized a mutually agreed work program pursuant to which the Company may
immediately commence exploration operations under the Zijinshan
PSC.
14
During
2009, the Company completed seismic data acquisition operations on the Zijinshan
Block and spent approximately $1.5 million to shoot 162 kilometers of seismic
under the work program. Based on the seismic interpretation, four
potential well locations were identified. A regional environmental
impact assessment study (“EIA”) has also been completed. Following
completion of a site-specific EIA study, the Company spudded well ZJS 001 on
September 30, 2009. This well intersected 4/5 coal seams in the
Shanxi formation and 8/9 coal seams in the Taiyuan formation as
anticipated. The well reached total depth in mid-November
2009. Core samples have undergone laboratory testing, including tests
for gas content, gas saturation and coal characteristics. Based on
the results of these tests, at the latest Zijinshan PSC Joint
Management Committee (JMC) meeting, the Company agreed to a 2010 work program
which includes undertaking further technical studies related to the CUCBM
Contract Area and drilling at least two additional wells there.
Chifeng
Oil Development Opportunity in Inner Mongolia
Inner
Mongolia, China’s northern border autonomous region, features a long, narrow
strip of land sloping from northeast to southwest. It stretches 2,400 km from
west to east and 1,700 km from north to south. Inner Mongolia traverses between
northeast, north, and northwest China. The third largest among China’s
provinces, municipalities, and autonomous regions, the region covers an area of
1.18 million square km, or 12.3% of the country’s territory. It neighbors eight
provinces and regions in its south, east and west and Mongolia and Russia in the
north, with a borderline of 4,200 km. In 2005 China and the Inner Mongolia
Municipality awarded to Chifeng the exclusive authority to develop and exploit
oil resources in the area known as the “ShaoGen Contract Area,” an area of
approximately 353 square kilometers located in Chifeng, China. In 2005 and 2006,
Chifeng drilled several wells throughout the ShaoGen Contract Area and
discovered oil.
In July
2006, the Company’s management began discussions with Chifeng and hired an
independent Chinese oil consultant to conduct a feasibility study on the
Company’s behalf. This feasibility study concluded that based on “investigation
and research in-depth for oil resources, exploitative environment and
international markets, it is feasible for exploitation of oil and gas . . .” The
report contained the following conclusions:
·
|
There
is a very high potential for oil resources with excellent geological
conditions for petroleum;
|
·
|
A
very significant oil field (part of the Liahoe oilfield, known as the
Kerqing oilfield) was discovered in the area, which makes drilling in the
ShaoGen Contract Area favorable;
and
|
·
|
The
petroleum system has been proved as there are existing wells in the area
with tested transmission infrastructure in
place.
|
In August
2006, the Company (through IMPCO Sunrise) and Chifeng entered into a Contract
for Cooperation and Joint Development (the “Chifeng Agreement”), setting forth
the terms and conditions for carrying out work and exploiting the development
acreage in the ShaoGen Contract Area owned by Chifeng (the “Development Area”).
Under the Chifeng Agreement:
15
·
|
Chifeng
is responsible for selecting well locations in consultation with the
Company;
|
·
|
Chifeng
has overall authority, responsibility and management over the Development
Area and all operations in the
field;
|
·
|
Chifeng
is responsible for drilling successive wells until there is a completed
successful well (defined as a well having produced at a minimum average
rate of 2-3 tons/day of crude oil over the first 60-day period, with the
Company owning 100% of the oil produced within such 60-day
period);
|
·
|
The
Company paid Chifeng 50% of the cost to drill the initial well (1,500,000
RMB, or approximately US$200,000 at the time of payment) as a
deposit;
|
·
|
The
Company is required to pay: (a) the same amount for the next two wells
after each successful well has been drilled, which at December 31, 2009
was approximately US$220,000; and (b) 1,500,000 RMB (about $220,000) for
each successful well; and (c) a 5% royalty/management fee from the gross
production of crude oil, which shall be paid “in kind” to
Chifeng;
|
·
|
The
balance of oil production will be owned by the Company. The Company is
obligated to provide the balance of the oil produced to Chifeng and
Chifeng is obligated to sell such oil on behalf of the
Company. Chifeng is obligated to pay the Company for such oil
at the same price as the oil is sold by Chifeng to a third
party;
|
·
|
The
funds paid by the Company to Chifeng under the Chifeng Agreement shall be
the total cost to be paid to Chifeng for carrying out the drilling and
other operations for a period of 20
years;
|
·
|
All
cost overruns in carrying out the work under the Chifeng Agreement are
required to be borne by Chifeng. This is a turnkey contract with a
guaranteed cost;
|
·
|
The
Company will continue to receive the revenues from the production of such
wells for a term of 20 years from the date that each well is determined to
be successful; and
|
·
|
Chifeng
is responsible for all health and safety matters, and for obtaining
insurance covering personnel and
equipment.
|
Pursuant
to the Chifeng Agreement, drilling operations commenced in October
2006. The first well drilled by Chifeng discovered oil and has been
completed as a producing well, but production operations were suspended in 2007
pending receipt of a production license from the Chinese government. Chifeng has
accounted for the Company’s share of the production revenue from the first
producing well in the form of a credit, which will be allocated to the Company
retroactively when and if the Production License is issued. Operations are
anticipated to resume when and if the Production License is received. To date,
the total production from the well has been approximately 400 tons of crude oil
(all of which has been sold) and total producing revenues credited to the
Company (after costs and royalties) were approximately $135,000. If a Production
License is not received, the Company will seek, but is not contractually
guaranteed, reimbursement from Chifeng for the Company’s outstanding
costs.
The
Company is pursuing a combination of strategies to have such production license
awarded, including a possible renegotiation of the Chifeng Agreement with the
goal of increasing the financial incentives to all the parties involved, and the
Company is also pursuing a strategy focused on entering into negotiations with
respect to an opportunity to participate in the existing production from the 22
sq. km. Kerqing Oilfield. Participation in the Kerqing Oilfield could
significantly enhance the Chifeng Agreement in scale and value. If
this Production License is not issued, the opportunities to drill additional
long-term production wells under the contract, including future production from
this first well, will be at risk. At December 31, 2009, there was no certainty
that any of these strategies will ultimately succeed in the Company obtaining a
Production License for the Chifeng area, but the Company intends to continue in
these efforts. Due to these significant uncertainties, the Company recorded an
impairment loss on its Chifeng investment in the fourth quarter of
2009.
16
Gas Distribution
Network
The
Company entered into a Letter of Intent in November 2008, to possibly acquire a
51% ownership interest in the Handan Chang Yuan Natural Gas Co., Ltd. (“HGC”)
from the Beijing Tai He Sheng Ye Investment Company Limited. HGC owns and
operates gas distribution assets in and around Handan City, China. HGC was
founded in May 2001, and is the primary gas distributer in Handan City, which is
located 250 miles south of Beijing, in the Hebei Province of the People’s
Republic of China. HGC has over 300,000 customers and owns 35 miles of a main
gas pipeline, and more than 450 miles of delivery gas pipelines, with a delivery
capacity of 300 million cubic meters per day. HGC also owns an 80,000
sq. ft. field distribution facility. Gas is being supplied by Sinopec and
PetroChina from two separate sources. On July 7, 2009 the Company
entered into a revised Letter of Intent with Handan Hua Ying Company Limited
(“Handan”) relating to the possible acquisition of a 49% ownership interest in
HGC. The Company will continue its evaluation of this possible
acquisition including the possibility of bringing in partners.
Enhanced
Oil Recovery and Production (“EORP”)
On May
13, 2009, PAP and its wholly-owned Hong Kong subsidiary, PAPE, entered into a
Letter of Understanding (“LOU”), which was amended and further detailed in
various other associated agreements that were executed on June 7, 2009, with Mr.
Li Xiangdong (“LXD”) and Mr. Ho Chi Kong (“HCK”), pursuant to which the parties
agreed to form Beijing Dong Fang Ya Zhou Petroleum Technology Service Company
Limited(“Dong Fang”) as a new Chinese joint venture company, to be 75.5% owned
by PAPE and 24.5% owned by LXD, into which LXD would assign certain
pending patent rights related to chemical enhanced oil recovery (the “LXD
Patents”). Dong Fang was officially incorporated under Chinese law on
September 24, 2009. As required by the LOU, and pursuant to that certain
Agreement on Cooperation, dated June 7, 2009, and as amended on June 25, 2009
(the “AOC”), entered into by and between PAPE and LXD, upon the effectiveness of
the assignment of the LXD Patents to Dong Fong by LXD on November 27, 2009, (i)
the Company paid LXD and HCK $100,000 each, (ii) PAP has issued shares of PAPE
to Best Source Group Holdings Limited, a Hong Kong company designated by HCK
(“BSG”), to provide BSG with a 30% ownership interest in PAPE, with the Company
retaining the balance 70% ownership interest in PAPE, and (iii) the Company has
issued to HCK’s designee 100,000 shares of Common Stock of the Company and
options to purchase up to 400,000 additional shares of Common Stock of the
Company. These options were approved for issuance by the Board of Directors on
January 21, 2010 at an exercise price of $4.62 per share, which was the closing
sale price of the Company’s Common Stock at that date the Company’s issuance
obligation was triggered upon achievement of the applicable milestone under the
LOU on November 27, 2009 as reported by NYSE Amex. The Company has also agreed
to issue 300,000 more shares of Company Common Stock to HCK or his designee upon
the signing of certain contracts by Dong Fang with respect to the Fulaerjiqu
oilfield. All the options granted to HCK do not vest
immediately; vesting will be contingent upon the achievement of certain
milestones related to the entry by Dong Fang into certain EORP-related
development contracts pertaining to oilfield projects in the Fulaerjiqu
Oilfield. These contracts are anticipated to each deliver to Dong Fang a
significant percentage of the incremental oil production and/or fixed fees per
ton for the incremental production which results from using the technology
covered by the LXD Patents.
In
addition, LXD has been engaged as a consultant by Dong Fang to provide research
and development services, training, and assistance in promoting certain other
opportunities developed by him that target the application of the technology
embodied in the LXD Patents, including assistance with entering into a contract
with respect to the Liaohe Oilfield (the “Liaohe Contract”), and helping to
develop projects in both the Shandong Province and the Xinjiang autonomous
region of the People’s Republic of China for the provision and application of
technology and chemicals developed by LXD.
The
Company has agreed to loan up to $5 million to PAPE, which may then invest up to
RMB 30,000,000 (approximately $ 4.4 million) into Dong Fang, with a portion of
this being a requirement to invest RMB 22,650,000 as PAPE’s share of the
registered capital of Dong Fang, when and to the extent required under
applicable law. PAPE’s capital investment will be used by Dong Fang
to carry out work projects, fund operations, and to make, together with PAPE,
aggregate payments of up to $1.5 million in cash to LXD and HCK. The payments of
up to $1.5 million in cash to LXD and HCK are subject to the
achievement of certain milestones pursuant to the LOU, including the formation
of Dong Fang, the transfer of the LXD Patents to Dong Fang, and the signing of
the contracts with respect to the Fularjiqu Oilfield and the Liaohe Contract by
Dong Fang, as well as certain production-based milestones resulting from the
implementation of these contracts. As of December 31, 2009, $500,000 of
milestone payments had been paid or accrued by PAPE. The loan from the Company
to PAPE will be repaid from funds distributed to PAPE by way of dividends or
other appropriate payments from Dong Fang. As of December 31, 2009,
the Company has loaned a total of $1.3 million to PAPE, and PAPE has invested a
total of RMB 4.8 million (approximately US$700,000) into Dong Fang.
17
In
accordance with the terms of the LOU, as amended on June 7, 2009, PAPE, LXD and
the Company’s existing Chinese joint venture company, Inner Mongolia Sunrise
Petroleum Co. Ltd. (“IMPCO Sunrise”), entered into an Assignment Agreement of
Application Right for Patent, Consulting Engagement Agreement, and an Interest
Assignment Agreement. Upon formation of Dong Fang on September 24,
2009, all these and other agreements entered into by IMPCO Sunrise on behalf of
Dong Fang were assigned by IMPCO Sunrise to Dong Fang.
With
these EORP-related agreements signed and in place, the Company through Dong Fang
has commenced operations in various oil fields located in the Liaoning,
Shandong, and Xinjiang Provinces in China. In the
year ended December 31, 2009, the Company recorded initial revenues,
cost of sales and expenses from the EORP business activities.
Strategy
in Nigeria
Oyo
Field Production Sharing Contract Interest
On
November 18, 2009, the Company entered into the Purchase and Sale Agreement (the
“Purchase and Sale Agreement”) with CAMAC Energy Holdings Limited and certain of
its affiliates (“CAMAC”) pursuant to which the Company agreed to acquire all of
CAMAC’s 60% interest in production sharing contract rights with respect to that
certain oilfield asset known as the Oyo Field (the “Contract Rights”) and the
transactions contemplated thereby, including the election of directors of the
Company (the “Transaction”). The Purchase and Sale Agreement,
provides that, among other things: (i) CAMAC will transfer the Contract Rights
to CAMAC Petroleum Limited, a newly-formed Nigerian entity wholly-owned by the
Company, in consideration for the Company’s payment of $38.84 million
in cash (subject to possible reduction pursuant to the agreement in
principle between CAMAC and the Company which will reduce such
payment amount by a portion of CAMAC’s net cash flow generated by
production from the Oyo Field through the closing of the Transaction) and the
issuance of the Company’s Common Stock, par value $0.001 per share, equal to
62.74% of the Company’s issued and outstanding Common Stock, after giving effect
to the Transaction; and (ii) for a period commencing on the closing of the
transactions contemplated by the Purchase and Sale Agreement (the “Closing”) and
ending the date that is one year following the Closing, the Company’s Board of
Directors will consist of seven members, four of whom will be nominated by
CAMAC.
The
Transaction is expected to close during the first quarter of 2010, and is
subject to the satisfaction of customary and other conditions to Closing,
including, without limitation: (i) the negotiation and entry by the
parties into certain other agreements as set forth in the Purchase and Sale
Agreement in forms reasonably satisfactory to the parties; (ii) the Company’s
consummation of a financing on terms reasonably acceptable to CAMAC resulting in
gross proceeds of at least $45 million to the Company ; and (iii) the approval
of the Company’s stockholders of the Purchase and Sale Agreement and the
transactions contemplated thereby. The Purchase and Sale Agreement also
contains other customary terms, including, but not limited to, representations
and warranties, indemnification and limitation of liability provisions,
termination rights, and break-up fees if either
party terminates under certain circumstances. The Company has already
raised $20 million in a financing (disclosed elsewhere in this report) from a
registered direct offering which was consummated on February 16,
2010. Net proceeds from the offering are planned to be used by the
Company for working capital purposes, and also may be used by the Company to
fund the Company’s acquisition from CAMAC of the Contract Rights with respect to
the Oyo Field, which began production in December 2009. The Company
plans to raise up to an additional $25 million in connection with its obligation
under the Purchase and Sale Agreement. However, if the Company is
unable to consummate such additional financing, agree upon the terms of the
other required agreements between the parties or satisfy any of the other
closing conditions set forth in the Purchase and Sale Agreement, the Company may
be unable to consummate the Purchase and Sale Agreement.
18
At the
Closing of the Transaction, and subject to stockholder approval prior to
Closing, the Company’s name will be changed to CAMAC Energy Inc. The
Transaction, if consummated, will result in a change of control of the
Company.
The
Oyo Field Oil Mining Lease
Allied
Energy Plc (“Allied”), a subsidiary of CAMAC, was awarded a deep offshore Oil
Prospecting License 210 (the “OPL 210”) on June 3, 1992 by the Ministry of
Petroleum Resources of Nigeria and assigned on September 30, 1992 an undivided
2.5% interest in the OPL 210 to CAMAC International (Nigeria) Limited (“CINL”),
a subsidiary of CAMAC. After commercial quantities of oil were identified in the
OPL 210, Allied successfully converted the OPL 210 into two Oil Mining Leases
(“OML”), one of which is the OML 120, each with a term of 20 years, commencing
from February 27, 2001. OML 120 contains the Oyo Field.
The Oyo
Field is located in the Gulf of Guinea approximately 75 miles off the Southern
Nigerian coast in deep-water, ranging in depth from 100 to 800 meters and
covering an area of approximately 910 km2. The Oyo Field within the
OML 120 has an average water depth of approximately 400 meters. The Oyo Field
came on stream with production in December 2009. CAMAC has reported to the
Company that production from the two producing wells has averaged between 12,000
bpd and 20,000 bpd since December 2009 and associated gas production has been
approximately 15 million cubic feet per day. Gas will be re-injected into
the field. The current development plan of the Oyo Field is for 10 years and
consists of initially four wells: two producer wells, one gas injection well and
one water injection well to maintain pressure. Gas injection is
expected to occur in the next several weeks. Additional production wells have
been proposed and a third production well may be drilled as early as the fourth
quarter of 2010. With the possible drilling of a third production
well, average production in 2011 is expected to possibly rise to between 23,000
and 25,000 bpd. In the Company’s December 2009 assessment of the valuation of
the interest it is acquiring in the Oyo field, it was projected that the net
present value was approximately $380 million. In the Company’s updated view,
using a reduced oil price scenario, and using an average production rate of only
15,000 bpd in 2010, and 23,000 bpd in 2011, the Company’s current estimated net
present value of the asset is approximately $330 million. The Oyo Field will
produce into the Floating Production Storage and Offloading (“FPSO”) vessel
constructed by Bumi Armada Berhad, the Armada
Perdana.
19
Some of
the nearby oilfields to the Oyo Field include (as shown in the above
map):
·
|
OML
125 (“Abo Oilfield”) and OPL 211 operated by Eni
S.p.A.;
|
·
|
OML
118 (“Bonga Oilfield”) operated by Shell; and
|
·
|
OML
133 (“Erha Oilfield”) operated by
Exxon.
|
The
Production Sharing Contract
On July
22, 2005, a Production Sharing Contract (the “PSC”) was signed among Allied,
CINL and Nigerian Agip Exploration Ltd (“NAE”), a subsidiary of Italy's ENI SpA
(one of the world’s largest international energy companies). Pursuant to the
PSC, NAE assumed the rights and obligations as the Operating Contractor to the
petroleum operations in the Oyo Field and was assigned an undivided 40% interest
in the OML 120. The parties to the OML 120 are represented by the
following diagram:
20
For
details regarding the Production Sharing Contract, see the Company’s preliminary
proxy statement on Schedule 14A, filed on December 31, 2009.
On
December 15, 2009, NAE and CAMAC announced that they had started the production
of the Oyo Field, less than 2 years from the date of the Oyo Field’s initial
sanctioning. The initial two subsea production wells are in water
depths of up to 400 meters, and are connected to the Armada Perdana Floating
Production Storage and Offloading (“FPSO”) vessel. The FPSO has a treatment
capacity of 40,000 barrels of liquids per day, with gas treatment and
re-injection facilities, and is capable of storing up to 1,000,000 barrels of
crude oil. The associated gas will be re-injected into the Oyo Field reservoir
by a third well, to prevent flaring and to maximize oil recovery. Additional
wells, including a third producer, may be drilled as warranted based on
production history.
Competition
The
Company anticipates that it will be competing with numerous large international
oil companies and smaller oil companies that target opportunities in markets
similar to the Company’s, including the CBM, natural gas and petroleum markets.
Many of these companies have far greater economic, political and material
resources at their disposal than the Company. The Company believes
that its management team’s prior experience in the fields of petroleum
engineering, geology, field development and production, operations,
international business development, and finance, together with its prior
experience in management and executive positions with Texaco Inc. and other
international energy companies and prior experience managing energy projects in
China and elsewhere, may provide the Company with a competitive advantage over
some of its competitors active in the region, particularly with respect to
relatively small opportunities that tend to be bypassed by larger companies.
Members of the Company’s management team also have experience in oil drilling,
operations, geological engineering, government and sales in China’s energy
sector. Nevertheless, the market in which we plan to operate is highly
competitive and the Company may not be able to compete successfully against its
current and future competitors. See “Part I, Item 1A. “Risks Related
to the Company’s Industry” for risk factors associated with competition in the
oil and gas industry.
21
Regulation
Regulation
in China
China’s
oil and gas industry is subject to extensive regulation by the Chinese
government with respect to a number of aspects of exploration, production,
transmission and marketing of crude oil and natural gas as well as production,
transportation and marketing of refined products and chemical products. The
following is a list of the primary Chinese central government authorities that
exercise control over various aspects of China’s oil and gas
industry:
·
|
The
Ministry of Land and Resources, which has the authority for granting,
examining and approving oil and gas exploration and production licenses,
the administration of registration and the transfer of exploration and
production licenses.
|
·
|
The
Ministry of Commerce, which was established in March 2003 to consolidate
the authorities and functions of the former State Economic and Trade
Commission and the former Ministry of Foreign Trade and Economic
Cooperation. Its responsibilities
include:
|
·
|
setting
the import and export volume quotas for crude oil and refined products
according to the overall supply and demand for crude oil and refined
products in China as well as the World Trade Organization requirements for
China;
|
·
|
issuing
import and export licenses for crude oil and refined products to oil and
gas companies that have obtained import and export quotas;
and
|
·
|
examining
and approving production sharing contracts and Sino-foreign equity and
cooperative joint venture
contracts.
|
·
|
The
National Development and Reform Commission, which was established in March
2003 to consolidate the authorities and functions of the former State
Development Planning Commission and the former State Economic and Trade
Commission. Its responsibilities
include:
|
·
|
exercising
industry administration and policy coordination authority over China’s oil
and gas industry;
|
·
|
determining
mandatory minimum volumes and applicable prices of natural gas to be
supplied to certain fertilizer
producers;
|
·
|
publishing
guidance prices for natural gas and retail median guidance prices for
certain refined products, including gasoline and
diesel;
|
·
|
approving
significant petroleum, natural gas, oil refinery and chemical projects set
forth under the Catalogues of Investment Projects Approved by the Central
Government; and
|
·
|
approving
Sino-foreign equity and cooperative projects exceeding certain capital
amounts.
|
22
Regulation
and Legislation in the Oil and Gas Industry in Nigeria
After the
closing of the Company’s acquisition from CAMAC of the Contract Rights with
respect to the Oyo Field located in Nigeria, the Company will also be subject to
various regulations in Nigeria. The following is a list of the
primary Nigerian government authorities that exercise control over various
aspects of Nigeria’s oil and gas industry:
· |
The
Minister for Petroleum Resources, who is supported by 3 junior ministers
overseeing different aspects of the energy sector.
|
· |
The
National Assembly as the legislative arm of government is empowered to
pass legislation regarding petroleum matters, which are on the Exclusive
Legislative List.
|
· |
The
Federal Ministry of Petroleum is responsible for formulating and
implementing Government policy.
|
· |
The
Department of Petroleum Resources is the regulatory arm of the oil and gas
industry.
|
· |
The
Ministry of Environment/The Federal Environmental Protection Agency was
established in 1988 (Decree No. 50) to protect, restore and preserve the
ecosystem of the Nigerian environment.
|
· |
The
Federation Inland Revenue Service is responsible for collection of
royalties and PPT on behalf of the Nigerian
Government.
|
The
primary petroleum legislation in Nigeria is the Petroleum Act of 1969, Section 1
of which provides that:
1.
|
The
entire ownership and control of all petroleum in, under or upon any lands
to which this section applies shall be vested in the
State.
|
2.
|
This
section applies to all land (including land covered by water) which “is in
Nigeria; or is under the territorial waters of Nigeria; or forms part of
the continental shelf; or forms part of the Exclusive Economic Zone of
Nigeria.”
|
|
The
Petroleum Act of 1969 provides for the grant by the Minister of Petroleum
Resources of three types of interests – exploration, prospecting and
production rights.
|
1.
|
Exploration: An
Oil Exploration License (“OEL”) is necessary to conduct preliminary
exploration surveys. The license is non-exclusive and is granted for a
period of one year. It is renewable
annually.
|
2.
|
Prospecting: An
Oil Prospecting License (“OPL”) allows for more extensive exploration
surveys. It is an exclusive license given for a period not exceeding 5
years. It includes the right to take away and dispose of oil discovered
while prospecting. Presently Production Sharing Contracts (PSC) are
awarded to parties pursuant to a successful bid process. Under the PSC the
NNPC is the holder of the legal title to the OPL, while the participating
company (the contractor) carries out all operations on a sole risk basis.
Upon making a commercial discovery, the proceeds realized are shared
between the NNPC and the contractor pursuant to commercial terms set out
in the PSC.
|
3.
|
Production:
The grant of an Oil Mining Lease (“OML”) allows for full scale
commercial production once oil is discovered in commercial quantities
(currently defined as a flow rate of 10,000 bpd or above). The lease
confers the exclusive right to carry out prospecting, exploration,
production and marketing activities in and under the specified acreage for
a period of 20 years.
|
The
Minister of Petroleum Resources exercises general supervision over all
operations carried on under licenses and leases and may make regulations
prescribing anything required to be done under the Petroleum Act.
A draft
Petroleum Industry Bill (“PIB”) is currently undergoing legislative process at
the Nigerian National Assembly. The draft PIB seeks to introduce significant
changes to legislation governing the oil and gas sector in Nigeria, including
new fiscal regulatory and tax obligations and expanded fiscal and regulatory
oversight that may impose additional operational and regulatory burdens on
operating contractors under PSCs. See “Risks Related to the CAMAC
Transaction” below.
23
Environmental Matters
China
China has
adopted extensive environmental laws and regulations that affect the operation
of its oil and gas industry. There are national and local standards applicable
to emissions control, discharges to surface and subsurface water, and the
generation, handling, storage, transportation, treatment and disposal of waste
materials.
The
environmental regulations require a company to register or file an environmental
impact report with the relevant environmental bureau for approval before it
undertakes any construction of a new production facility or any major expansion
or renovation of an existing production facility. A new, expanded or renovated
facility will not be permitted to operate unless the relevant environmental
bureau has inspected it and is satisfied that all necessary equipment has been
installed as required by applicable environmental protection requirements. A
company that wishes to discharge pollutants, whether it is in the form of
emission, water or materials, must submit a pollutant discharge declaration
statement detailing the amount, type, location and method of treatment. After
reviewing the pollutant discharge declaration, the relevant environmental bureau
will determine the amount of discharge allowable under the law and will issue a
pollutant discharge license for that amount of discharge subject to the payment
of discharge fees. If a company discharges more than is permitted in the
pollutant discharge license, the relevant environmental bureau can fine the
company up to several times the discharge fees payable by the offending company
for its allowable discharge, or require that the offending company cease
operations until the problem is remediated.
Compliance
and enforcement of environmental laws and regulations may cause the Company to
incur significant expenditures and require resources which it may not
have. The Company cannot currently predict the extent of future
capital expenditures, if any, required for compliance with environmental laws
and regulations, which may include expenditures for environmental control
facilities.
Product
Research and Development
The
Company has to date not engaged in any product research or development, however,
it does anticipate that Dong Fang will engage in research and development
related to its new EORP technology during the Next Year.
Employees
and Contractors
As of
December 31, 2009 the Company had 34 full-time employees and 13 part-time
contractors/employees employed as follows:
Employees
|
Part-Time
Contractors/
Employees
|
|||||||
Administration
|
26 | 7 | ||||||
Research
and Development/Technical Support
|
8 | 6 |
In order
for us to attract and retain quality personnel, we anticipate we will have to
offer competitive salaries to future employees. During the Next Year, the
Company may need to hire additional personnel in certain operational and other
areas as required for its expansion efforts, and to maintain focus on its
then-existing and new projects. The number and skill sets of individual
employees will be primarily dependent on the relative rates of growth of the
Company’s different projects, and the extent to which operations and development
are executed internally or contracted to outside parties. Subject to the
availability of sufficient working capital and assuming initiation of additional
projects, the Company currently plans to further increase full-time staffing to
a level adequate to execute the Company’s growth plans. As we continue to
expand, we will incur additional cost for personnel.
Intellectual
Property
The
Company through its 75.5%-owned subsidiary, Dong Fang, owns Patent
Application Rights with respect to six patents pending before the PRC Patent
Administration covering certain enhanced oil recovery technologies to be used in
connection with EORP operations.
24
ITEM 1A. RISK
FACTORS
The
Company’s operations and its securities are subject to a number of risks. The
Company has described below all the material risks that are known to the Company
that could materially impact the Company’s financial results of operations or
financial condition. If any of the following risks actually occur, the business,
financial condition or operating results of the Company and the trading price or
value of its securities could be materially adversely ffected.
Risks
Related to the Company’s Business
The Company’s
limited operating history makes it difficult to predict future results
and raises
substantial doubt as to its ability to successfully develop profitable
business
operations.
The
Company’s limited operating history makes it difficult to evaluate its current
business and prospects or to accurately predict its future revenue or results of
operations, and raises substantial doubt as to its ability to successfully
develop profitable business operations. The Company’s revenue and income
potential are unproven. As a result of its early stage of development, and to
keep up with the frequent changes in the energy industry, it is necessary for
the Company to analyze and revise its business strategy on an ongoing basis.
Companies in early stages of development, particularly companies in new and
rapidly evolving energy industry segments, are generally more vulnerable to
risks, uncertainties, expenses and difficulties than more established
companies.
The Company’s
ability to diversify risks by participating in multiple projects and joint
ventures depends upon its ability to raise capital and the availability of
suitable prospects, and any failure to raise needed capital and secure suitable
projects would negatively affect the Company’s ability to operate.
