10-K 1 skpi2012123110k.htm 10-K SKPI 2012.12.31 10K


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2012
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from            to
Commission file number: 333-99455
SKY PETROLEUM, INC.
 
(Exact Name of Registrant as Specified in its Charter) 
Nevada
 
32-0027992
(State of other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
401 Congress Avenue, Suite 1540
 
 
Austin, Texas
 
78701
(Address of Principal Executive Offices)
 
(Zip Code)
(512) 687-3427
 
(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 o No x
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 o No x
 
Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
 
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 x No o
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to the Form 10-K x
 
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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one): 
 Large Accelerated Filer       o
 Non-Accelerated Filer        o
 Accelerated Filer    o
 Smaller Reporting Company         x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter: $10,180,306.

The number of shares of the Registrant’s Common Stock outstanding as of March 22, 2013 was 68,118,709.





TABLE OF CONTENTS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K and the exhibits attached hereto contain certain statements that constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements concern our anticipated results and developments in our operations in future periods, planned exploration and development of our properties, plans related to our business and matters that may occur in the future. These statements relate to analysis and other information that are based on forecasts of future results, estimates of amounts not yet determinable and assumptions of management.

Any statements that express or involve discussions with respect to predictions, expectations, beliefs, plans, projections, objectives, assumptions or future events or performance (often, but not always, using words or phrases such as “expects” or “does not expect”, “is expected”, “anticipates” or “does not anticipate”, “plans”, “estimates” or “intends”, or stating that certain actions, events or results “may”, “could”, “would”, “might” or “will” be taken, occur or be achieved) are not statements of historical fact and may be forward-looking statements. Forward-looking statements are subject to a variety of known and unknown risks, uncertainties and other factors which could cause actual events or results to differ from those expressed or implied by the forward-looking statements, including, without limitation:
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 risks related to our limited operating history:
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risks and uncertainty related to the arbitration proceeding involving our production sharing contract with the Ministry of Economy, Trade and Energy of Albania, acting through the National Agency of Natural Resources of Albania;
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risks related to our properties and proposed exploration, development and operations in Albania;
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risks related to our reliance on third parties to complete certain activities in Albania;
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risks related to our ability to perform and satisfy our obligations under the terms of our production sharing contract;
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risks related to licensing, government regulations and approvals in the countries in which we operate, including Albania;
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risks and uncertainty related to our legal rights under the participation agreement for the Mubarek Field;
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risks related to our need to raise additional capital to fund litigation, planned exploration and development, operational expenditures and working capital requirements;
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risks related to the historical losses and expected losses in the future and our ability to continue as a going concern;
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risks related to our dependence on our executive officers;
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risks related to fluctuations in oil and natural gas prices;
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risks related to exploratory activities, drilling for and producing oil and natural gas;
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risks related to liability claims from oil and gas operations;
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risks related to legal compliance costs and litigation expenditures;
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risks related to the unavailability of drilling equipment and supplies;
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risks related to competition in the oil and natural gas industry;
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risks related to period to period comparison of our financial results;
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risks related to our securities, including trading activity, price fluctuation and volatility;
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risks related to our ability to raise capital or enter into joint venture or working interest arrangements to complete exploration and development programs on acceptable terms, if at all; and
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political, social and cultural risks associated with operations and conducting business in foreign countries.
 

This list is not exhaustive of the factors that may affect our forward-looking statements. Some of the important risks and uncertainties that could affect forward-looking statements are described further under the sections titled “Risk Factors”, “Business” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Annual Report. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, believed, estimated or expected. Our management has included projections and estimates in this Annual Report, which are based primarily on management’s experience in the industry, assessments of our results of operations, discussions and negotiations with third parties and a review of information filed by our competitors with the Securities and Exchange Commission (which we refer to as the “SEC”) or otherwise publicly available. We caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made. We disclaim any obligation subsequently to revise any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events, except as required by law.

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We qualify all the forward-looking statements contained in this Annual Report by the foregoing cautionary statements.



PART I

ITEM 1. BUSINESS
 
Overview

Our primary business is to identify opportunities to either make direct property acquisitions or to fund exploration or development of oil and natural gas properties of others under arrangements in which we will finance the costs in exchange for interests in the oil or natural gas revenue generated by the properties. Such arrangements are commonly referred to as farm-ins to us, or farm-outs by the property owners farming out to us.
 
On June 24, 2010, Sky entered into a Production Sharing Contract (“PSC”) with the Ministry of Economy, Trade and Energy of Albania, acting through the National Agency of Natural Resources of Albania (“AKBN”). An official copy of the document evidencing approval of the PSC by the Council of Ministers of the Republic of Albania was published in the Fletoren Zyrtare on December 17, 2010, and the PSC became effective ten working days thereafter on January 3, 2011. The PSC grants Sky Petroleum exclusive rights to three exploration blocks (Block Four, Block Five and Block Dumre) in the Republic of Albania (the “Concession Area”). The Concession Area covers approximately 1.2 million acres, representing approximately 20% of the landmass of Albania. The PSC has a seven-year term with three exploration periods. Upon commercial discovery of gas, the agreement allows for development and production periods of 25 years plus extensions at the Company’s option. To date, there have been more than ten identified prospects including three significant evaluation wells in each block: Palokastra well in Block Four, Kanina well in Block Five, and a Dumre well in Block Dumre. In November 2011, AKBN delivered a letter to Sky Petroleum alleging material breach of the PSC and providing notice of termination pursuant to Section 24.2(a) of the PSC for failures to commence its initial work program, deliver a bank guarantee, open an office in Albania and establish an Exploration Advisory Committee. On December 23, 2011, Sky Petroleum delivered Notice of Arbitration under the Arbitration Rules of the United Nations Commission on Internal Trade Law to AKBN and to the Ministry of Economy, Trade and Energy of Albania to institute an arbitration proceeding for breach of the PSC in accordance with Article 21of the PSC.

Subsequent to December 31, 2012, the Arbitration took place before the Tribunal at the International Dispute Resolution Centre in London, UK between February 18th and February 22nd, 2013.  At the conclusion of the arbitration hearing, the Chairman of the Tribunal indicated the Tribunal expected to produce a written decision in three months.   Sky Petroleum intends to continue to vigorously pursue its rights and remedies against AKBN under the mandatory arbitration provision in Article 21 of the PSC. See “Legal Proceedings,” below.

On May 18, 2005, the Company, through its wholly-owned subsidiary Sastaro Limited (“Sastaro”), entered into a Participation Agreement with Buttes Gas and Oil Co. International Inc. ( “Buttes”), a wholly-owned subsidiary of Crescent Petroleum Company International Limited ( “Crescent”) for the financing of a drilling program (the “Participation Agreement”). The project is located in the Ilam/Mishrif reservoir of the Mubarek Field area near Abu Musa Island in the Arabian Gulf. Under the terms of the Participation Agreement, the Company participated in a share of the future production revenue by contributing $25 million in drilling and completion costs related to two in-fill wells in an off-shore oil and gas project in the United Arab Emirates.

On December 31, 2009, the Company received written notice from Buttes that Buttes unilaterally and solely determined that the Mubarek Field had reached the end of its economic life. Buttes also notified Sastaro that the Concession Agreement, dated December 29, 1969, between His Highness Sheikh Sultan bin Mohamed Al-Qassimi III, The Ruler of Sharjah, UAE and Buttes with respect to the Mubarek Field (the “Concession Agreement”) was terminated. Buttes has stated that it handed over the Mubarek Field operations and facilities to representatives of His Highness Sheikh Sultan bin Mohamed Al-Qassimi III on December 28, 2009. Management is exercising its rights under the Participation Agreement and intends to protect our interests and our investment in the Mubarek Field. To date, Sky continues to seek discussions with Crescent regarding the Participation Agreement.

The operator of the drilling program, Crescent, secured a drilling rig and began drilling the first well, Mubarek H2, which was completed during the second quarter of 2006 at a total depth of 15,020 feet (drilled depth). The second well Mubarek K2-ST4 was completed on October 4, 2007, with a total depth of 13,533 feet. Since the Mubarek H2 well was completed it has produced a total of 150,413 gross barrels of oil as of December 31, 2010. Since the Mubarek K2-ST4 well was completed, it has produced a total of 149,471 gross barrels of oil as of December 31, 2010. The Company had no drilling activities during the years ended December 31, 2012 and 2011.

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History and Corporate Structure

We were incorporated in the State of Nevada in August 2002 under the corporate name The Flower Valet. In 2004, we began to reassess our business plan and to seek business opportunities in other industries, including the oil and gas industry. On December 20, 2004, at our annual meeting of stockholders, our stockholders approved an amendment to our Articles of Incorporation, changing our name from The Flower Valet to Seaside Exploration, Inc. Subsequently, on March 28, 2005, we changed our name from Seaside Exploration, Inc. to Sky Petroleum, Inc. and began actively identifying opportunities to make direct property acquisitions and to fund exploration and development of oil and natural gas properties.

On October 8, 2010, the Company filed a Certificate of Designation with the Secretary of State for the State of Nevada to designate 5,000,000 shares of the Company’s preferred stock as shares of Series B Preferred Stock (the "Series B Preferred Shares").  The Company issued 3,863,636 Series B Preferred Shares to a consultant (“the Consultant”) under the terms of a consultant agreement related to the final approval of the PSC.

As of December 31, 2012, the Company had three wholly-owned subsidiaries, two incorporated in Cyprus: Sastaro Limited (“Sastaro”) and Bekata Limited ("Bekata”) which owns 100% of Sastaro and a third Sky Petroleum (Albania) Inc., a Cayman Islands corporation and qualified branch in Albania, incorporated for the purposes of holding and operating our interests in the Concession Area (as defined below) in Albania.

SKY PETROLEUM, INC.
ORGANIZATION STRUCTURE


Sastaro was incorporated on March 28, 2005. Bekata was incorporated on February 7, 2005, and Sky Petroleum (Albania) Inc. was incorporated on February 17, 2011.

Our principal corporate and executive offices are located at 401 Congress Avenue, Suite 1540, Austin, Texas 78701. Our telephone number is (512) 687-3427. We maintain a website at www.skypetroleum.com. Information contained on our website is not part of this Annual Report.
 
Production Sharing Contract with the Ministry of Economy, Trade and Energy of Albania:

On June 24, 2010, Sky was granted exclusive rights under a PSC to three exploration blocks totaling approximately 5,000 km2 (1.2 million acres), representing approximately 20% of the landmass of Albania. In addition to the exploration rights, the Company will also have access to more than 1,200 km of 2-D seismic data. The PSC has a seven-year term with three exploration periods. Upon commercial discovery of gas, the agreement allows for development and production periods of 25 years plus extensions at the Company’s option.

The PSC grants Sky Petroleum exclusive rights to three exploration blocks (Block Four, Block Five and Block Dumre) in the Republic of Albania.

Block Four is located in southeast Albania, bordering Greece. The exploration block covers an area of approximately 2,264 km2 (540,000 acres). The area has four identified leads and prospects on the block with a total estimated reserve potential of 350 million barrels of oil equivalent (“MMBOE”).

Block Five is located in southwest Albania next to the Adriatic Sea and covers an area of approximately 2,076 km2 (498,000 acres). The block has a total of five identified prospects or leads with a total estimated reserve potential of 375 MMBOE.

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Block Dumre is located immediately north of the Kucova oil field and covers an area of approximately 623 km2 (149,000 acres). Based on analogous discoveries, it is estimated that the Dumre prospect contains approximately 500 to 700 MMBOE original oil in place (“OOIP”).

Sky received final approval and ratification for the PSC with respect to the three exploration blocks, Four, Five and Dumre. The PSC received regulatory approval from the Council of Ministers of the Government of the Republic of Albania on November 25, 2010.  On December 17, 2010, a copy of the document evidencing final approval of the Council of Ministers of the Republic of Albania was published in the Fletoren Zyrtare.  The PSC became effective 10 working days after publication of the document on January 3, 2011.

On September 23, 2010, Sky released the findings of a detailed report written in cooperation with McKinsey & Company, one of the world’s leading consulting firms, assessing the potential value of the three exploration blocks, Four, Five and Dumre of the concession area. The report estimates the explorations blocks have a potential market value of between $1 billion to $3 billion based on expected P90 reserves of approximately 105 MMBOE at $10 to $30 per barrel of oil equivalent (BOE); and possess a mean net present value of about $2.1 billion based on a stochastic discounted cash flow valuation of their likely commercialization.

According to these findings, which are based on previous reserve estimates, there are significant reserves contained in the Albanian Blocks. Each block has promising prospects with existing data, including seismic and well logs. AKBN provided the Company and its consultant access to previous reserves studies including one prepared by OMV, Austria’s largest oil-producing, refining and retail operating company.

The McKinsey Report was not prepared in compliance with Section 1200 of Regulation S-K standards for oil and gas reserves and only reports reserve potential.   You should not place undue reliance on the McKinsey Report.

About the Republic of Albania

Albania has a population of 3.5 million people and is located 50 km east of Italy, across the Adriatic Sea in Southeast Europe. Albania is a member of NATO, and has applied to join the European Union. Albania is a proven hydrocarbon producing region with earliest known bitumen production dating back to the Roman Empire. Modern exploration began in the early 1900s. The Patmos – Marinza and Kucova heavy oilfields are among the largest oilfields in Europe. To date there have been ten significant field discoveries that have produced more than 150 million barrels.

Exploration Periods

First Exploration Period: The first exploration period is an initial period of two years in which Sky Petroleum has agreed to undertake G&G (geological and geophysical work), including but not limited to acquisition of technical data, interpretation of geological, geophysical and well data, and conducting regional geological and structural studies (mapping, balanced cross sections); seismic reprocessing and seismic acquisition, with minimum expenditure commitments totaling $1,500,000.

Second Exploration Period:  Provided that Sky Petroleum has completed the minimum first exploration period work program or paid AKBN the minimum expenditure amount, Sky Petroleum may elect to extend the exploration period into a second exploration period of three years.  During the second exploration period, Sky Petroleum will undertake G&G; seismic acquisition and an exploration drilling program with minimum expenditure commitments totaling $2,650,000.

At the end of the first or second exploration period, Sky Petroleum shall have the right, subject to AKBN approval, to extend such periods by one year, reducing the later periods by one year.

Third Exploration Period:  Provided that Sky Petroleum has completed the minimum second exploration period work program or paid AKBN the minimum expenditure amount, if, as approved by the AKBN, there are special circumstances which require more time for the contractor to perform adequate exploration activity, Sky Petroleum may elect to extend the exploration period into a third exploration period of two years.  During the third exploration period, Sky Petroleum will undertake G&G; seismic acquisition and an exploration drilling program with minimum expenditure commitments totaling $3,150,000.

If during the exploration periods, Sky Petroleum discovers petroleum accumulations capable of commercial production within the Concession Area (a “Discovery Area”); it can submit to AKBN a development plan, and upon approval of the development plan, commence development of the Discovery Area.  Sky Petroleum will have production rights of 25 years for each field (a “Production Area”) from the date of initial commercial production, which may be extended, at Sky Petroleum’s option, for successive periods of five years on the same conditions, subject to approval by AKBN, which approval shall not be unreasonably

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withheld or delayed.  Sky Petroleum and AKBN will share profits from any commercial production of oil (after cost recovery by Sky Petroleum) based on a sliding scale formula, in which Sky Petroleum’s share of profits will range from 96% to 100%.  All available production is subject to a 10% royalty tax and Sky Petroleum’s profits are subject to a 50% Albania tax on petroleum profits.

