The Rotliegend in Poland Regional Setting

We are focused on Polish portion of the gas bearing Rotliegend fairway of the Northwest European Permian Basin. This fairway begins in the west in the UK sector of the Southern North Sea ("SNS"), extends through the Netherlands and Germany, and culminates in Poland. Similar aeolian Rotliegend sandstone reservoirs, formed by structural and/or stratigraphic traps, with gas sourced by Carboniferous coals and sealed by Zechstein evaporates, extend across the Basin.

Steady advances in geophysical techniques in these Permian basins have led to the discovery and development of over 200 trillion cubic feet (Tcf) of gas in the Rotliegend of the SNS Gas Basin and the Dutch onshore. In contrast, only 5 Tcf of gas has been discovered by POGC to date in the Rotliegend in Poland since the mid-sixties, mostly in shallow plays to the south of the Wolsztyn High. Between 1976 and 1985 however, 500 bcf of gas reserves was discovered by POGC in a deeper Rotliegend play, to the north of the Wolsztyn High. This Radlin trend bisects our Fences concession. There was little or no activity targeted towards the Rotliegend by POGC since these discoveries in the early eighties. During the past dozen years POGC’s attention has focused on the Main Dolomite and Basal Limestone plays in the Zechstein.

We have concluded that there are likely to be substantial additional gas reserves in the Rotliegend (and in the Main Dolomite and Basal Limestone) that can be identified through the application of geophysical techniques that have not previously been applied in this area in Poland.

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Exploration History

While many wells have been drilled "Soviet-style" in the region, effective exploration drilling density is relatively low at the Rotliegend horizon. The quality of seismic data in this area has been poor until very recently. Furthermore, interpretation is subject to the well-known complexities affecting the Rotliegend throughout the Northwest European Permian Basin. Interpretation lessons from the SNS were generally not applied. It is only in the last few years, with the entry of western companies, the computer enhancement of vintage seismic and the acquisition of good quality new seismic data, that the substantial additional exploration potential within the Rotliegend in Western Poland has been recognized.

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Geological Setting

The Rotliegend sandstone, our main target reservoir, is present throughout the Fences and Northwest concession project areas at depths of between approximately 2,500 to 4,000 meters (approximately 1,200 to 1,500 meters in Block 287). The Rotliegend dips gently towards the northeast, into the Foresudetic Monocline. To the southwest, the Rotliegend pinches out up dip onto the Wolsztyn High, with stratigraphic play potential.

Reservoir quality deteriorates somewhat as depth of burial increases. However, a down dip well at a depth of 3,750 meters, and our own commercial successes at Zaniemysl 3 (2,850 meters), Sroda 4 (3,600 meters), Winna Gora (3,550 meters), and Roszkow at a depth of 3,000 meters, support good reservoir characteristics over virtually the entire Fences area. The top Rotliegend horizon is quite heavily faulted, most frequently by normal faults. The dominant trend of these faults is northwest to southeast, with most tending to downthrow to the northeast. However, a number of potential traps, and the Radlin field itself, are set up by down thrown faults against the regional dip.

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Rotliegend Reservior Presence and Quality

In the Upper Rotliegend, desert sandstones, mainly aeolian with minor fluvial and sabkha deposits, are the dominant facies in the Fences areas. The Fences concession area is favorably located for aeolian facies sands with good porosity and permeability characteristics. Some of the best reservoir rock is found in the Fences area as the Rotliegend climbs up the Foresudetic Monocline around the Radlin field.

Reservoir quality in many wells in the area is extremely good in the top 40-65 meters of the Rotliegend, which is usually predominantly clean aeolian dune facies. Volumetrically, this interval would form at least 90% of the expected closure in all but the very biggest anticipated structural cases.

Based on offset well data and regional models, porosities in this upper interval range between 14% and 20%. Permeabilities are harder to predict and more variable, as they are dramatically affected by grain-size, which varies independently of facies and porosity. Nevertheless, core permeabilities show an average of 25 mD, generally within a range of 10 mD to 100 mD, with individual layers from less than 1 mD to several Darcies. Average permeabilities from well tests in the Radlin field are 185 mD.

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The Zechstein in Poland

The Zechstein has two proven productive carbonate horizons in Poland’s Permian Basin: the Basal Limestone or Ca1 and the Main Dolomite or Ca2. The Ca1 is gas productive and has been the target of extensive exploration since the early 1980’s. The Ca2 has more recently been proved to be oil as well as gas bearing in subtle stratigraphic plays apparent on 3-D seismic.