The
Company’s business strategy includes spreading the risk of oil and natural gas
exploration, development and drilling, and ownership of interests in oil and
natural gas properties, by participating in multiple projects and joint
ventures, in particular with major Chinese government-owned oil and gas
companies as joint venture partners. If the Company is unable to secure
sufficient attractive projects as a result of its inability to raise sufficient
capital or otherwise, the average quality of the projects and joint venture
opportunities may decline and the risk of the Company’s overall operations could
increase.
The loss of key
employees could adversely affect the Company’s ability to operate.
The
Company believes that its success depends on the continued service of its key
employees, as well as the Company’s ability to hire additional key employees,
when and as needed. Each of Frank C. Ingriselli, the Company’s President and
Chief Executive Officer, Stephen F. Groth, its Vice President and Chief
Financial Officer, and Richard Grigg, the Company’s Senior Vice President and
Managing Director, has the right to terminate his employment at any time without
penalty under his employment agreement. The unexpected loss of the services of
either Mr. Ingriselli, Mr. Groth, Mr. Grigg, or any other key employee, or the
Company’s failure to find suitable replacements within a reasonable period of
time thereafter, could have a material adverse effect on the Company’s ability
to execute its business plan and therefore, on its financial condition and
results of operations.
The Company may
not be able to raise the additional capital necessary to execute its
business strategy, which could result in the curtailment or cessation of the
Company’s operations.
The
Company will need to raise substantial additional funds to fully fund its
existing operations, consummate all of its current asset transfer and
acquisition opportunities currently contemplated and for the development,
production, trading and expansion of its business. On December 31, 2009, the
Company had positive working capital of approximately $3.9- (including $3.6
million in cash and cash equivalents). Other than the recent
financing transaction (registered direct offering) disclosed in this report, the
Company has no current arrangements with respect to sources of additional
financing , and the needed additional financing may not be available on
commercially reasonable terms on a timely basis, or at all. The inability to
obtain additional financing, when needed, would have a negative effect on the
Company, including possibly requiring it to curtail or cease operations. If any
future financing involves the sale of the Company’s equity securities, the
shares of Common Stock held by its stockholders could be substantially diluted.
If the Company borrows money or issues debt securities, it will be subject to
the risks associated with indebtedness, including the risk that interest rates
may fluctuate and the possibility that it may not be able to pay principal and
interest on the indebtedness when due.
Insufficient
funds will prevent the Company from implementing its business plan and will
require it to delay, scale back, or eliminate certain of its programs or to
license to third parties rights to commercialize rights in fields that it would
otherwise seek to develop itself.
25
Failure by the
Company to generate sufficient cash flow from operations could eventually result
in the cessation of the Company’s operations and require the Company to seek
outside financing or discontinue operations.
The
Company’s business activities require substantial capital from outside sources
as well as from internally-generated sources. The Company’s ability to finance a
portion of its working capital and capital expenditure requirements with cash
flow from operations will be subject to a number of variables, such
as:
·
|
the
level of production of existing wells;
|
· |
prices
of oil and natural gas;
|
· |
the
success and timing of development of proved undeveloped
reserves;
|
· |
cost
overruns;
|
· |
remedial
work to improve a well’s producing capability;
|
· |
direct
costs and general and administrative expenses of
operations;
|
· |
reserves,
including a reserve for the estimated costs of eventually plugging and
abandoning the wells;
|
· |
indemnification
obligations of the Company for losses or liabilities incurred in
connection with the Company’s activities; and
|
·
|
general
economic, financial, competitive, legislative, regulatory and other
factors beyond the Company’s
control.
|
The
Company might not generate or sustain cash flow at sufficient levels to finance
its business activities. When and if the Company
generates significant revenues, if such revenues were to decrease due
to lower oil and natural gas prices, decreased production or other factors, and
if the Company were unable to obtain capital through reasonable financing
arrangements, such as a credit line, or otherwise, its ability to execute its
business plan would be limited and it could be required to discontinue
operations.
The
Company’s failure to capitalize on its two existing definitive production
agreements, to fully consummate the transactions contemplated by the Letter of
Understanding related to its enhanced oil recovery and production
opportunities, and/or enter into additional agreements could result
in an inability by the Company to generate sufficient revenues and continue
operations even if the CAMAC Transaction is consummated.
The
Company’s only definitive production contracts that have been secured to date
are (i) the Contract for Cooperation and Joint Development with Chifeng
Zhongtong Oil and Natural Gas Co. (“Chifeng”) covering an oil field in Inner
Mongolia, and (ii) the Production Sharing Contract entered into with China
United Coalbed Methane Co., Ltd. (“CUCBM”) granting the Company exclusive rights
to a large contract area located in the Shanxi Province of China ( the “CUCBM
Contract Area”), for the exploitation of coalbed methane (“CBM”) and tight gas
sand resources (the "Zijinshan PSC"). The Company has not entered into
definitive agreements with respect to any other ventures that it is currently
pursuing other than (i) the Letter of Understanding, dated May 13, 2009, as
amended (the “LOU”), entered into with Mr. Li Xiangdong (“LXD”) and Mr. Ho Chi
Kong (“HCK”), related to the Company’s current enhanced oil recovery and
production (“EORP”) operations, and (ii) the proposed CAMAC Transaction. The
Company’s ability to consummate the CAMAC Transaction and secure one or more
additional ventures is subject to, among other things, (i) the amount of capital
the Company raises in the future; (ii) the availability of land for exploration
and development in the geographical regions in which the Company’s business is
focused; (iii) the nature and number of competitive offers for the same projects
on which the Company is bidding; and (iv) approval by government and industry
officials. The Company may not be successful in executing definitive agreements
in connection with any other ventures, or otherwise be able to secure any
additional ventures it pursues in the future. Failure of the Company to
capitalize on its existing contracts and/or to secure one or more additional
business opportunities would have a material adverse effect on the Company’s
business and results of operations, and could result in the cessation of the
Company’s business operations, even if the CAMAC Transaction is
consummated.
26
The Company’s oil
and gas operations will involve many operating risks that can cause substantial
losses.
The
Company expects to produce, transport and market potentially toxic materials,
and purchase, handle and dispose of other potentially toxic materials in the
course of its business. The Company’s operations will produce byproducts, which
may be considered pollutants. Any of these activities could result in liability,
either as a result of an accidental, unlawful discharge or as a result of new
findings on the effects the Company’s operations on human health or the
environment. Additionally, the Company’s oil and gas operations may also involve
one or more of the following risks:
·
|
fires;
|
·
|
explosions;
|
·
|
blow-outs;
|
·
|
uncontrollable
flows of oil, gas, formation water, or drilling fluids;
|
·
|
natural
disasters;
|
· |
pipe
or cement failures;
|
·
|
casing
collapses;
|
·
|
embedded
oilfield drilling and service tools;
|
·
|
abnormally
pressured formations;
|
·
|
damages
caused by vandalism and terrorist acts; and
|
· |
environmental
hazards such as oil spills, natural gas leaks, pipeline ruptures and
discharges of toxic gases.
|
In the
event that any of the foregoing events occur, the Company could incur
substantial losses as a result of (i) injury or loss of life; (ii) severe damage
or destruction of property, natural resources or equipment; (iii) pollution and
other environmental damage; (iv) investigatory and clean-up responsibilities;
(v) regulatory investigation and penalties; (vi) suspension of its operations;
or (vii) repairs to resume operations. If the Company experiences any of these
problems, its ability to conduct operations could be adversely affected.
Additionally, offshore operations are subject to a variety of operating risks,
such as capsizing, collisions and damage or loss from typhoons or other adverse
weather conditions. These conditions can cause substantial damage to facilities
and interrupt production.
27
The Company is a
development-stage company and may continue to incur losses for a
significant period of time, dependent upon whether the CAMAC Transaction is
consummated and the future net earnings, if any, from the
Transaction.
The
Company is a development-stage company with minimal revenues to
date. As of December 31, 2009, the Company had an accumulated deficit
to stockholders of approximately $20.5 million. The Company expects to continue
to incur significant expenses relating to its identification of new ventures and
investment costs relating to these ventures. Additionally, fixed commitments,
including salaries and fees for employees and consultants, rent and other
contractual commitments may be substantial and are likely to increase as
additional ventures are entered into and personnel are retained prior to the
generation of significant revenue. Energy ventures, such as oil well drilling
projects, generally require a significant period of time before they produce
resources and in turn generate profits. The CAMAC Transaction, if consummated,
may or may not result in net earnings in excess of the Company’s losses on other
ventures under development or in a start-up phase. The Company may not achieve
or sustain profitability on a quarterly or annual basis, or at all.
The Company will
be dependent upon others for the storage and transportation of oil and gas,
which could result in significant operational costs to the Company and depletion
of capital.
The
Company does not own storage or transportation facilities and, therefore, will
depend upon third parties to store and transport all of its oil and gas
resources when and if produced. The Company will likely be subject to price
changes and termination provisions in any contracts it may enter into with these
third-party service providers. The Company may not be able to identify such
third-parties for any particular project. Even if such sources are initially
identified, the Company may not be able to identify alternative storage and
transportation providers in the event of contract price increases or
termination. In the event the Company is unable to find acceptable third-party
service providers, it would be required to contract for its own storage
facilities and employees to transport the Company’s resources. The Company may
not have sufficient capital available to assume these obligations, and its
inability to do so could result in the cessation of its business.
The Company may
not be able to manage its anticipated growth, which could result in the
disruption
of the Company’s operations and prevent the Company from generating meaningful
revenue.
Subject
to its receipt of additional capital, the Company plans to significantly expand
operations to accommodate additional development projects and other
opportunities. This expansion will likely strain its management, operations,
systems and financial resources. To manage its recent growth and any future
growth of its operations and personnel, the Company must improve and effectively
utilize its existing operational, management and financial systems and
successfully recruit, hire, train and manage personnel and maintain close
coordination among its technical, finance, development and production staffs.
The Company may need to hire additional personnel in certain operational and
other areas during 2010. In addition, the Company may also need to increase the
capacity of its software, hardware and telecommunications systems on short
notice, and will need to manage an increasing number of complex relationships
with strategic partners and other third parties. The failure to manage this
growth could disrupt the Company’s operations and ultimately prevent the Company
from generating meaningful revenue.
An interruption
in the supply of materials, resources and services the Company plans to
obtain from
third party sources could limit the Company’s operations and cause
unprofitability.
Once it
has identified, financed, and acquired projects, the Company will need to obtain
other materials, resources and services, including, but not limited to,
specialized chemicals and specialty muds and drilling fluids, pipe,
drill-string, geological and geophysical mapping and interruption services.
There may be only a limited number of manufacturers and suppliers of these
materials, resources and services. These manufacturers and suppliers may
experience difficulty in supplying such materials, resources and services to the
Company sufficient to meet its needs or may terminate or fail to renew contracts
for supplying these materials, resources or services on terms the Company finds
acceptable including, without limitation, acceptable pricing terms. Any
significant interruption in the supply of any of these materials, resources or
services, or significant increases in the amounts the Company is required to pay
for these materials, resources or services, could result in a lack of
profitability, or the cessation of operations, if unable to replace any material
sources in a reasonable period of time.
28
The Company does
not have a plan to carry insurance policies in China and will be at risk of incurring
personal injury claims for its employees and subcontractors, and incurring
loss of business due to theft, accidents or natural
disasters.
The
Company does not carry, and does not plan to carry, any policies of insurance to
cover any type of risk to its business in China, including, without limitation,
the risks discussed above. In the event that the Company were to incur
substantial liabilities with respect to one or more incidents, this could
adversely affect its operations and it may not have the necessary capital to pay
its portion of such costs and maintain business operations.
The
Company is exposed to concentration of credit risk, which may result in losses
in the future.
The
Company is exposed to concentration of credit risk with respect to cash, cash
equivalents, short-term investments, long-term investments, and long-term
advances. At December 31, 2009, 65% ($1,291,455) of the Company’s
total cash was on deposit at HSBC in China and Hong Kong. Also at
that date (unaudited), 64% ($1,028,762) of the Company’s total cash equivalents
was invested in a single money market fund in the U.S. At December
31, 2008, 78% ($975,681) of the Company’s total cash was on deposit in China at
the Bank of China. Also at that date, 48.7% ($4,514,167) of the
Company’s total cash equivalents was invested in a single money market fund in
the U.S.
Risks
Related to the CAMAC Transaction
We
cannot be sure if or when the CAMAC Transaction will be completed, if at
all.
The
consummation of the CAMAC Transaction is subject to the satisfaction of various
conditions, many of which are beyond our control, including, but not limited to,
the approval of the CAMAC Transaction by the Company’s stockholders, the
Company’s ability to raise the minimum $45 million in financing (the “Minimum
Financing”) required on terms and conditions acceptable to the Company, and a
termination right by either party if the CAMAC Transaction is not completed by
March 31, 2010. The Company successfully raised approximately $20 million
through the offering and issuance of 5,000,000 shares of its Common Stock in the
recent financing (registered direct offering) described elsewhere in
this report, in addition to warrants exercisable for an aggregate of 4,000,000
shares of Common Stock, but there is no assurance that it will be able to raise
the remaining $25 million required to meet the Minimum Financing closing
condition. We cannot guarantee that we will be able to satisfy the
closing conditions set forth in the Purchase Agreement. If we are
unable to satisfy the closing conditions in the Purchase Agreement, CAMAC will
not be obligated to complete the CAMAC Transaction and we may still incur the
significant transaction costs described below.
We
will incur significant costs in connection with the CAMAC Transaction, whether
or not it is completed.
We
currently expect to incur approximately $500,000 in costs related to the CAMAC
Transaction. These expenses include, but are not limited to, financial advisory,
legal and accounting fees and expenses, employee expenses, filing fees, printing
expenses, proxy solicitation and other related charges. We may also incur
additional unanticipated expenses in connection with the CAMAC Transaction.
Approximately $400,000 of the costs related to the CAMAC Transaction, such as
legal fees and due diligence fees, will be incurred regardless of whether the
CAMAC Transaction is completed. The incurrence of these expenses will reduce the
amount of cash available to be used for other corporate purposes, including for
use in our ongoing operations.
The
Purchase Agreement will expose the Company to contingent
liabilities.
Under the
Purchase Agreement, we have agreed to indemnify CAMAC for a number of matters
including the breach of our representations, warranties and covenants contained
in the Purchase Agreement, which indemnification obligations could result in
significant cash payments by the Company that could materially and negatively
impact its results of operations.
29
We
may not realize the intended benefits of the CAMAC Transaction if revenues from
the Oyo Field Production Sharing Contract are not as
projected.
The Company conducted
extensive legal, financial and technical due diligence on the Oyo Field
Production Sharing Contract (“Oyo PSC”) and the Oyo Field, reviewed and analyzed
the Estimate of Reserves and Future Revenue report prepared for Allied Energy
Corporation by Netherland, Sewell & Associates, Inc., dated May 1, 2008 (the
“NSAI Report”), and commissioned Somerley Limited to prepare a valuation of the
Contract Rights based, in part, on the anticipated future revenues to be derived
through its interests in the Oyo Field. However, the reserve
information provided in the NSAI Report and the assumptions underlying the
Company’s valuation models, including, but not limited to, actual quantities of
oil produced from the Oyo Field, projected oil prices, anticipated tax rates,
and historic and future operating expenses allocable to the Oyo Field, are
subject to change. For example, since the Company's initial December 2009
assessment of the valuation of the interests being acquired in the Oyo Field and
Oyo Field PSC, CAMAC has reported to the Company that actual production from the
two producing wells has averaged between 12,000 bpd and 20,000 bpd since
December 2009, associated gas production has been approximately 15 million cubic
feet per day, and that the possible drilling of a third production well is
expected to increase average production in 2011 to between approximately 23,000
bpd and 25,000 bpd. As a result, the Company has updated its view of
the current estimated net present value of the interests being acquired from
approximately $380 million to approximately $330 million, using a reduced oil
price scenario and an average production rate of 15,000 bpd in 2010, and 23,000
bpd in 2011. If any of
the assumptions underlying the Company’s valuation models undergo further
material changes, then the estimated net present value of the Company’s
interests in the Oyo Field and Oyo Field PSC may be subject to further
change. If the value of the interests decrease substantially as a
result of such changes, the interests being acquired may ultimately prove to be
worth less than the total consideration the Company will be paying to CAMAC for
such intetests under the Purchase and Sale Agreement, and the Company may not
realize the intended benefits of the CAMAC Transaction.
Applicable Nigerian income tax rates could adversely affect the value of the Oyo Field asset.
The Oyo
Field, income derived therefrom, and CAMAC Petroleum Limited as our acquiring
subsidiary in the CAMAC Transaction (“CPL”), will be subject to the jurisdiction
of the Nigerian taxing authorities. The Nigerian government applies
different tax rates upon income derived from Nigerian oil operations ranging
from 50% to 85%, based on a number of factors. The final
determination of the tax liabilities with respect to the Oyo Field involves the
interpretation of local tax laws and related authorities. In addition, changes
in the operating environment, including changes in tax law and
currency/repatriation controls, could impact the determination of tax
liabilities with respect to the Oyo Field for a tax year. While CAMAC
believes the tax rate applicable to the Oyo Field and the Oyo Field PSC is 50%,
the actual applicable rate could be higher, which could result in a material
decrease in the profits allocable to the Company under the Oyo Field
PSC.
Failure
to complete the CAMAC Transaction could cause our stock price to
decline.
If the
CAMAC Transaction is not completed for any reason, our stock price may decline
because costs related to the CAMAC Transaction, such as legal and accounting,
must be paid even if the CAMAC Transaction is not completed. In addition, if the
CAMAC Transaction is not completed, our stock price may decline to the extent
that the current market price reflects a market assumption that the CAMAC
Transaction will be completed.
The
Company and CAMAC may waive one or more of the conditions to the CAMAC
Transaction without re-soliciting stockholder approval for the CAMAC
Transaction.
Each of
the conditions to the Company’s and CAMAC’s obligations to complete the CAMAC
Transaction may be waived, in whole or in part, to the extent permitted by
applicable laws, by agreement of the Company and CAMAC. The Board of Directors
of the Company will evaluate the materiality of any such waiver to determine
whether amendment of the proxy statement and resolicitation of proxies is
warranted. However, the Company generally does not expect any such waiver to be
sufficiently material to warrant resolicitation of the stockholders. In the
event that the Board of Directors of the Company determines any such waiver is
not sufficiently material to warrant resolicitation of stockholders, the Company
may determine to complete the CAMAC Transaction without seeking further
stockholder approval.
30
The
issuance of the consideration shares to CAMAC and the contemplated issuance
of additional securities to satisfy the Minimum Financing closing condition may
dilute our earnings per share, could lower our stock price and adversely affect
our ability to raise additional capital in a subsequent financing. If we are
unable to obtain additional capital in future years, we may be unable to proceed
with our plans and we may be forced to curtail our operations.
We will
require additional working capital to support our long-term growth strategies
and we may not be able to obtain adequate levels of additional financing,
whether through equity financing, debt financing or other
sources. Under the terms of the Purchase and Sale Agreement, the
Company is obligated to raise at least $45 million of additional equity and to
consummate the Purchase and Sale Agreement, and the Company is obligated to
issue shares equaling 62.74% of the Company’s issued and outstanding Common
Stock, after giving effect to the CAMAC Transaction and the Minimum
Financing. The Company successfully raised approximately $20 million
through the offering and issuance of 5,000,000 shares of its Common Stock in the
financing described elsewhere in this report, in addition to warrants
exercisable for an aggregate of 4,000,000 shares of Common Stock, but there is
no assurance that it will be able to raise the remaining $25 million required to
meet the Minimum Financing closing condition. Shares issued in
connection with the Purchase and Sale Agreement and Minimum Financing combined
may result in dilution to our earnings per share and could lead to the issuance
of securities with rights superior to our current outstanding
securities.
Following
completion of the CAMAC Transaction and the Minimum Financing, any additional
financing that involves the issuance of Company Common Stock or other securities
that are convertible into or exercisable for the Company’s Common Stock may
result in dilution to the Company’s stockholders, including CAMAC following the
CAMAC Transaction. In addition, we may grant registration rights to investors
purchasing our equity or debt securities in the future. If we are unable to
raise additional financing, we may be unable to implement our long-term growth
strategies, develop or enhance our products and services, take advantage of
future opportunities or respond to competitive pressures on a timely basis, if
at all. In addition, a lack of additional financing could force us to
substantially curtail operations.
The
passage into law of the Nigerian Petroleum Industry Bill could create additional
fiscal and regulatory burdens on the parties to the Oyo Field PSC, which could
have a material adverse effect on the profitability of the
production.
A draft
Petroleum Industry Bill (“PIB”) is currently undergoing legislative process at
the Nigerian National Assembly. The draft PIB seeks to introduce significant
changes to legislation governing the oil and gas sector in Nigeria, including
new fiscal regulatory and tax obligations and expanded fiscal and regulatory
oversight that may impose additional operational and regulatory burdens on the
operating contractor under the Oyo Field PSC and impact the economic benefits
anticipated by the parties to the Oyo Field PSC. Any such fiscal and
regulatory changes could have a negative impact on the profits allocable to the
Company under the Oyo Field PSC.
The
Oyo Field is subject to the instability of the Nigerian Government.
The
government of Nigeria originally granted the rights to the Oyo Field to CAMAC.
The government of Nigeria has historically experienced instability, which is out
of management’s control. The Company’s ability to exploit its interests in this
area pursuant to the Oyo Field PSC may be adversely impacted by unanticipated
governmental action. The future success of the Company’s Oyo Field interest may
also be adversely affected by risks associated with international activities,
including economic and labor conditions, political instability, risk of war,
expropriation, repatriation, termination, renegotiation or modification of
existing contracts, tax laws (including host-country import-export, excise and
income taxes and United States taxes on foreign subsidiaries) and changes in the
value of the U.S. dollar versus the local currencies in which future oil and gas
producing activities may be denominated. Changes in exchange rates may also
adversely affect the Company’s future results of operations and financial
condition. Realization of any of these factors could materially and
adversely affect our financial position, results of operations and cash
flows.
31
The
Oyo Field is located in an area where there are high security risks, which could
result in harm to the Oyo Field operations and our interest in the Oyo
Field.
The Oyo
Field is located approximately 75 miles off the Southern Nigerian coast in
deep-water. There are some risks inherent to oil production in
Nigeria. In June 2008, Shell’s Bonga Oilfield, which is near the Oyo Field, was
attacked by Nigerian militants, causing Shell to shut down the operation of the
field. In June 2009, another Nigerian offshore oilfield operated by Shell, the
Ofirma Field, and a flow station operated by Chevron were attacked by Nigerian
Militants. Subsequently, Shell was forced to shut down some of its oil
production in the region. In addition, an attack like that of September 11, 2001
or longer-lasting wars or international hostilities, including those currently
in Afghanistan and Iraq could damage the world economy and adversely affect the
availability of and demand for crude oil and petroleum products and negatively
affect our investment and our customers’ investment decisions over an extended
period of time. Despite undertaking various security measures and being situated
75 miles offshore the Nigerian coast, the Floating Production Storage and
Offloading (“FPSO”) vessel currently being used for petroleum
production in the Oyo Field may become subject to terrorist acts and other acts
of hostility like piracy. Such actions could adversely impact our overall
business, financial condition and operations. In addition, the Oyo Field’s
financial viability may also be negatively affected by changing economic,
political and governmental conditions in Nigeria. Moreover, we operate in a
sector of the economy that is likely to be adversely impacted by the effects of
political instability, terrorist or other attacks, war or international
hostilities.
The
FPSO vessel may be requisitioned by the Nigerian without adequate
compensation.
The
Nigerian government could requisition or seize the FPSO vessel. Under
requisition for title, a government takes control of a vessel and becomes its
owner. Under requisition for hire, a government takes control of a vessel and
effectively becomes its charterer at dictated charter rates. Generally,
requisitions occur during periods of war or emergency. Although we would be
entitled to compensation in the event of a requisition, the amount and timing of
payment would be uncertain.
Maritime
disasters and other operational risks may adversely impact our reputation,
financial condition and results of operations.
The
operation of the FPSO vessel has an inherent risk of maritime disaster,
environmental mishaps, cargo and property losses or damage and business
interruptions caused by, among others:
· |
mechanical
failure;
|
· |
damages
requiring dry-dock repairs;
|
· |
human
error;
|
· |
labor
strikes;
|
· |
adverse
weather conditions;
|
· | vessel off hire periods |
· |
regulatory
delays; and
|
·
|
political
action, civil conflicts, terrorism and piracy in countries where vessel
operations are conducted, vessels are registered or from which spare parts
and provisions are sourced and
purchased.
|
Any of
these circumstances could adversely affect the operation of the FPSO vessel, and
result in loss of revenues or increased costs and adversely affect our
profitability. Terrorist acts and regional hostilities around the world in
recent years have led to increase in insurance premium rates and the
implementation of special “war risk” premiums for certain
areas. Such increases in insurance rates may adversely affect
our profitability with respect to the Oyo Field asset.
We
will depend on NAE as the operating contractor under the Oyo Field PSC, which
may result in operating costs, methods and timing of operations and expenditures
beyond the Company’s control, and potential delay or discontinuation of
operations and production.
As
operating contractor of the Oyo Field under the Oyo Field PSC, Nigerian Agip
Exploration Ltd (“NAE”), a subsidiary of Italy's ENI SpA (one of the world’s
largest international energy companies), will manage all of the physical
development and operations with respect to the Oyo Field under the Oyo Field
PSC, including, but not limited to, the timing of drilling, production and
related operations, the timing and amount of operational costs, the technology
and service providers employed. We would be materially adversely
affected if NAE does not properly and efficiently manage operational and
production matters, or becomes unable or unwilling to continue acting as the
operating contractor under the Oyo Field PSC.
32
Stock
sales following the issuance of the consideration shares to CAMAC in the CAMAC
Transaction or issuance of shares to satisfy the Minimum Financing closing
condition may affect the stock price of the Company’s Common Stock.
After the
issuance of the consideration shares (as defined in the Purchase and Sale
Agreement) to CAMAC in the CAMAC Transaction and issuance of shares to satisfy
the Minimum Financing closing condition, the recipients of such shares may sell
all or a substantial portion of their shares in the public market, which could
result in downward pressure on the stock price of all the Company’s capital
stock. Moreover, in connection with the issuance of the consideration Shares to
CAMAC, the Company will enter into a registration rights agreement with CAMAC,
which agreement will provide CAMAC with rights to request that the Company file
a registration statement to register the sale of Company capital stock held by
CAMAC to the public, which registration could also result in downward pressure
on the stock price of all the Company’s capital stock.
Following
the Closing of the CAMAC Transaction, CAMAC will be our controlling stockholder,
and CAMAC may take actions that conflict with the interests of the other
stockholders.
Following
the Closing of the CAMAC Transaction, CAMAC will beneficially own 62.74% of our
outstanding shares of Common Stock. Accordingly, subject to the
voting agreement described above pursuant to which CAMAC has agreed to elect or
remove the three directors designated by a PAPI Representative (as defined in
the Purchase and Sale Agreement) for one year following the Closing, CAMAC will
control the power to elect our directors, to appoint members of management and
to approve all actions requiring the approval of the holders of our Common
Stock, including adopting amendments to our Certificate of Incorporation and
approving mergers, acquisitions or sales of all or substantially all of our
assets, subject to certain restrictive covenants. The interests of CAMAC as our
controlling stockholder could conflict with your interests as a holder of
Company Common Stock. For example, CAMAC as our controlling stockholder may have
an interest in pursuing acquisitions, divestitures, financings or other
transactions that, in its judgment, could enhance its equity investment, even
though such transactions might involve risks to you, as minority holders of the
Company.
A
substantial or extended decline in oil and natural gas prices may adversely
affect our business, financial condition or results of operations.
The price
NAE as operating contractor under the Oyo Field PSC may receives for production
with respect to the Oyo Field will heavily influence our revenue, profitability,
access to capital and future rate of growth. Oil is a commodity and, therefore,
its price is subject to wide fluctuations in response to relatively minor
changes in supply and demand. Historically, the market for oil has been
volatile. This market will likely continue to be volatile in the future. The
prices NAE will receive for its production under the Oyo Field PSC with respect
to the Oyo Field, and the levels of its production, depend on numerous factors
beyond our and NAE’s control. These factors include the following:
·
|
changes
in global supply and demand for
oil;
|
·
|
the
actions of the Organization of Petroleum Exporting
Countries;
|
·
|
the
price and quantity of imports of foreign
oil;
|
·
|
political
and economic conditions, including embargoes, in oil producing countries
or affecting other oil-producing
activity;
|
·
|
the
level of global oil exploration and production
activity;
|
·
|
the
level of global oil inventories;
|
·
|
weather
conditions;
|
·
|
technological
advances affecting energy
consumption;
|
·
|
domestic
and foreign governmental
regulations;
|
·
|
proximity
and capacity of oil pipelines and other transportation
facilities; and
|
·
|
the
price and availability of alternative
fuels.
|
Lower oil
prices may not only decrease our revenues on a per unit basis but also may
reduce the amount of oil that NAE can produce economically under the Oyo Field
PSC with respect to the Oyo Field. A substantial or extended decline in oil
prices may materially and adversely affect our future business, financial
condition, results of operations, liquidity or ability to finance planned
capital expenditures.
33
Fluctuations
in exchange rates could result in foreign currency exchange losses.