Sky Petroleum will relinquish to AKBN 25% of the Concession Area, as designated by Sky Petroleum, within 180 days after the end of each of the first exploration period and the second exploration period and all remaining acreage of the Concession Area at the end of the third exploration period, that is not then subject to a Discovery Area or in a Production Area.  Sky Petroleum will not be required to relinquish areas included in a Discovery Area or in Production Area.

Sky Petroleum or an affiliated entity designated by Sky Petroleum will serve as operator under the Agreement. Sky Petroleum intends to use affiliated entities to hold and operate the Concession Area. Sky Petroleum organized Sky Petroleum (Albania) Inc.,
a Cayman Island corporation to hold and operate the Concession Areas.

The Company’s investment in the Albania exploration blocks as of December 31, 2012 was $10,205,220.  The investment consisted of acquisition costs related to the PSC as follows: signing bonus $50,000, training and education $50,000, $850,000 for fees to consultants for locating and negotiating our investment in the Albania exploration blocks, and $265,220 for fees related to evaluations and assessments of the concession area.  In addition, 3 million shares of common stock of the Company with a fair value of $1,170,000, plus 3,863,636 Preferred Shares Series B of the Company with a value of $7,820,000, were issued to the Consultant for expertise provided to the Company in acquiring and negotiating the acquisition of oil and gas properties in Albania.

In November 2011, AKBN delivered a letter to Sky Petroleum alleging material breach of the PSC and providing notice of termination pursuant to Section 24.2(a) of the PSC for failures to commence its initial work program, deliver a bank guarantee, open an office in Albania and establish an Exploration Advisory Committee. On December 23, 2011, Sky Petroleum delivered Notice of Arbitration under the Arbitration Rules of the United Nations Commission on Internal Trade Law to AKBN and to the Ministry of Economy, Trade and Energy of Albania to institute an arbitration proceeding for breach of the PSC in accordance with Article 21 of the PSC.

Subsequent to year end, the Arbitration took place before the Tribunal at the International Dispute Resolution Centre in London, UK between February 18th and February 22nd, 2013.  At the conclusion of the arbitration hearing, the Chairman of the Tribunal indicated the Tribunal expected to produce a written decision in three months.   Sky Petroleum intends to continue to vigorously pursue its rights and remedies against AKBN under the mandatory arbitration provision in Article 21 of the PSC. See “Legal Proceedings,” below.

Mubarek Field - Participation Agreement:

The Company's wholly-owned subsidiary, Sastaro, entered into a Participation Agreement with Buttes in May 2005, pursuant to which Sastaro has the right to participate in a share of the future production revenue by contributing up to $25 million in drilling and completion costs related to two wells in an off-shore oil and gas project in the United Arab Emirates. The project is located in the Ilam/Mishrif reservoir of the Mubarek Field area near Abu Musa Island in the Arabian Gulf, which we refer to as the “Mubarek Concession Area”. The Participation Agreement does not grant Sastaro any interest in the Mubarek Concession Area other than the right to receive a share of future production revenue.
 
The Participation Agreement obligated Sastaro to pay $25 million in drilling and completion costs related to two wells. As of March 31, 2006, Sastaro had paid Buttes the full $25 million commitment. Buttes have the responsibility for carrying out all drilling and completion work related to the wells.
 
Under the Participation Agreement, if Buttes estimated that the drilling and completion costs of the second well increased the total drilling and completion costs of the two wells above $25 million, Sastaro would have the option, but not the obligation, to pay these additional costs. Upon exercising this option, Sastaro would become obligated to pay the total costs of the second well whether above or below Buttes’ estimate. As of December 31, 2008, Buttes reported that the drilling and completion costs for the Mubarek H2 and K2-ST4 wells totaled approximately $53 million. Sastaro did not exercise the option to pay the additional costs in completion of the first 2 wells.
 
In exchange for the payment obligations described above, Sastaro receives:

35.25% of the combined production revenue from the wells, if any, until Sastaro has been reimbursed its total investment;
thereafter, 18.84% of the combined production revenue from the wells, if any, until Sastaro has been reimbursed twice its total investment; and

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thereafter, 4.33% of the combined production revenue from the wells, if any, until the expiration of the Participation Agreement; and
less: (i) a 14.5% contribution to royalty obligations, (ii) $3 per barrel of crude oil for operating costs and (iii) certain other costs.

In December 2009, we received written notice from Crescent, the operator of the Mubarek Field, through its wholly owned subsidiary Buttes that Buttes had unilaterally and solely determined that the Mubarek Field had reached the end of its economic life. Accordingly, the Concession Agreement, dated December 29, 1969, between His Highness Sheikh Sultan bin Mohamed Al-Qassimi III, The Ruler of Sharjah, UAE and Buttes with respect to the Mubarek Field was terminated. Buttes have stated that it had handed over the Mubarek Field operations and facilities to representatives of His Highness Sheikh Sultan bin Mohamed Al-Qassimi III on December 28, 2009.

As a result of these events, Buttes alleges that the Participation Agreement between Sastaro and Buttes is terminated. We strongly disagree with Crescent and Butte’s assessment of the economic viability of the Mubarek Field. The Mubarek Field continued to produce substantial amounts of oil at termination and we believe that there is significant economic life left in the field. Consequently, we consider the Participation Agreement valid and in good standing. Management is exercising it’s rights under the Participation Agreement and intends to protect our interests and our investment in the Mubarek Field. Sky continues to seek discussions with Crescent regarding the Participation Agreement.

 Other Projects:

Komi Republic - Russian Federation
 
In 2007, we acquired a minority stake in the development of an oilfield in the Komi Republic of the Russian Federation by acquiring a 3.9% interest, subject to dilution, in Pechora Energy through its UK parent company, Concorde Oil & Gas Plc. (“Concorde”). This acquisition was essentially a carried interest. Pechora Energy holds the production license for the Luzskoye field in the Komi Republic. During March 2010, Concorde’s directors noted that Concorde was in the process of disposing its operating assets to one of its majority shareholders - Kuwait Energy Company (“KEC”). The completion of this transaction is subject to a number of conditions, including regulatory consents, bank consent, and approval of KEC shareholders. As a result of these events, and as of December 31, 2010, the investment in this project was impaired to zero. As of December 31, 2012, the Company has not received any proceeds related to the disposition of these assets.
 
Employees and Consultants
 
As of December 31, 2012, we have retained the services of the following consultants and employees:
 
Michael Noonan serves as our interim Chief Financial Officer, Vice President - Corporate, and Secretary, under a consulting agreement; and
Shafiq Ur Rahman serves as our Manager of Finance and Administration under an employment agreement.
 
The Company does not currently carry key-man life insurance on key management.
 
On February 5, 2007, we entered into a letter agreement with virtualcfo, Inc. (d/b/a/ vcfo), engaging the services of vcfo to provide oversight and guidance to our finance and accounting team. Under the agreement vcfo will assign staff members to assist us and will provide CFO level support, including assisting with operational and public reporting requirements, oversight and guidance of finance and accounting matters, and such other assistance as needed by our finance and accounting team. The Company ended its relationship with vcfo in 2012.

On May 18, 2010, Sky Petroleum entered into a consultant agreement for business development in the Republic of Albania with Orsett Ventures Inc., a British Virgin Islands company.  The Consultant Agreement was amended on June 29, 2010, and October 8, 2010. Under the terms of the Consultant Agreement, Sky Petroleum retained the Consultant as an independent consultant to use the Consultant’s experience, know-how, qualifications and expertise to acquire and negotiate the acquisition of oil and gas properties and projects in the Republic of Albania.  The agreement expired on April 30, 2011.

We entered into a consulting agreement effective February 1, 2011, with DT Premier Partners SH.P.K, an Albanian consulting company, to assist us with establishing our office and operations in Albania for a consulting fee of $3,500 per month.  The agreement expired on July 1, 2011.


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On November 21, 2011, we entered into a consultant service agreement (the “CEO Agreement”) with ETDDM Corporation (“ETDDM”), effective December 1, 2011 (the “Effective Date”). Pursuant to the CEO Agreement, the Company appointed one of ETDDM's directors, Tobias Gondorf in his capacity as director of ETDDM, as interim Chief Executive Officer (“Interim CEO”). The term of the CEO Agreement is for a one year period beginning on the Effective Date and continuing on a month to month basis thereafter until terminated; provided however, that the board of directors of the Company has the right to terminate the CEO Agreement following a 90 day probationary period or upon the appointment of a full time CEO. Either party may terminate the CEO Agreement with 30 days written notice. Pursuant to the terms of the CEO Agreement, the Company will compensate ETDDM for the services of Mr. Gondorf as Interim CEO as follows:

(a)
a signing bonus of 100,000 shares of common stock of the Company (the “Bonus Shares”), issuable within ten business days of Mr. Gondorf's appointment as Interim CEO;
(b)
a consultant fee of $15,000 per month, payable in accordance with the Company's standard payment practices;
(c)
commencing on March 1, 2012, a retention fee of 150,000 shares (the “Retention Shares”) for each three month period of service as the Interim CEO under the CEO Agreement, and payable each June 1, September 1, December 1 and March 1, thereafter during Mr. Gondorf's service as the Interim CEO; and
(d)
a grant of 250,000 stock options (the “Stock Options”) under the Company's stock option plan, exercisable to acquire shares of common stock at $0.25 per share, and vesting on the six month anniversary of such grant or immediately upon change of control of the Company.

On July 3, 2012, Tobias Gondorf resigned as interim chief executive officer of Sky Petroleum. Mr. Gondorf’s resignation and ETDDM’s notice of termination served result in the termination of the CEO Agreement between the Company and ETDDM dated November 21, 2011 and filed with the SEC as Exhibit 10.1 to the Company’s Current Report on Form 8-K dated November 28, 2011.

We have no other employees or consultants. In order to control costs and limit the number of our administrative personnel, we anticipate that we will retain consultants to provide or that our consultants will provide administrative type services until we are able to generate sufficient revenues from operations, if any, to hire personnel.

Competition

The oil and natural gas industry is intensely competitive, and we compete with other companies that have greater resources. Many of these companies not only explore for and produce oil and natural gas, but also carry on midstream and refining operations and market petroleum and other products on a regional, national or worldwide basis. These companies may be able to pay more for productive oil and natural gas properties and exploratory prospects or define, evaluate, bid for and purchase a greater number of properties and prospects than our financial or human resources permit. In addition, these companies may have a greater ability to continue exploration activities during periods of low oil and natural gas market prices. Our larger or integrated competitors may be able to absorb the burden of existing, and any changes to, federal, state, local and tribal laws and regulations more easily than we can, which would adversely affect our competitive position. Our ability to acquire additional properties and to discover reserves in the future will be dependent upon our ability to evaluate and select suitable properties and to consummate transactions in a highly competitive environment. In addition, because we have fewer financial and human resources than many companies in our industry, we may be at a disadvantage in bidding for exploratory prospects and producing oil and natural gas properties.

In Albania, our primary competitors are Bankers Petroleum Ltd., Petromanas Energy, Stream Oil and Gas Ltd., IEC Europetro plc, Cairn Energy plc, San Leon Energy plc, Beach Energy, Manas Petroleum Corp and Albpetro (the national Albanian oil company).
 
Government regulation
 
Sharjah, UAE

The operations of Buttes on the Ilam-Mishrif reservoir project in Sharjah, UAE are subject to governmental regulation applied through the Sharjah Supreme Petroleum Council (which we refer to as the “SPC”). The SPC controls well permitting and ensures operations are carried out in compliance with all applicable environmental and other regulation. Royalty payments and taxation as well as monitoring of oil lifts also come under the jurisdiction of the SPC.
 

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Albania

Petroleum operations in the Republic of Albania and the PSC are generally governed by the Laws of the Republic of Albania, including the following laws and regulations:-    Law No. 7746 dated 28.07.1993 “Petroleum Law (Exploration and Production)”, as amended (the “Petroleum Law”).

-
Law No. 7811 dated 12.04.1994 “On the Approval with Amendments of the Decree No. 782 dated 22.2.1994 “On the Fiscal System in the Petroleum Sector (Exploration-Production)”, as amended.
-
Law No. 9975, dated 28.07.2008, “On the National Taxes”, as amended.
-
Law No. 9946, dated 30.06.2008 “On the Sector of Natural Gas”, as amended.
-
Law No. 7928 “On Value Added Tax”, dated, 27.04.1995, as amended (the “VAT Law”).
-
Law No. 8976 dated 12.12.2002 “On Excises”, as amended (the “Excise Tax Law”).
-
Decision of Council of Ministers No. 547 dated 9.08.2006 “On Setting up the National Agency of Natural Resources”

These laws govern, among other petroleum related activities, the exploration and production of petroleum reserves in Albania, production taxes on petroleum production, and general business taxes for businesses operating in Albania.  Any changes to these laws and the regulations promulgated there under or the adoption of new laws and regulations in Albania could adversely affect our operations in Albania, decrease the potential profitability of those operations, or make such operations impossible or impracticable to continue.  The PSC is governed by Albanian regulations and law.

SEC Rules and Regulations

Our oil and gas reporting disclosure obligations with the SEC are regulated under Section 1200 of Regulation S-K and Rule 4-10 of Regulation S-X.

Pursuant to the SEC rules and regulations:

Companies must use first-of the month pricing to calculate the 12-month average commodity price unless contractual arrangements designate the price to be used;
Companies that produce oil and natural gas from nontraditional resources (such as oil sands, bitumen and shale) may report such resources as oil and gas reserves instead of mining reserves;
Probable and possible reserves may be disclosed separately on a voluntary basis;
For reserves to be proved, production of the reserves must be reasonably certain, meaning there is a high degree of confidence that the quantities will be recovered and the well from which the reserves are to be recovered is scheduled to be drilled within the next five years, unless the specific circumstances justify a longer time;
Reserves must be estimated through the use of reliable technology in addition to flow tests and production history;
Additional disclosure is required regarding the qualifications of the chief technical person who oversees the reserves estimation process and a general discussion of our internal controls used to assure the objectivity of the reserves estimate;
Disclosure of reserves, production, drilling activity and additional information is required to be given by geographic area; and
Companies must provide disclosure in tabular format of proved developed reserves, proved undeveloped reserves and total proved reserves.

Reserves Reported to Other Agencies

No reserve estimates were filed with a federal authority or agency other than with the SEC on our Annual Report on Form 10-K.

Production and Price Information
 
The following table summarizes sales volumes, sales prices, and production cost information for the periods indicated. The Company’s oil production comes from the Mubarek H2 and the Mubarek K2-ST4 wells located in the Mubarek Field in the UAE. We currently have no production. The Albania wells are currently under development, and as such, there was no production related to this project.
 

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UAE, Mubarek Field
 
Year Ended December 31, 2012
 
Year Ended December 31, 2011
 
Year Ended December 31, 2010
Sales
 
 
 
 
 
 
Oil (bbls)
 

 

 
1,521

Oil and natural gas sales
 
 

 
 

 
 

Oil sales
 
$

 
$

 
$
85,570

Average sales price
 
 

 
 

 
 

Oil ($ per bbl)
 
$

 
$

 
$
56.26

Average production cost
 
 

 
 

 
 

Total ($ per bbl)
 
$

 
$

 
$
3.00

 
Productive Wells and Acreage
 
As of December 31, 2012, we had no productive wells or acreage.

Undeveloped Acreage

Other than as noted in the Albania projects, the Company does not have any undeveloped acreage.

Drilling Activities

The Company had no drilling activities during the years ended December 31, 2012 and 2011.

Present Activities and Delivery Commitments

As of the date of this Annual Report, the Company does not have any wells in the process of drilling, water floods being installed, pressure maintenance operations, or other similar oil and gas related activities which it is conducting.