Based on this 3-D work, two significant oil prone stratigraphic plays have been recognized in the Ca2 in lowstand fan features down slope from structural highs. The potential of these plays is supported by the 90 million barrel plus 350 bcf BMB field discovered in 1993 and the 38 million barrel plus 160 bcf Miedzychod-Lubiatow-Grotow complex some 75 km west of Fences discovered in 2003.

New 2-D seismic shows that a Ca2 play may be present in the Fences area. We are pursuing this Ca2 possibility by drilling the Grundy-1 a exploratory well, which started drilling in February 2008.

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Project Areas

As of December 31, 2007, we held oil and gas exploration rights in Poland in the following gross acreage components:

As we explore and evaluate our acreage in Poland, we expect to increasingly focus our operational and financial efforts on higher potential areas. As we do so, we may add new concessions that we believe have high potential and relinquish acreage that we believe has lower potential.

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Exploratory Activities in Poland

Our ongoing activities in Poland are conducted in six areas: Fences, Northwest, Kutno, Warsaw South, Block 255 and Block 287. Our exploration activities are currently focused primarily on the core Fences area, where the gas-bearing Rotliegend sandstone reservoir rock is a direct analog to the Southern North Sea gas basin offshore the United Kingdom. We are focused on this core area because substantial gas reserves have already been discovered and developed by POGC, we have made five commercial gas discoveries, together with POGC, containing proved gas reserves of approximately 71 Bcf gross (31 Bcf net to our interest), and we have concluded that there is likely to be substantial additional natural gas in the same geologic horizon.

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Fences Area

The Fences concession area is 852,000 gross acres (3,450 sq. km.) in western Poland’s Permian Basin surrounding POGC’s Radlin gas field. The Radlin field and several other POGC gas fields located in the Fences area are “fenced off" or excluded from our exploration acreage. These fields, discovered by POGC between 1974 and 1982, produce from structural traps in the Rotliegend sandstone.

We hold a 49% interest in approximately 807,000 acres and 24.5% interest in the remaining 45,000 acres in the Fences area.

The Rotliegend is the primary target horizon throughout most of the Fences concession area, at depths from approximately 2,500 to 4,000 meters. There are two types of Rotliegend traps in the region: structural traps and stratigraphic (“pinch-out”) traps. Both of these trap types are known to produce gas in the region. In addition, we have identified what appear to be carbonates in the Zechstein, a third type of trap that is known to produce both oil and gas in the region.

Fences Area: Structural Traps

Based on our drilling experience since 2000 in the Fences area, we have emphasized the use of acquisition, processing, and interpretation techniques that have been used successfully in the Rotliegend gas fields of the United Kingdom's offshore Southern Gas Basin. With Rotliegend structures as our target, and utilizing improved seismic data processing and acquisition techniques, we have drilled six wells targeting Rotliegend structures. Five of these wells are commercial, with aggregate proved gas reserves of 71 Bcf gross (31 Bcf net to our interest).

In January 2007, we completed the Winna Gora well as a commercial success (with production anticipated to begin at the end of 2009). At year-end, gross proved reserves for the well were estimated at approximately 7.5 Bcf of gas (3.7 Bcf net to our 49% interest). 3-D seismic data in the Winna Gora area will be available during 2008 and should assist us in determining whether to produce the existing vertical well or, alternatively, drill a horizontal well in this structure. 

In May 2007, we completed the Roszkow-1 well as a commercial success (with initial production in late 2008 or early 2009). At December 31, 2007, gross proved reserves for the well were estimated at approximately 29.1 Bcf of gas (14.3 Bcf net to our 49% interest).

Three more wells targeting Rotliegend structural traps are scheduled to start drilling in 2008. Each well targets an as-yet undrilled structure in the area of the Sroda-4 and Sroda-5 wells. The structural targets are named: Kromolice-N, Kromolice-S, and Sroda City. These three wells will be located with the help of our recently completed 3-D seismic data.

As part of our focus on that part of the Fences area that is prone to Rotliegend structural traps, we have acquired several hundred square kilometers of 3-D seismic data and plan to acquire an additional 200 square kilometers of 3-D seismic data in 2008 in the area where the Sroda-4, Sroda-5, and Winna Gora wells are located and along the trend to the southeast. We also plan to acquire approximately 200 kilometers of 2-D seismic data over a lead, Taczanow, that lies on the trend southeast from the Zaniemysl and Roszkow wells, our two biggest discoveries to date.

Finally, in the northern-most part of our Fences concession and lying within the area covered by our recent 3-D seismic data, we have identified a very large upthrown block, or horst, of Rotliegend sandstone that encompasses approximately 50 square kilometers, or 12,000 acres, within our Fences concession, and continues into the area north of our concession. One well, the 1984 Plawce-1, was drilled on this Rotliegend block within what is now our Fences concession. Five other wells have been drilled in this block north of our concession boundary, all but one of them more than 20 years ago. All six of these wells had substantial gas columns, and all but the most recent well were plugged due to relatively tight reservoir rocks. The one new well, Trzek-1, located about 6 kilometers north of our concession, was drilled in 2007 and reportedly tested gas at rates between 2.5 and 7.5 million cubic feet of natural gas per day, or MMcfD, after hydraulic fracturing.