Because
some or all of our revenues arising under the Oyo Field PSC may be denominated
in foreign currencies, including the Nigerian naira, European Union euro and
British pound sterling, and our cash is denominated in U.S. dollars,
fluctuations in the exchange rates between the U.S. dollar and foreign
currencies will affect our balance sheet and earnings per share in U.S. dollars.
In addition, we will report our financial results in U.S. dollars, and
appreciation or depreciation in the value of such foreign currencies relative to
the U.S. dollar would affect our financial results reported in U.S. dollars
terms without giving effect to any underlying change in our business or results
of operations. Fluctuations in the exchange rates will also affect the relative
value of earnings from and the value of any U.S. dollar-denominated investments
we make in the future.
Very
limited hedging transactions are available in the Federal Republic of Nigeria to
reduce our exposure to exchange rate fluctuations with respect to the Nigerian
naira, although there are many hedging transactions available with respect to
the European Union euro and the British pound sterling. We have not entered into
any hedging transactions in an effort to reduce our exposure to foreign currency
exchange risk. While we may decide to enter into hedging transactions in the
future, the availability and effectiveness of these hedging transactions may be
limited and we may not be able to successfully hedge our subsidiaries' exposure
at all. In addition, our currency exchange losses with respect to the Nigerian
naira may be magnified by Nigerian exchange control regulations that restrict
our ability to convert Nigerian naira into foreign currency.
Risks
Related to the Company’s Industry
The Company may
not be successful in finding petroleum resources or developing resources, and if
it fails to do so, the Company will likely cease operations.
The
Company will be operating primarily in the petroleum extractive business;
therefore, if it is not successful in finding crude oil and natural gas sources
with good prospects for future production, and exploiting such sources, its
business will not be profitable and it may be forced to terminate its
operations. Exploring and exploiting oil and gas or other sources of energy
entails significant risks, which risks can only be partially mitigated by
technology and experienced personnel. The Company or any ventures it acquires or
participates in may not be successful in finding petroleum or other energy
sources; or, if it is successful in doing so, the Company may not be successful
in developing such resources and producing quantities that will be sufficient to
permit the Company to conduct profitable operations. The Company’s future
success will depend in large part on the success of its drilling programs and
creating and maintaining an inventory of projects. Creating and maintaining an
inventory of projects depends on many factors, including, among other things,
obtaining rights to explore, develop and produce hydrocarbons in promising
areas, drilling success, ability to bring long lead-time, capital intensive
projects to completion on budget and schedule, and efficient and profitable
operation of mature properties. The Company’s inability to successfully identify
and exploit crude oil and natural gas sources would have a material adverse
effect on its business and results of operations and would, in all likelihood,
result in the cessation of its business operations.
34
In
addition to the numerous operating risks described in more detail in this
report, exploring and exploitation of energy sources involve the risk that no
commercially productive oil or gas reservoirs will be discovered or, if
discovered, that the cost or timing of drilling, completing and producing wells
will not result in profitable operations. The Company’s drilling operations may
be curtailed, delayed or abandoned as a result of a variety of factors,
including:
·
|
adverse
weather conditions;
|
·
|
unexpected
drilling conditions;
|
·
|
pressure
or irregularities in formations;
|
·
|
equipment
failures or accidents;
|
·
|
inability
to comply with governmental
requirements;
|
·
|
shortages
or delays in the availability of drilling rigs and the delivery of
equipment; and
|
·
|
shortages
or unavailability of qualified labor to complete the drilling programs
according to the business plan
schedule.
|
The energy market
in which the Company operates is highly competitive and the Company may not
be able to compete successfully against its current and future competitors,
which could seriously harm the Company’s business.
Competition
in the oil and gas industry is intense, particularly with respect to access to
drilling rigs and other services, the acquisition of properties and the hiring
and retention of technical personnel. The Company expects competition in the
market to remain intense because of the increasing global demand for energy, and
that competition will increase significantly as new companies enter the market
and current competitors continue to seek new sources of energy and leverage
existing sources. Recently, higher commodity prices and stiff competition for
acquisitions have significantly increased the cost of available properties. Many
of the Company’s competitors, including large oil companies, have an established
presence in Asia and the Pacific Rim countries and have longer operating
histories, significantly greater financial, technical, marketing, development,
extraction and other resources and greater name recognition than the Company
does. As a result, they may be able to respond more quickly to new or emerging
technologies, changes in regulations affecting the industry, newly discovered
resources and exploration opportunities, as well as to large swings in oil and
natural gas prices. In addition, increased competition could result in lower
energy prices, and reduced margins and loss of market share, any of which could
harm the Company’s business. Furthermore, increased competition may harm the
Company’s ability to secure ventures on terms favorable to it and may lead to
higher costs and reduced profitability, which may seriously harm its
business.
The Company’s
business depends on the level of activity in the oil and gas industry, which
is significantly affected by volatile energy prices, which volatility could
adversely affect its ability to operate profitably.
The
Company’s business depends on the level of activity in the oil and gas
exploration, development and production in markets worldwide. Oil and gas
prices, market expectations of potential changes in these prices and a variety
of political and economic and weather-related factors significantly affect this
level of activity. Oil and gas prices are extremely volatile and are affected by
numerous factors, including:
35
·
|
the
domestic and foreign supply of oil and natural
gas;
|
·
|
the
ability of the Organization of Petroleum Exporting Countries, commonly
called “OPEC,” to set and maintain production levels and
pricing;
|
·
|
the
price and availability of alternative
fuels;
|
·
|
weather
conditions;
|
·
|
the
level of consumer demand;
|
·
|
global
economic conditions;
|
·
|
political
conditions in oil and gas producing regions;
and
|
·
|
government
regulations.
|
Within
the past 12 months, light crude oil futures have ranged from below $35 per
barrel to over $80 per barrel, and may continue to fluctuate significantly in
the future. With respect to ventures in China, the prices the Company will
receive for oil and gas, in connection with any of its production ventures, will
likely be regulated and set by the government. As a result, these prices may be
well below the market price established in world markets. Therefore, the Company
may be subject to arbitrary changes in prices that may adversely affect its
ability to operate profitably.
If the Company
does not hedge its exposure to reductions in oil and gas prices, it may be subject
to the risk of significant reductions in prices; alternatively, use by
the Company
of oil and gas price hedging contracts could limit future revenues from price
increases.
To date,
the Company has not entered into any hedging transactions but may do so in the
future. In the event that the Company chooses not to hedge its
exposure to reductions in oil and gas prices by purchasing futures and by using
other hedging strategies, it could be subject to significant reduction in prices
which could have a material negative impact on its profitability. Alternatively,
the Company may elect to use hedging transactions with respect to a portion of
its oil and gas production to achieve more predictable cash flow and to reduce
its exposure to price fluctuations. The use of hedging transactions could limit
future revenues from price increases and could also expose the Company to
adverse changes in basis risk, the relationship between the price of the
specific oil or gas being hedged and the price of the commodity underlying the
futures contracts or other instruments used in the hedging transaction. Hedging
transactions also involve the risk that the counterparty does not satisfy its
obligations.
The Company may
be required to take non-cash asset write-downs if oil and natural gas
prices decline, which could have a negative impact on the Company’s earnings.
Under
applicable accounting rules, the Company may be required to write down the
carrying value of oil and natural gas properties if oil and natural gas prices
decline or if there are substantial downward adjustments to its estimated proved
reserves, increases in its estimates of development costs or deterioration in
its exploration results. Accounting standards require the Company to review its
long-lived assets for possible impairment whenever changes in circumstances
indicate that the carrying amount of an asset may not be fully recoverable over
time. In such cases, if the asset’s estimated undiscounted future cash flows are
less than its carrying amount, impairment exists. Any impairment write-down,
which would equal the excess of the carrying amount of the assets being written
down over their fair value, would have a negative impact on the Company’s
earnings, which could be material.
36
Risks
Related to Chinese and Other International Operations
The Company’s
Chinese and other international operations will subject it to certain
risks inherent in
conducting business operations in China and other foreign countries,
including political
instability and foreign government regulation, which could significantly
impact the Company’s ability to operate in such countries and impact the
Company’s results of operations.
The
Company conducts substantially all of its business in China. The
Company’s Chinese operations and anticipated operations in other foreign
countries are, and will be, subject to risks generally associated with
conducting businesses in foreign countries, such as:
·
|
foreign
laws and regulations that may be materially different from those of the
United States;
|
·
|
changes
in applicable laws and regulations;
|
·
|
challenges
to, or failure of, title;
|
·
|
labor
and political unrest;
|
·
|
foreign
currency fluctuations;
|
·
|
changes
in foreign economic and political
conditions;
|
·
|
export
and import restrictions;
|
·
|
tariffs,
customs, duties and other trade
barriers;
|
·
|
difficulties
in staffing and managing foreign
operations;
|
·
|
longer
time periods in collecting
revenues;
|
·
|
difficulties
in collecting accounts receivable and enforcing
agreements;
|
·
|
possible
loss of properties due to nationalization or expropriation;
and
|
·
|
limitations
on repatriation of income or
capital.
|
Specifically,
foreign governments may enact and enforce laws and regulations requiring
increased ownership by businesses and/or state agencies in energy producing
businesses and the facilities used by these businesses, which could adversely
affect the Company’s ownership interests in then existing ventures. The
Company’s ownership structure may not be adequate to accomplish the Company’s
business objectives in China or in any other foreign jurisdiction where the
Company may operate. Foreign governments also may impose additional taxes and/or
royalties on the Company’s business, which would adversely affect the Company’s
profitability. In certain locations, governments have imposed restrictions,
controls and taxes, and in others, political conditions have existed that may
threaten the safety of employees and the Company’s continued presence in those
countries. Internal unrest, acts of violence or strained relations between a
foreign government and the Company or other governments may adversely affect its
operations. These developments may, at times, significantly affect the Company’s
results of operations, and must be carefully considered by its management when
evaluating the level of current and future activity in such
countries.
37
Compliance and
enforcement of environmental laws and regulations, including those related to
climate change, may cause the Company to incur
significant expenditures and require resources, which it may not
have.
Extensive
national, regional and local environmental laws and regulations in China and
other Pacific Rim countries are expected to have a significant impact on the
Company’s operations. These laws and regulations set various standards
regulating certain aspects of health and environmental quality, which provide
for user fees, penalties and other liabilities for the violation of these
standards. As new environmental laws and regulations are enacted and existing
laws are repealed, interpretation, application and enforcement of the laws may
become inconsistent. Compliance with applicable local laws in the future could
require significant expenditures, which may adversely affect the Company’s
operations. The enactment of any such laws, rules or regulations in the future
may have a negative impact on the Company’s projected growth, which could in
turn decrease its projected revenues or increase its cost of doing
business.
A foreign
government could change its policies toward private enterprise or even nationalize
or expropriate private enterprises, which could result in the total loss of the
Company’s investment in that country.
The
Company’s business is subject to significant political and economic
uncertainties and may be adversely affected by political, economic and social
developments in China or in any other foreign jurisdiction in which it operates.
Over the past several years, the Chinese government has pursued economic reform
policies including the encouragement of private economic activity, foreign
investment and greater economic decentralization. The Chinese government may not
continue to pursue these policies or may significantly alter them to the
Company’s detriment from time to time with little, if any, prior
notice.
Changes
in policies, laws and regulations or in their interpretation or the imposition
of confiscatory taxation, restrictions on currency conversion, restrictions or
prohibitions on dividend payments to stockholders, devaluations of currency or
the nationalization or other expropriation of private enterprises could have a
material adverse effect on the Company’s business. Nationalization or
expropriation could even result in the loss of all or substantially all of the
Company’s assets and in the total loss of your investment in the
Company.
Because the
Company plans to conduct substantial business in China, fluctuations in
exchange rates and restrictions on currency conversions could adversely affect
the Company’s results of operations and financial condition.
The
Company expects that it will conduct substantial business in China, and its
financial performance and condition there will be measured in terms of the
RMB. It is difficult to assess whether a devaluation or revaluation
(upwards valuation) of the RMB against the U.S. dollar would have an adverse
effect on the Company’s financial performance and asset values when measured in
terms of U.S. dollars. An increase in the RMB would raise the Company’s costs
incurred in RMB; however, it is not clear whether the underlying cause of the
revaluation would also cause an increase in the Company’s price received for oil
or gas which would have the opposite effect of increasing the
Company’s margins and improving its financial
performance.
The
Company’s financial condition could also be adversely affected as a result of
its inability to obtain the governmental approvals necessary for the conversion
of RMB into U.S. dollars in certain transactions of capital, such as direct
capital investments in Chinese companies by foreign investors.
Currently,
there are few means and/or financial tools available in the open market for the
Company to hedge its exchange risk against any possible revaluation or
devaluation of RMB. Because the Company does not currently intend to engage in
hedging activities to protect against foreign currency risks, future movements
in the exchange rate of the RMB could have an adverse effect on its results of
operations and financial condition.
38
If relations
between the United States and China were to deteriorate, investors might be
unwilling to hold or buy the Company’s stock and its stock price may
decrease.
At
various times during recent years, the United States and China have had
significant disagreements over political, economic and security issues.
Additional controversies may arise in the future between these two countries.
Any political or trade controversies between these two countries, whether or not
directly related to the Company’s business, could adversely affect the market
price of the Company’s Common Stock.
If the United
States imposes trade sanctions on China due to its current currency
policies, the Company’s operations could be materially and adversely
affected.
Trade
groups in the United States have blamed the cheap value of the Chinese currency
for causing job losses in American factories, giving exporters an unfair
advantage and making its imports expensive. Congress from time to time has been
considering the enactment of legislation with the view of imposing new tariffs
on Chinese imports. In 2005, the People’s Bank of China decided to strengthen
the exchange rate of the Chinese currency to the U.S. dollar, revaluing the
Chinese currency by 2.1% and introducing a “managed floating exchange rate
regime.” Since that time, the exchange rate of the Chinese currency has been
allowed to float against a basket of currencies.
If
Congress deems that China is still gaining a trade advantage from its exchange
currency policy and an additional tariff is imposed, it is possible that
China-based companies will no longer maintain significant price advantages over
U.S. and other foreign companies on their goods and services, and the rapid
growth of China’s economy would slow as a result. If the United States or other
countries enact laws to penalize China for its currency policies, the Company’s
business could be materially and adversely affected.
A lack of
adequate remedies and impartiality under the Chinese legal system may
adversely
impact the Company’s ability to do business and to enforce the agreements to
which it is a party.
The
Company anticipates that it will be entering into numerous agreements governed
by Chinese law. The Company’s business would be materially and adversely
affected if these agreements were not enforced. In the event of a dispute,
enforcement of these agreements in China could be extremely difficult. Unlike
the United States, China has a civil law system based on written statutes in
which judicial decisions have little precedential value. The government’s
experience in implementing, interpreting and enforcing certain recently enacted
laws and regulations is limited, and the Company’s ability to enforce commercial
claims or to resolve commercial disputes is uncertain. Furthermore, enforcement
of the laws and regulations may be subject to the exercise of considerable
discretion by agencies of the Chinese government, and forces unrelated to the
legal merits of a particular matter or dispute may influence their
determination. These uncertainties could limit the protections that are
available to the Company.
The Company’s
stockholders may not be able to enforce United States civil liabilities
claims.
Many of
the Company’s assets are, and are expected to continue to be, located outside
the United States and held through one or more wholly-owned subsidiaries
incorporated under the laws of foreign jurisdictions, including Hong Kong and
China. Similarly, a substantial part of the Company’s operations are, and are
expected to continue to be, conducted in China and other Pacific Rim countries.
In addition, some of the Company’s directors and officers, including directors
and officers of its subsidiaries, may be residents of countries other than the
United States. All or a substantial portion of the assets of these persons may
be located outside the United States. As a result, it may be difficult for
shareholders to effect service of process within the United States upon these
persons. In addition, there is uncertainty as to whether the courts of China and
other Pacific Rim countries would recognize or enforce judgments of United
States courts obtained against the Company or such persons predicated upon the
civil liability provisions of the securities laws of the United States or any
state thereof, or be competent to hear original actions brought in these
countries against the Company or such persons predicated upon the securities
laws of the United States or any state thereof.
39
Risks
Related to the Company’s Stock
The market price
of the Company’s stock may be adversely affected by a number of factors
related to
the Company’s performance, the performance of other energy-related companies and the
stock market in general.
The
market prices of securities of energy companies are extremely volatile and
sometimes reach unsustainable levels that bear no relationship to the past or
present operating performance of such companies.
Factors
that may contribute to the volatility of the trading price of the Company’s
Common Stock include, among others:
·
|
the
Company’s quarterly results of
operations;
|
·
|
the
variance between the Company’s actual quarterly results of operations and
predictions by stock analysts;
|
·
|
financial
predictions and recommendations by stock analysts concerning energy
companies and companies competing in the Company’s market in general, and
concerning the Company in
particular;
|
·
|
public
announcements of regulatory changes or new ventures relating to the
Company’s business, new products or services by the Company or its
competitors, or acquisitions, joint ventures or strategic alliances by the
Company or its competitors;
|
·
|
public
reports concerning the Company’s services or those of its
competitors;
|
·
|
the
operating and stock price performance of other companies that investors or
stock analysts may deem comparable to the
Company;
|
·
|
large
purchases or sales of the Company’s Common
Stock;
|
·
|
investor
perception of the Company’s business prospects or the oil and gas industry
in general; and
|
·
|
general
economic and financial conditions.
|
In
addition to the foregoing factors, the trading prices for equity securities in
the stock market in general, and of energy-related companies in particular, have
been subject to wide fluctuations that may be unrelated to the operating
performance of the particular company affected by such fluctuations.
Consequently, broad market fluctuations may have an adverse effect on the
trading price of the Common Stock, regardless of the Company’s results of
operations.
The limited
market for the Company’s Common Stock may adversely affect trading prices
or the ability of a
shareholder to sell the Company’s shares in the public market at or
near ask prices or at
all if a shareholder needs to liquidate its shares.
The
market price for shares of the Company’s Common Stock has been, and is expected
to continue to be, very volatile. Numerous factors beyond the
Company’s control may have a significant effect on the market price for shares
of the Company’s Common Stock, including the fact that the Company is a small
company that is relatively unknown to stock analysts, stock brokers,
institutional investors and others in the investment community that generate or
influence sales volume. Even if we came to the attention of such
persons, they tend to be risk-averse and may be reluctant to follow an unproven,
early stage company such as the Company or purchase or recommend the purchase of
its shares until such time as the Company becomes more seasoned and viable.
There may be periods of several days or more when trading activity in the
Company’s shares is minimal as compared to a seasoned issuer which has a large
and steady volume of trading activity that will generally support continuous
sales without an adverse effect on share price. Due to these conditions,
investors may not be able to sell their shares at or near ask prices or at all
if investors need money or otherwise desire to liquidate their
shares.
40
The Company’s
issuance of Preferred Stock could adversely affect the value of the Company’s
Common Stock.
The
Company’s Amended and Restated Certificate of Incorporation authorizes the
issuance of up to 50 million shares of Preferred Stock, which shares constitute
what is commonly referred to as “blank check” Preferred Stock. Approximately 26
million shares of Preferred Stock are currently available for issuance. This
Preferred Stock may be issued by the Board of Directors from time to time on any
number of occasions, without stockholder approval, as one or more separate
series of shares comprised of any number of the authorized but unissued shares
of Preferred Stock, designated by resolution of the Board of Directors, stating
the name and number of shares of each series and setting forth separately for
such series the relative rights, privileges and preferences thereof, including,
if any, the: (i) rate of dividends payable thereon; (ii) price, terms and
conditions of redemption; (iii) voluntary and involuntary liquidation
preferences; (iv) provisions of a sinking fund for redemption or repurchase; (v)
terms of conversion to Common Stock, including conversion price; and (vi) voting
rights. The designation of such shares could be dilutive of the interest of the
holders of our Common Stock. The ability to issue such Preferred Stock could
also give the Company’s Board of Directors the ability to hinder or discourage
any attempt to gain control of the Company by a merger, tender offer at a
control premium price, proxy contest or otherwise.
The Common Stock
may be deemed “penny stock” and therefore subject to special requirements that
could make the trading of the Company’s Common Stock more difficult
than for stock of a company that is not “penny stock”.
The
Company’s Common Stock may be deemed to be a “penny stock” as that term is
defined in Rule 3a51-1 promulgated under the Securities Exchange Act of 1934.
Penny stocks are stocks (i) with a price of less than five dollars per share;
(ii) that are not traded on a “recognized” national exchange; (iii) whose prices
are not quoted on the NASDAQ automated quotation system (NASDAQ-listed stocks
must still meet requirement (i) above); or (iv) of issuers with net tangible
assets of less than $2,000,000 (if the issuer has been in continuous operation
for at least three years) or $5,000,000 (if in continuous operation for less
than three years), or with average revenues of less than $6,000,000 for the last
three years.
Section
15(g) of the Exchange Act, and Rule 15g-2 promulgated thereunder, require
broker-dealers dealing in penny stocks to provide potential investors with a
document disclosing the risks of penny stocks and to obtain a manually signed
and dated written receipt of the document before effecting any transaction in a
penny stock for the investor’s account. Moreover, Rule 15g-9 promulgated under
the Exchange Act requires broker-dealers in penny stocks to approve the account
of any investor for transactions in such stocks before selling any penny stock
to that investor. This procedure requires the broker-dealer to (i) obtain from
the investor information concerning his or her financial situation, investment
experience and investment objectives; (ii) reasonably determine, based on that
information, that transactions in penny stocks are suitable for the investor and
that the investor has sufficient knowledge and experience as to be reasonably
capable of evaluating the risks of penny stock transactions; (iii) provide the
investor with a written statement setting forth the basis on which the
broker-dealer made the determination in (ii) above; and (iv) receive a signed
and dated copy of such statement from the investor, confirming that it
accurately reflects the investor’s financial situation, investment experience
and investment objectives. Compliance with these requirements may make it more
difficult for investors in the Common Stock to resell their shares to third
parties or to otherwise dispose of them.
The Company’s
executive officers, directors and major stockholders hold a substantial
amount of
the Company’s Common Stock and may be able to prevent other stockholders
from influencing
significant corporate decisions.
As
of March 1, 2010, the executive officers, directors and holders of 5% or
more of the outstanding Common Stock together beneficially owned approximately
11.1% of the outstanding Common Stock (including as outstanding the 5 million
additional shares in the recent registered direct offering). These stockholders,
if they were to act together, would likely be able to significantly influence
all matters requiring approval by stockholders, including the election of
Directors and the approval of significant corporate transactions. This
concentration of ownership may also have the effect of delaying, deterring or
preventing a change in control and may make some transactions more difficult or
impossible to complete without the support of these stockholders.
41
ITEM
1B. UNRESOLVED STAFF COMMENTS
Not
applicable
ITEM
2. PROPERTIES
Part I,
Item 1, Description of Business, contains a description of properties other than
office facilities and is incorporated herein by reference.
The
Company has two primary leased office facilities, one located in Hartsdale, New
York (the “Hartsdale Facility”), and the other located in Beijing, China (the
“Beijing Facility”).
The
Hartsdale Facility is occupied under a lease which commenced on December 1,
2006, and was extended two additional years to November 30, 2010 under an
amendment entered into in September 2008. At December 31, 2009, the
Hartsdale Facility lease covered 1,978 rentable square feet, and the rental
expense is currently $5,300 per month, plus a 7.96% share of operating expenses
of the property.
The
Beijing Facility covers approximately 5,300 square feet of office space. The
Beijing Facility is occupied under a tenancy agreement that commenced on
September 1, 2009 and ends on August 31, 2011. The Company’s rental
expense recorded for the Beijing Facility is $11,283 per month, plus allocated
share of utility charges.
The
Company believes that its current office facilities have the capacity to meet
its needs for the foreseeable future. It does not foresee significant
difficulty in renewing or replacing either lease under current market
conditions.
ITEM
3. LEGAL PROCEEDINGS
From time
to time, we may become involved in various lawsuits and legal proceedings in the
ordinary course of our business. We are currently not aware of any legal
proceedings the ultimate outcome of which, in our judgment based on information
currently available, would have a material adverse affect on our business,
financial condition or operating results.
ITEM
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No
matters were submitted to the Company’s shareholders for a vote during the
fourth quarter of 2009 that have not already been disclosed in a
Current Report on Form 8-K during the period.
42
PART
II
ITEM
5. MARKET FOR THE COMPANY'S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY
SECURITIES
|
Market
Information for Common Stock
Our
Common Stock has been listed on the NYSE Amex under the symbol “PAP” since
November 5, 2009. Prior to being listed on the NYSE Amex, the Common
Stock was quoted on the OTC Bulletin Board under the symbol “PFAP.OB” between
May 8, 2008 and November 4, 2009, and on the Pink Sheets under the symbol
“PFAP.PK.”
For 2008
the table below sets forth the high and low last bid prices for the Common Stock
for each fiscal quarter as reported by Pink Sheets LLC. These prices do not
reflect retail mark-ups, markdowns or commissions and may not represent actual
transactions. For 2009 and interim 2010, it shows
the high and low price as reported by the OTC Bulletin Board and NYSE Amex
including intra-day trading prices (as applicable) as reported by
Yahoo.com.
Fiscal
year ended December 31, 2010:
|
High
|
Low
|
||||||
First quarter (through March 1, 2010)
|
$5.15
|
$3.50
|
||||||
Fiscal
year ended December 31, 2009:
|
High
|
Low
|
||||||
First
quarter
|
$ | 1.15 | $ | 0.35 | ||||
Second
quarter
|
2.41 | 0.75 | ||||||
Third
quarter
|
3.70 | 1.50 | ||||||
Fourth
quarter
|
5.75 | 3.15 |
Fiscal
year ended December 31, 2008:
|
High
|
Low
|
||||||
First
quarter
|
$
|
17.00
|
$
|
7.50
|
||||
Second
quarter
|
22.00
|
14.50
|
||||||
Third
quarter
|
17.05
|
1.82
|
||||||
Fourth
quarter
|
1.93
|
0.45
|
Common
Stock Warrants and Options
As
of March 1, 2010, the Company had warrants outstanding to purchase (i)
an aggregate of 1,060,888 shares of Common Stock at a price per share of $1.25;
(ii) an aggregate of 200,000 shares of Common Stock at a price per share of
$1.375; (iii) an aggregate of 200,000 shares of Common Stock at a price per
share of $1.50; (iv) an aggregate of
2,000,000 shares of Common Stock at a price per share of $4.00; (v)
an aggregate of 2,000,000 shares of Common Stock at a price per share of
$4.50; and (vi) an aggregate of 150,000 shares of Common Stock at a
price per share of $5.00.
As of March 1, 2010, an aggregate of 2,857,310 shares of Common Stock were issuable upon exercise of outstanding stock options.
Holders
As
of March 1, 2010, there were approximately 91 registered holders of
record of our common stock, and there are an estimated 6,700 beneficial owners
of our common stock, including shares held in street
name.
Dividend
Policy
The
Company has not, to date, paid any cash dividends on its Common Stock. The
Company has no current plans to pay dividends on its Common Stock and intends to
retain earnings, if any, for working capital purposes. Any future determination
as to the payment of dividends on the Common Stock will depend upon the results
of operations, capital requirements, the financial condition of the Company and
other relevant factors.
43
Our Board
of Directors has complete discretion on whether to pay dividends, subject to the
approval of our shareholders. Even if our Board of Directors decides to pay
dividends, the form, frequency and amount will depend upon our future operations
and earnings, capital requirements and surplus, general financial condition,
contractual restrictions and other factors that the Board of Directors may deem
relevant.
Quarterly
Information (unaudited)
The table
below presents unaudited quarterly data for the years ended December 31, 2009
and December 31, 2008:
1st
Quarter
|
2nd
Quarter
|
3rd
Quarter
|
4th
Quarter
|
|||||||||||||
2009
|
||||||||||||||||
Revenues
– sales and services
|
$ | - | $ | - | $ | 55,409 | $ | 11,393 | ||||||||
Operating
Loss
|
$ | (2,939,025 | ) | $ | (2,149,474 | ) | $ | (2,696,731 | ) | $ | (3,803,749 | ) | ||||
Net
Loss
|
$ | (2,922,351 | ) | $ | (2,158,650 | ) | $ | (2,644,162 | ) | $ | (3,764,215 | ) | ||||
Basic
and diluted net loss per common share
|
$ | (.07 | ) | $ | (.05 | ) | $ | (.06 | ) | $ | (.09 | ) | ||||
2008
|
||||||||||||||||
Operating
Loss
|
$ | (1,085,980 | ) | $ | (1,265,498 | ) | $ | (1,250,923 | ) | $ | (2,181,419 | ) | ||||
Net
Loss
|
$ | (950,008 | ) | $ | (1,201,002 | ) | $ | (1,157,980 | ) | $ | (2,137,659 | ) | ||||
Basic
and diluted net loss per common share
|
$ | (.02 | ) | $ | (.03 | ) | $ | (.03 | ) | $ | (.05 | ) |
Fourth
quarter 2009 versus fourth quarter 2008
The 2009
fourth quarter operating loss exceeded the 2008 fourth quarter operating loss by
$1,622,329. The increase was principally due to increased consulting
expense of $905,905 of which $630,519 was for amounts paid as equity and
$275,386 was for amounts paid as cash. The increased consulting
expense was largely due to milestone payments under agreements related to
start-up of EORP operations. In addition, stock compensation expense
for restricted stock and stock options increased $358,528 due to greater value
of awards subject to amortization. Legal fees expense decreased
$82,309 principally due to lower expense related to China. All other
expenses reflected a net increase, including 2009 write-offs of deferred charges
of $85,000 on asset acquisition and financing transactions under negotiation
that were terminated.