As of the date of this Annual Report, the Company does not have any delivery commitments for oil and gas quantities in the future.


ITEM 1A. RISK FACTORS

There are many factors that affect our business, prospects, liquidity and the results of operations, some of which are beyond the control of the Company. The following is a discussion of some, but not all, of these and other important risk factors that may cause the actual results of our operations in future periods to differ materially from those currently expected or desired. Additional risks not presently known to management or risks that are currently believed to be immaterial, but which may become material, may also affect our business, prospects, liquidity and results of operations. Our failure to successfully address the risks and uncertainties described below would have a material adverse effect on our business, financial condition and/or results of operations, and the trading price of our common stock may decline and investors may lose all or part of their investment. We cannot assure you that we will successfully address these risks or other unknown risks that may affect our business. Readers should carefully consider the risks and uncertainties described below before deciding whether to invest in shares of our common stock.

Risks related to our company and the oil and natural gas industry

Our petroleum operations in the Republic of Albania are regulated by the Laws of the Republic of Albania, which include petroleum production taxes and business taxes, and changes in these laws could adversely affect our operations in the Republic of Albania and decrease the potential profitability of those operations.

Petroleum operations in the Republic of Albania and the PSC are generally governed by the Laws of the Republic of Albania, including the following laws and regulations:

-
Law No. 7746 dated 28.07.1993 “Petroleum Law (Exploration and Production)”, as amended (the “Petroleum Law”).
-
Law No. 7811 dated 12.04.1994 “On the Approval with Amendments of the Decree No. 782 dated 22.2.1994 “On the Fiscal System in the Petroleum Sector (Exploration-Production)”, as amended.
-
Law No. 9975, dated 28.07.2008, “On the National Taxes”, as amended.
-
Law No. 9946, dated 30.06.2008 “On the Sector of Natural Gas”, as amended.

11



-
Law No. 7928 “On Value Added Tax”, dated, 27.04.1995, as amended (the “VAT Law”).
-
Law No. 8976 dated 12.12.2002 “On Excises”, as amended (the “Excise Tax Law”).
-
Decision of Council of Ministers No. 547 dated 9.08.2006 “On Setting up the National Agency of Natural Resources”

These laws govern, among other petroleum related activities, the exploration and production of petroleum reserves in Albania, production taxes on petroleum production, and general business taxes for businesses operating in Albania.  Any changes to these laws and the regulations promulgated there under or the adoption of new laws and regulations in Albania could adversely affect our operations in Albania, decrease the potential profitability of those operations, or make such operations impossible or impracticable to continue.  The PSC is governed by Albanian regulations and law.

We are currently in arbitration with respect to our PSC, which is expensive and uncertain.
In November 2011, AKBN delivered a letter to Sky Petroleum alleging material breach of the PSC and providing notice of termination pursuant to Section 24.2(a) of the PSC for failures to commence its initial work program, deliver a bank guarantee, open an office in Albania and establish an Exploration Advisory Committee. On December 23, 2011, Sky Petroleum delivered Notice of Arbitration under the Arbitration Rules of the United Nations Commission on Internal Trade Law to AKBN and to the Ministry of Economy, Trade and Energy of Albania to institute an arbitration proceeding for breach of the PSC in accordance with Article 21of the PSC. The arbitration occurred from February 18 - 22, 2013 and the Chairman of the Tribunal indicated the Tribunal expected to produce a written decision within three months.

The arbitration process is expensive and diverts attention and resources away from our exploration and development operations. If we fail to win the arbitration proceeding, we will likely lose our Concessions in Albania, which are our primary assets. The pending arbitration and legal proceedings adversely affects our ability to raise capital to fund our exploration and development of our properties and creates uncertainty related to the status of our Concessions.

Although we successfully obtained an Order and Preliminary Injunction from the United States District Court, Western District of Texas, Austin Division (i) granting our preliminary injunction to maintain the status quo between the Parties pending arbitration, (ii) enjoining the AKBN and all persons acting in concert with them from awarding, transferring, or otherwise disposing of any rights to explore, develop and/or produce petroleum on the contract area until a final arbitration award is issued, (iii) ordering AKBN to remove from their website or other publicly available documents all references to the Contract Area being “free” or otherwise available for new contractors until a final arbitration award is issued, and (iv) ordering the Parties to arbitrate their dispute with the United Nations Commission on International Trade Law according to the terms of the PSC, we are awaiting to have the order recognized in Albania.

Even if we prevail, we may experience future problems working with AKBN or the Albania government in completing our exploration and development plans on a timely basis.

We have a history of losses and will require additional financing to fund working capital requirements and arbitration related to the PSC.  Failure to obtain additional financing could have a material adverse effect on our financial condition and could cast uncertainty on our ability to continue as a going concern.
 
We have limited working capital and we will need to raise additional capital to fund our on-going arbitration and working capital requirements. A large portion of our current assets are held in the form of restricted cash, which secures the $1.5 million bank guarantee and may be unavailable to fund non-exploration and development expenditures.

We believe that we will be required to raise additional funds during 2012 to finance the arbitration and our on-going working capital requirements in 2012. We may face difficulties raising additional capital due to the uncertain status of the PSC and our current arbitration. Failure to obtain sufficient financing may affect our ability to fund arbitration and result in the delay or indefinite postponement of exploration and development or production on one or more of our properties and any properties we may acquire in the future or even a loss of property interests.

We cannot be certain that additional capital or other types of financing will be available if needed or that, if available, the terms of such financing will be favorable or acceptable to us. Our ability to arrange additional financing in the future will depend, in part, on the prevailing capital market conditions as well as our business performance. Our ability to continue on a going concern basis beyond the next twelve months depends on its ability to successfully raise additional financing for the substantial capital expenditures required to achieve planned principal operations.


12



Our operations in the Republic of Albania are subject to certain foreign operations risks regarding the economic and political stability of the Republic of Albania which could adversely affect our operations in the Republic of Albania and decrease the potential profitability of those operations.

The Company’s primary current activities and current assets are conducted and located in Albania. Albania commenced the transition from a communist regime to a modern open-market economy in 1992, with an extensive program of privatization in progress. While that transition has brought greater economic stability to the country, significant challenges still exist. Albania is not yet a member of the European Union and the country is heavily dependent on foreign investment due to its large trade deficit. Albania’s energy and transportation infrastructure is in need of significant investment, to add to the Albanian government’s recent embarkation on a major program of road and rail rehabilitation and construction. While the government of Albania encourages direct financial investment to aid the country’s economic development, it provides little by way of tax, financial or other incentives.
 
Albania, like other developing countries, from time-to-time may face political and social unrest, which may cause delays and uncertainties related to our business and operations in Albania.

There is no assurance that future political, social and economic conditions in Albania will not result in the government adopting different policies in relation to foreign development and ownership of petroleum resources. Any such changes in policy may result in changes to laws affecting the ownership of assets, cancellation or modification of contractual rights, foreign exchange restrictions, taxation, rates of exchange, environmental protection, labor relations, repatriation of income, return of capital, nationalization, expropriation, and other areas, any of which could adversely affect both the Company’s ability to undertake exploration and development activities in respect of properties in the manner currently contemplated, and its ability to continue to explore and profitably develop those properties in respect of which it has obtained exploration and development rights to date.

We may experience delays in production, marketing and transportation, if and when our projects in Albania result in oil production.

Various production, marketing and transportation conditions may cause delays in oil production and adversely affect the Company’s business. Drilling wells in areas remote from distribution and production facilities may delay production from those wells until sufficient reserves are established to justify construction of the necessary transportation and production facilities. The Company’s inability to complete wells in a timely manner would result in production delays. Because there is less developed infrastructure in some areas in Albania in which the Company holds its interests, the Company is subject to the risk that building of the necessary infrastructure will not be timely. In addition, marketing demands, which tend to be seasonal, may reduce or delay production from wells. The marketability and price of oil that may be acquired or discovered by the Company will be affected by numerous factors beyond the control of the Company. The Company is also subject to deliverability uncertainties related to the proximity of its reserves to adequate pipeline and processing facilities and extensive government regulation relating to price, taxes, royalties, licenses, land tenure, allowable production, and the export of oil and many other aspects of the petroleum business.

We may rely on third party providers in relation to certain of the activities we undertake on our Albania projects which will expose us to uncertain control issues and potential liabilities.

The Company or an affiliated entity designated by the Company will serve as operator under the PSC.  The Company intends to use affiliated entities to hold and operate the Concession Area under the PSC.  The Company may hire third parties to conduct certain activities in the Concession Area related to its commitments under the PSC.  The Company’s success will depend on its ability to provide adequate oversight of these third party providers and to ensure that the work provided is adequate for its purposes.  If the Company is unable to provide adequate oversight of the work being conducted, the Company’s operations in Albania could be adversely affected and the Company could be exposed to certain liabilities for the actions of the third party providers.

Our legal rights under the Participation Agreement are difficult to assess.

The assessment of economic viability of the Mubarek Field and the options available to the Company will be difficult to assess. We may not be able to enforce our rights under the Participation Agreement, and we may receive an unfavorable interpretation of the Concession Agreement and the Participation Agreement which could adversely affect our business operations.

Because of our historical losses and expected losses in the future, it will be difficult to forecast when we will achieve profitability, if ever.


13



We have incurred net losses since our inception and expect to incur further losses for the foreseeable future.  It is difficult to determine when we will achieve profitability, if ever.  If we are unable to generate revenues and achieve profitability, we may be forced to go out of business.

We depend on our executive officers for critical management decisions and industry contacts.

We are dependent upon the continued services of Karim Jobanputra, our principal executive officer and chairman of the board and Michael Noonan, our interim chief financial officer, vice president, corporate and secretary, who have significant experience in the oil and gas industry. We do not carry key person insurance on their lives. Mr. Jobanputra and Mr. Noonan are entrepreneurs and may not dedicate 100% of their business efforts to the business of Sky. Our executive officers and directors have other business interests, some of which may be in the oil and gas industry, and may serve on the board of directors or provide consulting services for other companies. The loss of the services of either of our executive officers, through incapacity or otherwise, would be costly to us and would require us to seek and retain other qualified personnel. See “Directors, Executive Officers, and Corporate Governance” below.

A substantial or extended decline in oil and natural gas prices could reduce our future revenue and earnings.

The price we receive for future oil and natural gas production will heavily influence our revenue, profitability, access to capital and rate of growth. Oil and natural gas are commodities and their prices are subject to wide fluctuations in response to relatively minor changes in supply and demand. Historically, the markets for oil and natural gas have been volatile and in the recent past oil and natural gas prices have been significantly above historic levels. These markets will likely continue to be volatile in the future and current prices for oil and natural gas may decline in the future. The prices we may receive for any future production, and the levels of this production, depend on numerous factors beyond our control. These factors include the following:

changes in global supply and demand for oil and natural gas
actions by the Organization of Petroleum Exporting Countries, or OPEC;
actions by non OPEC countries;
political conditions, including embargoes, which affect other oil-producing activities;
levels of global oil and natural gas exploration and production activity;
levels of global oil and natural gas inventories;
weather conditions affecting energy consumption;
technological advances affecting energy consumption; and
prices and availability of alternative fuels.
 
Lower oil and natural gas prices may not only decrease our future revenues but also may reduce the amount of oil and natural gas that we can produce economically. A substantial or extended decline in oil or natural gas prices may reduce our earnings, cash flow and working capital and may subject us to full cost ceiling impairment.

Drilling for and producing oil and natural gas are high risk activities with many uncertainties that could substantially increase our costs and reduce our profitability.

Oil and natural gas exploration is subject to numerous risks beyond our control; including the risk that drilling will not result in any commercially viable oil or natural gas reserves.

The total cost of drilling, completing and operating wells will be uncertain before drilling commences. Overruns in budgeted expenditures are common risks that can make a particular project uneconomic. Further, many factors may curtail, delay or cancel drilling, including the following:

delays imposed by or resulting from compliance with regulatory requirements;
pressure or irregularities in geological formations;
shortages of or delays in obtaining equipment and qualified personnel;
equipment failures or accidents;
adverse weather conditions;
reductions in oil and natural gas prices; and
limitations in the market for oil and natural gas.

We may incur substantial losses and be subject to substantial liability claims as a result of our oil and natural gas operations.


14



Our operations will be subject to risks associated with oil and natural gas operations. Losses and liabilities arising from uninsured and underinsured events could materially and adversely affect the payment of production revenues to us, if any. Our oil and natural gas exploration activities will be subject to all of the operating risks associated with drilling for and producing oil and natural gas, including the possibility of:

environmental hazards, such as uncontrollable flows of oil, natural gas, brine, well fluids, toxic gas or other pollution into the environment, including groundwater contamination;
abnormally pressured formations;
mechanical difficulties, such as stuck oilfield drilling and service tools and casing collapse;
Unexpected failures of key equipment used in the oil and gas production process;
fires and explosions;
personal injuries and death; and
natural disasters.

Any of these risks could adversely affect our ability to operate or result in substantial losses. These risks may not be insurable or we may elect not to obtain insurance if the cost of available insurance is excessive relative to the risks presented. In addition, pollution and environmental risks generally are not fully insurable. If a significant accident or other event that is not fully covered by insurance occurs, it could adversely affect our operations.

Market conditions or operational impediments may hinder our access to oil and natural gas markets or delay our production.

Market conditions or the unavailability of satisfactory oil and natural gas transportation arrangements may hinder access to oil and natural gas markets or delay production, if any, on our properties. The availability of a ready market for our future oil and natural gas production will depend on a number of factors, including the demand for and supply of oil and natural gas and the proximity of reserves to pipelines and terminal facilities.

We are subject to complex laws that can affect the cost, manner and feasibility of doing business thereby increasing our costs and reducing our profitability.

Development, production and sale of oil and natural gas are subject to laws and regulations. Matters subject to regulation include:

permits for drilling operations;
reports concerning operations;
spacing of wells;
unitization and pooling of properties; and
taxation.

Failure to comply with these laws may also result in the suspension or termination of operations and liabilities under administrative, civil and criminal penalties. Moreover, these laws could change in ways that substantially increase the costs of doing business. Any such liabilities, penalties, suspensions, terminations or regulatory changes could materially and adversely affect our financial condition and results of operations.

The unavailability or high cost of drilling rigs, equipment, supplies, personnel and oilfield services could adversely affect our ability to execute our plans on a timely basis and within our budget.

Shortages or the high cost of drilling rigs, equipment, supplies or personnel could delay or adversely affect development operations on our properties, which could have a material adverse effect on our business, financial condition or results of operations. Rising or unforeseen costs related to drilling and technical engineering may increase the cost related to drilling and completing the wells, which may either require us to contribute additional capital to drilling of the wells or cause dilution in our right to receive revenue from production, if any.

Competition in the oil and natural gas industry is intense, which may increase our costs and otherwise adversely affect our ability to compete.

We operate in a highly competitive environment for prospects suitable for exploration, marketing of oil and natural gas and securing the services of trained personnel. Many of our competitors possess and employ financial, technical and personnel resources substantially greater than ours, which can be particularly important in the areas in which we operate. Those companies may be able to pay more for prospective oil and natural gas properties and prospects and to evaluate, bid for and purchase a greater number

15



of properties and prospects than our financial or personnel resources permit. In order for us to compete with these companies, we may have to increase the amounts we pay for prospects, thereby reducing our profitability.

We may not be able to compete successfully in acquiring prospective reserves, developing reserves, marketing oil and natural gas, attracting and retaining quality personnel and raising additional capital.

