CHAR AND GRAYLING PROSPECT WELLS
Two Well Drilling Project
Kern County, California
June 2008
EXECUTIVE SUMMARY
Overview
Princeton Natural Gas, LLC (“Princeton”) is seeking a $5.5 million project investment to drill a well pair in Kern County, California with an excellent potential return and managed downside protection. Probable reserves for both wells are calculated to be 580,000 barrels of oil, with potential reserves of up to 1,975,000 barrels of oil.
The Char and Grayling Project is a two-well drilling project that pairs a low-risk infill prospect within Kern County’s prolific Aqueduct Oil Field (the Char Prospect) with a higher-risk prospect that will test the northwest extension of a channel system that has been productive in the large San Emidio Oil Field (the Grayling Prospect) nearby.
Figure One – Char and Grayling Prospect Location Map
The Char Prospect has probable reserves of 223,000 barrels of oil; the Grayling Prospect has probable reserves of 357,000 barrels of oil. Both wells will test the Upper Stevens Sands.
The Char Prospect well will be drilled to 12,400 feet and the Grayling Prospect well will be drilled to 12,500 feet. The wells will be drilled by Irani Engineering, Inc. – a highly experienced drilling company that has drilled and completed more than 500 oil and gas wells in California for both independent operators and large oil and gas companies. Operationally, each well will take about four to six weeks to drill once a rig is scheduled.
The project seeks to pair the two wells to limit potential downside for the investor. Operationally, the Char Prospect will be drilled first. The goal of the first well is to locate recoverable reserves of at least 85,000 barrels of crude oil. Of the $5.5m required for the project, approximately $1.8m will be incurred to drill and test the Char. The Grayling Prospect can then be drilled under the reasonable assumption that all of the project’s costs, including the drilling and testing costs for the second well and that well’s completion costs, will be offset by expected future cash flows from the Char well.
The capital for the project will be held in escrow and drawn down based on project milestones. The first drawdown will be for drilling and testing the Char well, reimbursement of $200,000 of GG&L (geological, geophysical and land) expenses incurred setting up the project and an operating capital reserve of $90,000, totaling $2,126,000. This drawdown will occur immediately after closing. The second planned drawdown will be to complete the Char well, totaling $769,000. This drawdown will occur six to eight weeks after closing. The third drawdown will be for the drilling and testing of the Grayling well, and the fourth and final drawdown will be to complete the Grayling well. See Table One - Sources and Uses of Funds below.
Table One – Sources and Uses of Funds
Potential
Sources of funds Time Frame
First drawdown (at closing) $2,126,000 30 – Nov – 08
Second drawdown $796,000 30 – Dec - 08
Third drawdown $1,836,000 15 – Jan – 09
Fourth drawdown $769,000 28 – Feb - 09
$5,550,000
Use of funds
GG&L expenses & operating reserve $290,000
Drilling & testing – Char Prospect $1,836,000
Completion – Char Prospect $769,000
Drilling & testing – Grayling Prospect $1,836,000
Completion – Grayling Prospect $769,000
$5,550,000
Project Economics
In exchange for the capital, the investor will receive a 100% working interest (75% net revenue interest) in each well, less a working interest earned by Princeton for developing and operating the project. The other 25% net revenue interest is divided among the land owner (20%) and the geologists and geophysicists who have worked on the project (totaling 5%), as is customary in the industry. Princeton’s working interest will be 10% before investor capital is returned, and an additional 15% once all of the investor capital is returned. This is advantageous for the investor compared with the industry-standard “third-for-a-quarter” structure in which the prospect developer gets a 25% working interest up front. This equates to 90% working interest or a net revenue interest for the investor of 67.5% initially, and 75% working interest or 56.25% net revenue interest after capital is returned. See Chart One – Ending Net Revenue Interest Ownership of Wells, below.
Chart One – Ending Net Revenue Interest Ownership of Wells
Using the 580,000 barrel probable reserve estimate as an example, the investor would have a return of approximately $23.7m on his $5.5m investment assuming a price of $70 per barrel for crude oil. In May and June 2008, crude oil was priced at $125 to $135 per barrel. See Table Two – Example Return Dynamics below.