44
Performance
Graph
The graph
below compares the value at December 31, 2007, 2008 and 2009 of a $100
investment in our Common Stock with $100 investments in the S&P 500 index
and the S&P Small Cap 600 Energy Index assuming the initial investment was
made on October 15, 2007. Pursuant to Item 201(e) of Regulation S-K (§220.201),
the period covered by the comparison commences on October 15, 2007, which is the
date our Common Stock became registered under section 12 of the Exchange Act of
1943, as amended.
Securities
Authorized for Issuance under Equity Compensation Plans
The
following table includes the information as of the end of 2009 for each category
of our equity compensation plans:
P
Plan category
|
Number
of securities to be issued upon exercise of outstanding options, warrants
and rights
(a)
|
Weighted-average
exercise price of outstanding options, warrants and rights
(b)
|
Number
of securities remaining available for future issuance under equity
compensation plans (excluding securities reflected in column
(a))
(c)
|
|||||||||
Equity
compensation plans approved by security holders (1)(3)
|
4,268,013 | $ | 2.00 | (4) | 5,013,375 | |||||||
$ | 1.30 | (5) | ||||||||||
Equity
compensation plans not approved by security holders (2)
|
755,200 | $ | .56 | - | ||||||||
Total
|
5,023,213 | 5,013,375 |
(1)
|
Includes the
2007 Stock Plan and 2009 Equity Incentive Plan. On July 21,
2009 the Company and its stockholders approved the 2009 Equity Incentive
Plan.
|
(2)
|
Represents
individual compensation arrangements entered into between the Company and
certain employees and consultants in September 2006 for options
exercisable for Common Stock.
|
(3)
|
Includes remaining
warrants exercisable for 1,460,888 shares of Common Stock, originally
issued on May 7, 2007 to placement agents, for
which issuance was approved by stockholders of the
Company.
|
(4)
|
The
weighted average exercise price of stock
options.
|
(5)
|
The
weighted average exercise price of stock
warrants.
|
45
Recent
Sales of Unregistered Securities
Unregistered
Sales to United States Persons
On
November 2, 2009, the Company issued 2,214 shares of the Company’s Common Stock
to one person upon the exercise of a placement agent warrant exercisable for
2,214 shares of the Company’s Common Stock at a price of $1.25, which exercise
price was paid in cash by such person.
On
November 3, 2009, the Company issued an aggregate of 96,739 shares of Common
Stock to one person upon the cashless "net" exercise by such person on such date
of a placement agent warrant exercisable at $1.25 per share for an
aggregate of 136,000 shares of the Company's Common Stock. The aggregate number
of shares of Common Stock issued upon cashless “net” exercise was reduced from
136,000 shares of Common Stock to 96,739 shares of Common Stock to effect the
cashless "net" exercise of the warrant in accordance with its terms, assuming a
deemed fair market value of $4.33 per share, as calculated under the warrant as
the closing price quoted for one share of the Company's Common Stock on the last
trading day prior to the exercise date.
On
November 16, 2009, the Company issued an aggregate of 64,375 shares of Common
Stock to one person upon the cashless "net" exercise by such person on such date
of a placement agent warrant exercisable at $1.25 per share for an
aggregate of 83,045 shares of the Company's Common Stock. The aggregate number
of shares of Common Stock issued upon cashless “net” exercise was reduced from
83,045 shares of Common Stock to 64,375 shares of Common Stock to effect the
cashless "net" exercise of the warrant in accordance with its terms, assuming a
deemed fair market value of $5.56 per share, as calculated under the warrant as
the closing price quoted for one share of the Company's Common Stock on the last
trading day prior to the exercise date.
Each of
the warrants described above were originally issued to Garden State Securities,
Inc. (the “Original Holder”) in its role as a placement agent for the Company on
May 7, 2007, and subsequently assigned to the individual warrant holders in
August 2007.
No
underwriters were involved in the transactions described above. All
of the securities issued in the foregoing transactions were issued by the
Company in reliance upon the exemption from registration available under Section
4(2) of the Securities Act, including Regulation D promulgated thereunder, in
that the transactions involved the issuance and sale of the Company’s securities
to financially sophisticated individuals or entities that were aware of the
Company’s activities and business and financial condition and took the
securities for investment purposes and understood the ramifications of their
actions. The Company did not engage in any form of general
solicitation or general advertising in connection with the
transaction. The Original Holder of the warrants represented that it
was an “accredited investor” as defined in Regulation D at the time of issuance
of the original warrants, and that it was acquiring such securities for its own
account and not for distribution. All certificates representing the
securities issued have a legend imprinted on them stating that the shares have
not been registered under the Securities Act and cannot be transferred until
properly registered under the Securities Act or an exemption
applies.
Unregistered
Sales to Non-United States Persons
On July
30, 2009, the Company entered into an amended Advisor Agreement with Somerley
Limited, amending the original Advisor Agreement dated August 4,
2008. Under the amended Advisor Agreement, the Company was obligated
to issue to Somerley Limited shares of Common Stock as partial compensation upon
the achievement of certain milestones set forth in that agreement. On
September 15, 2009 15,000 shares of Common Stock were recorded as issued at a
price of $2.09 per share, the fair market value per share as determined by the
Board of Directors at July 30, 2009, the date the Company initially determined
it was obligated to issue the Common Stock. However, these shares
were not physically issued at that time, and the issuance was later rescinded
upon the determination by the Company in October 2009 that the specific
milestone had not yet been achieved. On October 21, 2009, 20,000
shares of Common Stock were issued to Somerley Limited at a price of $3.34 per
share upon achievement of a different milestone under the amended Advisor
Agreement.
46
No
underwriters were involved in the transactions described above. All
of the securities issued in these transactions were issued by us in reliance
upon the exemption from registration under Regulation S of the Securities Act,
in that the transactions involved the issuance and sale of our securities
outside the United States in offshore transactions that did not involve directed
selling efforts within the United States. All certificates
representing the securities issued have a legend imprinted on them stating that
the shares have not been registered under the Securities Act and cannot be
transferred until properly registered under the Securities Act or an exemption
applies.
Stock
Repurchases
The
Company did not repurchase any shares of its Common Stock during the quarter
ending December 31, 2009.
ITEM
6. SELECTED FINANCIAL DATA
Financial
Summary Data
|
For
the year ended December 31, 2009
|
For
the year ended December 31, 2008
|
For
the year ended December 31, 2007
|
For
the year ended December 31, 2006
|
For
the period
from inception
(August
25, 2005)
through
December
31,
2005
|
For
the period
from inception
(August
25, 2005)
through
December
31,
2009
|
||||||||||||||||||
Net
Loss – Pacific Asia Petroleum, Inc. and subsidiaries
|
$ | (11,489,378 | ) | $ | (5,446,649 | ) | $ | (2,383,684 | ) | $ | (1,086,387 | ) | $ | (51,344 | ) | $ | (20,457,442 | ) | ||||||
Net
Loss per share of common stock-basic and diluted
|
$ | (.28 | ) | $ | (.14 | ) | $ | (.08 | ) | $ | (.10 | ) | $ | (.03 | ) | |||||||||
Cash
Used in Operating Activities
|
$ | 7,111,002 | $ | 3,208,017 | $ | 2,060,887 | $ | 814,024 | $ | 10,071 | $ | 13,204,001 | ||||||||||||
Capital
Expenditures
|
$ | 232,535 | $ | 329,782 | $ | 80,689 | $ | 207,833 | $ | - | $ | 850,839 | ||||||||||||
As
of December 31,
|
||||||||||||||||||||
2009
|
2008
|
2007
|
2006
|
2005
|
||||||||||||||||
Selected
Balance Sheet Data
|
||||||||||||||||||||
Working
Capital
|
$ | 3,909,991 | $ | 11,223,902 | $ | 13,316,694 | $ | 3,110,818 | $ | (39,344 | ) | |||||||||
Property,
Plant and Equipment-Net
|
$ | 450,703 | $ | 569,303 | $ | 285,027 | $ | 208,511 | $ | - | ||||||||||
Total
Assets
|
$ | 7,435,693 | $ | 14,119,089 | $ | 17,456,927 | $ | 3,929,321 | $ | 101,929 | ||||||||||
See Part
II, Item 7. “Management’s Discussion and Analysis of Financial Condition and
Results of Operations” and “Part II, Item 8. Financial Statements”
for further information regarding the comparability of the Selected Financial
Data.
47
ITEM
7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
|
Our
Business
The
Company is a development stage company formed to develop new energy ventures,
directly and through joint ventures and other partnerships in which it may
participate. Members of the Company’s senior management team have
experience in the fields of international business development, finance,
petroleum engineering, geology, field development and production, and
operations. Members of the Company’s management team have held
management and executive positions with Texaco Inc. and with other international
energy companies and have managed energy projects in China and elsewhere.
Members of the Company’s management team also have experience in oil drilling,
operations, geological engineering, sales and government relations in China’s
energy sector.
The
cumulative net losses of the Company from inception through December 31, 2009
attributable to common stockholders are $20,457,442. Our losses have
resulted primarily from exploration activities on our Zijinshan Block, start-up
of EORP activities, general and administrative expenditures associated with
developing a new enterprise, and consulting, legal and accounting
expenses.
The
Company’s current operations commenced in 2005 through IMPCO, formed as a
limited liability company under New York State law on August 25, 2005. These
operations currently consist of development of oil production in Inner Mongolia,
China, exploration and development operations with respect to CBM opportunities
in the Shanxi Province of China, and enhanced oil recovery production activities
in the Liaoning, Shandong and Xinjiang Provinces of China. We consider the
Company to be a single line of business.
In the
fourth quarter of 2006, pursuant to a joint development contract with Chifeng
Zhongtong Oil and Natural Gas Co. (“Chifeng”), a company incorporated in Inner
Mongolia, China, the Company drilled its first oil well in Inner Mongolia. This
well was producing during part of 2007 under an exploration and development
license issued by the relevant Chinese authorities. However, no revenue or
related depletion expense have been recognized to date due to uncertainty of
realization of the revenue until a permanent production license is obtained.
Chifeng has accounted for our share of the production revenue in the form of a
credit which will be allocated to the Company retroactively when and if the
production license is issued. Operations from the well were suspended in 2007,
and it is planned to resume operations when and if the production license is
received. To date, the total production from the well has been approximately 400
tons of crude oil (all of which has been sold), and total producing revenues
credited to the Company (after costs and royalties) were approximately
$135,000.The Company is pursuing a combination of strategies to have such
production license awarded, including a possible renegotiation of the Chifeng
Agreement increasing the financial incentives to all the parties involved and
the Company is also pursuing a strategy focused on entering into negotiations
with respect to an opportunity to acquire the existing production from the 22
sq. km. Kerqing Oilfield. The acquisition of the Kerqing Oilfield could
significantly enhance the Chifeng Agreement in scale and value. If
this Production License is not issued, the opportunities to drill additional
long-term production wells under the contract, including future production from
this first well, will be at risk. In year 2010 the Company will be
continuing to evaluate the available approaches toward securing this Production
License. As of December 31, 2009 there was no certainty that any of these
strategies will ultimately be successful in resulting in a production license
for the Chifeng area, but the Company intends to continue in these
efforts. Due to these significant uncertainties, the company recorded
an impairment loss on its Chifeng investment in the fourth quarter of
2009.
On
October 26, 2007, PAPL, a wholly-owned subsidiary of the Company, entered into
the Zijinshan PSC with CUCBM for the exploitation of CBM resources in the
Zijinshan Block, which is located in the Shanxi Province in China. The Zijinshan
PSC provides, among other things, that PAPL, following approval of the PSC by
the Ministry of Commerce of China, has a minimum commitment for the first three
years to drill three exploration wells and to carry out 50 km of 2-D seismic
data acquisition (an estimated expenditure of $2.8 million), and in the fourth
and fifth years PAPL will drill four pilot development wells at an
estimated cost of $2 million (in each case subject to PAPL’s right to terminate
the Zijinshan PSC). That five year period constitutes the exploration period.
During the development and production period, CUCBM will have the right to
acquire a 40% participating interest and to work jointly and pay its
participating share of costs to develop and produce CBM under the Zijinshan PSC.
The Zijinshan PSC has a term of 30 years. Pursuant to the Zijinshan PSC, all CBM
resources (including all other related hydrocarbon resources) produced from the
Zijinshan block is to be shared as follows: (i) 80% of production is provided to
PAPL and CUCBM for recovery of all costs incurred; (ii) PAPL has the first right
to recover all of its exploration costs from such 80% and then development costs
are recovered by PAPL and CUCBM pursuant to their respective participating
interests; and (iii) the remainder of the production is split by CUCBM and PAPL
receiving between 99% and 90% of such remainder depending on the actual
producing rates (a sliding scale) and the balance of the remainder (between 1%
and 10%) is provided to the Government of China. On April 2, 2008, the Company
received written confirmation that the Ministry of Commerce of The People’s
Republic of China approved the entry by PAPL into the above Production Sharing
Contract. On December 9, 2008 the Company and CUCBM finalized a mutually agreed
work program pursuant to which the Company may immediately commence development
operations under the Zijinshan PSC.
48
The
Company has completed seismic data acquisition operations on the Zijinshan Block
and spent approximately $1.5 million to shoot 162 kilometers of seismic under
the work program. This seismic data has since been processed and
interpreted. Based on the seismic interpretation, four potential well
locations have been identified. A regional environmental impact assessment study
(“EIA”) has also been completed. Following completion of a site specific EIA
study the Company spudded well ZJN 001 on September 30, 2009. This well was
targeted at the 4/5 coal seams in the Shanxi formation and 8/9 coal seams in the
Taiyuan formation. The well reached total depth in November
2009. Core samples have undergone laboratory testing, including tests
for gas content, gas saturation and coal characteristics. Based on
the results of these tests, the Company has at the latest Zijinshan PSC Joint
Management Committee (JMC) meeting agreed to a 2010 work program which includes
undertaking further technical studies related to the CUCBM Contract Area and
drilling at least two additional wells there.
The
Company entered into a Letter of Intent in November 2008 to possibly acquire a
51% ownership interest in the Handan Chang Yuan Natural Gas Co., Ltd. (“HGC”)
from the Beijing Tai He Sheng Ye Investment Company Limited. HGC owns and
operates gas distribution assets in and around Handan City, China. HGC was
founded in May 2001, and is the primary gas distributer in Handan City, which is
located 250 miles south of Beijing, in the Hebei Province of the People’s
Republic of China. HGC has over 300,000 customers and owns 35 miles of a main
gas pipeline, and more than 450 miles of delivery gas pipelines, with a delivery
capacity of 300 million cubic meters per day. HGC also owns an 80,000
sq. ft. field distribution facility. Gas is being supplied by Sinopec and
PetroChina from two separate sources. On July 7, 2009 the Company
entered into a revised Letter of Intent with Handan Hua Ying Company Limited
(“Handan”) relating to the possible acquisition of a 49% ownership interest in
HGC. The Company will continue its evaluation of this possible
acquisition including the possibility of bringing in partners.
On May
13, 2009, Pacific Asia Petroleum, Inc. and its wholly-owned Hong Kong
subsidiary, PAPE, entered into a Letter of Understanding (“LOU”), which was
amended and further detailed in various other associated agreements that were
executed on June 7, 2009, with Mr. Li Xiangdong (“LXD”) and Mr. Ho Chi Kong
(“HCK”), pursuant to which the parties agreed to form Beijing Dong Fang Ya Zhou
Petroleum Technology Service Company Limited (“Dong Fang”) as a new Chinese
joint venture company, to be 75.5% owned by PAPE and 24.5% owned by LXD, into
which LXD would assign certain pending patent rights related to chemical
enhanced oil recovery (the “LXD Patents”). Dong Fang was officially
incorporated under Chinese law on September 24, 2009. As required by the LOU,
and pursuant to that certain Agreement on Cooperation, dated June 7, 2009, and
as amended on June 25, 2009 (the “AOC”), entered into by and between PAPE and
LXD, upon the effectiveness of the assignment of the LXD Patents to Dong Fong by
LXD on November 27, 2009, (i) the Company paid LXD and HCK $100,000 each, (ii)
PAP has issued shares of PAPE to Best Source Group Holdings Limited, a Hong Kong
company designated by HCK (“BSG”), to provide BSG with a 30% ownership interest
in PAPE, with the Company retaining the balance 70% ownership interest in PAPE,
and (iii) the Company has issued to HCK’s designee 100,000 shares of Common
Stock of the Company and options to purchase up to 400,000 additional shares of
Common Stock of the Company. These options were approved for issuance by the
Board of Directors on January 21, 2010 at an exercise price of $4.62 per share,
which was the closing sale price of the Company’s Common Stock at that date the
Company’s issuance obligation was triggered upon achievement of the applicable
milestone under the LOU on November 27, 2009 as reported by NYSE Amex. The
Company has also agreed to issue 300,000 more shares of Company Common Stock to
HCK or his designee upon the signing of certain contracts by Dong Fang with
respect to the Fulaerjiqu oilfield. All the options granted to
HCK do not vest immediately; vesting will be contingent upon the achievement of
certain milestones related to the entry by Dong Fang into certain EORP-related
development contracts pertaining to oilfield projects in the Fulaerjiqu
Oilfield. These contracts are anticipated to each deliver to Dong Fang a
significant percentage of the incremental oil production and/or fixed fees per
ton for the incremental production which results from using the technology
covered by the LXD Patents.
In
addition, LXD has been engaged as a consultant by Dong Fang to provide research
and development services, training, and assistance in promoting certain other
opportunities developed by him that target the application of the technology
embodied in the LXD Patents, including assistance with entering into a contract
with respect to the Liaohe Oilfield (the “Liaohe Contract”), and helping to
develop projects in both the Shandong Province and the Xinjiang autonomous
region of the People’s Republic of China for the provision and application of
technology and chemicals developed by LXD.
49
The
Company has agreed to loan up to $5 million to PAPE, which may then invest up to
RMB 30,000,000 (approximately $ 4.4 million) into Dong Fang, with a portion of
this being a requirement to invest RMB 22,650,000 as PAPE’s share of the
registered capital of Dong Fang, when and to the extent required under
applicable law. PAPE’s capital investment will be used by Dong Fang
to carry out work projects, fund operations, and to make, together with PAPE,
aggregate payments of up to $1.5 million in cash to LXD and HCK. The payments of
up to $1.5 million in cash to LXD and HCK are subject to the
achievement of certain milestones pursuant to the LOU, including the formation
of Dong Fang, the transfer of the LXD Patents to Dong Fang, and the signing of
the contracts with respect to the Fularjiqu Oilfield and the Liaohe Contract by
Dong Fang, as well as certain production-based milestones resulting from the
implementation of these contracts. As of December 31, 2009, $500,000 of
milestone payments had been paid or accrued by PAPE. The loan from the Company
to PAPE will be repaid from funds distributed to PAPE by way of dividends or
other appropriate payments from Dong Fang. As of December 31, 2009,
the Company has loaned a total of $1.3 million to PAPE, and PAPE has invested a
total of RMB 4.8 million (approximately US$700,000) into Dong Fang.
In
accordance with the terms of the LOU, as amended on June 7, 2009, PAPE, LXD and
the Company’s existing Chinese joint venture company, Inner Mongolia Sunrise
Petroleum Co. Ltd. (“IMPCO Sunrise”), entered into an Assignment Agreement of
Application Right for Patent, Consulting Engagement Agreement, and an Interest
Assignment Agreement. Upon formation of Dong Fang on September 24,
2009, all these and other agreements entered into by IMPCO Sunrise on behalf of
Dong Fang were assigned by IMPCO Sunrise to Dong Fang.
With
these EORP-related agreements signed and in place, the Company through Dong Fang
has commenced operations in various oil fields located in the Liaoning,
Shandong, and Xinjiang Provinces in China. In the year ended December
31, 2009, the Company recorded initial revenues, cost of sales and expenses from
the EORP business activities.
Recent
Developments
Oyo
Field Production Sharing Interest
On
November 18, 2009, the Company entered into the Purchase and Sale Agreement (the
“Purchase and Sale Agreement”) with CAMAC Energy Holdings Limited and certain of
its affiliates (“CAMAC”) pursuant to which the Company agreed to acquire all of
CAMAC’s 60% interest in production sharing contract rights with respect to that
certain oilfield asset known as the Oyo Field (the “Contract Rights”) and the
transactions contemplated thereby, including the election of directors of the
Company (the “Transaction”). The Purchase and Sale Agreement,
provides that, among other things: (i) CAMAC will transfer the Contract Rights
to CAMAC Petroleum Limited, a newly-formed Nigerian entity wholly-owned by the
Company, in consideration for the Company’s payment of $38.84 million
in cash (subject to possible reduction pursuant to the agreement in
principle between CAMAC and the Company which will reduce such
payment amount by a portion of CAMAC’s net cash flow generated by
production from the Oyo Field through the closing of the Transaction) and the
issuance of the Company’s Common Stock, par value $0.001 per share, equal to
62.74% of the Company’s issued and outstanding Common Stock, after giving effect
to the Transaction; and (ii) for a period commencing on the closing of the
transactions contemplated by the Purchase and Sale Agreement (the “Closing”) and
ending the date that is one year following the Closing, the Company’s Board of
Directors will consist of seven members, four of whom will be nominated by
CAMAC.
50
The
Transaction is expected to close during the first quarter of 2010, and is
subject to the satisfaction of customary and other conditions to Closing,
including, without limitation: (i) the negotiation and entry by the
parties into certain other agreements as set forth in the Purchase and Sale
Agreement in forms reasonably satisfactory to the parties; (ii) the Company’s
consummation of a financing on terms reasonably acceptable to CAMAC resulting in
gross proceeds of at least $45 million to the Company; and (iii) the
approval of the Company’s stockholders of the Purchase and Sale Agreement and
the transactions contemplated thereby. The Purchase and Sale Agreement
also contains other customary terms, including, but not limited to,
representations and warranties, indemnification and limitation of liability
provisions, termination rights, and break-up fees if either party terminates
under certain circumstances. The Company has already raised $20 million in
a registered direct offering (disclosed below) and plans to raise an additional
$25 million in connection with its obligation under the Purchase and Sale
Agreement. However, if the Company is unable to consummate such
additional financing, agree upon the terms of the other required agreements
between the parties or satisfy any of the other closing conditions set forth in
the Purchase and Sale Agreement, the Company may be unable to consummate the
Purchase and Sale Agreement.
At the
Closing of the Transaction, and subject to stockholder approval prior to
Closing, the Company’s name will be changed to CAMAC Energy Inc. The
Transaction, if consummated, will result in a change of control of the
Company.
Registered
Direct Offering
On
February 16, 2010, the Company consummated the offer and sale of 5,000,000
shares (the "Shares") of its common stock, par value $0.001 per share ("Common
Stock"), for an aggregate purchase price of $20 million, or $4.00 per share (the
"Purchase Price"), pursuant to a Securities Purchase Agreement, dated February
10, 2010, among the Company and certain purchasers signatory thereto (the
“Purchasers”). In addition, the Company issued to the Purchasers (1)
warrants to purchase up to an additional 2,000,000 shares of Common Stock of the
Company, in the aggregate, at an exercise price of $4.50 (subject to
customary adjustments), exercisable commencing six months following the closing
for a period of 36 months after such commencement date (the “Series A
Warrants”); and (2) warrants to purchase up to an additional
2,000,000 shares of Common Stock of the Company, in the aggregate, at an
exercise price $4.00 per share (subject to customary adjustments), exercisable
immediately at the closing until November 1, 2010 (the “Series B Warrants” and
together with the Series A Warrants, the “Warrants”). If all the
Warrants are exercised, the Company would receive additional gross proceeds of
$17 million. The Shares and the Warrant Shares are to be sold pursuant to a
shelf registration statement on Form S-3 declared effective by the SEC on
February 3, 2010 (File No. 333-163869), as amended by the prospectus supplement
filed with the SEC on February 12, 2010 and delivered to the
Purchasers.
Rodman
& Renshaw, LLC served as the Company’s exclusive placement agent in
connection with the offering. As consideration for its services as
placement agent, Rodman received a cash fee equal to 6.0% of the gross proceeds
of the offering ($1,200,000), as well as a 5-year warrant to purchase shares of
Common Stock of the Company equal to 3.0% of the aggregate number of shares sold
in the offering (150,000 shares of Common Stock), plus any shares underlying the
Warrants. Rodman’s warrant has the same terms as the Warrants issued
to the Purchasers in the offering except that the warrant is not exercisable
until the 6-month anniversary of the closing and the exercise price is 125% of
the per share purchase price of the shares issued in the offering ($5.00 per
share). In addition, subject to compliance with Financial Industry
Regulatory Authority ("FINRA") Rule 5110(f)(2)(D), the
Company reimbursed Rodman’s out-of-pocket accountable expenses
actually incurred in the amount of $25,000.
Net
proceeds from the offering are planned to be used by the Company for working
capital purposes, and also may be used by the Company to fund the Company’s
acquisition from CAMAC of the Contract Rights with respect to the Oyo Field,
which began production in December 2009.
51
Plan
of Operation
The
following describes in general terms the Company’s plan of operation and
development strategy for the twelve-month period ending December 31, 2010 (the
“Next Year”). During the Next Year, the Company plans to focus its efforts
toward consummating the Oyo Field PSC interest acquisition and to continue
operations under its 100% owned and operated Zijinshan PSC. The Zijinshan
operations will include the possible drilling of two additional wells and
continuing geological modeling and mapping. The Company also plans to continue
putting into commercial use the new EORP technology to produce incremental oil
in oilfields located in the Heilongjiang, Liaoning, Shandong, Henan and Xinjiang
Provinces in China through the operations of Dong Fang. The Company
will also assess the applicability of the new EORP technology to the Company’s
August 2006 Contract for Cooperation and Joint Development with Chifeng pursuant
to which drilling operations were suspended in 2007 pending receipt of a
production license from the Chinese government. The Company’s revised strategy
with regards to Chifeng is to seek to enhance all the relevant parties’ economic
positions and use these benefits to acquire the necessary production licenses in
order to carry out the plans under that agreement. As of December 31, 2009,
there was no certainty that any of these strategies will ultimately be
successful in resulting in a production license for the Chifeng area, but the
Company intends to continue in these efforts.
In
addition to these opportunities, the Company is continuing to seek to identify
other opportunities in the energy sectors in China and the Pacific Rim, and
elsewhere around the world that will enhance its production and cash flow,
particularly with respect to oil and gas exploration, development, production,
refining and distribution. Since we are a development stage company, we are
limited in our ability to grow by the availability of capital for our businesses
and each project. The Company’s ability to successfully consummate any of its
projects, including the projects described above, is contingent upon the making
of any required deposits, obtaining the necessary governmental approvals and
executing binding agreements to obtain the rights we seek within limited
timeframes.
Additionally,
assuming the consummation of the Transaction contemplated by the Purchase and
Sale Agreement with respect to the Oyo Field PSC, the Company plans to focus
significant efforts on developing corporate infrastructure, accounting controls,
policies and procedures, and establishing foreign and domestic human and
operational resources necessary to integrate, support and maximize its contract
rights acquired from CAMAC, and to realize and maximize value under the related
Oyo Field PSC in coordination with the Oyo Field’s operating contractor,
Nigerian Agip Exploration Ltd (“NAE”), a subsidiary of Italy's ENI SpA (one of
the world’s largest international energy companies).
The
Company has assembled a management team with experience in the fields of
international business development, petroleum and geologic engineering, geology,
petroleum field development and production, operations, sales, government
relations and finance. Members of the Company’s management
team previously held management and executive positions at Texaco
Inc. and other international energy companies and have managed energy
projects in China and elsewhere. They will seek to utilize their
contacts in Asia to provide us with access to a variety of energy projects.
Among the strategies that we plan to use are:
·
|
Focusing
on projects that play to the expertise of our management
team;
|
·
|
Leveraging
our productive asset base and capabilities to develop
value;
|
·
|
Actively
managing our assets and ongoing operations while attempting to limit
capital exposure;
|
·
|
Enlisting
external resources and talent as necessary to operate/manage our
properties during peak operations;
and
|
·
|
Implementing
an exit strategy with respect to each project with a view to maximizing
asset values and returns
|
Results
of Operations
As a
development stage company, we have had only minimal revenues from operations. We
may experience fluctuations in operating results in future periods due to a
variety of factors, including our ability to obtain additional financing in a
timely manner and on terms favorable to us, our ability to successfully develop
our business model, the amount and timing of operating costs and capital
expenditures relating to the expansion of our business, operations and
infrastructure and the implementation of marketing programs, key agreements, and
strategic alliances, and general economic conditions specific to our
industry.
52
As a
result of limited capital resources and minimal revenues from operations from
the date of IMPCO’s inception on August 25, 2005, the Company has relied on the
issuance of equity securities as a means of compensating employees and
non-employees for services. The Company enters into equity compensation
agreements with non-employees if it is in the best interest of the Company and
in accordance with applicable federal and state securities laws. In order to
conserve its limited operating capital resources, the Company anticipates
continuing to compensate employees and non-employees partially with equity
compensation for services during the Next Year. This policy may have
a material effect on the Company’s results of operations during the Next
Year.
Revenues
We have
generated $66,802 in total revenues from operations since IMPCO’s inception on
August 25, 2005 through December 31, 2009. Revenues commenced in the
year ended December 31, 2009, and all revenues were in China. We expect to
generate additional revenues from operations in 2010, as the Company transitions
from a development stage company to an active growth stage company.