Our ability to acquire additional prospects and to find and develop reserves in the future will depend on our ability to evaluate and select suitable properties and to consummate transactions in a highly competitive environment. In addition, there is substantial competition for capital available for investment in the oil and natural gas industry. Our inability to compete successfully in these areas could have a material adverse effect on our business, financial condition or results of operations.

Recent market events and general economic conditions.

The recent unprecedented events in global financial markets have had a profound impact on the global economy. Many industries, including the oil and gas industry, are impacted by these market conditions. Notwithstanding various actions by the United States. and foreign governments, concerns about the general condition of the capital markets, financial instruments, banks, investment banks, insurers and other financial institutions could cause the broader credit markets to further deteriorate and stock markets to decline substantially. In addition, general economic indicators have deteriorated, including declining consumer sentiment, increased unemployment and declining economic growth and uncertainty about corporate earnings.

These unprecedented disruptions in the current credit and financial markets have had a significant material adverse impact on a number of financial institutions and have limited access to capital and credit for many companies. These disruptions could, among other things, make it more difficult for us to obtain, or increase its cost of obtaining, capital and financing for its operations. A continued or worsened slowdown in the financial markets or other economic conditions, including but not limited to, consumer spending, employment rates, business conditions, inflation, fuel and energy costs, consumer debt levels, lack of available credit, the state of the financial markets, interest rates, and tax rates may adversely affect our growth and profitability. Specifically:

the global credit/liquidity crisis could impact the cost and availability of financing and our overall liquidity;
the volatility of oil and gas prices may impact our revenues, profits and cash flow;
volatile energy prices, commodity and consumables prices and currency exchange rates impact potential production costs; and
the devaluation and volatility of global stock markets impacts the valuation of our equity securities

These factors could have a material adverse effect on our financial condition and results of operations.

We have never declared or paid cash dividends on our common stock. We currently intend to retain future earnings to finance the operation, development and expansion of our business.

We do not anticipate paying cash dividends on our common stock in the foreseeable future. Payment of future cash dividends, if any, will be at the discretion of our board of directors and will depend on our financial condition, results of operations, contractual restrictions, capital requirements, business prospects and other factors that our board of directors considers relevant.

Accordingly, investors will only see a return on their investment if the value of our securities appreciates.

The market for our common shares has been volatile in the past, and may be subject to fluctuations in the future.

The market price of our common stock on the OTCBB has ranged from a high of $0.20 and a low of $0.08 during the twelve-month period ended December 31, 2012. As of March 22, 2013, the market price for our common stock closed at $0.10 on the OTCBB. See “Market for Registrant’s Common Equity, and Related Stockholder Matters and Issuer Purchases of Equity Securities”. We cannot assure you that the market price of our common stock will not significantly fluctuate from its current level. The market price of our common stock may be subject to wide fluctuations in response to quarterly variations in operating results, changes in financial estimates by securities analysts, or other events or factors. In addition, the financial markets have experienced significant price and volume fluctuations for a number of reasons, including the failure of the operating results of certain companies to meet market expectations that have particularly affected the market prices of equity securities of many companies that have often been unrelated to the operating performance of such companies. These broad market fluctuations, or any industry-specific market fluctuations, may adversely affect the market price of our common stock. In the past, following periods of volatility in the market price of a company’s securities, class action securities litigation has been instituted against such a company. Such litigation, whether with or without merit, could result in substantial costs and a diversion of management’s attention and resources, which would have a material adverse effect on our business, operating results and financial condition.

16




Broker-dealers may be discouraged from effecting transactions in our common stock because our common shares are considered a penny stock and are subject to the penny stock rules.

Rules 15g-1 through 15g-9 promulgated under the Securities Exchange Act of 1934 as amended (“Exchange Act”), impose sales practice and disclosure requirements on certain brokers-dealers who engage in certain transactions involving a penny stock. Subject to certain exceptions, a penny stock generally includes any non-NASDAQ equity security that has a market price of less than $5.00 per share. The market price of our common stock on the OTCBB during the period from November 6, 2003 to December 31, 2012 ranged between a high of $3.20 and a low of $0.03 per share, and our common stock is deemed penny stock for the purposes of the Exchange Act. The additional sales practice and disclosure requirements imposed upon brokers-dealers may discourage broker-dealers from effecting transactions in our common stock, which could severely limit the market liquidity of the stock and impede the sale of our stock in the secondary market.

A broker-dealer selling penny stock to anyone other than an established customer or accredited investor, generally, an individual with net worth in excess of $1,000,000 or an annual income exceeding $200,000, or $300,000 together with his or her spouse, must make a special suitability determination for the purchaser and must receive the purchaser’s written consent to the transaction prior to sale, unless the broker-dealer or the transaction is otherwise exempt. In addition, the penny stock regulations require the broker-dealer to deliver, prior to any transaction involving a penny stock, a disclosure schedule prepared by the SEC relating to the penny stock market, unless the broker-dealer or the transaction is otherwise exempt. A broker-dealer is also required to disclose commissions payable to the broker-dealer and the registered representative and current quotations for the securities. Finally, a broker-dealer is required to send monthly statements disclosing recent price information with respect to the penny stock held in a customer’s account and information with respect to the limited market in penny stocks.

There is substantial doubt about our ability to continue our activities as a going concern, which may hinder our ability to obtain future financing.

The continuation of our company as a going concern is dependent upon our company attaining and maintaining profitable operations, and raising additional capital. The financial statements do not include any adjustment relating to the recovery and classification of recorded asset amounts or the amount and classification of liabilities that might be necessary should our company discontinue operations. Due to the uncertainty of our ability to meet our current operating expenses, in their report on the annual financial statements for the years ended December 31, 2012, our independent auditors included an explanatory paragraph regarding the doubt about our ability to continue as a going concern. Our financial statements contain additional note disclosures describing the status of the company. The continuation of our business is dependent upon us raising additional financial support, and maintaining profitable operations. The issuance of additional equity securities by us could result in a substantial dilution in the equity interests of our current stockholders. Obtaining commercial loans, assuming those loans would be available, will increase our liabilities and future cash commitments. If the Company should fail to continue as a going concern, you may lose the value of your investment in the Company.


ITEM 1B. UNRESOLVED STAFF COMMENTS

Not Applicable



17



ITEM 2. PROPERTIES

Our principal corporate and executive offices are located at 401 Congress Avenue, Suite 1540, Austin, Texas 78701. Our telephone number is (512) 687-3427. We rent our corporate office space on a month-to-month basis at $2,000 per month. We do not currently maintain any investments in real estate, real estate mortgages or securities of persons primarily engaged in real estate activities, nor do we expect to do so in the foreseeable future.

We entered into a Participation Agreement with Crescent for the financing of a drilling program in the Mubarek field, an offshore region in a concession area surrounding Abu Musa Island in the Arabian Gulf. The Participation Agreement does not grant Sastaro any interest in the Mubarek Concession Area. Sastaro’s rights are limited to receiving a share of future production revenue, if any.

On December 31, 2009, the Company received written notice from Buttes, a wholly-owned subsidiary of Crescent that Buttes unilaterally and solely determined that the Mubarek Field had reached the end of its economic life. Buttes also notified Sastaro that the Concession Agreement, dated December 29, 1969, between His Highness Sheikh Sultan bin Mohamed Al-Qassimi III, The Ruler of Sharjah, UAE and Buttes with respect to the Mubarek Field was terminated. Buttes have stated that it handed over the Mubarek Field operations and facilities to representatives of His Highness Sheikh Sultan bin Mohamed Al-Qassimi III on December 28, 2009. Management is exercising its rights under the Participation Agreement and intends to protect our interest and our investment in the Mubarek Field.

Sky Petroleum has exclusive rights to three exploration blocks (Block Four, Block Five and Block Dumre) in the Concession Area under the PSC. The Concession Area covers approximately 1.2 million acres, representing approximately 20% of the landmass of Albania. The PSC has a seven-year term with three exploration periods. Upon commercial discovery of gas, the agreement allows for development and production periods of 25 years plus extensions at the Company's option. The PSC is subject to an arbitration proceeding against AKBN. See “Legal Proceedings” below.


ITEM 3. LEGAL PROCEEDINGS

We are not aware of any material pending or threatened litigation or of any proceedings known to be contemplated by governmental authorities which are, or would be, likely to have a material adverse effect upon us or our operations, taken as a whole other than stated below. There are no material proceedings pursuant to which any of our directors, officers or affiliates or any owner of record or beneficial owner of more than 5% of our securities or any associate of any such director, officer or security holder is a party adverse to us or has a material interest adverse to us.

On June 24, 2010, Sky Petroleum, Inc. entered into the PSC with the Ministry of Economy, Trade and Energy of Albania, acting through the AKBN ratified by the Council of Ministers and published in the Fletoren Zyrtare on December 17, 2010. The PSC became effective on January 3, 2011.  The PSC grants Sky Petroleum exclusive rights to three exploration blocks (Block Four, Block Five and Block Dumre) in the Concession Area, which constitute the primary property interests of Sky Petroleum.

As reported in Sky Petroleum's Quarterly Report Form 10-Q for the quarter ended September 30, 2011, filed with the Securities and Exchange Commission on November 14, 2011, AKBN delivered an untranslated letter to Sky Petroleum on November 4, 2011.  Sky Petroleum received an English translation of the letter on November 9, 2011.  The AKBN letter alleged material breach of the PSC and providing notice of termination pursuant to Section 24.2(a) of the PSC.  AKBN alleged breaches for failures to commence its initial work program, deliver a bank guarantee, open an office in Albania and establish an Exploration Advisory Committee.  Sky Petroleum responded to AKBN on November 10, 2011, and provided AKBN notice of its intent to institute an arbitration proceeding under the terms of the PSC against AKBN for breach of the PSC.

On November 18, 2011, Sky Petroleum's legal counsel delivered to the AKBN a notice that the alleged termination of the PSC was made in breach of the PSC and that Sky Petroleum intended to institute an arbitration proceeding in accordance with Article XXI of the PSC.

ABKN posted a notice on its official web site containing a notice that the PSC had been terminated and stating the Concession Area is free.  The notice cited termination based on non-fulfillment of the following obligations:

a) Within three months after the Effective Date, the Company should have been commenced the performance of the Minimum Work Program;
b) Within ninety days after the Effective Date, the Company should have been executed and delivered to AKBN, the Bank Guarantee;
c) The Company should have been registered an office in Albania in order to receive valid notice from AKBN;

18



d) and within thirty days from the Effective Date should have been appointed the Company's members in the Exploration Advisory Committee.
 
Section 24.2(a) of the PSC requires that AKBN provide 120 days notice prior to termination and provides that the PSC can be terminated only if Sky Petroleum has failed to commence to remedy such breach within a reasonable period of time.  Sky Petroleum was not in breach of any of these terms.  Management believes that the allegations are without merit and the termination notice was issued without cause. 

Notice of Arbitration

On December 23, 2011, Sky Petroleum delivered Notice of Arbitration under the Arbitration Rules of the United Nations Commission on Internal Trade Law to National Agency of Natural Resources and to the Ministry of Economy, Trade and Energy of Albania to institute an arbitration proceeding against the Ministry of Economy, Trade and Energy of Albania, acting by and through AKBN, for breach of the PSC in accordance with Article XXI of the PSC.  The arbitration proceeding arises out of the alleged termination of the PSC in breach of the expressed termination provisions in Article 24 of the PSC.

Article XXI of the PSC provides that any dispute, controversy, claim or difference of opinion, arising out of or relating to the PSC or the breach, termination or validity of the PSC shall be finally and conclusively settled by arbitration in accordance with the UNCITRAL Arbitration Rules. The appointing authority for the arbitrators shall be the President of the Court of International Arbitration of the International Chamber of Commerce in Paris, France (the “Appointing Authority”).
Sky Petroleum is not in breach of any of its obligations under the PSC. Management believes that the allegations of AKBN are without merit.
The dispute will be arbitrated before a panel of three arbitrators ("Tribunal"), all of which have been appointed. The provisional budget as submitted by the Tribunal totals CHF 310,000.
Sky Petroleum is seeking the following relief:
an order that the PSC has not been validly terminated and that it remains in full force and effect; and
monetary damages that include, but are not limited to, the lost revenue due to Sky Petroleum under the terms of the PSC, estimated to be in excess of one billion dollars.
On January 10, 2012, Sky Petroleum filed a complaint (Case No.: A-12-CA-023-SS) with the United States District Court, Western District of Texas, Austin Division (the “Court”) for declaratory and injunctive relief against the Ministry of Economy, Trade, and Energy of Albania, acting by and through AKBN (collectively, the “Defendants”). The action for declaratory and injunctive relief under the Foreign Sovereign Immunities Act and the Albania-America Bilateral Investment Treaty sought to compel arbitration of the dispute between Sky Petroleum and the Defendants (collectively, the “Parties”) under the PSC and to preserve the status quo ante between the Parties pending completion of arbitration under the United Nations Commission on International Trade Law.
On January 19, 2012, Sky Petroleum, through legal counsel and a corporate representative, appeared before the Court to argue the merits of Sky Petroleum's Motion for Preliminary Injunction and on January 20, 2012, the Court delivered an Order and Preliminary Injunction (i) granting Sky Petroleum's preliminary injunction to maintain the status quo between the Parties pending arbitration, (ii) enjoining the Defendants and all persons acting in concert with them from awarding, transferring, or otherwise disposing of any rights to explore, develop and/or produce petroleum on the Contract Area until a final arbitration award is issued, (iii) ordering the Defendants to remove from their website or other publicly available documents all references to the Contract Area being “free” or otherwise available for new contractors until a final arbitration award is issued, and (iv) ordering the Parties to arbitrate their dispute with the United Nations Commission on International Trade Law according to the terms of the PSC. Additionally, the Court ordered that Sky Petroleum only be required to post a surety bond of $50,000 in lieu of the $500,000 surety bond that the Court had previously requested. On January 25, 2012, the Company deposited $50,000 to the Registry of the Court for the Austin Division of the United States District Court for a required surety bond related to the Order.
On February 28, 2012, Sky Petroleum petitioned the Albanian Appeal Court, Tirana, to seek to enforce the Order and Preliminary Injunction granted by the United States District Court, Western District of Texas, Austin Division. On March 1, 2012, the Appeal Court refused to recognize the Order in Albania.
Accordingly, Sky Petroleum intends to continue to vigorously pursue its rights and remedies against the Defendants under the mandatory arbitration provision in Article 21 of the PSC.
A Statement of Claim was filed with the Tribunal on April 24, 2012, by the Company.


19



On April 30, 2012, the Company paid approximately $112,000 (CHF 100,000) to the Tribunal for the first tranche of the provisional budget which are included in other current assets on the Consolidated Balance Sheets as of December 31, 2012. Both Sky and AKBN were required to pay the advances, however AKBN failed to deliver its portion of the advance. Subsequent to the year end, AKBN again failed to deliver its portion of the balance of the provisional budget, therefore the Company paid CHF 210,000 to the Tribunal.

A procedural calender was issued by the Tribunal for Arbitration proceedings. The Statement of Defense was filed by AKBN on June 22, 2012. Sky Petroleum filed its Statement of Reply on August 3, 2012. Sky Petroleum filed its Request for Documents in connection with the Arbitration on October 31, 2012.

Subsequent to year end, the Arbitration took place before the Tribunal at the International Dispute Resolution Centre in London, UK between February 18th and February 22nd, 2013.  At the conclusion of the arbitration hearing, the Chairman of the Tribunal indicated the Tribunal expected to produce a written decision in three months.  

Sky Petroleum intends to continue to vigorously pursue its rights and remedies against the Defendants under the mandatory arbitration provision in Article 21 of the PSC.