Table Two – Example Return Dynamics
Probable reserve estimate (barrels) 580,000
Assumed price per barrel $70
Value of probable reserves $40,600,000
Barrels required for return of investment 116,265
Amount returned (at 67.5% NRI) $5,493,554
Remaining barrels in probable reserve 463,745
Amount returned (at 56.25% NRI) $18,259,565
Total amount returned to investors $23,753,119
Princeton’s working interest will be taken after the casing point to ensure that a US-domiciled investor is positioned to receive 100% of the tax benefit of the project’s intangible drilling costs. See Exhibit One – Authority for Expenditure (AFE) for intangible drilling cost details. Assuming an average of 300 barrels per day of production from the two wells, the investor will have all of his capital returned about 14 months after the first production check is cut, and the investor will realize his full return over a period of approximately 6 years. Extending this example, the investor’s gross monthly check at 300 barrels per day at $70 per barrel would be about $355,950 (using the 56.25% NRI figure).
Once production levels are established and new reserve estimates are made, Princeton may seek to sell one or both wells to oil and gas groups seeking to buy production. A potential sale, if the investor elects to sell his interest, may increase the investor’s IRR.
Prospect Details
The prospect areas are 100% leased and contain approximately 349 acres. Princeton has no knowledge of any adverse claims of ownership that have been made on the leasehold tract.
The Char and Grayling Prospects are located in the prolific oil producing area in the southern San Joaquin Valley where the valley floor starts to transition into the valley’s south bounding mountain ranges. Several oil fields produce from the Upper Stevens Sands in this area. They are the Yowlumne Oil Field (100 MMBO), the Landslide Oil Field (15 MMBO), the Rio Viejo Oil Field (8 MMBO), San Emidio Nose Oil Field (8 MMBO from the Upper Stevens), and the Aqueduct Oil Field (1 MMBO). The Aqueduct Field is also known as San Emidio Northwest. See Figure Two – Char and Grayling Location Detail, below.
Figure Two – Char and Grayling Location Detail
The oil fields listed above all produce from Upper Stevens Sands that were deposited in restricted channels or upper mid-fan facies. The source for these channels was the emerging southern margin. The channels generally trend southeast to northwest. The salient structural feature is an east plunging anticlinal nose. The sands were deposited within topographic lows in the original sea floor. After structuring, the sands are draped over the structural nose. Correlation of sands within the discrete channel and mid-fan areas are problematic and structural maps on any given sand are almost impossible due to the discontinuous nature of the deposition. Additionally, syn-depositional and post-depositional deformation varies across the area resulting in varying hydrocarbon migration patterns, different diagenetic histories, and multiple trapping mechanisms.
Char Prospect
The Char Prospect well will test the Upper Stevens Sands by drilling to 12,400 feet. The Char will test the channel system that produces in the Aqueduct Oil Field in the 55X-6, 66X-6, 78X-6 (S6/T11N/R21W), and 24X-8 RD1 wells (S8/T11N/R21W). These wells encountered good sands where the channel is thick (as evidenced by the isochron map, see Figure 3 below).
Figure Three – Char and Grayling Isochron Channel Map
The 55X, 66X, and 78X wells produced 522,214 BO, 85,468 BO, and 119,888 BO, respectively. Cumulative production for these three wells is approximately 727,520 BO. The 24X-8 RD1 well has cumulative oil production to date of 108,457 BO. Wells 55X-6, 66X-6, and 78X-6 penetrate the channel in the thicker area northwest of the 24X-8 which penetrates the channel in a relatively restricted and laterally thin area of the channel. The discontinuous nature of the sands can be seen in dramatic fashion when recognizing that the 55X-6 well has the best cumulative production while being the structurally lowest well. The Char will be drilled updip of the 78X-6 well to exploit oil that has not been produced by the other wells in the channel.
The drilling license, permits and environmental clearances for the Char Prospect well are in process at the time of this writing.