Costs
and Operating Expenses
Years
ended December 31,
|
||||||||||||
2009
|
2008
|
2007
|
||||||||||
Salaries
and cash bonus
|
$ | 2,140,166 | $ | 1,672,694 | $ | 898,875 | ||||||
Consulting
and PSC management fees
|
2,606,728 | 669,441 | 803,485 | |||||||||
Stock-based
compensation
|
2,432,006 | 1,355,590 | 195,442 | |||||||||
Exploratory
|
1,705,217 | 249,440 | - | |||||||||
Legal
fees
|
321,851 | 361,096 | 300,228 | |||||||||
Travel,
meals and entertainment
|
314,130 | 332,565 | 194,071 | |||||||||
Payroll
taxes
|
239,947 | 74,029 | 38,010 | |||||||||
Rent
|
233,042 | 110,013 | 78,183 | |||||||||
Auditing
|
182,668 | 169,368 | 135,305 | |||||||||
Impairment
of assets
|
219,388 | 273,618 | - | |||||||||
All
other
|
1,260,638 | 515,966 | 338,648 | |||||||||
Total
Costs and Operating Expenses
|
$ | 11,655,781 | $ | 5,783,820 | $ | 2,982,247 |
For the
fiscal year 2009, total pre-tax costs and operating expenses were $11,655,781 as
compared to $5,783,820 in 2008 and $2,982,247 in
2007. Over this three year period, the Company’s expenses have
increased as the commencement of physical operations has occurred in the
Zijinshan PSC area and in EORP activity. The Company has only
generated nominal revenues to date and as such is still a
development stage company. The major components of expense differences are as
follows:
Year 2009 versus Year
2008
·
|
Salaries and cash
bonus: The increase of $467,472 ($2,140,166 versus
$1,672,694) resulted from an increase in the number of employees and
increased compensation associated with expanded activity in
China.
|
·
|
Consulting and PSC management
fees: The increase of $1,937,287 ($2,606,728 versus
$669,441) was due to an increase of $886,965 in consulting fees payable as
vested equity compensation and an increase of
$1,050,322 in cash consulting fees. The increase in consulting
payable as equity was principally due to public relations work and an
accrual of $462,000 for a milestone payment obligation related
to start-up of EORP activities. The increase in cash
consulting was principally due to $500,000 in milestone payments paid or
accrued related to the start-up of EORP activities and
increased PSC and other management consulting fees
relative to Zijinshan and other operations in
China.
|
53
·
|
Stock-based
compensation: The increase of $1,076,416 ($2,432,006
versus $1,355,590) reflects a larger value of restricted stock and stock
option awards subject to amortization in 2009 versus
2008.
|
·
|
Exploratory: The
increase of $1,455,777 ($1,705,217 versus $249,440) reflects increased
seismic and drilling activity for Zijinshan in
2009.
|
·
|
Legal
fees: The decrease of $39,245 ($321,851 versus $361,096)
was principally due to decreased legal expense related to transactions and
proposed transactions in China.
|
·
|
Travel, meals, and
entertainment: Expenses decreased by $18,435 ($314,130
versus $332,565), reflecting travel in connection with China activities
and reviews of other oil and gas
opportunities.
|
·
|
Payroll taxes: The
increase of $165,918 ($239,947 versus $74,029) was principally due to
increased U.S. payroll and increased expatriate payroll in
China.
|
·
|
Rent: The increase of
$123,029 ($233,042 versus $110,013) was principally due to increased
expense in China.
|
·
|
Auditing: The increase
of $13,300 ($182,668 versus $169,368) was due to increased auditor
involvement from expanded
operations.
|
·
|
Impairment of
assets: The decrease of $54,230 ($219,388 versus
$273,618) reflects the net effect of two nonrecurring items occurring in
different years: the 2009 write-off of Chifeng property, plant
and equipment versus the 2008 write-down of the notes receivable from the
noncontrolling interest investor in a China subsidiary
company.
|
·
|
All other: The increase
of $744,672 ($1,260,638 versus $515,966) was principally due to 2009
start-up expenses of EORP operations that have not yet generated
significant revenues, increased corporate promotional activity, 2009
write-off of deferred expenses on terminated transactions, and increased
China employee housing allowances.
|
Year 2008 versus Year
2007
·
|
Salaries and bonus: The
increase of $773,819 ($1,672,694 versus $898,875) resulted principally
from an increase in the number of
employees.
|
·
|
Consulting and PSC management
fees: The decrease of $134,044 ($669,441 versus $803,485) was
principally due to a decrease of $197,312 in non-cash fees paid as equity,
mainly from increased activity involving potential oil and gas
opportunities, an increase of $124,776 in cash consulting fees related to
Sarbanes-Oxley compliance work, and a decrease of $46,212 in other cash
consulting fees due to nonrecurring 2007 financing and merger-related
negotiation assistance.
|
·
|
Stock-based
compensation: The increase of $1,160,148 ($1,355,590 versus
$195,442) reflects a larger value of restricted stock and stock option
awards subject to amortization in 2008 versus
2007.
|
·
|
Exploratory: The
increase of $249,440 ($249,440 versus zero) reflects initial activity in
2008.
|
·
|
Legal fees: The
increase of $60,868 ($361,096 versus $300,228) was due to the legal
requirements to prepare SEC filings, assistance in compliance with
Sarbanes-Oxley requirements and the general increase in the Company’s
activities.
|
·
|
Travel, meals and
entertainment: The increase of $138,494 ($332,565 versus $194,071)
was due to increases in travel to review potential oil and gas
opportunities and related financing
activities.
|
·
|
Payroll taxes: The
increase of $36,019 ($74,029 versus $38,010) was due to increased number
of employees.
|
·
|
Rent: The increase of
$31,830 ($110,013 versus $78,183) was due to increased rental expense
principally in China.
|
54
·
|
Auditing: The increase
of $34,063 ($169,368 versus $135,305) was due to the increased
requirements for SEC filings subsequent to the Merger in May
2007.
|
·
|
Impairment of assets:
The increase of $273,618 ($273,618 versus zero) was due to the 2008
write-down of notes receivable from the noncontrolling interest investor
in a China subsidiary company.
|
·
|
All other: The increase
of $177,318 ($515,966 versus $338,648) reflects the increase in activity
of the Company in 2008 versus 2007.
|
Liquidity
and Capital Resources
The
Company has sufficient funds to fund all of its current committed operations for
the next two years. The following table provides summarized
statements of net cash flows for the years ended December 31, 2009 and 2008:
Cash
Flows
|
Years
Ended December 31,
|
|||||||
2009
|
2008
|
|||||||
Net
Cash Used in Operating Activities
|
$ | (7,111,002 | ) | $ | (3,208,017 | ) | ||
Net
Cash Provided by Investing Activities
|
191,553 | 11,511,505 | ||||||
Net
Cash Provided by (Used in) Financing Activities
|
13,944 | (2,513 | ) | |||||
Effect
of Exchange Rate Changes on Cash
|
(8,041 | ) | 5,713 | |||||
Net
(decrease) increase in Cash and Cash Equivalents
|
(6,913,546 | ) | 8,306,688 | |||||
Cash
and Cash Equivalents – Beginning of Period
|
10,515,657 | 2,208,969 | ||||||
Cash
and Cash Equivalents – End of Period
|
3,602,111 | 10,515,657 |
As of
December 31, 2009, the Company had net working capital of $3,909,991 and cash,
cash equivalents and short-term investments of $5,337,507. For
the year ended December 31, 2009, the Company incurred a net loss attributable
to common stockholders of $11,489,378.
As a
result of our operating losses from our inception through December 31, 2009, we
generated a cash flow deficit of $13,204,001 from operating activities. Cash
flows used in investing activities were $2,936,985 during the period from
inception through December 31, 2009. We met our cash requirements
during this period through net proceeds of $19,671,092 from the private
placement of restricted equity securities.
Net cash
used in operating activities was $7,111,002 in 2009 compared to $3,208,017 in
2008. The increase in 2009 versus 2008 was due to increases in
expenses, principally for exploratory expenses incurred on the Zijinshan Block,
consulting and Zijinshan PSC management fees, and milestone payments related to
start-up of EORP activity.
Net cash
provided by investing activities was $191,553 in 2009, as compared to
$11,511,505 in 2008. The net change was principally due to $475,397
in net purchases of available for sale short-term securities in 2009 versus net
sales of $9,940,000 of such securities in 2008. Also affecting the
decrease in cash flows were lower net cash refunds of prior deposits from
Chevron and BHP in 2009 versus 2008, for amounts the Company had previously paid
to them in connection with transactions that were later
terminated.
Net cash
provided by or used in financing activities was not significant in 2009 and 2008
on a total basis or on an individual item basis.
Our
available working capital and capital requirements will depend upon numerous
factors, including progress of our exploration and development programs,
progress of our EORP efforts, market developments, the status of our competitors
and completion of the CAMAC Transaction.
55
Our
continued operations will depend on whether we are able to raise additional
funds through various potential sources, such as equity and debt financing and
strategic alliances. Such additional funds may not become available on
acceptable terms, if at all, and any additional funding obtained may not be
sufficient to meet our needs in the long-term. Through December 31, 2009
virtually all of our financing had been raised through private placements of
equity instruments. The Company at December 31, 2009 had no credit
lines for financing and no short-term or long-term debt.
In
February 2010 the Company raised $20 million of equity financing through a
registered direct offering. Proceeds from this offering are planned
to be used for working capital purposes, and also may be used by the Company to
fund the acquisition from CAMAC of the Contract Rights with respect to the Oyo
Field. The Company does expect to raise additional funds to complete
the Transaction.
Whether
or not the CAMAC Transaction is completed, the Company expects to
have sufficient cash flow to fund its current operational and development plans
over the next two years. To the extent the Company acquires
additional energy- related investments and rights, consistent with its business
plan, the Company may need to raise additional funds for such
projects.
Long-Lived
Assets
The
Company’s long-lived assets (other than financial instruments) by geographic
area were as follows.
As
of December 31,
|
2009
|
2008
|
||||||
Property, plant
and equipment, net
|
||||||||
United
States
|
$ | 118,627 | $ | 94,352 | ||||
China
|
332,076 | 474,951 | ||||||
Total
|
$ | 450,703 | $ | 569,303 |
Obligations
under Material Contracts
The
following table summarizes the Company’s significant contractual obligations at
December 31, 2009. See also Part I Item 2. Properties for
further information regarding the Company’s operating leases payment
obligations shown in the table below.
Payments
Due By Period
|
|||||||||
Contractual
Obligations
|
Total
|
Less
than 1 year
|
1-3
years
|
3-5
years
|
More
than 5 years
|
||||
Operating
Lease Obligations
|
$297,106
|
$210,748
|
$86,358
|
$-
|
$-
|
Critical
Accounting Policies and Estimates
The
discussion and analysis of our plan and results of operations is based upon our
consolidated financial statements, which have been prepared in accordance with
accounting principles generally accepted in the United States of America. The
preparation of our consolidated financial statements requires us to make
estimates and assumptions that affect our reported results of operations and the
amount of reported assets, liabilities and proved oil and gas reserves. Some
accounting policies involve judgments and uncertainties to such an extent that
there is reasonable likelihood that materially different amounts could have been
reported under different conditions, or if different assumptions had been used.
Actual results and timing may differ from the estimates and assumptions used in
the preparation of our consolidated financial statements. Described below are
the most significant policies we apply, or intend to apply, in preparing our
consolidated financial statements, some of which are subject to alternative
treatments under accounting principles generally accepted in the United States
of America. We also describe the most significant estimates and assumptions we
make in applying these policies.
56
Oil
and Gas Activities
Accounting
for oil and gas activities is subject to special, unique rules. Two generally
accepted methods of accounting for oil and gas activities are available —
successful efforts and full cost. The most significant differences between these
two methods are the treatment of exploration costs and the manner in which the
carrying value of oil and gas properties are amortized and evaluated for
impairment. The successful efforts method requires exploration costs to be
expensed as they are incurred while the full cost method provides for the
capitalization of these costs. Both methods generally provide for the periodic
amortization of capitalized costs based on proved reserve quantities. Impairment
of oil and gas properties under the successful efforts method is based on an
evaluation of the carrying value of individual oil and gas properties against
their estimated fair value, while impairment under the full cost method requires
an evaluation of the carrying value of oil and gas properties included in a cost
center against the net present value of future cash flows from the related
proved reserves, using period-end prices and costs and a 10% discount
rate.
The
Company at present reports no proved oil and gas reserves as we are a
development stage company. Management, in making investment decisions
regarding the acquisition and development of oil and gas properties, performs
economic and technical evaluations including assessment of commerciality based
upon estimates and assumptions that it believes are reasonable. In
order to recognize new proved reserves, the positive technical assessment of
producibility, our financial capability for development, and management
commitment for capital expenditures must be demonstrated to ensure that the
reserves will be developed and are producible under existing economic and
operating conditions.
Successful
Efforts Method
We use
the successful efforts method of accounting for our oil and gas activities.
Under this method, costs of drilling successful wells are capitalized. Costs of
drilling exploratory wells not placed into production are charged to expense.
Geological and geophysical costs are charged to expense as
incurred.
Depreciation,
Depletion and Amortization
The
quantities of estimated proved oil and gas reserves are expected to be a
significant component of our calculation of future depreciation and depletion
expense related to oil and gas properties and equipment, and revisions in such
estimates may alter the rate of future expense. Holding all other factors
constant, if reserves are revised upward, earnings would increase due to lower
depletion expense. Likewise, if reserves are revised downward, earnings would
decrease due to higher depletion expense.
Future
Development and Abandonment Costs
Future
development costs include costs incurred to obtain access to proved reserves
such as drilling costs and the installation of production equipment. Future
abandonment costs include costs to dismantle and relocate or dispose of our
production platforms, gathering systems and related structures and restoration
costs of land and seabed. Our operators develop estimates of these costs for
each of our properties based upon their geographic location, type of production
structure, well depth, currently available procedures and ongoing consultations
with construction and engineering consultants. Because these costs typically
extend many years into the future, estimating these future costs is difficult
and requires management to make judgments that are subject to future revisions
based upon numerous factors, including changing technology and the political and
regulatory environment. We review our assumptions and estimates of future
development and future abandonment costs on an annual basis.
Liabilities
for future abandonment costs are recorded at the discounted fair value of the
asset retirement obligation in the period in which it is incurred, and the
corresponding cost capitalized by increasing the carrying amount of the related
long-lived asset. The liability is accreted to its present value each period,
and the capitalized cost is depreciated over the useful life of the related
asset. Holding all other factors constant, if our estimate of future abandonment
and development costs is revised upward, earnings would decrease due to higher
depreciation, depletion and amortization (“DD&A”) expense. Likewise, if
these estimates are revised downward, earnings would increase due to lower
DD&A expense.
57
Consolidation
The
financial statements include Pacific Asia Petroleum, Inc. (successor company to
IMPCO) and its majority owned direct and indirect subsidiaries in the respective
periods. Periods prior to the Merger date of May 7, 2007 included in
the 2007 and prior year financial statements include only the results of IMPCO
and IMPCO’s subsidiaries.
Allocation
of Purchase Price in Business Combinations
As part
of our business strategy, we actively pursue the acquisition of oil and gas
properties. The purchase price in an acquisition is allocated to the assets
acquired and liabilities assumed based on their relative fair values as of the
acquisition date, which may occur many months after the announcement date.
Therefore, while the consideration to be paid may be fixed, the fair value of
the assets acquired and liabilities assumed is subject to change during the
period between the announcement date and the acquisition date. Our most
significant estimates in our allocation typically relate to the value assigned
to future recoverable oil and gas reserves and unproved properties. As the
allocation of the purchase price is subject to significant estimates and
subjective judgments, the accuracy of this assessment is inherently
uncertain.
Revenue
Recognition
Revenues
are recognized only when the earnings process is complete and an exchange
transaction has taken place. An exchange transaction may be a physical sale, the
providing of services, or an exchange of rights and privileges. The
recognition criteria are satisfied when there exists a signed contract with
defined pricing, delivery and acceptance (as defined in the contract) of the
product or service have occurred, there is no significant uncertainty of
collectibility, and the amount is not subject to refund.
Short-Term
Investments
Debt and
equity securities are classified into one of three categories: held-to-maturity,
available-for-sale, or trading. Securities may be classified as
held-to-maturity only if the Company has the positive intent and ability to hold
them to maturity. Trading securities are defined as those bought and
held principally for the purpose of selling them in the near
term. All other securities are classified as
available-for-sale. Declines in the fair value of held-to-maturity
and available-for-sale securities below their cost that are deemed to be other
than temporary are reflected in earnings as realized losses. The
Company’s short-term investments are classified as
available-for-sale.
Foreign
Currency Translation
The
Company uses both the U.S. dollar and local currency as functional currencies
based upon the principal currency of operation of each subsidiary. The
functional currency for operations in China (other than Hong Kong) is the local
currency. The Company at present expects that the future revenues from its
operations in China will be in local currency. Balance sheet
translation effects from translating local functional currency into U.S. dollars
(the reporting currency) are recorded directly to other comprehensive
income.
Stock-based
Compensation
The
Company values its stock options awarded on or after January 1, 2006 at the fair
value at grant date using the Black-Scholes option pricing
model. Compensation expense for stock options and restricted stock
awards is recorded over the vesting periods on a straight line basis for each
award group. Compensation paid in stock fully vested at award date is valued at
fair value at that date and charged to expense at that time. The Company made no
stock-based compensation grants before 2006.
Recently
Issued Accounting Standards Not Yet Adopted
Information
on accounting standards not yet adopted is contained in Note 4 to the
consolidated financial statements in this Form 10-K.
Off-Balance
Sheet Arrangements
The
Company does not have any off-balance sheet arrangements other than the
operating leases disclosed below.
58
Inflation
It is the
opinion of the Company that inflation has not had a material effect on its
operations.
ITEM
7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
The
Company may be exposed to certain market risks related to changes in foreign
currency exchange and interest rates.
Foreign
Currency Exchange Risk
In
addition to the U.S. dollar, the Company conducts its business in RMB and
therefore is subject to foreign currency exchange risk on cash flows related to
expenses and investing transactions.
In July
2005, the Chinese government began to permit the RMB to float against the U.S.
dollar. All of our costs to operate our Chinese office and operations are paid
in RMB. Our exploration costs in China may be incurred under contracts
denominated in RMB or U.S. dollars. To date the Company has not
engaged in hedging activities to hedge our foreign currency exposure. In the
future, the Company may enter into hedging instruments to manage its foreign
currency exchange risk or continue to be subject to exchange rate
risk.
The
Company currently holds notes carried at $33,015 as of December 31, 2009 after
impairment adjustment. The notes are denominated and receivable in RMB and are
held by Inner Mongolia Production Company (HK) Limited, which recognizes
appreciation and depreciation of the RMB note. A 20%
appreciation of the RMB would result in a gain of approximately
$7,000. A 20% decline of the RMB would result in a loss of
approximately $7,000.
Interest
Rate Risk
See Note
6 to the financial statements in Part II, Item 8. “Financial Statements” for
information regarding our financial instruments. At December 31, 2009
the Company had investments in fixed rate financial instruments
subject to interest rate risk affecting fair value. However, those instruments
were bank certificates of deposit with remaining terms of less than one year or
break clauses permitting withdrawal in less than one year, with the exception of
$25,141 of principal with a remaining term of 15 months. Therefore, the effect
of an increase or decrease in interest rates on the fair value of those
financial instruments would not be material.
59
ITEM 8. FINANCIAL STATEMENTS
The
following index lists the financial statements and supplementary data of Pacific
Asia Petroleum, Inc. that are included in this report.
Page
|
|
Report
of Independent Registered Public Accounting Firm
|
61
|
Financial
Statements:
|
|
Consolidated
Balance Sheets December
31, 2009 and 2008
|
62 |
|
|
Consolidated
Statements of Operations For
the years ended December 31, 2009, 2008 and 2007, and for the period from
inception
(August 25, 2005) through December 31, 2009 |
63
|
Consolidated
Statements of Comprehensive Income For
the years ended December 31, 2009, 2008 and 2007, and for the period from
inception
(August 25,2005) through December 31, 2009 |
64
|
Consolidated
Statement of Stockholders’ Equity (Deficiency) For
the period from inception (August 25, 2005) through December 31,
2009
|
65 |
|
|
Consolidated
Statements of Cash Flows For
the years ended December 31, 2009, 2008 and 2007, and for the
period from inception
(August 25, 2005) through December 31, 2009 |
66 |
Notes
to Consolidated Financial Statements
|
67-81
|
Schedules
not disclosed above or elsewhere in this report have been omitted since they are
either not required, are not applicable or the required information is shown in
the financial statements or the related notes.
60
RBSM
LLP
CERTIFIED
PUBLIC ACCOUNTANTS
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of
Directors
Pacific
Asia Petroleum, Inc.
Hartsdale,
NY
We
have audited the accompanying consolidated balance sheets of Pacific Asia
Petroleum, Inc. and its subsidiaries (the “Company”) (a development stage
company) as of December 31, 2009 and 2008, and the related consolidated
statements of operations, comprehensive income, stockholders’ equity and cash
flows for each of the three years in the period ended December 31, 2009 and the
period August 25, 2005 (date of inception) through December 31, 2009. These
financial statements are the responsibility of the Company’s management. Our
responsibility is to express an opinion on these financial statements based upon
our audits.
We
conducted our audits in accordance with standards of the Public Company
Accounting Oversight Board (United States of America). Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatements. An audit includes
examining on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe our audits
provide a reasonable basis for our opinion.
In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Pacific Asia Petroleum, Inc.
and its subsidiaries (a development stage company) as of December 31, 2009 and
2008 and the results of its operations and its cash flows for each of the three
years in the period ended December 31, 2009 and the period August 25, 2005 (date
of inception) through December 31, 2009, in conformity with accounting
principles generally accepted in the United States of America.
We have
also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the Company’s internal control over financial
reporting as of December 31, 2009, based on the criteria established in
Internal Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO) and our report dated expressed
an unqualified opinion on the Company’s internal control over financial
reporting.
/s/
RBSM LLP
New York,
New York
March 2,
2010
61
AUDITED
FINANCIAL STATEMENTS
|
Pacific
Asia Petroleum, Inc. and Subsidiaries
|
||||||||
(A
Development Stage Company)
|
|||||||||
Consolidated
Balance Sheets
|
|||||||||
As
of December 31,
|
2009
|
2008
|
|||||||
Assets
|
|||||||||
Current assets
|
|||||||||
Cash
and cash equivalents
|
$ | 3,602,110 | $ | 10,515,657 | |||||
Short-term
investments
|
1,735,397 | 1,260,000 | |||||||
Accounts
receivable (2009 - related parties: $55,441)
|
68,771 | - | |||||||
Income
tax refunds receivable
|
- | 8,500 | |||||||
Prepaid
expenses
|
427,101 | 90,657 | |||||||
Inventories (2009
- unfinished: $51,097; finished: $22,297)
|
73,394 | - | |||||||
Deposits
|
35,262 | 37,556 | |||||||
Advances
|
5,121 | 383 | |||||||
Total
current assets
|
5,947,156 | 11,912,753 | |||||||
Non-current assets
|
|||||||||
Property,
plant and equipment - at cost (net of accumulated depreciation and
amortization:
|
|||||||||
$2009 - 181,765; 2008 - $88,577) | 450,703 | 569,303 | |||||||
Intangible
assets
|
384 | 384 | |||||||
Investment
in long-term certificate of deposit
|
25,141 | - | |||||||
Long-term
advances
|
33,015 | 386,415 | |||||||
Investment
in nonsubsidiary - at fair value
|
478,255 | - | |||||||
Deposits
on prospective property acquisitions
|
- | 1,150,000 | |||||||
Deferred
charges
|
501,039 | 100,234 | |||||||
Total
Assets
|
$ | 7,435,693 | $ | 14,119,089 | |||||
Liabilities and Equity
|
|||||||||
Current liabilities
|
|||||||||
Accounts
payable (2009 - related parties: $75,748)
|
$ | 172,140 | $ | 25,446 | |||||
Income
taxes payable
|
12,801 | 5,148 | |||||||
Accrued
contracting and development fees (2009 - related parties:
$662,000)
|
920,486 | 294,020 | |||||||
Accrued
bonuses and vacations
|
367,957 | 158,473 | |||||||
Accrued
and other liabilities
|
563,781 | 205,764 | |||||||
Total
current liabilities
|
2,037,165 | 688,851 | |||||||
Equity
|
|||||||||
Stockholders'
equity - Pacific Asia Petroleum, Inc. and Subsidiaries:
|
|||||||||
Common
stock
|
|||||||||
Authorized
- 300,000,000 shares at $.001 par value; Issued and outstanding
-
|
|||||||||
43,037,596
as of December 31, 2009; 40,061,785 as of December 31,
2008
|
43,038 | 40,062 | |||||||
Preferred
stock
|
|||||||||
Authorized
- 50,000,000 shares at $.001 par value;
|
|||||||||
Issued
- 23,708,952 as of December 31, 2009 and December 31, 2008
|
|||||||||
Outstanding
- none as of December 31, 2009 and December 31, 2008
|
- | - | |||||||
Paid-in
capital
|
26,034,871 | 21,741,965 | |||||||
Deficit
accumulated during the development stage
|
(20,457,442 | ) | (8,968,064 | ) | |||||
Other
comprehensive income
|
91,572 | 229,860 | |||||||
Total
stockholders' equity - Pacific Asia Petroleum, Inc. and
Subsidiaries
|
5,712,039 | 13,043,823 | |||||||
Noncontrolling
interests (deficit) equity
|
(313,511 | ) | 386,415 | ||||||
Total
equity
|
5,398,528 | 13,430,238 | |||||||
Total
Liabilities and Equity
|
$ | 7,435,693 | $ | 14,119,089 | |||||
The
accompanying notes to the consolidated financial statements are an
integral part of this statement.
|
62
AUDITED
FINANCIAL STATEMENTS
|
Pacific
Asia Petroleum, Inc. and Subsidiaries
|
||||||||
(A
Development Stage Company)
|
|||||||||
Consolidated
Statements of Operations
|
|||||||||
For
the years ended December 31, 2009, 2008, and 2007 and for the
period
|
|||||||||
from
inception (August 25, 2005) through December 31, 2009
|
For
the period
|
||||||||||||||||
from
inception
|
||||||||||||||||
(August
25, 2005)
|
||||||||||||||||
through
|
||||||||||||||||
2009
|
2008
|
2007
|
December
31, 2009
|
|||||||||||||
Revenues
|
||||||||||||||||
Sales
and services
|
$ | 66,802 | $ | - | $ | - | $ | 66,802 | ||||||||
Costs and Operating
Expenses
|
||||||||||||||||
Depreciation
|
132,052 | 66,769 | 18,850 | 219,411 | ||||||||||||
All
other
|
11,523,729 | 5,717,051 | 2,963,397 | 21,440,794 | ||||||||||||
Total
costs and operating expenses
|
11,655,781 | 5,783,820 | 2,982,247 | 21,660,205 | ||||||||||||
Operating
Loss
|
(11,588,979 | ) | (5,783,820 | ) | (2,982,247 | ) | (21,593,403 | ) | ||||||||
Other Income (Expense)
|
||||||||||||||||
Interest
Income
|
37,885 | 323,762 | 618,089 | 1,079,142 | ||||||||||||
Interest
Expense
|
(939 | ) | - | - | (939 | ) | ||||||||||
Other
Income
|
217 | 14,695 | 12,937 | 27,849 | ||||||||||||
Other
Expense
|
(11 | ) | (172 | ) | (714 | ) | (897 | ) | ||||||||
Total
Other Income
|
37,152 | 338,285 | 630,312 | 1,105,155 | ||||||||||||
Net
loss before income taxes and
|
||||||||||||||||
noncontrolling
interests
|
(11,551,827 | ) | (5,445,535 | ) | (2,351,935 | ) | (20,488,248 | ) | ||||||||
Income
tax expense
|
(39,575 | ) | (13,082 | ) | (38,826 | ) | (91,483 | ) | ||||||||
Net
loss
|
(11,591,402 | ) | (5,458,617 | ) | (2,390,761 | ) | (20,579,731 | ) | ||||||||
Less:
Net loss - noncontrolling interests
|
102,024 | 11,968 | 7,077 | 122,289 | ||||||||||||
Net
Loss - Pacific Asia Petroleum, Inc. and
Subsidiaries
|
$ | (11,489,378 | ) | $ | (5,446,649 | ) | $ | (2,383,684 | ) | $ | (20,457,442 | ) | ||||
Net
loss per common share - Pacific Asia
|
||||||||||||||||
Petroleum
Inc. common shareholders -
|
||||||||||||||||
basic
and diluted
|
$ | (0.28 | ) | $ | (0.14 | ) | $ | (0.08 | ) | |||||||
Weighted
average number of common
|
||||||||||||||||
shares
outstanding, basic and diluted
|
41,647,002 | 39,992,512 | 31,564,121 |
The
accompanying notes to the consolidated financial statements are an integral part
of this statement.