The Company's investment in the Albania exploration blocks as of December 31, 2012, was $10,205,220. This investment consisted of acquisition costs related to the PSC totaling $50,000, and $850,000 for fees to consultants for locating and negotiating the Company's investment in the Albania exploration blocks; $265,220 for fees related to evaluations and assessments of the concession area, and $50,000 towards the $100,000 allocation for training and education for the first year exploration period. In addition, 3 million shares of common stock with a fair value of $1,170,000, plus 3,863,636 Preferred Shares Series B with a value of $7,820,000, were issued to Orsett for expertise provided to the Company in acquiring and negotiating the acquisition of oil and gas properties.

ITEM 4. MINE SAFETY DISCLOSURE

Not applicable.


PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Information

Our common stock is quoted as “SKPI” on the Over the Counter Bulletin Board ( “OTCBB”), which is sponsored by the Financial Industry Regulatory Authority ( “FINRA”). The OTCBB is a network of security dealers who buy and sell stock. The dealers are connected by a computer network, which provides information on current “bids” and “asks” as well as volume information. The OTCBB is not considered a “national exchange.” Our common stock commenced trading on the OTCBB on November 3, 2003.

The high and low bid quotations of our common stock on the OTCBB as reported by the FINRA were as follows:
Period
 
High
 
Low
2012
 
 
 
 
First Quarter
 
$
0.17

 
$
0.08

Second Quarter
 
$
0.19

 
$
0.09

Third Quarter
 
$
0.20

 
$
0.10

Fourth Quarter
 
$
0.20

 
$
0.10

2011
 
 

 
 

First Quarter
 
$
0.60

 
$
0.40

Second Quarter
 
$
0.49

 
$
0.35

Third Quarter
 
$
0.42

 
$
0.15

Fourth Quarter
 
$
0.25

 
$
0.10


The above quotations reflect inter-dealer prices, without retail mark-up, markdown or commission and may not necessarily represent actual transactions.

20




As of December 31, 2012, the closing bid quotation for our common stock was $0.16 per share as quoted by the OTCBB. On March 22, 2013, the closing bid quotation on our common stock was $0.10 as quoted by the OTCBB.

Holders

As of March 22, 2013, we had 68,118,709 shares of common stock issued and outstanding, held by 31 registered stockholders.
 
Dividends

The declaration of dividends on our common shares is within the discretion of our board of directors and will depend upon the assessment of, among other factors, results of operations, capital requirements and the operating and financial condition of the Company. The Board has never declared a dividend on the common shares. At the present time, we anticipate that all available funds will be invested to finance the growth of our business.

Securities Authorized for Issuance under Equity Compensation Plans

EQUITY COMPENSATION PLAN INFORMATION

 
 
Number of securities to be issued upon exercise of outstanding options, warrants, and rights
 
Weighted-average exercise price of outstanding options, warrants, and rights
 
Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
 
 
(a)
 
(b)
 
(c)
Equity compensation plans approved by security holders (1)
 
2,100,000

 
$
0.66

 
4,500,959

Equity compensation plans not approved by security holders
 
N/A

 
N/A

 
N/A


(1)
We have two stock option plans: a stock incentive plan for non-U.S. residents and a stock incentive plan for U.S. residents. Our stock incentive plan for non-U.S. residents authorizes the issuance of stock options to acquire up to 10% of our issued and outstanding shares of common stock (currently 6,811,870 shares, based on 68,118,709 issued and outstanding shares of common stock at December 31, 2012) , and our stock incentive plan for U.S. residents authorizes the issuance of stock options to acquire up to a maximum of 3,321,600 shares of common stock (less the number of shares issuable upon exercise of options granted by us under all other stock incentive plans on the date of any grant under the U.S. plan). As of December 31, 2012, 950,000 options were granted under the U.S. plan and 1,150,000 options were granted under the non-U.S. plan. A total of 5,661,870 options are available for grant under the Non-U.S. Plan and a total of 1,221,600 are available for grant under the U.S. Plan.

Adoption of Non-U.S. Stock Option Plan

On July 26, 2005, we adopted, and on July 31, 2006, our stockholders approved, the Sky Petroleum, Inc. Non-U.S. Stock Option Plan, effective as of April 1, 2005. The Non-U.S. Plan authorizes the issuance of stock options to acquire up to 10% of our issued and outstanding shares of common stock. The purpose of the Non-U.S. Plan is to aid us in retaining and attracting Non-U.S. residents that are capable of enhancing our prospects for future success, to offer such personnel additional incentives to exert maximum efforts for the success of our business, and to afford such personnel an opportunity to acquire a proprietary interest in the company through stock options. Our Compensation Committee administers the Non-U.S. Plan and determines the terms and conditions under which options to purchase shares of our common stock may be awarded. The term of an option granted under the Non-U.S. Plan cannot exceed seven years and the exercise price for options granted under the Non-U.S. Plan cannot be less than the fair market value of our common stock on the date of grant.


21



Adoption of 2005 U.S. Stock Incentive Plan

On August 25, 2005, we adopted, and on July 31, 2006 our stockholders approved, the Sky Petroleum, Inc. 2005 U.S. Stock Incentive Plan for U.S. residents. The U.S. Plan authorizes the issuance of stock options and other awards to acquire up to a maximum of 3,321,600 shares of our common stock (less the number of shares issuable upon exercise of options granted by us under all other stock incentive plans on the date of any grant under the plan). The purpose of the U.S. Plan is to aid the Company in retaining and attracting U.S. personnel capable of enhancing our prospects for future success, to offer such personnel additional incentives to exert maximum efforts for the success of our business, and to afford such personnel an opportunity to acquire a proprietary interest in the company through stock options and other awards. The U.S. Plan provides for the grant of incentive stock options (within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended), options that are not incentive stock options, stock appreciation rights and various other stock-based grants. Our Compensation Committee administers the U.S. Plan and determines the terms and conditions under which options to purchase shares of our common stock or other awards may be granted to eligible participants. The term of an incentive stock option granted under the U.S. Plan cannot exceed ten years and the exercise price for options granted under the U.S. Plan cannot be less than the fair market value of our common stock on the date of grant.

Sales of Unregistered Securities

During the year ended December 31, 2012, the Company sold and issued the following securities that were not registered under the Securities Act of 1933, as amended.

On August 17, 2012, we granted 150,000 shares of common stock to Peter Briger, Chairman of the Advisory Board.

On December 6, 2012, we granted 100,000 shares of common stock to Jaloul Ayed, member of the Advisory Board.

The above securities were issued pursuant to exemptions from the registration requirements of the Securities Act of 1933, as amended, available under Rule 903 of Regulation S.  The securities were issued in off-shore transactions to non-U.S. persons and are “restricted securities” as defined Rule 144(a) (3) of the Securities Act of 1933, as amended.

Repurchase of Securities
 
During the period covered by this Annual Report, neither us nor any of our affiliates repurchased common shares of the Company registered under Section 12 of the Exchange Act of 1934, as amended.
 
ITEM 6. SELECTED FINANCIAL DATA
 
Not applicable.
 

22




ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
You should read the following discussion and analysis of our financial condition and results of operations together with our consolidated financial statements and related notes appearing elsewhere in this Annual Report. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including, but not limited to, those set forth under “Risk Factors” above and elsewhere in this Annual Report. See section” Cautionary Note Regarding Forward-Looking Statements” above.
 
This discussion and analysis should be read in conjunction with the accompanying consolidated financial statements of the Company and related notes. The discussion and analysis of the financial condition and results of operations are based upon the consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of any contingent liabilities at the financial statement date and reported amounts of revenue and expenses during the reporting period. On an on-going basis the Company reviews its estimates and assumptions. The estimates were based on historical experience and other assumptions that the Company believes to be reasonable under the circumstances. Actual results are likely to differ from those estimates under different assumptions or conditions, but the Company does not believe such differences will materially affect our financial position or results of operations. Critical accounting policies, the policies the Company believes are most important to the presentation of its financial statements and require the most difficult, subjective and complex judgments, are outlined below in the sub-section Management’s Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies,” and have not changed significantly.

Overview and Plan of Operations

Our primary business is to identify opportunities to either make direct property acquisitions or to fund exploration or development of oil and natural gas properties of others under arrangements in which we will finance the costs in exchange for interests in the oil or natural gas revenue generated by the properties. Such arrangements are commonly referred to as farm-ins to us, or farm-outs by the property owners farming out to us. There can be no assurance that we will successfully implement our business strategy or meet our goals during the next twelve months.

Comparison of 2012 Statement of Operations to 2011 Statement of Operations

Net Losses:

During the year ended December 31, 2012 we had a net loss of $1,946,450 as compared to a net loss of $1,824,697 during the year ended December 31, 2011, for a total increase in losses of $121,753.

We did not generate any revenue from operations in 2012 or 2011.
We do not expect to generate any operating revenue until we complete exploration and development on our properties.

Operating expenses:

Total operating expenses in 2012 of $1,961,853 as compared to total operating expenses of $1,825,272 for 2011, increased in total in 2012 by $136,581 or 7%. The operating expenses increased in 2012 primarily attributable to increases in expenses for legal expenses related to Arbitration ($890,544 in 2012; $429,326 in 2011;) of $461,218, increases in other general and administrative expenses ($645,240 in 2012; $543,009 in 2011) of $102,231, and decreases in consulting fees ($316,569 in 2012; $602,216 in 2011) of $285,647. The increase in the other general and administrative expenses is primarily attributable to rent for the Dubai and Albania offices. Operating expenses decreased in 2012 for travel expenses ($98,881 in 2012; $243,109 in 2011; ) of $144,228, offset by increases in share based compensation expense ($93,302 in 2012; $68,029 in 2011) of $25,273. We expect operating expenses to decrease in 2013 as we wrap-up arbitration expenses and our expenditures and obligations under the PSC.

General and administrative expenses are expected to remain flat in 2013 compared to 2012 as we fund expenditures and hire additional employees and consultants in connection with our exploration and development of activities in Albania. Expenses may also increase if we elect to pursue additional projects or properties.


23



Liquidity and Capital Resources

A component of our operating plan is the ability to obtain additional capital through additional equity and/or debt financing to fund our Albania projects. Our only source of internal operating cash flow historically has been derived from our participation interest in the Mubarek Field, which ceased production at the end of 2009. We had cash on hand of approximately $46,058 at December 31, 2012, plus restricted cash of $1,500,000, totaling $1,546,058.

Since inception, we have financed our cash flow requirements through the issuance of equity and revenue from our working interest in the Mubarek Field, which terminated production in 2009. We have no revenue from operations and do not expect any revenues from operations for the foreseeable future.

We anticipate that we will be required to raise additional funds in 2013 to finance the arbitration and meet our minimum working capital requirements. Additionally we anticipate that we may require additional financing to fund exploration and development obligations under the PSC activities and our on-going litigation through common stock or preferred stock offerings, debt financings and bank borrowings, to the extent available, or to obtain additional financing to the extent necessary to augment working capital.

The current market conditions could make it difficult or impossible for us to raise necessary funds to meet our capital requirements. If we are unable to obtain financing through equity investments, we will seek alternative financing solutions including, but not limited to, credit facilities, debenture issuances or third party funding of our arbitration.

Net cash used in operating activities during the year ended December 31, 2012 was $1,143,796 as compared to net cash used in operating activities of $1,548,902 for the comparable period in 2011, an decrease of $405,106. Cash used in investing activities in 2012 of $55,930 for purchase of fixed assets and a surety bond, as compared to $1,616,778 in 2011. Cash from investing activities was $640,000 for 2012 for the private placement proceeds compared to $860,000 in 2011.

Total assets as of December 31, 2012 were $11,962,233 compared to total assets of $12,407,459 as of December 31, 2011.  Stockholder’s equity as of December 31, 2012 was $10,775,216 compared to stockholders’ equity of $11,988,364 as of December 31, 2011. The decrease in assets and stockholder’s equity was primarily related to cash outflows and continued losses.

As of December 31, 2012, we had current assets of $1,718,470 including cash and cash equivalents of $1,546,058. We had current liabilities of $1,187,017 resulting in working capital of $531,453 as compared to $1,739,932 for the same period ended 2011.

Over the next twelve months, we anticipate that our working capital requirements will increase due to the continued costs associated with the arbitration proceeding related to the PSC.  We anticipate that we will raise additional capital through equity, debt or other securities offerings during 2013 to fund the arbitration, exploration and working capital requirements.  Alternatively, we may explore joint venture, work-in or other arrangements for exploration, development or other activities on our projects or third party funding arrangements to fund the arbitration.

On January 8, 2013 the Company agreed to obtain loans through the offer of 8% Convertible Promissory Notes due January 8, 2014 (the “Notes”) in the aggregate amount of up to US$1,000,000 (the “Offering”). The Notes are convertible into shares of common shares of the Company (“Common Shares”) at a conversion price of US$0.25 per share (the “Conversion Price”) and interest on the Notes is payable in cash or, at the option of the Company, in-kind in Common Shares at the Conversion Price.

Our lack of operating history makes predictions of future operating results difficult to ascertain. Our prospects must be considered in light of the risks, expenses and difficulties frequently encountered by companies in their early stage of development, particularly companies searching for opportunities in the oil and gas industry. Such risks include, but are not limited to, our ability to secure a drilling rig, our ability to successfully drill for hydrocarbons, commodity price fluctuations, delays in drilling or bringing production, if any, on line, an evolving business model and unpredictable availability of qualified oil and gas exploration prospects and the management of growth. To address these risks we must, among other things, implement and successfully execute our business and development plan, successfully identify future drilling locations, continue to rely on qualified independent consultants, respond to competitive developments, and attract, retain and motivate qualified personnel. There can be no assurance that we will be successful in addressing such risks, and the failure to do so can have a material adverse effect on our business prospects, financial condition and results of operations.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements.


24



Inflation

We do not believe that inflation has had a significant impact on our consolidated results of operations or financial condition.

Critical Accounting Policies

Use of estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ significantly from those estimates.

Fair value of financial instruments

Fair value estimates discussed herein are based upon certain market assumptions and pertinent information available to management for each period presented herein. The respective carrying value of certain on-balance sheet financial instruments approximated their fair values. These financial instruments include cash and cash equivalents and restricted cash. Fair values were assumed to approximate carrying values for cash, cash equivalents, and accounts payable and accrued expenses because they are short term in nature and their carrying amounts approximate fair values as they are payable on demand.

The Company calculates the fair value of its assets and liabilities which qualify as financial instruments and includes this additional information in the notes to consolidated financial statements when the fair value is different than the carrying value of these financial instruments. The estimated fair value of accounts receivable, accounts payable and accrued liabilities approximate their carrying amounts due to the relatively short maturity of these instruments. None of these instruments are held for trading purposes.

ASC Topic 820, Fair Value Measurements and Disclosures, defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and requires certain disclosures about fair value measurements. In general, fair values of financial instruments are based upon quoted market prices, where available (Level 1). If such quoted market prices are not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters (Level 2). Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality and the customer’s creditworthiness, among other things, as well as unobservable parameters (Level 3). Any such valuation adjustments are applied consistently over time.

Investment in oil and gas properties

The Company follows the full cost method of accounting for oil and gas operations whereby exploration and development expenditures are capitalized. Such costs may include geological and geophysical, drilling, equipment and technical consulting directly related to exploration and development activities. The aggregate of net capitalized costs and estimated future development costs is amortized using the units of production method based on estimated proved oil and gas reserves.

Advances for oil and gas interests are transferred to oil and gas properties as actual exploration and development expenditures are incurred.

Costs related to unproved properties and major development projects may be excluded from costs subject to depletion until proved reserves have been determined or their value is impaired. These properties are assessed periodically and any impairment is transferred to costs subject to depletion.