We are currently working with service companies that specialize in production from tight Rotliegend reservoirs in the southern United Kingdom gas basin and in Germany. Over the next few months we will prepare a plan to appraise and develop the gas resource in the Plawce area. We have scheduled additional field work in 2008 that will enhance the quality of our 3-D seismic and appraisal data in the Plawce area.

Fences Area: Stratigraphic Traps

In the southwestern portion of the Fences concession, outside the area prone to Rotliegend structures, there is potential for stratigraphic trapping, or pinch-outs, in the Rotliegend. Based on data from the Rusocin-1 and the Lugi-1 wells we drilled in 2005, and on the presence of wells that produce from stratigraphic traps further to the west from our concession, we plan to acquire 3-D data in 2009 that will help us determine the next steps in exploring the pinch-out area.

Fences Area: Carbonate (Reef) Traps

In the northeastern portion of the Fences concession, also outside the area prone to Rotliegend structures, we have identified what appear to be carbonate (reef) targets in the Zechstein (Ca2) horizon of the lower Permian, just above the Rotliegend. In February 2008 we began drilling the Grundy-1 well to to test a possible Ca2 reef build-up identified on 2D seismic. The Grundy-1 is located approximately 30 kilometers east of the Company’s Sroda area. The nearest significant Ca2 producing fields, the BMB and Miedzychód-Lubiatow-Grotów ("MLG") oil and gas fields owned by POGC, are located approximately 60 to 80 kilometers northwest of the Grundy well location and reportedly contain approximately 125 million barrels of oil and 500 Bcf of gas.

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Northwest Concession Area

In 2006, the Company acquired 100% interest in a concession in west-central Poland covering 1.6 million acres.  The concession is in Poland’s Permian Basin directly north of POGC's BMB and MLG oil and gas fields.  As in the Company’s Fences concession, the Northwest concession has three separate possible exploration models: Rotliegend sands trapping gas in structural closures; Rotliegend sands trapping gas in stratigraphic traps or pinchouts; and Zechstein Ca2 dolomitic sands, reefs, and talus trapping oil and gas.  

During 2007 the Company’s technical team reviewed the existing sparse, 20 year old geological and geophysical data from the area.  In an area of 1.6 million acres, there were only about 2,500 kilometers of 2-D seismic data and only three wells drilled to target depths.  As a result of this review, we elected to relinquish approximately 500,000 acres from the northeast corner of this concession, retaining approximately 1.1 million acres.  In January 2008, we initiated field work to acquire just over 200 kilometers of new 2-D seismic over several of the leads identified the previous year.  We plan to seek industry participation while continuing to carry out early stage exploration work on our own.

Kutno Concession Area

In 2007, we acquired 100% interest in a concession in central Poland covering 284,000 acres.  The area encompasses a Rotliegend mega-structure ("Kutno") with projected four-way dip closure. The interpreted gas column is 280 meters over an area of 143 square kilometers.  With expected porosity of between 5% and 15%, the structure has a calculated potential gross volume of up to 19 trillion cubic feet.  Depth of the structure is estimated at approximately 6,000 meters (19,200 feet).  In view of the depth and cost, we are seeking industry participation to drill Kutno.

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Warsaw South Concession Area

In 2007, we acquired 100% interest in a concession in east central Poland covering approximately 935,000 acres.  The Warsaw South concession has several possible exploration opportunities, including carboniferous sands with structural or truncation trapping and Zechstein reefs trapped by overlying evaporates and salt.  During 2007, our technical group reviewed the geological and geophysical data from the area.  The team identified a dozen carboniferous leads and two possible Zechstein reef targets.  We plan to seek industry participation while continuing to carry out early stage exploration work on our own.

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Block 255 Concession Area

The Block 255/Wilga concession area in east central Poland consists of an 82% working interest in approximately 250,000 acres. We have one producing well, Wilga-2, in Block 255, the result of an exploration project conducted several years ago by us and Apache Corporation.  As of December 31, 2007, the Wilga well had remaining gross proved reserves of approximately 0.55 Bcf of gas and 16,900 barrels of light crude oil (0.45 Bcf and 14,000 barrels, net to our interest).  Wilga-2 is currently producing approximately 1 MMcfD of high methane gas and 20 barrels of light crude oil per day from sands in the Carboniferous.