63
AUDITED FINANCIAL STATEMENTS |
Pacific
Asia Petroleum, Inc. and Subsidiaries
(A
Development Stage Company)
|
Consolidated
Statements of Comprehensive Income
|
|
For the years ended December
31, 2009, 2008 and 2007, and for
the period from inception (August 25,
2005) through December 31, 2009
|
For
the period
|
||||||||||||||||
from
inception
|
||||||||||||||||
(August
25, 2005)
|
||||||||||||||||
through
|
||||||||||||||||
2009
|
2008
|
2007
|
12/31/2009
|
|||||||||||||
Net
loss
|
$ | (11,591,402 | ) | $ | (5,458,617 | ) | $ | (2,390,761 | ) | $ | (20,579,731 | ) | ||||
Other
comprehensive income (loss) -
|
||||||||||||||||
pre-tax
and net of tax:
|
||||||||||||||||
Currency
translation adjustment
|
(63,643 | ) | 101,799 | 108,833 | 166,217 | |||||||||||
Unrealized
gain (loss) on
|
||||||||||||||||
investments
in securities
|
(74,645 | ) | - | - | (74,645 | ) | ||||||||||
Total
other comprehensive income (loss)
|
(138,288 | ) | 101,799 | 108,833 | 91,572 | |||||||||||
Comprehensive
income (loss)
|
(11,729,690 | ) | (5,356,818 | ) | (2,281,928 | ) | (20,488,159 | ) | ||||||||
Less:
Comprehensive (income) loss -
|
||||||||||||||||
Noncontrolling
interests' share:
|
||||||||||||||||
Net
loss plus pre-tax and net of
|
||||||||||||||||
tax
other comprehensive income/loss
|
102,175 | 8,679 | 3,116 | 115,190 | ||||||||||||
Comprehensive
income (loss) -
|
||||||||||||||||
Pacific
Asia Petroleum, Inc. and
|
||||||||||||||||
Subsidiaries
|
$ | (11,627,515 | ) | $ | (5,348,139 | ) | $ | (2,278,812 | ) | $ | (20,372,969 | ) |
The
accompanying notes to the consolidated financial statements are an
integral part of this statement.
|
64
AUDITED
FINANCIAL STATEMENTS
|
Pacific
Asia Petroleum, Inc. and Subsidiaries
|
(A
Development Stage Company)
|
|
Consolidated
Statement of Stockholders' Equity (Deficiency)
|
For
the period from inception (August 25, 2005) through December 31,
2009
|
Pacific
Asia Petroleum, Inc. Stockholders
|
||||||||||||||||||||||||||||||||||||||||
No.
of Common |
Common Stock |
Subscriptions Receivable |
No.
of Preferred |
Preferred Stock |
Paid-in Capital |
Deficit Accumulated |
Other Comprehensive |
Noncontrolling Interests |
Total Equity |
|||||||||||||||||||||||||||||||
Balance
- August 25, 2005
|
- | $ | - | $ | - | - | $ | - | $ | - | $ | - | $ | - | $ | - | $ | - | ||||||||||||||||||||||
Issued
for cash
|
1,852,320 | 1,852 | - | - | - | 10,148 | - | - | - | 12,000 | ||||||||||||||||||||||||||||||
Subscriptions
|
3,451,680 | 3,452 | (28,000 | ) | - | - | 24,548 | - | - | - | - | |||||||||||||||||||||||||||||
Net
loss
|
- | - | - | - | - | - | (51,344 | ) | - | - | (51,344 | ) | ||||||||||||||||||||||||||||
Balance
- December 31, 2005
|
5,304,000 | 5,304 | (28,000 | ) | - | - | 34,696 | (51,344 | ) | - | - | (39,344 | ) | |||||||||||||||||||||||||||
Subscriptions
paid
|
- | - | 28,000 | - | - | - | - | - | - | 28,000 | ||||||||||||||||||||||||||||||
Issued
for fees and services
|
- | - | - | 1,829,421 | 1,829 | 195,776 | - | - | - | 197,605 | ||||||||||||||||||||||||||||||
Issued
for cash
|
- | - | - | 8,161,802 | 8,162 | 4,215,262 | - | - | - | 4,223,424 | ||||||||||||||||||||||||||||||
Subsidiary
paid-in capital additions
|
- | - | - | - | - | - | - | - | 359,410 | 359,410 | ||||||||||||||||||||||||||||||
Amortization
of options fair value
|
- | - | - | - | - | 29,065 | - | - | - | 29,065 | ||||||||||||||||||||||||||||||
Currency
translation
|
- | - | - | - | - | - | - | 19,228 | - | 19,228 | ||||||||||||||||||||||||||||||
Net
loss
|
- | - | - | - | - | - | (1,086,387 | ) | - | (1,220 | ) | (1,087,607 | ) | |||||||||||||||||||||||||||
Balance
- December 31, 2006
|
5,304,000 | 5,304 | - | 9,991,223 | 9,991 | 4,474,799 | (1,137,731 | ) | 19,228 | 358,190 | 3,729,781 | |||||||||||||||||||||||||||||
Issued
for services - pre-merger
|
600,032 | 600 | - | 117,729 | 118 | 334,594 | - | - | - | 335,312 | ||||||||||||||||||||||||||||||
Shares
retained by Pacific Asia Petroleum original stockholders in
merger - 5/7/07 |
468,125 | 468 | - | - | - | 83,323 | - | - | - | 83,791 | ||||||||||||||||||||||||||||||
Shares
issued to ADS members in merger - 5/7/07
|
9,850,000 | 9,850 | - | 13,600,000 | 13,600 | 15,453,957 | - | - | - | 15,477,407 | ||||||||||||||||||||||||||||||
Post-merger
acquisition costs and adjustments
|
- | - | - | - | - | (291,093 | ) | - | - | - | (291,093 | ) | ||||||||||||||||||||||||||||
Automatic
conversion of Preferred Shares - 6/5/07
|
23,708,952 | 23,709 | - | (23,708,952 | ) | (23,709 | ) | - | - | - | - | - | ||||||||||||||||||||||||||||
Issued
for services, compensation cost of stock options
|
||||||||||||||||||||||||||||||||||||||||
and
restricted stock
|
- | - | - | - | - | 195,442 | - | - | - | 195,442 | ||||||||||||||||||||||||||||||
Subsidiary
paid-in capital additions
|
- | - | - | - | - | - | - | - | 40,020 | 40,020 | ||||||||||||||||||||||||||||||
Currency
translation
|
- | - | - | - | - | - | - | 108,833 | 3,961 | 112,794 | ||||||||||||||||||||||||||||||
Net
loss
|
- | - | - | - | - | - | (2,383,684 | ) | - | (7,077 | ) | (2,390,761 | ) | |||||||||||||||||||||||||||
Balance
- December 31, 2007
|
39,931,109 | 39,931 | - | - | - | 20,251,022 | (3,521,415 | ) | 128,061 | 395,094 | 17,292,693 | |||||||||||||||||||||||||||||
Issued
on exercise of warrants
|
79,671 | 80 | - | - | - | (83 | ) | - | - | - | (3 | ) | ||||||||||||||||||||||||||||
Vesting
of restricted stock
|
76,400 | 76 | - | - | - | (76 | ) | - | - | - | - | |||||||||||||||||||||||||||||
Cancellation
of restricted stock
|
(10,400 | ) | (10 | ) | 10 | - | - | - | ||||||||||||||||||||||||||||||||
Compensation
cost of stock options and restricted stock
|
- | - | - | - | - | 1,355,590 | - | - | - | 1,355,590 | ||||||||||||||||||||||||||||||
Issued
for services
|
15,000 | 15 | - | - | - | 137,985 | - | - | - | 138,000 | ||||||||||||||||||||||||||||||
Issued
for acquisition of Navitas Corporation
|
450,005 | 450 | - | - | - | 8,176,141 | - | - | - | 8,176,591 | ||||||||||||||||||||||||||||||
Acquired
on acquisition of Navitas Corporation
|
(480,000 | ) | (480 | ) | - | - | - | (8,178,624 | ) | - | - | - | (8,179,104 | ) | ||||||||||||||||||||||||||
Currency
translation
|
- | - | - | - | - | - | - | 101,799 | 3,289 | 105,088 | ||||||||||||||||||||||||||||||
Net
loss
|
- | - | - | - | - | - | (5,446,649 | ) | - | (11,968 | ) | (5,458,617 | ) | |||||||||||||||||||||||||||
Balance
- December 31, 2008
|
40,061,785 | 40,062 | - | - | - | 21,741,965 | (8,968,064 | ) | 229,860 | 386,415 | 13,430,238 | |||||||||||||||||||||||||||||
Issued
on exercise of warrants and options
|
238,811 | 239 | - | - | - | 13,705 | - | - | - | 13,944 | ||||||||||||||||||||||||||||||
Exchanged
for stock of Sino Gas & Energy Holdings Limited
|
970,000 | 970 | - | - | - | 551,930 | - | - | - | 552,900 | ||||||||||||||||||||||||||||||
Vesting
of restricted stock
|
738,000 | 738 | - | - | - | (738 | ) | - | - | - | - | |||||||||||||||||||||||||||||
Compensation
cost of stock options and restricted stock
|
- | - | - | - | - | 2,432,006 | - | - | - | 2,432,006 | ||||||||||||||||||||||||||||||
Issued
for services
|
1,029,000 | 1,029 | - | - | - | 1,052,071 | - | - | - | 1,053,100 | ||||||||||||||||||||||||||||||
Adjustments
to noncontrolling interests in subsidiary equity
|
- | - | - | - | - | 243,932 | - | (21 | ) | (597,751 | ) | (353,840 | ) | |||||||||||||||||||||||||||
Currency
translation
|
- | - | - | - | - | - | - | (63,622 | ) | (151 | ) | (63,773 | ) | |||||||||||||||||||||||||||
Unrealized
gain (loss) on investments in securities
|
- | - | - | - | - | - | - | (74,645 | ) | - | (74,645 | ) | ||||||||||||||||||||||||||||
Net
loss
|
- | - | - | - | - | - | (11,489,378 | ) | - | (102,024 | ) | (11,591,402 | ) | |||||||||||||||||||||||||||
Balance
- December 31, 2009
|
43,037,596 | $ | 43,038 | $ | - | - | $ | - | $ | 26,034,871 | $ | (20,457,442 | ) | $ | 91,572 | $ | (313,511 | ) | $ | 5,398,528 |
The
accompanying notes to the consolidated financial statements are an integral part
of this statement.
65
AUDITED
FINANCIAL STATEMENTS
|
Pacific
Asia Petroleum, Inc. and Subsidiaries
|
|||||
(A
Development Stage Company)
|
||||||
Consolidated
Statement of Cash Flows
|
For
the years ended December 31, 2009, 2008 and 2007,
|
|||||
and
for the period from inception (August 25, 2005) through December 31,
2009
|
For
the period
|
||||||||||||||||
from
inception
|
||||||||||||||||
(August
25, 2005)
|
||||||||||||||||
through
|
||||||||||||||||
2009
|
2008
|
2007
|
December
31, 2009
|
|||||||||||||
Cash
flows from operating activities
|
||||||||||||||||
Net
loss - Pacific Asia Petroleum, Inc. and subsidiaries
|
$ | (11,489,378 | ) | $ | (5,446,649 | ) | $ | (2,383,684 | ) | $ | (20,457,442 | ) | ||||
Adjustments
to reconcile net loss to cash
|
||||||||||||||||
used
in operating activities:
|
||||||||||||||||
Interest
income on long-term advances
|
- | (88,440 | ) | (90,602 | ) | (188,987 | ) | |||||||||
Currency
transaction (gain) loss
|
(56,476 | ) | 41,047 | 43,444 | 28,015 | |||||||||||
Stock
and options compensation expense
|
3,456,971 | 1,493,590 | 530,754 | 5,707,985 | ||||||||||||
Noncontrolling
interest in net loss
|
(102,024 | ) | (11,969 | ) | (7,077 | ) | (122,290 | ) | ||||||||
Depreciation
expense
|
132,052 | 66,769 | 18,850 | 219,411 | ||||||||||||
Impairment
of assets adjustment
|
219,388 | 273,618 | - | 493,006 | ||||||||||||
Changes
in current assets and current
|
||||||||||||||||
liabilities:
|
||||||||||||||||
(Increase)
decrease in income tax refunds receivable
|
8,500 | (8,500 | ) | - | - | |||||||||||
(Increase)
in accounts and other receivables
|
(68,771 | ) | - | - | (68,771 | ) | ||||||||||
(Increase)
in inventory
|
(73,394 | ) | - | - | (73,394 | ) | ||||||||||
(Increase)
decrease in advances
|
(4,738 | ) | 2,375 | (2,758 | ) | (5,121 | ) | |||||||||
(Increase)
decrease in deposits
|
2,294 | (14,602 | ) | (11,456 | ) | (35,262 | ) | |||||||||
(Increase)
decrease in prepaid expenses
|
23,033 | (44,410 | ) | (14,761 | ) | (67,624 | ) | |||||||||
Increase
(decrease) in accounts payable
|
146,694 | 22,707 | (55,638 | ) | 156,989 | |||||||||||
Increase
(decrease) in income tax and accrued liabilities
|
694,847 | 506,447 | (87,959 | ) | 1,209,484 | |||||||||||
Net
cash used in operating activities
|
(7,111,002 | ) | (3,208,017 | ) | (2,060,887 | ) | (13,204,001 | ) | ||||||||
Cash
flows from investing activities
|
||||||||||||||||
Net
sales (purchases) of available for sale securities
|
(475,397 | ) | 9,940,000 | (9,800,000 | ) | (1,735,397 | ) | |||||||||
Purchase
of long-term certificate of deposit
|
(25,000 | ) | - | - | (25,000 | ) | ||||||||||
Refunds/(deposits)
on prospective property acquisitions
|
1,150,000 | 1,900,000 | (3,050,000 | ) | - | |||||||||||
(Increase)
decrease in long-term advances and deferred charges
|
(225,515 | ) | 5,824 | (106,058 | ) | (325,749 | ) | |||||||||
Additions
to property, plant and equipment
|
(232,535 | ) | (334,319 | ) | (84,118 | ) | (850,839 | ) | ||||||||
Net
cash provided by (used in) investing activities
|
191,553 | 11,511,505 | (13,040,176 | ) | (2,936,985 | ) | ||||||||||
Cash
flows from financing activities
|
||||||||||||||||
Payment
and proceeds of notes payable
|
- | - | (5,000 | ) | (5,000 | ) | ||||||||||
Increase
in noncontrolling interest investment in subsidiary
|
- | - | 40,020 | 399,430 | ||||||||||||
Increase
in long-term advances to noncontrolling interest
stockholder
|
- | - | - | (400,507 | ) | |||||||||||
Proceeds
from exercise of stock options and warrants
|
13,944 | - | - | 13,944 | ||||||||||||
Decrease
in subscriptions receivable
|
- | - | - | 28,000 | ||||||||||||
Issuance
of common stock net of issuance costs
|
- | (2,513 | ) | 15,385,982 | 19,671,092 | |||||||||||
Net
cash provided by (used in) financing activities
|
13,944 | (2,513 | ) | 15,421,002 | 19,706,959 | |||||||||||
Effect
of exchange rate changes on cash
|
(8,041 | ) | 5,713 | 21,656 | 36,138 | |||||||||||
Net
(decrease) increase in cash and cash equivalents
|
(6,913,546 | ) | 8,306,688 | 341,595 | 3,602,111 | |||||||||||
Cash
and cash equivalents at beginning of period
|
10,515,657 | 2,208,969 | 1,867,374 | - | ||||||||||||
Cash
and cash equivalents at end of period
|
$ | 3,602,111 | $ | 10,515,657 | $ | 2,208,969 | $ | 3,602,111 | ||||||||
Supplemental
disclosures of cash flow information
|
||||||||||||||||
Interest
paid
|
$ | 939 | $ | - | $ | - | $ | 939 | ||||||||
Income
taxes paid
|
$ | 24,723 | $ | 48,832 | $ | 35 | $ | 73,590 | ||||||||
Supplemental
schedule of non-cash investing and
|
||||||||||||||||
financing
activities
|
||||||||||||||||
Common
and preferred stock issued for services and fees
|
$ | 1,053,100 | $ | 138,000 | $ | 335,312 | $ | 1,724,017 | ||||||||
Common
stock issued for stock of nonsubsidiary
|
$ | 552,900 | $ | - | $ | - | $ | 552,900 | ||||||||
Issuance
costs paid as warrants issued
|
$ | - | $ | - | $ | 868,238 | $ | 929,477 | ||||||||
Increase
in fixed assets accrued in liabilities
|
$ | - | $ | - | $ | 4,537 | $ | - | ||||||||
Warrants
exercised for common stock
|
$ | - | $ | (3 | ) | $ | - | $ | (3 | ) | ||||||
Decrease
to long-term advances to noncontrolling interest
shareholder
|
$ | 353,840 | $ | - | $ | - | $ | 353,840 | ||||||||
Disposition
of partial interest in a subsidiary
|
$ | 243,911 | $ | - | $ | - | $ | 243,911 | ||||||||
Decrease
in noncontrolling interest investment in subsidiary
|
$ | (597,751 | ) | $ | - | $ | - | $ | (597,751 | ) |
The
accompanying notes to consolidated financial statements are an integral part of
this statement.
66
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE
1. --- DESCRIPTION OF BUSINESS
Pacific
Asia Petroleum, Inc. (the “Company”) is the successor company from a reverse
merger involving the former Pacific East Advisors, Inc. and other entities on
May 7, 2007. The Company’s activities commenced in 2005 through Inner
Mongolia Production Company, LLC (“IMPCO”), a limited liability company formed
under New York State law on August 25, 2005.
Coalbed
Methane
In
October 2007 Pacific Asia Petroleum, Limited (“PAPL”), a wholly-owned subsidiary
of the Company, entered into a production sharing contract (“PSC”) with China
United Coalbed Methane Co. (“CUCBM”) with respect to coalbed methane (“CBM”)
production covering an area in the Shanxi Province of China referred to as the
Zijinshan Block. During the development and production period, CUCBM
will have the right to acquire a 40% participating interest and work jointly to
develop and produce CBM under the PSC. The PSC has a term of 30 years
and was approved by the Ministry of Commerce of China in 2008. In
2009 the Company completed seismic data acquisition, performed
seismic shooting, and drilled its first well in the Zijinshan
Block. Core samples have undergone laboratory testing, including
tests for gas content, gas saturation and coal characteristics. Based
on the results of these tests, at the latest Zijinshan PSC Joint Management
Committee (JMC) meeting, the Company agreed to a 2010 work program which
includes undertaking further technical studies related to the CUCBM Contract
Area and drilling at least two additional wells there.
Chifeng
Joint Development Contract
In 2006 a
subsidiary of the Company entered into a joint development contract with Chifeng
Zhongtong Oil and Natural Gas Co., Ltd., (“Chifeng”), a company incorporated in
Inner Mongolia, China. Pursuant to the Chifeng Agreement, drilling
operations commenced in October 2006. The first well drilled by
Chifeng discovered oil and was completed as a producing well, but production
operations were suspended in 2007 pending receipt of a production license from
the Chinese government. The Company is pursuing a combination of strategies to
have such production license awarded, including a possible renegotiation of the
Chifeng Agreement and/or possible negotiations toward acquiring the existing
production from the 22 sq. km. Kerqing Oilfield and extending its production
license to the Chifeng area. As of year-end 2009, new activity toward
accomplishing this result had not commenced. If this Production
License is not issued, the opportunities to drill additional long-term
production wells under the contract, including future production from this first
well, will be at risk. No revenue has been recognized to date due to
uncertainty of realization of the revenue until a permanent production license
is obtained. See Note 7. - Property, Plant and Equipment regarding
the impairment adjustment recorded on Chifeng capitalized costs in
2009.
Natural
Gas Distribution
In July
2009 the Company entered into a revised Letter of Intent to possibly acquire a
49% ownership interest in the Handan Chang Yuan Natural Gas Co., Ltd.
(“HGC”) from the Handan Yua Ying Company Limited (“Handan”). HGC owns
and operates gas distribution assets in and around Handan City, China. HGC was
founded in May 2001, and is the primary gas distributer in Handan City, which is
located 250 miles south of Beijing, in the Hebei Province of the People’s
Republic of China. HGC has over 300,000 customers and owns 35 miles of a main
gas pipeline, and more than 450 miles of delivery gas pipelines, with a delivery
capacity of 300 million cubic meters per day. HGC also owns an 80,000
sq. ft. field distribution facility. Gas is being supplied by Sinopec and
PetroChina from two separate sources. The Company will continue its final legal
and financial due diligence with an objective of entering into a mutually agreed
final sale and purchase agreement in 2010.
67
Enhanced Oil Recovery and Production
(“EORP”)
In May
and June 2009, Pacific Asia Petroleum Energy Limited (“PAPE”), a subsidiary of
the Company, entered into a Letter of Understanding and associated agreements
with two persons pursuant to which a China joint venture company, Beijing Dong
Fang Ya Zhou Petroleum Technology Service Company Limited (“Dong Fang”), was
formed in September 2009 to engage in EORP operations using the patent rights
contributed by a noncontrolling owner of Dong Fang. Dong Fang is
owned 75.5% by PAPE and 24.5% by a joint venture partner, LXD. In
conjunction with these agreements, a 30% ownership interest in PAPE was issued
to one of the joint venture partners, BSG. Operations have commenced in various
oil fields in the Liaoning, Shandong, and Xinjiang Provinces in
China. Initial revenues were recorded in 2009. The Company intends to
negotiate additional agreements for EORP operations in 2010.
Oyo
Field Production Sharing Contract Interest
In
November 2009, the Company entered into a Purchase and Sale Agreement with CAMAC
Energy Holdings Limited and certain of its affiliates (“CAMAC”)
involving the acquisition of a 60% interest in production sharing contract
rights in the Oyo Field in Nigeria in return for $38.84 million in cash (subject
to possible reduction in cash payment by a portion of CAMAC’s net cash flows
from the Oyo Field through the closing date) and a 62.74% ownership in the
Company’s Common Stock after giving effect to this transaction and related
financing transaction (the “Transaction”). If the Transaction is
completed, CAMAC will own a majority interest in the Company and designate four
of the seven members of the Company’s Board of Directors, and therefore a change
of control of the Company will occur. The Transaction is expected to
close during the first quarter of 2010.
NOTE
2. --- BASIS OF PRESENTATION
The
Company’s financial statements are prepared on a consolidated
basis. All significant intercompany transactions and balances have
been eliminated in consolidation. The financial statements include Pacific Asia
Petroleum, Inc. (successor company to IMPCO) and its majority-owned direct and
indirect subsidiaries in the respective periods. Net income for 2007 excludes
the results of Pacific East Advisors, Inc. (PEA) and Advanced
Drilling Services, LLC (ADS) prior to May 7, 2007, the date of the
Mergers.
The
Company’s financial statements are prepared under U.S. Generally Accepted
Accounting Principles as a development stage company. Refer to Note 5 regarding
adoption in 2009 of revised presentation of noncontrolling interests
in the balance sheet and income statement which have been applied
retrospectively to prior years as required under ASC 810-10. Certain
reclassifications have been made to the prior year financial statements to
conform to current year presentation.
NOTE 3. --- LIQUIDITY AND
CAPITAL RESOURCES
During
the period from its inception (August 25, 2005) to December 31, 2006, the
Company was able to fund its expenses through member equity contributions and
member loans. In 2006 the Company sold equity units in the private
market in exchange for consideration totaling $4,561,000, and received $28,000
from collection of subscriptions on equity units subscribed for in
2005. Proceeds from the equity offering were used to repay $240,000
of notes payable ($100,000 with an officer) outstanding from loans incurred in
late 2005 and the first quarter of 2006.
In May
2007, immediately prior to the merger, ADS issued equity units for cash of
$17,000,000, of which net proceeds were $15,497,773 after offering costs. The
proceeds were invested in temporary investments and were available for
operations of the Company after the merger date.
To date
the Company has incurred expenses and sustained losses and has generated minimal
revenue from operations. Consequently, its operations are subject to all risks
inherent in the establishment of a new business enterprise. The Company will
require significant financing in excess of its December 31, 2009 available cash,
cash equivalents, and short-term and long-term cash investments in order to
achieve its business plan. It is not certain that this amount of financing will
be successfully obtained.
Refer to
Note 20. – Subsequent Event regarding the registered direct offering of Common
Stock sold in February 2010.
68
NOTE
4. --- SIGNIFICANT ACCOUNTING POLICIES
In July
2009, The Financial Accounting Standards Board (FASB) issued the FASB Accounting
Standards Codification (the “Codification”)(“ASC”) which became the source of
authoritative accounting principles effective with financial statements of
interim and annual periods ending after September 15, 2009. Sources
of accounting principles referred to in this report refer to Topics, Subtopics
and Sections of the Codification.
Use of
Estimates – Management uses estimates and assumptions in preparing these
financial statements in accordance with generally accepted accounting
principles. Those estimates and assumptions affect the reported
amounts of assets and liabilities, disclosures of contingencies, and reported
revenues and expenses. Actual results could vary from those
estimates.
Cash and
Cash Equivalents – Cash and cash equivalents include cash on hand, demand
deposits and short-term investments with initial maturities of three months or
less.
Short-term
Investments – The Company applies the provisions of Accounting Standards
Codification (ASC) Topic 320 (Investments in Debt and Equity Securities). The
Company classifies debt and equity securities into one of three categories:
held-to-maturity, available-for-sale or trading. These security classifications
may be modified after acquisition only under certain specified conditions.
Securities may be classified as held-to-maturity only if the Company has the
positive intent and ability to hold them to maturity. Trading securities are
defined as those bought and held principally for the purpose of selling them in
the near term. All other securities must be classified as available-for-sale.
Declines in the fair value of held-to-maturity and available-for-sale securities
below their cost that are deemed to be other than temporary are reflected in
earnings as realized losses.
Inventories
– The Company’s inventories of chemicals are carried at lower of cost or market,
with cost determined using average cost. The Company had no other
inventories as of the balance sheet dates.
Property,
Plant and Equipment – For oil and gas properties, the successful efforts method
of accounting is used. Costs of drilling successful wells are
capitalized. Costs of drilling exploratory wells not placed into
production are charged to expense. Geological and geophysical costs are charged
to expense as incurred. For depreciable tangible property, the
minimum capitalization threshold is $1,000.
Leaseholds—The
Company initially capitalizes the costs of acquiring leaseholds on productive
and prospective oil and gas properties. Capitalized leasehold costs
for productive properties are amortized as part of the cost of oil and gas
produced. Capitalized leasehold costs on both proven and unproven
properties are periodically assessed for impairment and an impairment loss is
recorded when necessary.
Depreciation,
Depletion and Amortization - Depreciation, depletion and amortization for oil
and gas related property is recorded on a unit-of-production
basis. For other depreciable property, depreciation is recorded on a
straight line basis based on depreciable lives of five years for office
furniture and three years for computer related equipment. Repairs and
maintenance costs are charged to expense as incurred.
Reserves
for Uncollectible Advances and Loans – The Company reviews its advances and
loans receivable for possible impairment and records reserves for possible
losses on amounts believed to be uncollectible. This includes the
recording of impairment on debt securities classified as held-to-maturity under
ASC Topic 320 (Investments in Debt and Equity Securities), when impairment is
deemed to be other than temporary.
69
Impairment
of Long-Lived Assets – The Company reviews its long-lived assets in property,
plant and equipment for impairment in accordance with ASC Topic 360 (Property,
Plant and Equipment). Review for impairment of long-lived assets occurs whenever
changes in circumstances indicate that the carrying amount of assets in
property, plant and equipment may not be fully recoverable. An
impairment loss is recognized for assets to be held and used when the estimated
undiscounted future cash flows expected to result from the asset including
ultimate disposition are less than its carrying
amount. Impairment is measured by the excess of carrying amount
over the fair value of the assets.
Asset
Retirement Obligations – The Company accounts for asset retirement obligations
in accordance with ASC Topic 410 (Asset Retirement and Environmental
Obligations). The Company at December 31, 2009 and 2008 had no long-lived assets
subject to significant asset retirement obligations. The nature or
amount of any asset retirement obligations which the Company may become subject
to from its future operations is not determinable at this time and will be
assessed as significant operations and development efforts begin.
Revenues
– Revenues are recognized only when the earnings process is complete and an
exchange transaction has taken place. An exchange transaction may be a physical
sale, the providing of services, or an exchange of rights and
privileges. The recognition criteria are satisfied when there exists
a signed contract with defined pricing, delivery and acceptance (as defined in
the contract) of the product or service have occurred, there is no significant
uncertainty of collectibility, and the amount is not subject to
refund
Income
Taxes – Commencing May 7, 2007, the Company became subject to taxation as a
corporation but at December 31, 2009 was in an operating loss position for U.S.
income tax purposes. Therefore, the Company does not accrue U.S. current income
taxes. Deferred income taxes are provided using the asset and liability method
for financial reporting purposes in accordance with the provisions of ASC Topic
740 (Income Taxes). Under this method, deferred tax assets and liabilities are
recognized for temporary differences between the tax bases of assets and
liabilities and their carrying values for financial reporting purposes and for
operating loss and tax credit carry forwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
removed or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in the statement of operations in the period
that includes the enactment date. A valuation allowance is established to reduce
deferred tax assets if it is more likely than not that the related tax benefits
will not be realized. For dates prior to May 7, 2007, the Company was an LLC
pass-through entity treated similar to a partnership for income tax purposes in
the United States, and therefore did not accrue or pay income
taxes.
Foreign
Currency Translation – The functional currency of the U.S. parent company is the
U.S. dollar. The functional currency of China subsidiaries is
the local currency (RMB). For Hong Kong subsidiaries, the functional currency is
the U.S. dollar or RMB, depending on the primary activity of the subsidiary.
Balance sheet translation effects from translating functional currency into U.S.
dollars (the reporting currency) are recorded directly to other comprehensive
income in accordance with ASC Topic 200 (Comprehensive Income).