Under the full cost method of accounting, the net book value of oil and natural gas properties, less related deferred income taxes, may not exceed a calculated ceiling”. The ceiling limitation is the discounted estimated after-tax future net cash flows from proved oil and natural gas properties. In calculating future net cash flows, current prices and costs are generally held constant indefinitely. The net book value of oil and natural gas properties, less related deferred income taxes is compared to the ceiling on a quarterly and annual basis. Any excess of the net book value, less related deferred income taxes, is generally written off as an expense. Under rules and regulations of the SEC, all or a portion of the excess above the ceiling may not be written off if, subsequent to the end of the quarter or year but prior to the release of the financial results, prices have increased sufficiently that all or a portion of such excess above the ceiling would not have existed if the increased prices were used in the calculations.


25



As of December 31, 2009, the Company had accumulated impairment of $15,468,368 on the Mubarek Field wells as a result of the full cost ceiling test for the years 2006 through 2009. As of December 31, 2012 and 2011, the net carrying value of the Company’s investment in these wells was $0.

During the year ended December 31, 2012 the Company had incurred $10,205,220 in acquisition and development costs for oil and gas projects in Albania.  These costs, relate to the PSC with the Ministry of Economy, Trade and Energy of Albania. Sales of proved and unproved properties are accounted for as an adjustment of capitalized costs with no gain or loss recognized, unless such adjustments would significantly alter the relationship between capitalized costs and proved oil and natural gas reserves, in which case the gain or loss is recognized.

Revenue is recognized in the period in which title to the petroleum or natural gas transfers to the purchaser.

Income taxes

We follow the Financial Accounting Stardards Board ("FASB") guidance issued within ASC Topic No. 740, Accounting for Income Taxes, for recording the provision for income taxes. Deferred tax assets and liabilities are computed based upon the difference between the financial statement and income tax basis of assets and liabilities using the enacted marginal tax rate applicable when the related asset or liability is expected to be realized or settled. Deferred income tax expenses or benefits are based on the changes in the asset or liability each period. If available evidence suggests that it is more likely than not that some portion or all of the deferred tax assets will not be realized, a valuation allowance is required to reduce the deferred tax assets to the amount that is more likely than not to be realized. Future changes in such valuation allowance are included in the provision for deferred income taxes in the period of change. Deferred income taxes may arise from temporary differences resulting from income and expense items reported for financial accounting and tax purposes in different periods. Deferred taxes are classified as current or non-current, depending on the classification of assets and liabilities to which they relate. Deferred taxes arising from temporary differences that are not related to an asset or liability are classified as current or non-current depending on the periods in which the temporary differences are expected to reverse.

Undistributed earnings of the Company’s foreign subsidiaries are considered to be indefinitely reinvested and, accordingly, no provision for U.S. federal income taxes has been provided thereon. Upon distribution of those earnings in the form of dividends or otherwise, the Company may be subject to both U.S. income taxes (subject to an adjustment for foreign tax credits) and withholding taxes payable to the foreign countries.

The Company’s wholly owned subsidiaries have prepared required foreign tax returns that were due for the years ended December 31, 2005 through 2010 totaling approximately $33,000 has been included for potential tax liabilities, penalties and interest which will be due upon filing the returns with the appropriate countries.

ASC Topic No. 740 Income Taxes which clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements. ASC Topic No. 740 also prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This topic provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The Company adopted this topic as of January 1, 2007, as required.

The current Company policy classifies any interest recognized on an underpayment of income taxes as interest expense and classifies any statutory penalties recognized on a tax position taken as other general and administrative expense. There was no interest or other general and administrative expenses accrued or recognized related to income taxes for the year ended December 31, 2012 and 2011, respectively. The Company has not taken a tax position that would have a material effect on the financial statements or the effective tax rate for the year ended December 31, 2012 or during any prior years. It is determined not to be reasonably possible for the amounts of unrecognized tax benefits to significantly increase or decrease within the next 12 months.

Contractual Obligations

Leases

The Company rents office facilities in Austin, Texas on a month to month basis, totaling approximately $30,000 per year.

The Company leases office facilities in Dubai, United Arab Emirates, under a one year operating lease agreement that expires on October 24, 2013, totaling approximately $38,000 per year.

The Company leases office facilities in Tirana, Albania on a month to month basis, totaling approximately $50,000 per year.

26




Oil and Gas Properties Commitments and Contingencies

Mubarek Field Operations:

On December 31, 2009, Sastaro received written notice from Buttes that Buttes had unilaterally and solely determined that the Mubarek Field had reached the end of its economic life. Buttes also notified Sastaro that the Concession Agreement, dated December 29, 1969, between His Highness Sheikh Sultan bin Mohamed Al-Qassimi III, The Ruler of Sharjah, UAE and Buttes with respect to the Mubarek Field was terminated. Buttes stated that it handed over the Mubarek Field operations and facilities to representatives of His Highness Sheikh Sultan bin Mohamed Al-Qassimi III on December 28, 2009.As a result of these events, Buttes notified Sastaro that the Participation Agreement between Sastaro and Buttes was terminated.

The Mubarek Field wells H2 and K2-ST4 continue to produce commercial amounts of oil, and the Company believes that there is significant residual value in H2 and K2-ST4. Consequently, the Company considers the Participation Agreement valid and in good standing.  Management is exercising its rights under the Participation Agreement and intends to protect our interest and our investment in the Mubarek Field.

Production Sharing Contract related to Blocks Four, Five and Dumre in Albania:

Under the terms of the PSC, Sky Petroleum has agreed to undertake exploration work on the blocks during the following three exploration periods over the next seven years commencing on the effective date of the PSC.

First Exploration Period:

The First Exploration Period is an initial period of two years in which Sky Petroleum has agreed to undertake G&G, including but not limited to acquisition of technical data, interpretation of geological, geophysical and well data, and conducting regional geological and structural studies (mapping, balanced cross sections); seismic reprocessing and seismic acquisition, with the following minimum expenditure commitments:
Minimum Work Program
Minimum Expenditure in USD
G&G Evaluation1, (Minimum expenditures for G&G will be split $150,000 for blocks 4 & 5 and $50,000 for Dumre block.)
$
200,000

Seismic Reprocessing (2D)
50,000

Seismic Acquisition (2D)2 150 km (Seismic acquisition: seismic acquisition will be split 100km in blocks 4 & 5 and 50km in Dumre block.)
1,250,000

Total Commitment
$
1,500,000


Any additional exploration work in excess of the minimum amounts during any exploration period (whether G&G or exploration wells) may be credited against Sky Petroleum’s minimum work obligations in subsequent exploration periods.  If Sky Petroleum fails to complete the minimum work program, Sky Petroleum may elect to pay AKBN the minimum expenditure amount.

Second Exploration Period:

Provided that Sky Petroleum has completed the minimum First Exploration Period work program or paid AKBN the minimum expenditure amount, Sky Petroleum may elect to extend the exploration period into a Second Exploration Period of three years.  During the Second Exploration Period, Sky Petroleum will undertake G&G; seismic acquisition and an exploration drilling program with the following minimum expenditure commitments:
Minimum Work Program
Minimum Expenditure in USD
G&G Evaluation
$
150,000

Exploration Wells or 1 Exploration Well and 100km Seismic Acquisition1 (Either (a) drill one well in blocks 4 & 5 and another well in Dumre block or (b) drill one well in blocks 4 & 5 and acquire 100km seismic in Dumre block.  The well(s) shall be drilled to a minimum vertical depth of 2,000 meters or until it reaches the Carbonates of the Eocene or Cretaceous, whichever first occurs.)
2,500,000

Total Commitment
$
2,650,000


27




Third Exploration Period:

Provided that Sky Petroleum has completed the minimum Second Exploration Period work program or paid AKBN the minimum expenditure amount, if, as approved by the AKBN, there are special circumstances which require more time for the contractor to perform adequate exploration activity, Sky Petroleum may elect to extend the exploration period into a Third Exploration Period of two years.  During the Third Exploration Period, Sky Petroleum will undertake G&G; seismic acquisition and an exploration drilling program with the following minimum expenditure commitments:
Minimum Work Program
Minimum Expenditure in USD
G&G Evaluation
$
150,000

2 Exploration Wells or 1 – 2000m (Drill one well in blocks 4 & 5 and another well in Dumre block. The wells are to be drilled to a minimum vertical depth of 2,000 meters or until it reaches the Carbonates of the Eocene or Cretaceous, whichever first occurs.)
3,000,000

Total Commitment
$
3,150,000


At the end of the First Exploration Period or the Second Exploration Period, Sky Petroleum has the right, subject to AKBN approval, to extend such period by one year.  In such a case, the duration of the Second Exploration Period or the Third Exploration Period shall be reduced to one year.  Sky Petroleum may terminate the PSC at the end of any exploration period.

If during the exploration periods, Sky Petroleum discovers petroleum accumulations capable of commercial production within the Concession Area (a “Discovery Area”); it can submit to AKBN a development plan and commence development of the Discovery Area.  Sky Petroleum will have production rights of 25 years for each field (a “Production Area”) from the date of initial commercial production, which may be extended, at Sky Petroleum’s option, for successive periods of five years on the same conditions, subject to approval by AKBN, which approval shall not be unreasonably withheld or delayed.  Sky Petroleum and AKBN will share profits from any commercial production of oil (after cost recovery by Sky Petroleum) based on a sliding scale formula, in which Sky Petroleum’s share of profits will range from 96% to 100%.  All available production is subject to a 10% royalty tax and Sky Petroleum’s profits are subject to a 50% Albania tax on petroleum profits.

Sky Petroleum will relinquish to AKBN 25% of the Concession Area, as designated by Sky Petroleum, within 180 days after the end of each of the First Exploration Period and the Second Exploration Period and all remaining acreage of the Concession Area at the end of the Third Exploration Period, that is not then subject to a Discovery Area or in a Production Area.  Sky Petroleum will not be required to relinquish areas included in a Discovery Area or in a Production Area.

In addition, to the work program undertakings, Sky Petroleum has also agreed to the following:

Education and Training Program:  Sky Petroleum has agreed to allocate $100,000 for training and education during each year of the Exploration period. Sky paid $50,000 of the amount during the year ended December 31, 2011.

Bonus Payment Obligations:  Sky Petroleum paid to AKBN a signing bonus of $50,000 during the year ended December 31, 2011.

Production Bonuses:

$150,000 on start-up of production from the Contract Area
$250,000 when average daily crude oil production over any consecutive ninety-day period reaches fifteen thousand (15,000) Barrels of oil per day
$500,000 when average daily crude oil production over any consecutive ninety-day period reaches thirty thousand (30,000) Barrels of oil per day.

Bank Guarantee:

On December 17, 2010, a copy of the document evidencing final approval of the Council of Ministers of the Republic of Albania was published in the Fletoren Zyrtare. The PSC became effective 10 working days after publication of the document on January 3, 2011.  Under the terms of the PSC, Sky Petroleum agreed to provide a bank guarantee within 90 days of the effective date of the PSC in an amount to guarantee expenditures during the first exploration period totaling $1,500,000.  Since the ratification, there have been numerous changes in personnel and officials at AKBN that have caused delays in completing our undertakings

28



and satisfying our obligations under the PSC in a timely manner.  Notwithstanding the above, Sky Petroleum delivered the bank guarantee on August 10, 2011 to AKBN. The bank guarantee was issued as a Letter of Credit in the name of AKBN.

Under the terms of the Letter of Credit, AKBN can submit a demand accompanied by a statement stating that the principal is in material breach of its obligations under the underlying contract; a copy of a notice to the Company (dated at least thirty (30) days prior to the date of your demand), informing the Company of a material breach of  its Work Program obligations under the PSC (as defined below), the nature and quantum of the material breach and of its intention to demand payment under the Letter of Credit if the material breach is not remedied within fifteen (15) days; and a signed declaration stating that the Company has failed to remedy the material breach detailed in your notice by the date specified.

The principal under the Letter of Credit shall be reduced every month or three months, as agreed between AKBN and the Company during the First Exploration Period, as defined under the PSC, by an amount equal to the sum spent by the Company on its Work Program obligations, as defined under the PSC, during such month or three months, such reductions to be effected in accordance with monthly or quarterly written statements issued by AKBN to the Company. As of December 31, 2012 the letter of credit was $1,500,000. The Letter of Credit was effective through February 22, 2013. On March 29, 2013, the Letter of Credit expired and restricted cash was relieved.

Sky Petroleum or an affiliated entity designated by Sky Petroleum will serve as operator under the Agreement. Sky Petroleum intends to use affiliated entities to hold and operate the Concession Area.

PSC Arbitration

The PSC is currently subject to an arbitration proceeding. (See "Legal Proceedings", above).

On January 20, 2012, Sky obtained an Order and Preliminary Injunction from the United States District Court, Western District of Texas, Austin Division (the “Court”) against the Ministry of Economy, Trade, and Energy of Albania, acting by and through AKBN.
On February 28, 2012, Sky Petroleum petitioned the Albanian Appeal Court, Tirana, to seek to enforce the Order and Preliminary Injunction granted by the United States District Court, Western District of Texas, Austin Division. On March 1, 2012, the Appeal Court refused to recognize the Order in Albania.
Accordingly, Sky Petroleum intends to continue to vigorously pursue its rights and remedies against the Defendants under the mandatory arbitration provision in Article 21 of the PSC.
A Statement of Claim was filed with the Tribunal on April 24, 2012, by the Company.

A procedural calender was issued by the Tribunal for Arbitration proceedings. The Statement of Defense was filed by AKBN on June 22, 2012. Sky Petroleum filed its Statement of Reply on August 3, 2012. Sky Petroleum filed its Request for Documents in connection with the Arbitration on October 31, 2012.

Subsequent to year end, the Arbitration took place before the Tribunal at the International Dispute Resolution Centre in London, UK between February 18th and February 22nd, 2013.  At the conclusion of the arbitration hearing, the Chairman of the Tribunal indicated the Tribunal expected to produce a written decision in three months.  

Sky Petroleum intends to continue to vigorously pursue its rights and remedies against the Defendants under the mandatory arbitration provision in Article 21 of the PSC.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable.

29






ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA



30




REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of Sky Petroleum, Inc.

We have audited the accompanying consolidated balance sheets of Sky Petroleum, Inc. and subsidiaries, as of December 31, 2012 and 2011, and the related consolidated statements of operations, changes in stockholders’ equity, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits 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 the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that 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 Sky Petroleum, Inc. and subsidiaries, as of December 31, 2012 and 2011, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As more fully described in Note 1, the Company will need additional working capital to fund operations. This condition raises substantial doubt about the Company's ability to continue as a going concern.  Management's plans in regard to these matters are also described in Note 1. The consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets, or the amounts and classification of liabilities that may result from the outcome of this uncertainty.