Grayling Prospect
The Grayling Prospect well will test the Upper Stevens Sands by drilling to 12,500 feet. Grayling will test the channel system that produced in the San Emidio Field in the 65-9, 83-9, 85-9, and 87-9 wells (S9/T11N/R21W). These wells encountered good sands where the channel is thick (See Figure Three above). Cumulative production for these zones is not available since production was co-mingled with Reef Ridge production. The channel system traverses the anticlinal nose northwest from the 63-9 well where the channel system thins and virtually disappears near the 81-8 well (S8/T11N/R21W). The 81-8 well penetrated the channel at this very thin location. Some thin sands were encountered in this zone and oil shows were present. However, the zone was generally tight, shaley and cherty, and the zone was not perforated.
As the channel system travels to the northwest it again thickens at the Grayling location and then joins the Char/Aqueduct channel system. Reservoir sands should be encountered at the proposed location. Structurally, the location will be drilled where the top of the O Chert/Top Channel horizon shows a slight nosing. This is indicative of differential compaction due to the presence of sand.
The drilling license, permit and environmental clearances for the Grayling Prospect well are complete.
The entire
project area is encompassed by a high-quality 3D seismic survey. The data were
shot in the 1980s but has since been combined with other 3D data in the area and
reprocessed into an excellent seismic volume.
Figure Four – Char and Grayling Seismic Profile
All wells in the area of interest were digitized and correlation synthetic seismograms were utilized to tie the well data to the seismic data. The updated time-depth tables produced from individual synthetic seismogram correlations were then used to build a 3D velocity model which is used for final correlation of the seismic and well data. As stated above, structural maps on any given sand are nearly impossible to create due to the discontinuous and disconnected nature of the channel sands. The channel systems are well defined by the well control and 3D seismic data. The channel systems are defined by mapping the O Chert and noting where the O Chert marker bifurcates and creates a “bird’s eye” in the seismic data.
Operational Details
Once permitting and licensing for the Char Prospect is complete, which Princeton estimates will be complete by July 2008, Princeton management will schedule the use of a drilling rig for the Char no later than October 2008 (and likely to be at least a month sooner). Once the Char well is completed, Princeton will schedule a drilling rig for the Grayling Prospect. Princeton management estimates that if the capital is raised by August 2008, both wells can be drilled and completed by the end of January 2009.
Princeton will operate the wells once they are drilled and completed by Irani Engineering, Inc. Princeton reserves the right to sub-contract the well operation to a reputable firm in the future.
Risk Factors
Drilling for oil and gas involves a high degree of inherent risk, and is marked by unprofitable efforts, not only from dry holes, but also from wells which, though productive, do not produce oil and gas in sufficient quantities to return a profit. The results of any well project cannot be determined in advance, including the Char and Grayling Prospect Wells discussed herein. The selection of leases and drill sites, even when done by experts, are not exact sciences and the results of such drilling cannot be predicted. Even though wells like the Char and Grayling Prospect Wells are drilled in an area adjacent to known and existing production, there is no assurance that such drilling will locate oil or gas sands or those sands, if located, will have the attributes necessary for commercial production sufficient to recoup the capital expended in placing such wells into production.
The initial potential of wells estimated before drilling or as determined by tests run following completion will not always be determinative of actual production. Commercial-quality wells may also be rendered dry or non-commercial during drilling, completion or production due to technical or mechanical difficulties.
The investor should not expect to be able to readily liquidate his working interests in the wells even if they are successfully completed and producing hydrocarbons in commercial quantities. These working interests are not liquid assets and the investor may have to bear the economic risks of holding his investment in such working interests for an indefinite period of time.
Prospective investors are strongly urged to consult their tax advisors before investing in the Char and Grayling Prospect Wells. While the project will be structured to optimize the tax benefits for the investor, certain tax benefits, such as the right to deduct intangible drilling costs and the right to claim a depletion allowance, may or may not be interpreted to be available to the investor under the provisions of the Internal Revenue Code, as amended by the Tax Reform Act of 1986.
Additional Information
Please contact us via the contact page on this web site for further information. A full geological and seismic analysis of the prospects is available, along with other due diligence material such as copies of the lease and permits, to prospective investors willing to sign a confidentiality agreement.