Stock
Based Compensation – The Company accounts for stock based compensation in
accordance with ASC Topics 718 (Compensation) and 505 (Equity) which specify the
revised accounting alternative requirements for pre-2006 stock based
compensation grants existing at January 1, 2006 and the required accounting for
new grants starting January 1, 2006. The Company made no stock based
compensation grants before 2006. Accordingly, the ASC provisions pertaining to
pre-2006 grants do not apply. The Company values its stock
options awarded on or after January 1, 2006 at the fair value at grant date
using the Black-Scholes option pricing model. Compensation expense for stock
options is recorded over the vesting period on a straight line basis.
Compensation paid in vested stock is valued at the fair value at the applicable
measurement date and charged to expense at that date. Compensation
paid in restricted stock is valued at fair value at the award date and is
charged to expense over the vesting period.
Net
Income (Loss) Per Common Share –The Company computes earnings per share under
ASC Topic 260 (Earnings Per Share). Net loss per common share is computed by
dividing net loss by the weighted average number of shares of common stock and
dilutive common stock equivalents outstanding during the year. Dilutive
common stock equivalents consist of shares issuable upon the exercise of the
Company's stock options, unvested restricted stock, and warrants (calculated
using the treasury stock method).
70
New
Accounting Pronouncements – As of the balance sheet date, there were no new
accounting pronouncements not yet adopted that are expected to materially affect
the Company other than possibly those below.
Accounting
Standards Update (ASU) No. 2009-17 – Consolidations (Topic 810) – “Improvements
to Financial Reporting by Enterprises with Variable Interest
Entities.” This standard amends Topic 810 by requiring consolidation
of certain special purpose entities that were previously exempted from
consolidation. The revised criteria will define a controlling
financial interest for requiring consolidation as: the power to
direct the activities that most significantly affect the entity’s performance,
and (1) the obligation to absorb losses of the entity or (2) the right to
receive benefits from the entity. This standard is effective for
fiscal years beginning after November 15, 2009.
NOTE
5. ADOPTION OF UPDATES TO THE FASB ACCOUNTING STANDARDS
CODIFICATION
ASC
820-10
Effective
January 1, 2009 the Company adopted the portion of ASC Topic 820 (Fair Value
Measurements and Disclosures) that relates to assets measured at fair value on a
nonrecurring basis. The Company had previously adopted the remainder
of ASC Topic 820 effective January 1, 2008. Neither adoption had a
material effect on the Company’s measurement practices for determining fair
value.
ASC
825-10
Commencing
with the interim period ending June 30, 2009, the Company adopted new
requirements for quarterly disclosures related to fair values of financial
instruments whether or not currently reflected on the balance sheet at fair
value. Previously, qualitative and quantitative information about
fair value estimates for financial instruments not measured on the balance sheet
at fair value were disclosed only annually. Quarterly
disclosures were required under an update to ASC Topic 825 (Financial
Instruments) effective for interim periods ending after June 15,
2009. The adoption of this update did not have a material
impact on the Company’s results of operations or financial
condition.
ASC
810-10
Effective
January 1, 2009 the Company adopted an update to ASC Topic 810 (Consolidation)
that changes the accounting and reporting for noncontrolling interests (formerly
known as minority interests) in subsidiaries and for the deconsolidation of a
subsidiary. The presentation of noncontrolling interests in the
balance sheet and income statement has been revised to report noncontrolling
interests as a separate component of total consolidated equity and total
consolidated net income, rather than as reduction adjustments. In
addition, if a subsidiary is deconsolidated, the parent company will now
recognize a gain or loss to net income based upon the fair value of the
noncontrolling equity at that date.
The
update is applied prospectively except for the provisions involving financial
statements line detail presentation. All of the Company’s financial
statements contain changes as a result of the update. Under the
update, the amount formerly titled “Net Loss” in the income statement is now
referred to as “Net Loss - Pacific Asia Petroleum, Inc. and Subsidiaries,” to
designate the portion of total net loss attributable to the controlling
shareholder interest of the parent company. Financial statements for
years prior to 2009 have been revised retrospectively in this report to reflect
the revised presentation basis.
ASC
855-10
Effective
with the six months ended June 30, 2009, the Company adopted an update to ASC
Topic 855 (Subsequent Events). Subsequent events are events or
transactions about which information becomes available after the balance sheet
date but before the financial statements are issued or are available to be
issued. In the case of the Company as a public entity, the applicable
cutoff date is the date the financial statements are issued, whereas previously
the cutoff date could be the date the financial statements were available for
issuance.
The
update requires that certain subsequent events (“recognized subsequent events”)
be recorded in the financial statements of the latest preceding period currently
being issued. These items provide evidence about conditions that
existed at the date of that balance sheet, including estimates inherent in
preparing the financial statements for that period. Other
subsequent events (“nonrecognized subsequent events”) are not recorded in
balance sheet for the latest preceding period currently being issued. Those
items relate to conditions that arose only after the balance sheet
date. Disclosure is required for nonrecognized subsequent
events if necessary to prevent those financial statements from being
misleading.
71
NOTE 6. --- FINANCIAL
INSTRUMENTS
Fair Value of Financial
Instruments
The
carrying amounts of the Company’s financial instruments for cash equivalents,
short-term and long-term cash investments, accounts receivable, deposits,
advances, accounts payable, accrued expenses, and notes payable,
approximate fair value at December 31, 2009, and 2008. The carrying amount for
the investment in nonsubsidiary is fair value from a market price. The recorded
amounts for fair values of securities were as follows at December 31, 2009 and
2008:
2009
|
2008
|
|||||||
Available
for sale:
|
||||||||
Short-term
investments
|
$ | 1,735,397 | $ | 1,260,000 | ||||
Investment
in nonsubsidiary
|
478,255 | - | ||||||
Held
to maturity:
|
||||||||
Long-term
certificate of deposit
|
$ | 25,141 | $ | - | ||||
Long-term
advances
|
33,015 | 386,415 |
Long-Term
Advances
At
December 31, 2008, and December 31, 2007, 100% of the Company’s long-term
advances ($33,015 in 2009, $386,415 in 2008) were comprised of a note receivable
from a single borrower. In 2006, IMPCO HK advanced $400,507 to Beijing Jinrun
Hongda Technology Co., Ltd. (“BJHTC”), which then invested that amount in IMPCO
Sunrise. The notes are repayable in RMB. As of December 31, 2008 no
repayments had been made. The balance of $386,415 at December 31,
2008 reflects an impairment loss recorded in 2008, as described further
below. As of December 31, 2007 IMPCO HK had accrued $100,547 in
interest and $33,476 in currency gains on the notes, for a total balance of
$534,530. BJHTC is obligated to apply any remittances received
from IMPCO Sunrise directly to IMPCO HK. IMPCO Sunrise is authorized to pay
these remittances directly to IMPCO HK on BJHTC’s behalf, until the debt is
satisfied. The note matures November 14, 2014. BJHTC is
only responsible to make payments under the note for the share of profits it
receives from IMPCO Sunrise. On December 31, 2009 the total recorded capital of
IMPCO Sunrise was reduced by agreement among IMPCO Sunrise and its owners, and
the reduction (including the BJHTC share) was reclassified to an intercompany
loan from IMPCO HK to IMPCO Sunrise. The recorded amount for the
outside note receivable of IMPCO HK from BJHTC was reduced to $33,015 as a
result.
Under the
provisions of ASC Topic 320 (Investments - Debt and Equity Securities), the
BJHTC note has been accounted for as “held-to-maturity” based on an intent and
ability to hold to maturity. ASC Topic 320 also provides that such securities
are to be assessed for declines in value that are other than
temporary. In addition, we considered the guidance in ASC Topic 820
(Fair Value Measurements and Disclosures). Based upon the delay in
achieving net income in IMPCO Sunrise, the impact of the significant decline in
the price of oil in the second half of 2008, the amount of uncollected interest
on the note, and the required date for repayment, it was determined in the
fourth quarter of 2008 that the note was impaired. Additionally the
recording of interest income on the note was discontinued effective October 1,
2008. An impairment loss of $273,618 was recorded in 2008 operating
expenses to reduce the carrying amount of the note to the recorded amount of the
BJHTC-related minority interest liability in the consolidated balance sheet as
of December 31, 2008. As IMPCO Sunrise had no positive cash flows from
operations, projections of future potential positive cash flows at several rates
of return were utilized to determine that the revised carrying amount was
realistic based upon the rate of return inherent in that amount. The difference
between the impairment adjustment and the net change in carrying amount from
December 31, 2007 represents interest income and currency transaction
adjustments recorded during 2008 prior to recording the
impairment. In accordance with ASC Topic 820, the calculation of
impairment was based upon a “level 3” unobservable input because there are no
direct or indirect observable inputs of fair value available for this
note given that it is not publicly traded and is not comparable to publicly
traded securities. It is not comparable to publicly traded securities
because by its terms the note is repayable only from cash distributions to the
noncontrolling interest owned by the debtor in which the debtor has no at risk
cash investment and no active involvement in the management of the
entity. After reduction in the note balance at December 31, 2009 as
previously described above, it was concluded that no additional impairment
adjustment was required for 2009.
72
Concentration
of Credit Risk
The
Company is exposed to concentration of credit risk with respect to cash, cash
equivalents, short-term investments, long-term investments, and long-term
advances. At December 31, 2009, 65% ($1,291,455) of the Company’s
total cash was on deposit at HSBC in China and Hong Kong. Also at
that date, 64% ($1,028,762) of the Company’s total cash equivalents was invested
in a single money market fund in the U.S. At December 31, 2008, 78%
($975,681) of the Company’s total cash was on deposit in China at the Bank of
China. Also at that date, 48.7% ($4,514,167) of the Company’s total
cash equivalents was invested in a single money market fund in the
U.S.
NOTE
7. --- PROPERTY, PLANT AND EQUIPMENT
Gross
|
Accumulated
Depreciation
|
Net
|
||||||||||
December
31, 2009
|
||||||||||||
Oil
and gas leases
|
$ | 150,000 | $ | - | $ | 150,000 | ||||||
Office
and computer equipment
|
358,320 | 161,078 | 197,242 | |||||||||
Enhanced
oil recovery equipment
|
34,202 | 2,028 | 32,174 | |||||||||
Leasehold
improvements
|
89,946 | 18,659 | 71,287 | |||||||||
Total
|
$ | 632,468 | $ | 181,765 | $ | 450,703 | ||||||
December
31, 2008
|
||||||||||||
Oil
and gas wells
|
$ | 221,805 | $ | - | $ | 221,805 | ||||||
Oil
and gas leases
|
150,000 | - | 150,000 | |||||||||
Office
and computer equipment
|
244,595 | 59,894 | 184,701 | |||||||||
Leasehold
improvements
|
41,480 | 28,683 | 12,797 | |||||||||
Total
|
$ | 657,880 | $ | 88,577 | $ | 569,303 |
Depreciation
expense for the years ended December 31, 2009, 2008 and 2007 was $132,052,
$66,769, and $18,850, respectively.
No
interest expense has been capitalized through December 31, 2009.
Impairment of Chifeng Oil
Well Costs
In 2009,
the Company conducted an impairment review of its Chifeng contract capitalized
oil well cost for recoverability as an asset to be held and
used. This review was prompted based on the continuing lack of
production license that would enable recovery of these costs through production
revenues and that three years have passed with no progress in this regard.
Without a production license, the opportunities to drill additional production
wells under the contract and future production from this initial well are
significantly at risk. The Company has alternate strategies it intends to pursue
toward possibly obtaining a production license through modification of the
existing agreement and/or inclusion of this area in a production license for a
neighboring area should the Company be able to obtain a production license for
that other area. However, as of December 31, 2009, activity toward
accomplishing this result by specific negotiations and agreements had not
commenced, and the likelihood of possible success and when it might occur could
not be reasonably estimated. Therefore, the Company concluded that an
estimate of future cash flows from this asset no longer could be
made. Absent the likely ability to obtain a production license, the
fair value of the asset is zero under Level 3 unobservable inputs for estimation
of fair value under ASC Topic 820. Those conditions required the recording of an
impairment charge to expense and retirement of capitalized costs of
$219,388. The impairment is included in “all other” within costs and
operating expenses in the income statement.
73
NOTE
8. – FAIR VALUE MEASUREMENTS
The
Company calculates fair values for assets and liabilities utilizing a three
level hierarchy as follows:
Level 1: | Quoted market prices in active markets for identical items. |
Level 2: | Observable inputs not included in Level 1, such as quoted prices for similar assets or liabilities, broker quotations, or other observable inputs for a similar contract term. |
Level 3: | Unobservable inputs where Level 1 or Level 2 inputs are not available. Level 3 inputs may involve internal models of risk-adjusted expected cash flows using present value techniques. |
The
tables below exclude current assets and current liabilities other than assets
for short-term investments, as fair value and cost are deemed to be identical
for the excluded items.
Assets
Measured at Fair Value on a Recurring Basis – as of December 31
2009
|
Level
1
Measurements
|
2008
|
Level
1
Measurements
|
|||||||||||||
Short-term
investments
|
$ | 1,735,397 | $ | 1,735,397 | $ | 1,260,000 | $ | 1,260,000 | ||||||||
Investment
in nonsubsidiary
|
478,255 | 478,255 | - | - | ||||||||||||
Total
|
$ | 2,313,652 | $ | 2,313,652 | $ | 1,260,000 | $ | 1,260,000 |
Assets
Measured at Fair Value on a Nonrecurring Basis – as of December 31
2009
|
Level
3
Measurements
|
Loss
Recorded for Year
|
||||||||||
Property,
plant and equipment
to
be held and used
|
$ | 450,703 | $ | 450,703 | $ | (219,388 | ) | |||||
Long-term
advances
|
33,015 | 33,015 | - |
Refer to
Note 7. – Property, Plant and Equipment regarding determination of the
impairment loss recorded to net loss in
2009.
NOTE
9. – ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
Following
is a detail of activity by category for accumulated other comprehensive income
(loss).
Currency
translation adjustment
|
Gain
(loss) on investments in securities
|
Total
|
||||||||||
Balance
– December 31, 2006
|
$ | 19,228 | $ | - | $ | 19,228 | ||||||
Change
during 2007
|
108,833 | - | 108,833 | |||||||||
Balance
– December 31, 2007
|
128,061 | - | 128,061 | |||||||||
Change
during 2008
|
101,799 | - | 101,799 | |||||||||
Balance
– December 31, 2008
|
229,860 | - | 229,860 | |||||||||
Change
during 2009
|
( 63,643 | ) | ( 74,645 | ) | (138,288 | ) | ||||||
Balance
– December 31, 2009
|
$ | 166,217 | $ | ( 74,645 | ) | $ | 91,572 |
74
NOTE 10.
--- INCOME TAXES
Income
tax expense was as follows for the respective periods:
2009
|
2008
|
2007
|
||||||||||
Current:
|
||||||||||||
U.S.
Federal
|
$ | - | $ | (19,044 | ) | $ | 19,085 | |||||
State
and other
|
39,575 | 32,126 | 19,741 | |||||||||
Total income
tax expense
|
$ | 39,575 | $ | 13,082 | $ | 38,826 |
The
Company’s subsidiaries outside the United States did not have any undistributed
net earnings at December 31, 2009, due to accumulated net losses.
Following
is a reconciliation of the expected statutory U.S. Federal income tax provision
to the actual income tax expense for the respective periods:
2009
|
2008
|
2007
|
||||||||||
Net
(loss) before income tax expense
|
$ | (11,449,802 | ) | $ | (5,433,567 | ) | $ | (2,344,858 | ) | |||
Expected
income tax provision at statutory rate of 35%, assuming U.S. Federal
filing as a corporation
|
$ | (4,007,431 | ) | $ | (1,901,748 | ) | $ | (820,700 | ) | |||
Increase (decrease) due to:
|
||||||||||||
Foreign-incorporated
subsidiaries
|
1,585,060 | 433,577 | 40,011 | |||||||||
U.S.
Federal filing as a partnership during LLC
periods
|
- | - | 315,254 | |||||||||
State and
other income tax
|
39,575 | 32,126 | 19,741 | |||||||||
Net
losses not realizable currently for U.S. tax
purposes
|
2,422,371 | 1,468,171 | 465,435 | |||||||||
Penalties
and miscellaneous
|
- | (19,044 | ) | 19,085 | ||||||||
Total
income tax expense
|
$ | 39,575 | $ | 13,082 | $ | 38,826 |
The Company records interest and penalties related to income taxes as income tax expense.
The
Company records zero net deferred income tax assets and liabilities on the
balance sheet on the basis that its overall net deferred income tax asset
position is offset by a valuation allowance due to its net losses since
inception for both book basis and tax basis.
Deferred
income tax assets by category are as follows as of December 31:
2009
|
2008
|
2007
|
||||||||||
Tax
basis operating loss carryovers
|
$ | 5,171,772 | $ | 1,746,203 | $ | 444,756 | ||||||
Stock
compensation
|
386,465 | 402,323 | 24,156 | |||||||||
Depreciation
|
- | 3,712 | - | |||||||||
5,558,237 | 2,152,238 | 468,912 | ||||||||||
Valuation
allowance
|
(5,558,237 | ) | (2,152,238 | ) | (468,912 | ) | ||||||
Net
deferred income tax assets
|
$ | - | $ | - | $ | - |
The
Company’s total tax basis loss carryovers at December 31, 2009 were
$15,594,950. Of this amount, $448,457 has no expiration
date. The remainder expires from 2011 to 2029.
75
NOTE
11. --- RELATED PARTY TRANSACTIONS
Consulting
Agreements and Employment Contracts
Effective
December 15, 2005 the Company entered into two-year consulting agreements with
three key personnel who were also IMPCO members (shareholders of the Company
following the Mergers). The agreements provided for the performance of specified
services by the personnel in return for a fixed rate per month. The agreements
were subject to termination by either party on 90 days notice. If an agreement
is terminated by the Company, the consultant was entitled to receive the balance
of payments that would have been payable through the original term. The
Company’s commitments under these contracts were $33,350 per month, which
increased to $34,350 per month in July 2006. In September 2006, new executive
employment agreements were entered into between the Company and two IMPCO
members to replace two of the three existing consulting
agreements. The agreements have no expiration date, and either party
may terminate at will. The minimum commitment under these contracts is a total
of $618,000 per year. In the event of termination by the
Company other than for cause or disability, multi-year severance payments are
required. However, the operable effective date for the compensation rates under
these agreements was delayed subject to the Company achieving certain financial
benchmarks. Therefore, payments continued
at the rates set forth under the consulting agreements through March 31,
2007. The new agreements became fully effective at the contracted
rates on April 1, 2007. These agreements are with Frank C.
Ingriselli, President and Chief Executive Officer, and Stephen F. Groth, Vice
President and Chief Financial Officer.
On August
1, 2008, the Company entered into an Employment Agreement with Richard Grigg,
the Company’s Senior Vice President and Managing Director (the “Grigg
Agreement”). The Grigg Agreement, which superseded the prior
employment agreement the Company entered into with Mr. Grigg in March 2008, had
a three year term, and provided for a base salary of 1,650,000 RMB
(approximately $241,000) per year and an annual performance-based bonus award
targeted at between 30% and 40% of his then-current annual base salary awardable
in the discretion of the Company’s Board of Directors. Mr. Grigg was
also entitled to reimbursement of certain accommodation expenses in Beijing,
China, medical insurance, annual leave expenses, and certain other
transportation fees and expenses. In addition, in the event the
Company terminated Mr. Grigg’s employment without Cause (as defined in the Grigg
Agreement), the Company would have been required to pay to Mr. Grigg a lump sum
amount equal to 50% of Mr. Grigg’s then-current annual base
salary. However, on January 27, 2009, the Company revised the terms
of its employment relationship with Richard Grigg by entering into an Amended
and Restated Employment Agreement with Mr. Grigg (the “Amended Employment
Agreement”) and a Contract of Engagement (“Contract of Engagement”) with KKSH
Holdings Ltd., a company registered in the British Virgin Islands (“KKSH”). Mr.
Grigg is a minority shareholder and member of the board of directors of
KKSH. The Amended Employment Agreement superseded the Grigg Agreement
and now governs the employment of Mr. Grigg in the capacity of Managing Director
of the Company for a period of three years. The Amended Employment
Agreement provides for a base salary of 990,000 RMB (approximately $144,000) per
year and the reimbursement of certain accommodation expenses in Beijing, China,
annual leave expenses, and certain other transportation and expenses of Mr.
Grigg. In addition, in the event the Company terminates Mr. Grigg’s
employment without Cause (as defined in the Amended Employment Agreement), the
Company must pay to Mr. Grigg a lump sum amount equal to 50% of Mr. Grigg’s
then-current annual base salary. The Contract of Engagement governs
the engagement of KKSH for a period of three years to provide the services of
Mr. Grigg through KKSH as Senior Vice President of the Company strictly with
respect to the development and management of business opportunities for the
Company outside of the People’s Republic of China. The basic fee for
the services provided under the Contract of Engagement is 919,000 (approximately
$134,000) RMB per year, to be prorated and paid monthly and subject to annual
review and increase upon mutual agreement by the Company and
KKSH. Pursuant to the Contract of Engagement, the Company shall also
provide Mr. Grigg with medical benefits and life insurance coverage, and an
annual performance-based bonus award targeted at between 54% and 72% of the
basic fee, awardable in the discretion of the Company’s Board of
Directors. In addition, in the event the Company terminates the
Contract of Engagement without Cause (as defined in the Contract of Engagement),
the Company must pay to KKSH a lump sum amount equal to 215% of the then-current
annual basic fee.
The
Company was a party to a consulting agreement, dated November 8, 2005, with
Jamie Tseng, the Company’s former Executive Vice President (“Tseng Consulting
Agreement”), which was assigned on September 1, 2006 by Mr. Tseng to Golden Ring
International Consultants Limited, a British Virgin Islands registered company
wholly-owned and controlled by Mr. Tseng, and which was later superseded in its
entirety effective January 1, 2009 by that certain Employment Agreement, dated
April 22, 2009 and effective January 1, 2009, entered into by and between the
Company and Mr. Tseng. Mr. Tseng served in the role of Executive Vice
President to the Company from November 2005 to January 15, 2010, on which date
Mr. Tseng retired as an executive officer and employee of the
Company.
76
Management
Service Contracts
In
connection with the merger on May 7, 2007, the Company assumed an Advisory
Agreement, dated December 1, 2006, by and between ADS and Cagan McAfee Capital
Partners, LLC (“CMCP”), pursuant to which CMCP agreed to provide certain
financial advisory and management consulting services to the Company. Pursuant
to the Advisory Agreement, CMCP was entitled to receive a monthly advisory fee
of $9,500 for management work commencing on December 11, 2006 and continuing
until December 11, 2009. The Company received services from CMCP
under this agreement since the Mergers. Laird Q. Cagan, the
Managing Director and 50% owner of CMCP, served as a member of the Company’s
Board of Directors until his resignation in May 2009. During 2008,
the Company paid $123,500 in fees under this contract, including an amount due
for 2007. During 2009, the Company paid $85,500 in fees under this contract,
including amounts paid for early termination of this contract in June
2009.
Merger-Related
Transactions
In
connection with the Mergers on May 7, 2007, the Company assumed the obligation
of ADS to pay Chadbourn Securities, Inc., a NASD licensed broker-dealer for
which Mr. Laird Cagan (at that time a director and significant shareholder
of the Company) served as a registered representative and Managing Director,
$1,195,430 in placement fees and expense reimbursements relative to the previous
securities offering of ADS. This amount has been paid in full.
Immediately
prior to the Mergers, ADS issued to its placement agents 1,860,001 warrants to
purchase Class B membership units of ADS. Included were (i) warrants
to purchase 3,825 Class B membership units of ADS issued to Michael
McTeigue, an executive officer of ADS, (ii) warrants to purchase 83,354
Class B membership units of ADS issued to Chadbourn Securities, Inc., a
NASD licensed broker-dealer for which Laird Q. Cagan served as a registered
representative and Managing Director, and (iii) warrants to purchase
696,094 Class B membership units of ADS issued to Laird Q. Cagan, a former
member of the Company’s Board of Directors and the then-beneficial
owner of 7.7% of the Company’s Common Stock. These warrants were
exchanged in the Mergers for warrants exercisable for 1,860,001 shares of Common
Stock of the Company. The Company has accounted for this as an offering cost
applicable to paid-in capital and therefore will not record any compensation
expense on these warrants. At December 31, 2009, 1,460,888 warrants remained
unexercised, at a weighted average exercise price of $1.30 per share of Common
Stock, and expire May 7, 2012.
Acquisition
of SGE Common Stock
In March,
2009, the Company issued 970,000 shares of Company Common Stock, to Mr. Richard
Grigg, the Company’s Senior Vice President and Managing Director, in exchange
for 3,825,000 Ordinary Fully Paid Shares of Sino Gas & Energy Holdings
Limited (SG&E) owned by Mr. Grigg. This represented approximately 3.26% of
the outstanding shares of SG&E as of March 9, 2009. The acquired shares were
originally accounted for by the Company as a non-current investment carried at
cost. Commencing with the interim period ending September 30, 2009,
the carrying amount is recorded at fair value. Mr. Grigg is a former executive
of SG&E who joined the Company in October 2007. The SG&E
shares were acquired in order to eliminate possible conflicts of interest
involving Mr. Grigg regarding possible future transactions that may occur
between the Company and SG&E, as both companies’ business plans involve
developing operations in China.
Chemical
Sales Agent Arrangement
During
the third quarter of 2009, the Company conducted its initial business involving
EORP chemicals through an arrangement with Tongsheng, a subsidiary of the
family-owned business of Mr. Li Xiangdong (LXD). A new China
Joint Venture Company (CJVC) was established for this purpose in September 2009,
known as Beijing Dong Fang Ya Zhou Petroleum Technology Services Company Ltd.
(Dong Fang). LXD is a 24.5% owner of Dong Fang as a result of
contributing patent rights and related technology for specialty chemicals and
processes to Dong Fang. Prior to formation of Dong Fang, the Company was not
licensed in China to purchase or blend chemicals for resale or to sell
chemicals. Under the arrangement with Tongsheng, Tongsheng manufactured
specialty blends of chemicals using technology developed by LXD and sold
finished product to customers of the Company. Tongsheng collects the
revenues from customers in advance on these sales, bills the Company for the
cost of sales, and is obligated to remit the revenues to the
Company.
77
NOTE
12. --- OTHER COMMITMENTS
Lease
Commitments
At
December 31, 2009, the Company had non-cancelable lease commitments for two
operating leases on office facilities. Future minimum lease rentals by year are
as follows:
2010 - $
210,748
2011 -
$ 86,358
Rental
expense for the years ended December 31, 2009, 2008 and 2007 was $233,042,
$110,013, and $78,183, respectively.
NOTE
13. --- CAPITALIZATION
Capital
Stock Authorized and Issued
The
authorized capital stock of the Company consists of 300,000,000 shares of Common
Stock, $0.001 par value per share, and 50,000,000 shares of Preferred Stock,
$0.001 par value per share, of which 30,000,000 shares have been designated as
“Series A Convertible Preferred Stock.” 6,291,048 shares of
Series A Convertible Preferred Stock remain unissued following the automatic
conversion of 23,708,952 shares of the Company’s Series A Convertible
Preferred Stock into Common Stock of the Company on June 5, 2007.
The
Company’s capitalization at December 31, 2009 was 43,037,596 shares of Common
Stock issued and outstanding, and 23,708,952 shares of Series A Convertible
Preferred Stock issued but none outstanding. The Company’s capitalization at
December 31, 2008 was 40,061,785 shares of Common Stock issued and outstanding,
and 23,708,952 shares of Series A Convertible Preferred Stock issued but none
outstanding .
Common
Stock Issued as Compensation for Consultant Services
In 2009,
the Company issued 1,029,000 shares of Common Stock for consultant compensation
valued at $1,053,100, as follows: 879,000 shares at $.85 per share
($747,150); 90,000 shares at $1.92 per
share ($172,800); 10,000 shares at $.65 per
share ($6,500); 15,000 shares at $1.90 per share
($28,500); 15,000 shares at $2.09 per share ($31,350); and
20,000 shares at $3.34 per share ($66,800).
In 2008,
the Company issued 15,000 shares of Common Stock for consultant compensation
valued at $138,000, as follows: 5,000 shares at $22.90 per share
($114,500); and 10,000 shares at $2.35 per share ($23,500).
Other
Equity-Based Compensation
Refer to
Note 15. – Stock-Based Compensation Plans regarding activity for stock options
and stock compensation not immediately vested at award date.
NOTE 14. --- NAVITAS ACQUISITION
On July
1, 2008, the Company entered into an Agreement and Plan of Merger (the “Merger
Agreement”) with (i) Navitas Corporation, a Nevada corporation (“Navitas”),
whose primary assets at the time of merger were comprised of 480,000 shares of
Common Stock of the Company and certain deferred tax assets, and (ii) Navitas
LLC, a Nevada limited liability company affiliated with Navitas and whose
members consisted of Navitas shareholders. The shareholders of Navitas received
a total of 450,005 shares of Company Common Stock in return for 100% of the
shares of Navitas. The merger was effective July 2,
2008. At that date, Navitas was merged into the Company, and Navitas
ceased to exist as a separate corporation. The transaction resulted
in a net decrease of 29,995 shares of the Company’s outstanding Common
Stock.