/s/ WHITLEY PENN LLP
 
Dallas, Texas
March 29, 2013


31







Sky Petroleum, Inc.
Consolidated Balance Sheets
 
December 31,

2012
 
2011
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
46,058

 
$
605,784

Restricted cash
1,500,000

 
1,500,000

Other current assets
172,412

 
53,243

Total Current Assets
1,718,470

 
2,159,027

 
 
 
 
Investment in oil and gas properties, net
10,205,220

 
10,205,220

Fixed assets, net
23,775

 
28,444

Deposits and other assets
14,768

 
14,768

Total Assets
$
11,962,233

 
$
12,407,459

 
 
 
 
Liabilities and Stockholders’ Equity
 

 
 

Current liabilities:
 

 
 

 
 
 
 
Accounts payable and accrued liabilities
$
1,114,139

 
$
419,095

Accounts payable, related party
72,878

 
$

Total Current Liabilities
1,187,017

 
419,095

 
 
 
 
Commitments and contingencies


 


 
 
 
 
Stockholders’ equity:
 

 
 

Series A Preferred stock, $0.001 par value, 10,000,000 shares authorized, none outstanding

 

Series B Preferred stock, no par value, 5,000,000 shares authorized, 3,863,636 issued and outstanding
7,820,000

 
7,820,000

Common stock, $0.001 par value, 150,000,000 shares authorized, 68,118,709 and 61,868,709 shares issued and outstanding, respectively
68,119

 
61,869

Additional paid-in capital
43,274,539

 
42,547,487

Accumulated deficit
(40,387,442
)
 
(38,440,992
)
Total Stockholders’ Equity
10,775,216

 
11,988,364

 
 
 
 
Total Liabilities and Stockholders’ Equity
$
11,962,233

 
$
12,407,459


The accompanying notes are an integral part of these consolidated financial statements

32








Sky Petroleum, Inc.
Consolidated Statement of Operations
 
Year Ended December 31.
 
2012
 
2011
Oil revenues
$

 
$

Expenses:
 

 
 

Depreciation
10,599

 
7,612

Legal and accounting
890,544

 
429,326

Travel
98,881

 
243,109

Consulting services
316,569

 
602,216

Other general and administrative
645,260

 
543,009

Total expenses
1,961,853

 
1,825,272

Net operating loss
(1,961,853
)
 
(1,825,272
)
Interest income
15,403

 
575

Net loss
$
(1,946,450
)
 
$
(1,824,697
)
 
 
 
 
Net loss per share - basic and diluted
$
(0.03
)
 
$
(0.03
)
Weighted average number of common shares outstanding basic and diluted
67,386,523

 
62,326,791


The accompanying notes are an integral part of these consolidated financial statements.

33



Sky Petroleum, Inc.
Consolidated Statements of Changes in Stockholders’ Equity
Years Ended December 31, 2012 and 2011



 
 
Preferred
Series B Shares
 
Preferred
Series B Amount
 
Common
Shares
 
Common Shares
Amount
 
Additional
Paid-in
Capital
 
Accumulated Deficit
 
Total
Stockholders’ Equity
Balance at December 31, 2010
 
3,863,636

 
$
7,820,000

 
61,868,709

 
$
61,869

 
$
41,619,458

 
$
(36,616,295
)
 
$
12,885,032

Proceeds from private placement for 4,000,000 Class A Units and 4,000,000 Class A Warrants
 

 

 

 

 
860,000

 

 
860,000

Stock issued to Consultants
 

 

 

 

 

 

 

Stock issued to Directors
 

 

 

 

 
15,000

 

 
15,000

Stock based compensation
 

 

 

 

 
53,029

 

 
53,029

Net loss
 

 

 

 

 

 
(1,824,697
)
 
(1,824,697
)
Balance at December 31, 2011
 
3,863,636

 
7,820,000

 
61,868,709

 
61,869

 
42,547,487

 
(38,440,992
)
 
11,988,364

Proceeds from private placement for 4,000,000 Class A Units and 4,000,000 Class A Warrants
 

 

 
6,000,000

 
6,000

 
634,000

 

 
640,000

Stock issued to Directors
 

 

 
250,000

 
250

 
40,750

 

 
41,000

Stock based compensation
 

 

 

 

 
52,302

 

 
52,302

Net loss
 

 

 

 

 

 
(1,946,450
)
 
(1,946,450
)
Balance at December 31, 2012
 
3,863,636

 
$
7,820,000

 
68,118,709

 
$
68,119

 
$
43,274,539

 
$
(40,387,442
)
 
$
10,775,216


The accompanying notes are an integral part of these consolidated financial statements


34




Sky Petroleum, Inc.
Consolidated Statements of Cash Flows

 
Twelve Months Ended
  
December 31,
2012
 
December 31,
2011
Cash flows from operating activities:
 
 
 
Net loss
$
(1,946,450
)
 
$
(1,824,697
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 

Depreciation
10,599

 
7,612

Share based compensation
93,302

 
68,029

Changes in operating assets and liabilities:
 
 
 

Other current assets
(69,169
)
 
26,477

Accounts payable and accrued liabilities
767,922

 
173,677

Net cash used in operating activities
(1,143,796
)
 
(1,548,902
)
Cash flows from investing activities:
 
 
 

 Purchase of fixed assets
(5,930
)
 
(26,778
)
 Investment in Albania Oil and Gas

 
(90,000
)
Purchases of surety-bond
(50,000
)
 
 
Purchases of CD for bank guarantee

 
(1,500,000
)
Net cash used in investing activities
(55,930
)
 
(1,616,778
)
Cash flows from financing activities:
 

 
 

Proceeds from private placement
640,000

 
860,000

Net cash provided by financing activities
640,000

 
860,000

Net decrease in cash and cash equivalents
(559,726
)
 
(2,305,680
)
Cash and cash equivalents at the beginning of period
605,784

 
2,911,464

Cash and cash equivalents at the end of period
$
46,058

 
$
605,784


The accompanying notes are an integral part of these consolidated financial statements.

35



Sky Petroleum, Inc.
Notes to Consolidated Financial Statements

As used herein, the terms, “Sky Petroleum,” “Sky,” “Company,” “we,” “us,” and “our” refer to Sky Petroleum, Inc. and related subsidiaries.


Note 1 - Organization and Basis of Presentation

The Company was organized on August 22, 2002 under the laws of the State of Nevada, as The Flower Valet. On December 20, 2004 the Company amended its articles of incorporation to change its name to Seaside Explorations, Inc. Subsequently, on March 28, 2005 the Company changed its name to Sky Petroleum, Inc ("Sky", "Sky Petroleum", or "Company"). The Company has three wholly-owned subsidiaries, two incorporated in Cyprus: Sastaro Limited (“Sastaro”) and Bekata Limited (Bekata”) which owns 100% of Sastaro, of which the companies relate to our Mubarek field operations, and a third Sky Petroleum (Albania) Inc., ("Sky Petroleum Albania") a Cayman Islands corporation and qualified branch in Albania, incorporated for the purposes of holding and operating our interests in the Concession Area (as defined below) in Albania.

The Company is engaged in the exploration and development of oil and natural gas properties of others under arrangements in which we finance the costs in exchange for interests in the oil or natural gas revenue generated by the properties. Such arrangements are commonly referred to as farm-ins to us, or farm-outs by the property owners farming out to us.

On June 24, 2010, Sky entered into a Production Sharing Contract (“PSC”) with the Ministry of Economy, Trade and Energy of Albania, acting through the National Agency of Natural Resources of Albania (“AKBN”).  The PSC grants Sky Petroleum exclusive rights to three exploration blocks (Block Four, Block Five and Block Dumre) in the Republic of Albania (the “Concession Area”). The Concession Area covers approximately 1.2 million acres, representing approximately 20% of the landmass of Albania. The PSC has a seven-year term with three exploration periods. Upon commercial discovery of gas, the agreement allows for development and production periods of 25 years plus extensions at the Company's option.

On December 23, 2011, Sky Petroleum delivered Notice of Arbitration under the Arbitration Rules of the United Nations Commission on Internal Trade Law to National Agency of Natural Resources and to the Ministry of Economy, Trade and Energy of Albania to institute an arbitration proceeding against the Ministry of Economy, Trade and Energy of Albania, acting by and through AKBN, for breach of the PSC in accordance with Article XXI of the PSC. The arbitration proceeding arises out of the alleged termination of the PSC in breach of the expressed termination provisions in Article 24 of the PSC. See "Contingencies" in Note 7 to Consolidated Financial Statements for further details.

On May 18, 2005, our wholly owned subsidiary Sastaro entered into a Participation Agreement with Buttes Gas and Oil Co. International Inc. (which we refer to as “Buttes”), a wholly-owned subsidiary of Crescent Petroleum Company International Limited (which we refer to as “Crescent”) for the financing of a drilling program in the Mubarek field. The field is an offshore region in a concession area surrounding Abu Musa Island in the Arabian Gulf. Under the terms of the Participation Agreement, the Company participated in a share of the future production revenue by contributing 25 million in drilling and completion costs related to two wells in an off-shore oil and gas project in the United Arab Emirates. The operator of the drilling program, Crescent completed the first well in 2006 and the second well in 2007. As of December 31, 2009, the first well produced a total of 150,413 gross barrels, and the second well produced a total of 149,471 gross barrels . Both wells terminated production in 2009.

On December 31, 2009, Sastaro received written notice from Buttes that Buttes unilaterally and solely determined that the Mubarek Field had reached the end of its economic life. Buttes also notified Sastaro that the Concession Agreement, dated December 29, 1969, between His Highness Sheikh Sultan bin Mohamed Al-Qassimi III, The Ruler of Sharjah, UAE and Buttes with respect to the Mubarek Field was terminated. Buttes stated it handed over the Mubarek Field operations and facilities to representatives of His Highness Sheikh Sultan bin Mohamed Al-Qassimi III on December 28, 2009. Management is exercising its rights under the Participation Agreement and intends to protect our interests and our investment in the Mubarek Field. Sky continues to seek discussions with Crescent regarding the Participation Agreement.

The Company cannot be certain that its existing sources of cash will be adequate to meet our liquidity requirements including cash requirements that may be due under the PSC and arbitration. However, management has implemented plans to improve liquidity through slowing or stopping certain planned expenditures and improvements to results from operations. Management plans to obtain funding through equity, debt or other securities offerings. There can be no assurance that the capital raising efforts will be successful or that our results of operations will materially improve in either the short-term or long-term and accordingly, we may be unable to meet our obligations as they become due.

36




A fundamental principle of the preparation of financial statements in accordance with generally accepted accounting principles is the assumption that an entity will continue in existence as a going concern, which contemplates continuity of operations and the realization of assets and settlement of liabilities occurring in the ordinary course of business. However, this principle is applicable to all entities except for entities in liquidation or entities for which liquidation appears imminent. In accordance with this requirement, our policy is to prepare our consolidated financial statements on a going concern basis unless we intend to liquidate or have no other alternative but to liquidate. The Company's consolidated financial statements have been prepared on a going concern basis and do not reflect any adjustments that might specifically result from the outcome of this uncertainty.

Note 2 - Summary of Significant Accounting Policies

The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America pursuant to the rules and regulations of the SEC and stated in US dollars.

Basis of Consolidation

The financial statements present the consolidated accounts of the Company and its wholly owned subsidiaries, Bekata, Sastaro and Sky Petroleum (Albania). All intercompany account balances and transactions have been eliminated.

Nature of Operations

The Company's focus is on the acquisition, development and exploitation of long-lived oil and natural gas reserves and, to a lesser extent, exploration for new oil and natural gas reserves. The Company's business activities are currently carried out in off-shore Sharjah, UAE, and in concession areas in Albania.

Investments

Investments in non-affiliated companies with a less than 20% ownership interest, no significant influence, and market prices are not readily available, are accounted for under the cost method.

Property and Equipment

Oil and natural gas properties:

The Company uses the full cost method of accounting for its oil and natural gas producing activities. Accordingly, all costs associated with acquisition, exploration, and development of oil and natural gas reserves, including directly related overhead costs, are capitalized. Management and service fees received under contractual arrangements, if any, are treated as reimbursement of costs, offsetting the costs incurred to provide those services.

Depletion is provided using the units-of-production method based upon estimates of proved oil and natural gas reserves with oil and natural gas production being converted to a common unit of measure based upon their relative energy content. Investments in unproved properties and major development projects are not amortized until proved reserves associated with the projects can be determined or until impairment occurs. If the results of an assessment indicate that the properties are impaired, the carrying value of the assets is reduced accordingly. Once the assessment of unproved properties is complete and when major development projects are evaluated, the costs previously excluded from amortization are transferred to the full cost pool and amortization begins.

Under the full cost method of accounting, the net book value of oil and natural gas properties, less related deferred income taxes, may not exceed a calculated “ceiling”. The ceiling limitation is the discounted estimated after-tax future net cash flows from proved oil and natural gas properties. In calculating future net cash flows, current prices and costs are generally held constant indefinitely. The net book value of oil and natural gas properties, less related deferred income taxes is compared to the ceiling on a quarterly and annual basis. Any excess of the net book value, less related deferred income taxes, is generally written off as an expense. Under rules and regulations of the SEC, all or a portion of the excess above the ceiling may not be written off if, subsequent to the end of the quarter or year but prior to the release of the financial results, prices have increased sufficiently that all or a portion of such excess above the ceiling would not have existed if the increased prices were used in the calculations.

As of December 31, 2012, the net carrying value of the Company's investment in the Mubarek wells was $0.


37



As of December 31, 2012, the Company has incurred $10,205,220 in acquisition and development costs for oil and gas projects in Albania.  These costs relate to the Production Sharing Contract with the Ministry of Economy, Trade and Energy of Albania approved as of December 17, 2010.

Sales of proved and unproved properties are accounted for as an adjustment of capitalized costs with no gain or loss recognized, unless such adjustments would significantly alter the relationship between capitalized costs and proved oil and natural gas reserves, in which case the gain or loss is recognized.

Other Property and Equipment:

Maintenance and repairs are charged to operations. Renewals and betterments are capitalized to the appropriate property and equipment accounts.

Upon retirement or disposition of assets other than oil and natural gas properties, the cost and related accumulated depreciation are removed from the accounts with the resulting gains or losses, if any, recognized in income. Depreciation of other property and equipment is computed using the straight-line method based on the estimated useful lives of the property and equipment.

Income Taxes

We follow the guidance issued within Accounting Standards Codification ("ASC") Topic No.740, Income Taxes, for recording the provision for income taxes. Deferred tax assets and liabilities are computed based upon the difference between the financial statement and income tax basis of assets and liabilities using the enacted marginal tax rate applicable when the related asset or liability is expected to be realized or settled. Deferred income tax expenses or benefits are based on the changes in the asset or liability each period. If available evidence suggests that it is more likely than not that some portion or all of the deferred tax assets will not be realized, a valuation allowance is required to reduce the deferred tax assets to the amount that is more likely than not to be realized. Future changes in such valuation allowance are included in the provision for deferred income taxes in the period of change. Deferred income taxes may arise from temporary differences resulting from income and expense items reported for financial accounting and tax purposes in different periods. Deferred taxes are classified as current or non-current, depending on the classification of assets and liabilities to which they relate. Deferred taxes arising from temporary differences that are not related to an asset or liability are classified as current or non-current depending on the periods in which the temporary differences are expected to reverse.

Undistributed earnings of the Company's foreign subsidiaries are considered to be indefinitely reinvested and, accordingly, no provision for U.S. federal income taxes has been provided thereon. Upon distribution of those earnings in the form of dividends or otherwise, the Company may be subject to both U.S. income taxes (subject to an adjustment for foreign tax credits) and withholding taxes payable to the foreign countries.

The Company's wholly owned subsidiaries have prepared required foreign tax returns that were due for the years ended December 31, 2005 through 2011. The Company has accrued approximately $33,000. This amount includes potential tax liabilities, penalties and interest which will be due upon filing the returns with the appropriate countries.

Stock-Based Compensation

The Company measures all share-based payments, including grants of employee stock options, using a fair-value based method in accordance with the FASB ASC Topic No. 505, Equity, and Topic No. 718 (formerly SFAS No. 123R), Share-Based Payments. The cost of services received in exchange for awards of equity instruments is recognized in the consolidated statement of operations based on the grant date fair value of those awards amortized over the requisite service period.