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Block 287 Concession Area

The Block 287 concession area is 213,000 acres (863 sq. km.) located approximately 25 miles south of the Fences concession area.  We own 100% of the exploration rights.  Block 287 was part of a larger concession area which we relinquished in 2007 based on our technical evaluation and on a 2006 dry hole that we drilled. 

Within Block 287 there are three Rotliegend gas wells known as the Grabowka wells.  Originally drilled by POGC in 1983-85, these three wells tested gas but never produced commercially.  In early 2007, we entered into a joint venture agreement with an unrelated party, PL Energia S.A., headquartered in Krzywoploty, Poland, under which all costs of re-entering and completing the three Grabowka wells and building production facilities will be paid by our joint venture partner in exchange for discounted pricing on gas.  If our re-entry of these wells is commercial, the project is expected to come on-stream in the second half of 2008. We do not plan to conduct further technical work on Block 287.

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Additional Concession Acreage

We have applied for additional concession blocks in Poland that have not yet been issued.  We may apply for yet more concession blocks in Poland in 2008.  We will allocate modest technical and financial resources to these areas during 2008, primarily in the form of data collection and seismic reprocessing, with a view to ascertaining relative hydrocarbon potential and exploration risk.

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Activities and Assets in the United States

Nevada

During 2007, we did not drill any wells.  We may drill one or two exploratory wells in 2008 on land that is near our existing producing properties in Nevada. 

Montana

During 2007, we did not drill any wells in Montana.  We may drill one or two exploratory wells in 2008 using our own drilling rig.

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Oil and Gas Terms

The following terms have the indicated meaning when used in this report:

"Appraisal well" means a well drilled following a successful exploratory well used to determine the physical extent, reserves and likely production rate of a field.

"Bbl" means oilfield barrel.

"Bcf" means billion cubic feet of natural gas.

"Bcfe" means billion cubic feet of natural gas equivalent using a ratio of one barrel of oil to 6,000 cubic feet of natural gas.

"Development well" means a well drilled within the proved area of an oil or gas reservoir to the depth of a stratigraphic horizon known to be productive.

"Exploratory well" means a well drilled to find and produce oil or gas in an unproved area, to find a new reservoir in a field previously found to be productive of oil or gas in another reservoir, or to extend a known reservoir.

"Field" means an area consisting of a single reservoir or multiple reservoirs all grouped on or related to the same individual geological structural feature and/or stratigraphic conditions.

"Gross" acres and "gross" wells mean the total number of acres or wells, as the case may be, in which an interest is owned, either directly or through a subsidiary or other Polish enterprise in which we have an interest.

"Horizon" means an underground geological formation that is the portion of the larger formation that has sufficient porosity and permeability to constitute a reservoir.

"LCO" means light crude oil.

"MBbls" means thousand oilfield barrels.

"Mcf"means thousand cubic feet of natural gas.

"MMcf" means million cubic feet of natural gas.

"MMcfD" means million cubic feet of natural gas per day.

"Net" means, when referring to wells or acres, the fractional ownership working interests held by us, either directly or through a subsidiary or other Polish enterprise in which we have an interest, multiplied by the gross wells or acres.

"Proved reserves" means the estimated quantities of crude oil, gas and gas liquids that geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions, i.e., prices and costs as of the date the estimate is made. “Proved reserves” may be developed or undeveloped.

"PV-10 Value" means the estimated future net revenue to be generated from the production of proved reserves discounted to present value using an annual discount rate of 10.0%, the Standardized Measure of Future Net Cash Flows ("SMOG"). These amounts are calculated net of estimated production costs, future development costs and future income taxes, using prices and costs in effect as of a certain date, without escalation and without giving effect to non property-related expenses, such general and administrative costs, debt service, and depreciation, depletion and amortization.

"Reservoir" means a porous and permeable underground formation containing a natural accumulation of producible oil and/or gas that is confined by impermeable rock or water barriers and that is distinct and separate from other reservoirs.

"Usufruct"means the Polish equivalent of a U.S. oil and gas lease.

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Data Source

Note: Information about the estimated recoverable natural gas reserves established by PGNiG in western Poland is derived from: Karnkowski, Piotr, "Oil and Gas Deposits in Poland", University of Mining and Metallurgy Geosynoptics Society, Krakow, 1999; Mamczur, Stanislaw and Edward Czekanski, "Oil and Gas Deposit Barnowko-Mostno-Buszewo and Exploration for Hydrocarbon Deposits in the Koscian-Wielichowo Area," edited by Wojciech Gorecki, PGNiG Oil and Gas News from Poland 10 (2000). Information on Block 287 is derived from the Geological Information Package, Wroclaw North, Ministry of the Environment Department of Geology, Poland.