A
majority of interest of Navitas’ and Navitas LLC’s shareholders and members,
respectively, were shareholders of the Company prior to the
merger. In addition, Adam McAfee, the President of Navitas and
Managing Director of Navitas, LLC, is the brother of Eric A.
McAfee. At the time of the merger, Eric McAfee was a beneficial owner
of approximately 5.6% of the Company’s Common Stock and 50% owner of Cagan
McAfee Capital Partners, LLC, a fund owned 50% by Mr. Laird Q.
Cagan. At the time of the merger, Mr. Cagan was a member of the
Company’s Board of Directors and beneficial owner of approximately 7.2% of the
Company’s Common Stock.
78
The
acquisition was accounted for as a merger involving treasury stock and
immaterial net working capital. No value was assigned to deferred tax
assets acquired. The purchase price paid of 450,005 shares of Common
Stock of the Company was valued at $18.17 per share based on a seven-day
weighted average related to the measurement date. No gain was
recognized on the net reduction of 29,995 shares outstanding of the Company’s
capital stock. The total absolute dollar amounts recorded for shares
issued and shares acquired were the same except for certain transaction costs
recorded as additional cost of shares acquired. No cash consideration
was paid by the Company in the merger.
NOTE
15. --- STOCK-BASED COMPENSATION PLANS
Stock
Options
Under the
Company’s 2009 Equity Incentive Plan, the Company may issue stock, options or
units to result in issuance of a maximum aggregate of 6,000,000 shares of Common
Stock. Options awarded expire 10 years from date of grant or shorter term as
fixed by the Board of Directors. In 2009, the Company issued a total
of 460,070 stock options with vesting periods from 6 months to 25 months. The
approximate percentages of the 2009 awards vesting by year is as follows: 2010 -
53%; 2011 – 23%; 2012 – 24%.
The
following is a table of options activity:
Number
of Shares Underlying Options
|
Weighted
Average
Exercise
Price per
Share
|
Weighted
Average Remaining Contractual Term(Years)
|
||||||||||
Outstanding
at December 31, 2008
|
2,137,200 | $ | 1.04 | 9.07 | ||||||||
Granted
in 2009
|
460,070 | $ | 3.96 | 5.25 | ||||||||
Exercised
in 2009
|
(30,000 | ) | $ | .59 | ||||||||
Forfeited
in 2009
|
(25,000 | ) | $ | .64 | ||||||||
Outstanding
at December 31, 2009
|
2,542,270 | $ | 1.57 | 8.16 | ||||||||
Expected
to vest
|
2,474,610 | $ | 1.56 | 8.17 | ||||||||
Exercisable
at December 31, 2009
|
1,291,488 | $ | 1.06 | 8.85 |
The total
intrinsic values of options at December 31, 2009 were $7,090,724 for options
outstanding and expected to vest and $4,811,400 for options that were
exercisable at that date. The total intrinsic values realized by
recipients on options exercised were $117,824 in 2009 and none in
2008 and 2007.
The
Company recorded compensation expense relative to stock options in 2009, 2008
and 2007 of $583,547, $378,025, and $167,325 respectively.
The fair
values of stock options used in recording compensation expense are computed
using the Black-Scholes option pricing model. The table below shows
the weighted average amounts for the assumptions used in the model for options
awarded in each year.
2009 |
2008
|
2007
|
||||||||||
Expected
price volatility (basket of comparable public companies)
|
77.54 | % | 65.60 | % | 55.80 | % | ||||||
Risk-free
interest rate (U.S. Treasury bonds)
|
1.42 | % | 2.04 | % | 4.09 | % | ||||||
Expected
annual dividend rate
|
0.00 | % | 0.00 | % | 0.00 | % | ||||||
Expected
option term – weighted average
|
3.17
yrs.
|
5.95
yrs.
|
5.98yrs.
|
|||||||||
Grant
date fair value per common share-weighted average
|
$ | 2.05 | $ | .39 | 3.38 |
79
Restricted
Stock
|
Number
Of Grants
|
Weighted
Average Grant Date Fair Value
|
||||||
Outstanding
at December 31, 2008
|
834,000 | $ | 1.78 | |||||
Granted
in 2009
|
924,055 | $ | 2.42 | |||||
Vested
in 2009
|
(738,000 | ) | $ | 1.87 | ||||
Outstanding
at December 31, 2009
|
1,020,055 | $ | 2.29 |
The Company recorded compensation expense relative to restricted stock in years 2009, 2008 and 2007 of $1,848,459, $977,565 and $28,117 respectively.
Unamortized
Compensation
At
December 31, 2009, the remaining future compensation expense to be recorded on
unvested stock options and restricted stock was $2,530,180, to be recognized
over a weighted average period of 1.66 years, assuming that no forfeitures
occur.
Fair
Value Data
The total
grant date fair value of shares vested during 2009, 2008, and 2007 were
$1,383,370, $763,510, and $173,441 respectively.
The total
grant date fair values of stock options and restricted shares issued during the
years 2009, 2008, and 2007 were $3,185,240, $1,478,080, and $1,660,800
respectively.
NOTE 16. --- POTENTIALLY DILUTIVE SECURITIES
Warrants,
options and restricted stock described in the immediately preceding notes are
potentially dilutive in future periods if the Company has net income. They have
been anti-dilutive for all periods to date because the Company has been in a
loss position.
NOTE
17. --- PENSION AND POSTRETIREMENT PLANS
In 2007
the Company adopted a defined contribution 401(k) plan for its
employees. The plan provides for Company matching of 200% on up
to the first 3% of salary contributed by employees. The plan includes the option
for employee contributions to be made from either pre-tax or after-tax basis
income as elected by the employee. Company contributions are immediately vested
to the employee. In 2009, the Company contributions were $75,322
under this plan including third party administration fees.
NOTE
18. --- PATENT APPLICATION RIGHTS
On
November 27, 2009, the State Intellectual Property Office of the PRC in
China recognized Dong Fang as the official owner of the six LXD
Patent Application Rights (the “Rights”), covering enhanced oil recovery
technologies developed by LXD (the “EORP Technologies”). LXD contributed the
Rights in satisfaction of his 24.5% share of Dong Fang’s registered capital of
RMB 30,000,000. The fair value of the Rights was verified by a certified Chinese
valuation firm.
Thus far,
Dong Fang has used the Rights to utilize the EORP Technologies in both service
and sale scenarios. Dong Fang intends to pursue various short-
and long-term strategies to expand its EORP operations in order to
add value to the Company.
Under
interpretation SAB No. 48 issued by the Staff of the U.S. Securities and
Exchange Commission, the Company in this case is not permitted to
record a capitalized asset value on the Rights for U.S. reporting. This ruling
in no way lessens the fair value of the Rights to the Company.
80
NOTE
19. --- LITIGATION AND CONTINGENCIES
The
Company at December 31, 2009 had no litigation, actual or potential, of which it
was aware and which could have a material effect on its financial
position.
NOTE
20. --- SUBSEQUENT EVENT
On
February 16, 2010, the Company consummated the offer and sale of 5,000,000
shares (the "Shares") of its common stock, par value $0.001 per share ("Common
Stock"), for an aggregate purchase price of $20 million, or $4.00 per share (the
"Purchase Price"), pursuant to a Securities Purchase Agreement, dated February
10, 2010, among the Company and certain purchasers signatory thereto (the
“Purchasers”). In addition, the Company issued to the Purchasers (1)
warrants to purchase up to an additional 2,000,000 shares of Common Stock of the
Company, in the aggregate, at an exercise price of $4.50 (subject to
customary adjustments), exercisable commencing six months following the closing
for a period of 36 months after such commencement date (the “Series A
Warrants”); and (2) warrants to purchase up to an additional
2,000,000 shares of Common Stock of the Company, in the aggregate, at an
exercise price $4.00 per share (subject to customary adjustments), exercisable
immediately at the closing until November 1, 2010 (the “Series B Warrants” and
together with the Series A Warrants, the “Warrants”). If all the
Warrants are exercised, the Company would receive additional gross proceeds of
$17 million. The Shares and the Warrant Shares are to be sold pursuant to a
shelf registration statement on Form S-3 declared effective by the SEC on
February 3, 2010 (File No. 333-163869), as amended by the prospectus supplement
filed with the SEC on February 12, 2010 and delivered to the
Purchasers.
Rodman
& Renshaw, LLC (“Rodman”) served as the Company’s exclusive placement agent
in connection with the offering. As consideration for its services as
placement agent, Rodman received a cash fee equal to 6.0%
of the gross proceeds of the offering ($1,200,000), as well as a 5-year warrant
to purchase shares of Common Stock of the Company equal to 3.0% of the aggregate
number of shares sold in the offering (150,000 shares of Common Stock), plus any
shares underlying the Warrants. Rodman’s warrant has the same terms as the
Warrants issued to the Purchasers in the offering except that the warrant is not
exercisable until the 6-month anniversary of the closing and the exercise price
is 125% of the per share purchase price of the shares issued in the offering
($5.00 per share). In addition, subject to compliance with Financial
Industry Regulatory Authority ("FINRA") Rule 5110(f)(2)(D), the Company
reimbursed Rodman’s out-of-pocket accountable expenses actually incurred in the
amount of $25,000.
Net
proceeds from the offering are planned to be used by the Company for working
capital purposes, and also may be used by the Company to fund the
Company’s acquisition from CAMAC of the Contract Rights with respect
to the Oyo Field, which began production in December
2009.
Quarterly
Information (unaudited)
The table
below presents unaudited quarterly data for the years ended December 31, 2009
and December 31, 2008:
1st
Quarter
|
2nd
Quarter
|
3rd
Quarter
|
4th
Quarter
|
|||||||||||||
2009
|
||||||||||||||||
Revenues
– sales and services
|
$ | - | $ | - | $ | 55,409 | $ | 11,393 | ||||||||
Operating
Loss
|
$ | (2,939,025 | ) | $ | (2,149,474 | ) | $ | (2,696,731 | ) | $ | (3,803,749 | ) | ||||
Net
Loss
|
$ | (2,922,351 | ) | $ | (2,158,650 | ) | $ | (2,644,162 | ) | $ | (3,764,215 | ) | ||||
Basic
and diluted net loss per common share
|
$ | (.07 | ) | $ | (.05 | ) | $ | (.06 | ) | $ | (.09 | ) | ||||
2008
|
||||||||||||||||
Operating
Loss
|
$ | (1,085,980 | ) | $ | (1,265,498 | ) | $ | (1,250,923 | ) | $ | (2,181,419 | ) | ||||
Net
Loss
|
$ | (950,008 | ) | $ | (1,201,002 | ) | $ | (1,157,980 | ) | $ | (2,137,659 | ) | ||||
Basic
and diluted net loss per common share
|
$ | (.02 | ) | $ | (.03 | ) | $ | (.03 | ) | $ | (.05 | ) |
Fourth
quarter 2009 versus fourth quarter 2008
The 2009
fourth quarter operating loss exceeded the 2008 fourth quarter operating loss by
$1,622,329. The increase was principally due to increased consulting
expense of $905,905 of which $630,519 was for amounts paid as equity and
$275,386 was for amounts paid as cash. The increased consulting
expense was largely due to milestone payments under agreements related to
start-up of EORP operations. In addition, stock compensation expense
for restricted stock and stock options increased $358,528 due to greater value
of awards subject to amortization. Legal fees expense decreased
$82,309 principally due to lower expense related to China. All other
expenses reflected a net increase, including 2009 write-offs of deferred charges
of $85,000 on asset acquisition and financing transactions under negotiation
that were terminated.
81
ITEM
9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM
9A. CONTROLS AND PROCEDURES
Evaluation
of Disclosure Controls and Procedures
The
Company maintains disclosure controls and procedures that are designed to ensure
that information required to be disclosed in the Company’s reports under the
Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded,
processed, summarized and reported within the time periods specified in the
SEC’s rules and forms, and that such information is accumulated and communicated
to management, including its Chief Executive Officer (“CEO”) and Chief
Financial Officer (“CFO”), as appropriate, to allow timely decisions
regarding required disclosure.
Management
of the Company, with the participation of its CEO and CFO, evaluated the
effectiveness of the Company’s disclosure controls and procedures. Based on
their evaluation, as of the end of the period covered by this Form 10-K, the
Company’s CEO and CFO have concluded that the Company’s disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934, as amended) were effective.
Management’s
Report On Internal Control Over Financial Reporting
Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting. Internal control over financial reporting is
defined in Rules 13a-15(f) and 15d-15(f) promulgated under the Exchange Act
as a process designed by, or under the supervision of, our principal executive
and principal financial officers and is effected by the Company’s board of
directors, management and other personnel, to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted
accounting principles (“GAAP”) and includes those policies and procedures
that:
•
|
Pertain
to the maintenance of records that, in reasonable detail, accurately and
fairly reflect our transactions and dispositions of our
assets,
|
•
|
Provide
reasonable assurance that transactions are recorded as necessary to permit
preparation of our financial statements in accordance with GAAP, and that
our receipts and expenditures are being made only in accordance with
authorizations of management and directors of the Company,
and
|
•
|
Provide
reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use or disposition of our assets that could have
a material effect on the financial
statements.
|
Because
of its inherent limitations, a system of internal control over financial
reporting can provide only reasonable assurance and may not prevent or detect
misstatements. Further, because of changes in conditions, effectiveness of
internal controls over financial reporting may vary over time. Our system
contains self-monitoring mechanisms, and actions are taken to correct
deficiencies as they are identified.
Management
assessed the effectiveness of our internal control over financial reporting as
of December 31, 2009 based on the criteria described in Internal
Control—Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission (“COSO”).
Based on
this assessment, management, including the Company’s CEO and CFO, concluded that
our internal control over financial reporting was effective as of December 31,
2009.
RBSM LLP,
the independent registered public accounting firm that has audited the financial
statements included in this Report, has issued an attestation report on the
Company’s internal control over financial reporting as of December 31, 2009
which is given below.
82
RBSM
LLP
CERTIFIED
PUBLIC ACCOUNTANTS
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of
Directors
Pacific
Asia Petroleum, Inc.
Hartsdale,
NY
We have
audited Pacific Asia Petroleum, Inc. and its subsidiaries (the "Company")
(a development stage company) internal control over financial reporting as of
December 31, 2009, based on criteria established in Internal Control -
Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). The Company’s management is responsible for
maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial
reporting, included in the accompanying Management's Report on Internal Control
over Financial Reporting. Our responsibility is to express an opinion on the
Company's internal control over financial reporting based on our
audit.
We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit of internal control over financial reporting included
obtaining an understanding of internal control over financial reporting,
assessing the risk that a material weakness exists, testing and evaluating the
design and operating effectiveness of internal control based on assessed
risk. Our audit also included performing such other procedures as we
considered necessary in the circumstances. We believe that our audit provides a
reasonable basis for our opinion.
A
company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the
company's assets that could have a material effect on the financial
statements.
Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our
opinion, Pacific Asia Petroleum, Inc. and its subsidiaries maintained, in all
material respects, effective internal control over financial reporting as
of December 31, 2009, based on criteria established in Internal Control --
Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO).
We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheets of Pacific Asia
Petroleum, Inc. and its subsidiaries as of December 31, 2009 and 2008, and the
related consolidated statements of operations, comprehensive income,
stockholders’ equity and cash flows for each of the three years in the period
ended December 31, 2009 and for the period August 25, 2005 (date of inception)
through December 31, 2009, and our report dated March
2, 2010 expressed an unqualified opinion.
/s/ RBSM LLP | ||
New
York, New York
March
2, 2010
|
83
Changes
in Internal Control Over Financial Reporting
No change
in the Company’s internal control over financial reporting (as defined in
Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the
quarter ended December 31, 2009 that has materially affected, or is reasonably
likely to materially affect, our internal control over financial
reporting.
ITEM
9B. OTHER INFORMATION
None.
84
PART
III
ITEM
10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
On August
15, 2007, the Company adopted a Code of Ethics and Business Conduct (the “Code”)
applicable to the Company’s Chief Executive Officer, Chief Financial Officer and
all other employees. Among other provisions, the Code sets forth
standards for honest and ethical conduct, full and fair disclosure in public
filings and shareholder communications, compliance with laws, rules and
regulations, reporting of code violations and accountability for adherence to
the Code. The text of the Code has been posted on the Company’s
website (www.papetroleum.com). A copy of the Code can be obtained
free-of-charge upon written request to:
Corporate Secretary
Pacific Asia Petroleum,
Inc.
250 East Hartsdale Ave., Suite
47
Hartsdale, New York 10530
If the
Company makes any amendment to, or grant any waivers of, a provision of the Code
that applies to our principal executive officer or principal financial officer
and that requires disclosure under applicable SEC rules, we intend to disclose
such amendment or waiver and the reasons for the amendment or waiver on our
website.
Other
information called for by Item 10 of Form 10-K is set forth in the Company’s
Proxy Statement for its annual meeting of shareholders to be held on June
9, 2010 (the “Proxy Statement”), which is incorporated herein by
reference.
ITEM
11. EXECUTIVE COMPENSATION
Information
called for by Item 11 of Form 10-K is set forth in the Proxy Statement, which is
incorporated herein by reference.
ITEM
12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND RELATED STOCKHOLDER MATTERS
Information
called for by Item 12 of Form 10-K is set forth in the Proxy Statement, which is
incorporated herein by reference.
ITEM
13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
Information
called for by Item 13 of Form 10-K is set forth in the Proxy Statement, which is
incorporated herein by reference.
ITEM
14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information
called for by Item 14 of Form 10-K is set forth in the Proxy Statement, which is
incorporated herein by reference.
85
ITEM
15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Documents
Filed as Part of this Report:
(1,2) Financial
Statements and Schedules.
The
following financial documents of Pacific Asia Petroleum, Inc. are filed as part
of this report under Item 8:
Consolidated Balance Sheets – December 31, 2009 and 2008 |
Consolidated
Statements of Operations – For the years ended December 31, 2009, 2008 and
2007, and
for the
period from inception (August 25, 2005) through December 31,
2009
|
Consolidated
Statements of Comprehensive Income – For the years ended December 31,
2009, 2008 and 2007,
and for
the period from inception (August 25, 2005) through December 31,
2009
|
Consolidated
Statement of Stockholders’ Equity (Deficiency) – For the period from
inception
(August
25, 2005) through December 31, 2009
|
Consolidated
Statements of Cash Flows – For the years ended December 31, 2009, 2008 and
2007,
and for
the period from inception (August 25, 2005) through December 31,
2009
|
Notes to Consolidated Financial Statements |
(3) EXHIBITS:
Exhibit
Number
|
Description
|
|
2.1
|
Amended
and Restated Agreement and Plan of Merger and Reorganization, dated
February 12, 2007, as amended on April 20, 2007, by and among the Company,
IMPCO and IMPCO Merger Sub (incorporated by reference to Exhibit 10.16 of
our Form 10-SB (No. 000-52770) filed on August 16,
2007).
|
|
2.2
|
Agreement
and Plan of Merger, dated July 1, 2008, by and among Pacific Asia
Petroleum, Inc., Navitas Corporation and Navitas LLC (incorporated by
reference to Exhibit 10.1 of our Current Report on Form 8-K (No.
000-52770) filed on July 8, 2008).
|
|
2.3
|
Amended
and Restated Agreement and Plan of Merger and Reorganization, dated
February 12, 2007, as amended on April 20, 2007, by and among the Company,
ADS and ADS Merger Sub (incorporated by reference to Exhibit 10.15 of our
Form 10-SB (No. 000-52770) filed on August 16, 2007).
|
|
3.1
|
Amended
and Restated Certificate of Incorporation of the Company (incorporated by
reference to Exhibit 3.1 of our Form 10-SB (No. 000-52770) filed on August
16, 2007).
|
|
3.2
|
Bylaws
of the Company (incorporated by reference to Exhibit 3.2 of our Form 10-SB
(No. 000-52770) filed on August 16, 2007).
|
|
4.1
|
Specimen
Common Stock Certificate (incorporated by reference to Exhibit 4.1 of our
Form 10-SB (No. 000-52770) filed on August 16, 2007).
|
|
4.2
|
Form
of Common Stock Warrant (incorporated by reference to Exhibit 4.2 of our
Form 10-SB (No. 000-52770) filed on August 16,
2007).
|
86
4.3
|
Company
2007 Stock Plan (incorporated by reference to Exhibit 10.1 of our Form
10-SB (No. 000-52770) filed on August 16, 2007). *
|
|
4.4
|
Company
2009 Equity Incentive Plan. (incorporated by reference to Registration
Statement on Form S-8 (No. 333-160737) filed on July 22, 2009).
*
|
|
4.5
|
Form
of Series A Warrant (incorporated by reference to Exhibit 4.1 of our
Current Report on Form 8-K filed on February 10,
2010).
|
|
4.6
|
Form
of Series B Warrant (incorporated by reference to Exhibit 4.2 of our
Current Report on Form 8-K filed on February 10,
2010).
|
|
10.1
|
Form
of Securities Purchase Agreement, dated February 10, 2010 (incorporated by
reference to Exhibit 10.1 of our Current Report on Form 8-K filed on
February 12, 2010).
|
|
10.2
|
Company
2007 Stock Plan form of Stock Option Agreement (incorporated by reference
to Exhibit 10.2 of our Form 10-SB (No. 000-52770) filed on August 16,
2007). *
|
|
10.3
|
Company
2007 Stock Plan form of Restricted Stock Agreement (incorporated by
reference to Exhibit 10.3 of our Form 10-SB (No. 000-52770) filed on
August 16, 2007). *
|
|
10.4
|
Company
Form of Indemnification Agreement (incorporated by reference to Exhibit
10.4 of our Form 10-SB (No. 000-52770) filed on August 16,
2007).
|
|
10.5
|
Company
2009 Equity Incentive Plan form of Stock Option Agreement.
*
|
|
10.6
|
Company
2009 Equity Incentive Plan form of Restricted Shares Grant Agreement.
*
|
|
10.7
|
Subscription
Agreement, dated March 2, 2009, by and between the Company and Richard
Grigg (incorporated by reference to Exhibit 10.1 of our Current Report on
Form 8-K (No. 000-52770) filed March 4, 2009).
|
|
10.8
|
Consulting
Agreement, dated February 28, 2007, by and between Christopher B. Sherwood
and IMPCO (incorporated by reference to Exhibit 10.9 of our Form 10-SB
(No. 000-52770) filed on August 16, 2007).
|
|
10.9
|
Consulting
Agreement, dated February 28, 2007, by and between Dr. Y.M. Shum and IMPCO
(incorporated by reference to Exhibit 10.10 of our Form 10-SB (No.
000-52770) filed on August 16, 2007).
|
|
10.10
|
Executive
Employment Agreement, dated September 29, 2006, by and between Frank C.
Ingriselli and the Company (incorporated by reference to Exhibit 10.11 of
our Form 10-SB (No. 000-52770) filed on August 16, 2007).
*
|
|
10.11 | Executive Employment Agreement, dated September 29, 2006, by and between Stephen F. Groth and the Company (incorporated by reference to Exhibit 10.12 of our Form 10-SB (No. 000-52770) filed on August 16, 2007). * | |
10.12 | Amended and Restated Employment Agreement, dated January 27, 2009, entered into by and between the Company and Richard Grigg (incorporated by reference to Exhibit 10.1 of our Current Report on Form 8-K (No. 000-52270) filed on February 3, 2009). * | |
10.13 | Contract of Engagement, dated January 27, 2009, entered into by and between the Company and KKSH Holdings Ltd. (incorporated by reference to Exhibit 10.2 of our Current Report on Form 8-K (No. 000-52270) filed on February 3, 2009). * | |
10.14
|
Employment
Agreement, dated April 22, 2009, entered into by and between the Company
and Jamie Tseng (incorporated by reference to Exhibit 10.1 of our Current
Report on Form 8-K (No. 000-52770) filed on April 28, 2009).
*
|
|
10.15
|
Lease,
dated December 1, 2006, by and between Station Plaza Associates, and IMPCO
(incorporated by reference to Exhibit 10.13 of our Form 10-SB (No.
000-52770) filed on August 16, 2007).
|
|
10.16
|
First
Amendment to Lease, effective September 10, 2008, entered into by and
between the Company and Station Plaza Associates (incorporated by
reference to Exhibit 10.1 of our Current Report on Form 8-K (No.
000-52770) filed on September 18, 2008).
|
|
10.17
|
Tenancy
Agreement, dated June 12, 2009, by and between Bluewater Property
Management Co., Ltd. and the Company (incorporated by reference to Exhibit
10.1 of our Quarterly Report on Form 10-Q (No. 000-52770) filed on August
6, 2009).**
|
87
10.18
|
Contract
for Cooperation and Joint Development, dated August 23, 2006, by and
between Chifeng Zhongtong Oil and Natural Gas Co., Ltd. and Inner Mongolia
Production Company (HK) Ltd. (incorporated by reference to Exhibit 10.18
of our Form 10-SB (No. 000-52770) filed on August 16, 2007).
***
|
|
10.19
|
Agreement
on Joint Cooperation, dated May 31, 2007, by and between Sino Geophysical
Co., Ltd. and the Company (incorporated by reference to Exhibit 10.20 of
our Form 10-SB (No. 000-52770) filed on August 16, 2007).
***
|
|
10.20 | Production Sharing Contract for Exploitation of Coalbed Methane Resources in Zijinshan Area, Shanxi Province, The People’s Republic of China, dated October 26, 2007, by and between Pacific Asia Petroleum, Ltd. and China United Coalbed Methane Corp. Ltd. (incorporated by reference to Exhibit 10.1 of our Current Report on Form 8-K (No. 000-52770) filed on October 31, 2007). *** | |
10.21 | The Articles of Association of the Chinese-foreign Equity Joint Venture Inner Mongolia Sunrise Petroleum Co Ltd. (incorporated by reference to Exhibit 10.21 of our Form 10-SB/A (No. 000-52770) filed on October 12, 2007). ** | |
10.22
|
The
Contract of the Chinese-Foreign Equity Joint Venture Inner Mongolia
Sunrise Petroleum Co. Ltd., by and between Beijing Jin Run Hang Da
Technology Company Ltd. and Inner Mongolia Production Company (HK) Ltd.,
dated October 25, 2006 (incorporated by reference to Exhibit 10.22 of our
Form 10-SB/A (No. 000-52770) filed on October 12, 2007).
**
|
|
10.23
|
Amendment
to the Contract of the Chinese-Foreign Equity Joint Venture Inner Mongolia
Sunrise Petroleum Co. Ltd., Promissory Note, by and between Beijing
Jin Run Hang Da Technology Company Ltd. and Inner Mongolia Production
Company (HK) Ltd., dated December 31, 2009 and Promissory Note, by and
between Inner Mongolia Sunrise Petroleum Co. Ltd. and Inner Mongolia
Production Company (HK) Ltd., dated December 31, 2009.
|
|
10.24
|
Purchase
and Sale Agreement, dated November 18, 2009, by and among the Company,
CAMAC Energy Holdings Limited, CAMAC International (Nigeria) Limited, and
Allied Energy Plc. (incorporated by reference to Exhibit 10.1 of our
Current Report on Form 8-K (No. 001-34525) filed on November 23,
2009).
|
|
21.1
|
Subsidiaries
of the Company.
|
|
23.1
|
Consent
of RBSM LLP , Independent Registered Certified Public Accounting Firm,
filed herewith.
|
|
31.1
|
Certification
of Chief Executive Officer Pursuant to 15 U.S.C. § 7241, as Adopted
Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
|
|
31.2
|
Certification
of Chief Financial Officer Pursuant to 15 U.S.C. § 7241, as Adopted
Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
|
|
32.1
|
Certification
of Chief Executive Officer Pursuant to 18 U.S.C. § 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
|
|
32.2
|
Certification
of Chief Financial Officer Pursuant to 18 U.S.C. § 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
|
____________
____________
* | Indicates a management contract or compensatory plan or arrangement. |
** | English translation of executed Chinese original document included. Document provides that in the event of any inconsistencies between the Chinese and English versions of these documents, the Chinese versions shall govern. |
*** | Document provides that inconsistencies between the Chinese and English versions to be resolved in accordance with Chinese law. |
88
SIGNATURES
Pursuant to the requirements of Section
13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
Dated:
March 2, 2010
|
Pacific
Asia Petroleum, Inc.
|
|
|
||
By:
|
/s/
Frank C.
Ingriselli
|
|
Frank
C. Ingriselli
|
||
President
and Chief Executive Officer
(Principal
Executive Officer)
|
By:
|
/s/
Stephen F.
Groth
|
|
Stephen
F. Groth
|
||
Chief
Financial Officer
(Principal
Financial and Accounting Officer)
|
Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
Signature
|
Title
|
Date
|
||
/s/
Frank C.
Ingriselli
|
Director,
President and Chief Executive Officer
|
March 2, 2010 | ||
Frank
C. Ingriselli
|
(Principal
Executive Officer)
|
|||
/s/
Stephen F.
Groth
|
Vice
President and Chief Financial Officer
|
March 2, 2010 | ||
Stephen
F. Groth
|
(Principal
Accounting and Financial Officer)
|
|||
/s/ James
F. Link,
Jr.
|
Director
|
March 2, 2010 | ||
James
F. Link, Jr.
|
||||
/s/ Elizabeth P. Smith
|
Director
|
March 2, 2010 | ||
Elizabeth
P. Smith
|
||||
/s/ William E.
Dozier
|
Director
|
March 2, 2010 | ||
William
E. Dozier
|
||||
/s/ Robert C. Stempel
|
Director
|
March 2, 2010 | ||
Robert
C. Stempel
|
89