Basic and Diluted Net Loss Per Share

Net loss per share is presented in accordance FASB ASC Topic No. 260, Earnings Per Share. Basic net loss per share is computed based on the weighted average shares of common stock outstanding for the period. Common stock equivalents which represent stock options (approximately 2,100,000 stock options) and warrants (approximately 12,000,000 warrants), have been excluded from the computation of diluted net loss per share at as their effect is anti-dilutive.  There were 4,000,000 remaining warrants that are outstanding as of March 29, 2013, 8,000,000 warrants expired on January 20, 2013.





38



Use of Estimates in the Preparation of Consolidated Financial Statements

Preparation of the accompanying consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Fair Value of Financial Instruments

The Company calculates the fair value of its assets and liabilities which qualify as financial instruments and includes this additional information in the notes to consolidated financial statements when the fair value is different than the carrying value of these financial instruments. The estimated fair value of accounts payable and accrued liabilities approximate their carrying amounts due to the relatively short maturity of these instruments. None of these instruments are held for trading purposes.

FASB ASC Topic 820, Fair Value Measurements defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and requires certain disclosures about fair value measurements. In general, fair values of financial instruments are based upon quoted market prices, where available (Level 1). If such quoted market prices are not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters (Level 2). Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality and the customer's creditworthiness, among other things, as well as unobservable parameters (Level 3). Any such valuation adjustments are applied consistently over time.

Cash Equivalents and Restricted Cash

For purposes of the consolidated statements of cash flows, the Company considers all demand deposits, money market accounts and certificates of deposit purchased with an original maturity of three months or less to be cash equivalents.

On August 10, 2011, the Company delivered a bank guarantee in the form of a letter of credit under the terms of the PSC with AKBN. In connection with the bank guarantee, Sky Petroleum deposited the principal balance of the $1,500,000 promissory note with Texas Citizens Bank N.A. to secure payment under the letter of credit. Subsequently, $1,500,000 was transferred to a certificate of deposit (“CD”) with the issuing bank.  The issuing bank has the right of offset with the CD for any amounts used under the letter of credit. As of March 29. 2013 the Letter of Credit had matured and the proceeds were moved to unrestricted cash.

Revenue Recognition

Oil and natural gas revenues are recorded using the sales method, whereby the Company recognizes oil and natural gas revenue based on the amount of oil and natural gas sold to purchasers. As of December 31, 2012 and December 31, 2011, the Company did not have any oil or natural gas imbalances recorded. The Company does not recognize revenues until they are realized or realizable and earned. Revenues are considered realized or realizable and earned when: (i) persuasive evidence of an arrangement exists; (ii) delivery has occurred or services have been rendered; (iii) the seller's price to the buyer is fixed or determinable; and (iv) collectability is reasonably assured.


Note 3 - Investment in Oil and Gas Properties

Blocks Four, Five and Dumre in Albania:

On June 24, 2010, Sky Petroleum executed a PSC, covering three exploration blocks, Four, Five, and Dumre in the Republic of Albania totaling approximately 1.2 million acres representing approximately 20% of the landmass of Albania. Under the terms of the PSC, Sky Petroleum has agreed to undertake exploration work on the blocks during the following three exploration periods over the next seven years commencing on the effective date of the PSC (January 3, 2011).

Under the terms of the PSC, Sky Petroleum was obligated to, among other things, (a) establish an office in Albania (established), (b) pay a signing bonus of $50,000 (paid); (c) prepare an exploration work program and budget (completed), (c) designate three members to a nine member Exploration Advisory Committee, (completed), (d) provide AKBN with a bank guarantee for $1,500,000 to guarantee expenditures during the first exploration period within 90 days of the Effective Date (the “AKBN Bank Guarantee”) (guarantee has been provided) and (e) commence performance of a minimum work program (commenced).


39



First Exploration Period: The first exploration period is an initial period of two years in which Sky Petroleum has agreed to undertake geological and geophysical (“G&G”) preparations, including but not limited to acquisition of technical data, interpretation of geological, geophysical and well data, and conducting regional geological and structural studies (mapping, balanced cross sections); seismic reprocessing and seismic acquisition, with minimum expenditure commitments totaling $1,500,000.

Second Exploration Period: Provided that Sky Petroleum has completed the minimum first exploration period work program or paid AKBN the minimum expenditure amount, Sky Petroleum may elect to extend the exploration period into a second exploration period of three years. During the second exploration period, Sky Petroleum will undertake G&G; seismic acquisition and an exploration drilling program with minimum expenditure commitments totaling $2,650,000.

Third Exploration Period: Provided that Sky Petroleum has completed the minimum second exploration period work program or paid AKBN the minimum expenditure amount, if, as approved by the AKBN, there are special circumstances which require more time for the contractor to perform adequate exploration activity, Sky Petroleum may elect to extend the exploration period into a third exploration period of two years. During the third exploration period, Sky Petroleum will undertake G&G; seismic acquisition and an exploration drilling program with minimum expenditure commitments totaling $3,150,000.

At the end of the First Exploration Period or the Second Exploration Period, Sky Petroleum has the right, subject to AKBN approval, to extend such period by one year. In such a case, the duration of the Second Exploration Period or the Third Exploration Period shall be reduced to one year. Sky Petroleum may terminate the PSC at the end of any exploration period.

If during the exploration periods, Sky Petroleum discovers petroleum accumulations capable of commercial production within the Concession Area (a “Discovery Area”); it can submit to AKBN a development plan and commence development of the Discovery Area. Sky Petroleum will have production rights of 25 years for each field (a “Production Area”) from the date of initial commercial production, which maybe extended, at Sky Petroleum's option, for successive periods of five years on the same conditions, subject to approval by AKBN, which approval shall not be unreasonably withheld or delayed. Sky Petroleum and AKBN will share profits from any commercial production of oil (after cost recovery by Sky Petroleum) based on a sliding scale formula, in which Sky Petroleum's share of profits will range from 96% to 100%. All available production is subject to a 10% royalty tax and Sky Petroleum's profits are subject to a 50% Albania tax on petroleum profits.

Sky Petroleum will relinquish to AKBN 25% of the Concession Area, as designated by Sky Petroleum, within 180 days after the end of each of the First Exploration Period and the Second Exploration Period and all remaining acreage of the Concession Area at the end of the Third Exploration Period, that is not then subject to a Discovery Area or in a Production Area. Sky Petroleum will not be required to relinquish areas included in a Discovery Area or in a Production Area.

In addition, to the work program undertakings, Sky Petroleum has also agreed to allocate $100,000 for training and education during each year of the Exploration period. On April 5, 2011, Sky paid $50,000 towards the $100,000 allocation for training and education for the first year exploration period related to the Albania concession area. Sky also paid a signing bonus of $50,000 in 2010.

Production Bonuses:

$150,000 on start-up of production from the Contract Area

$250,000 when average daily crude oil production over any consecutive ninety-day period reaches fifteen thousand (15,000) Barrels of oil per day

$500,000 when average daily crude oil production over any consecutive ninety-day period reaches thirty thousand (30,000) Barrels of oil per day.

Bank Guarantee: On December 17, 2010, a copy of the document evidencing final approval of the Council of Ministers of the Republic of Albania was published in the Fletoren Zyrtare. The PSC became effective 10 working days after publication of the document on January 3, 2011.  Under the terms of the PSC, Sky Petroleum agreed to provide a bank guarantee within 90 days of the effective date of the PSC in an amount to guarantee expenditures during the first exploration period totaling $1,500,000Since the ratification, there have been numerous changes in personnel and officials at AKBN that have caused delays in completing our undertakings and satisfying our obligations under the PSC in a timely manner.  Notwithstanding the above, Sky Petroleum delivered the bank guarantee on August 10, 2011 to AKBN. The bank guarantee was issued as a Letter of Credit in the name of AKBN.


40



Under the terms of the Letter of Credit, AKBN can submit a demand accompanied by a statement stating that the principal is in material breach of its obligations under the underlying contract; a copy of a notice to the Company (dated at least thirty (30) days prior to the date of your demand), informing the Company of a material breach of  its Work Program obligations under the PSC (as defined below), the nature and quantum of the material breach and of its intention to demand payment under the Letter of Credit if the material breach is not remedied within fifteen (15) days; and a signed declaration stating that the Company has failed to remedy the material breach detailed in your notice by the date specified.

The Letter of Credit is effective through February 22, 2013. The principal under the Letter of Credit shall be reduced every month or three months, as agreed between AKBN and the Company during the First Exploration Period, as defined under the PSC, by an amount equal to the sum spent by the Company on its Work Program obligations, as defined under the PSC, during such month or three months, such reductions to be effected in accordance with monthly or quarterly written statements issued by AKBN to the Company. As of December 31, 2012 the letter of credit was $1,500,000. On February 22, 2013 the Letter of Credit expired and restricted cash was relieved.

Sky Petroleum or an affiliated entity designated by Sky Petroleum will serve as operator under the Agreement. Sky Petroleum intends to use affiliated entities to hold and operate the Concession Area. Sky Petroleum Albania was organized for the purpose of holding and operating the Concession Area.On December 23, 2011, Sky Petroleum delivered Notice of Arbitration under the Arbitration Rules of the United Nations Commission on Internal Trade Law to National Agency of Natural Resources and to the Ministry of Economy, Trade and Energy of Albania to institute an arbitration proceeding against the Ministry of Economy, Trade and Energy of Albania, acting by and through AKBN, for breach of the PSC in accordance with Article XXI of the PSC. The arbitration proceeding arises out of the alleged termination of the PSC in breach of the expressed termination provisions in Article 24 of the PSC. See "Contingencies" in the Notes to Consolidated Financial Statements for further details.

Consulting Agreement- On May 18, 2010, Sky Petroleum entered into a Consultant Agreement for Business Development in the Republic of Albania (the “Orsett Agreement”) with Orsett Ventures Inc., a British Virgin Islands company (“Orsett”). The Orsett Agreement was amended on September 29, 2010 (“Amendment #1”) and on October 8, 2010 (“Amendment #2”). Under the terms of the Orsett Agreement, Sky Petroleum retained Orsett as an independent consultant to use Orsett's experience, expertise, qualifications and expertise to acquire and negotiate the acquisition of oil and gas properties and projects in the Republic of Albania. The Orsett Agreement terminated under its term on April 30, 2011.

Pursuant to the Amendment #1, Sky Petroleum agreed to pay Orsett in connection with the execution and delivery of the PSC $700,000 and 1.5 million shares of common stock, all of which was paid and tendered, respectively as of December 31, 2010.

Pursuant to Amendment #2, Sky agreed to pay Orsett for additional services, $150,000, an additional 1.5 million shares of common stock; and 3,863,636 shares of newly designated Series B Preferred Stock. Following notification of approval by the Council of Ministers for the Republic of Albania of the PSC, the Company issued the Series B Preferred Stock. As of December 31, 2010, all fees and common and preferred shares were paid and tendered.

The fair market value of the total 3 million common shares issued to Orsett was approximately $1,170,000, and the fair market value of the 3,863,636 shares ("Orsett Shares") issued for Preferred Series B Stock of $7,820,000 have been included in oil and gas investments as of December 31, 2012. The fair value of the preferred stock was determined using quoted market prices along with internally developed models that primarily use, as inputs, observable market-based parameters, and other valuation adjustments made to ensure that financial instruments are recorded at fair value.

Orsett and its affiliates, agents and representatives, are subject to ongoing obligations of confidentiality and covenants of non-compete and non-interference under the terms of the Orsett Agreement between Sky Petroleum and Orsett dated May 18, 2010, as amended.  Notwithstanding the expiration of the Orsett Agreement on April 30, 2011, Orsett and its affiliates, agents and representatives, are subject to confidentiality undertakings for a period of three years following the expiration of the term.  In addition, Orsett and its affiliates, agents and representatives have agreed not to circumvent any opportunities of Sky Petroleum.

Total Orsett Agreement costs of $9,840,000 along with other payments related to the investment totaling $365,220 are included in the investment in oil and gas properties totaling $10,205,220 as of December 31, 2012. On June 25, 2012, the Company issued a stop order notice to its transfer agent under which the transfer agent was instructed to: not to remove the restrictive legends from the share certificates representing the Orsett Shares; not to effect or facilitate the transfer, assignment, conveyance or sale of any of the Orsett Shares; and not to effect the conversion of the Series B Preferred Stock into shares of common stock of the Corporation, unless the transfer agent receives the expressed written instructions of the Secretary of the Registrant.

The Company's investment in the Albania exploration blocks as of December 31, 2012 was $10,205,220. This investment consisted of acquisition costs related to the PSC totaling $50,000, and $850,000 for fees to consultants for locating and negotiating the

41



Company's investment in the Albania exploration blocks, $265,220 for fees related to evaluations and assessments of the concession area, and $50,000 towards the $100,000 allocation for training and education for the first year exploration period. In addition, 3 million shares of common stock with a fair value of $1,170,000, plus 3,863,636 Preferred Shares Series B with a value of $7,820,000, were issued to Orsett for expertise provided to the Company in acquiring and negotiating the acquisition of oil and gas properties.

Mubarek Field Operations:

On May 18, 2005, the Company entered into a Participation Agreement with Buttes, whereby the Company provided cash in the amount of $25,000,000, to be used for drilling costs associated with two oil wells located in the Arabian Gulf in exchange for a variable percentage of future production revenue. Pursuant to the Participation Agreement, the Company provided capital to Buttes in developmental increments. Upon commencement of production, which occurred in May 2006, the Company was to receive a preferred 75% of combined production revenue until such time as the Company recouped its total investment, and thereafter an incremental decrease of production revenue to 40%, until the Company has recouped two times its initial investment, and thereafter at 9.2%.

As of June 30, 2008, Buttes incurred drilling costs totaling approximately $53,219,000, exceeding the original cost estimates and funding by the Company of $25,000,000, and thus reducing the Company's preferred share of combined production revenue from 75% to 35.25% until such time as the Company has recouped its total investment, and thereafter an incremental decrease of production revenue to 18.84% until the Company has recouped two times its initial investment, and thereafter at 4.33%.

The Company's operating costs are capped at $3.00 per barrel and royalty fees are 14.5% of gross production revenues under the Participation Agreement.

On December 31, 2009, Sastaro received written notice from Buttes that Buttes had unilaterally and solely determined that the Mubarek Field had reached the end of its economic life. Buttes also notified Sastaro that the Concession Agreement, dated December 29, 1969, between the His Highness Sheikh Sultan bin Mohamed Al-Qassimi III, The Ruler of Sharjah, UAE and Buttes with respect to the Mubarek Field was terminated. Buttes stated that it handed over the Mubarek Field operations and facilities to representatives of His Highness Sheikh Sultan bin Mohamed Al-Qassimi III on December 28, 2009.

Buttes notified Sastaro that the Participation Agreement between Sastaro and Buttes is terminated. Under the terms of the Participation Agreement, the Registrant, through Sastaro, contributed $25 million in drilling and completion costs related to two in-fill wells for the right for the Registrant to participate in a share of their future production revenue.

As a result of these events, and as of December 31, 2009, the investment in the wells was impaired to zero.  

As of December 31, 2012 and December 31, 2011, the Company's investment in the Mubarek field oil and gas properties was zero.

Note 4 – Restricted Cash and Bank Guarantee

On August 10, 2011, the Company delivered a bank guarantee in the form of a letter of credit under the terms of the PSC with AKBN. In connection with the bank guarantee, Sky Petroleum made a cash deposit of $1,500,000 with Texas Citizens Bank N.A. in 2011. The cash deposit is considered restricted cash.

The Letter of Credit was effective through February 22, 2013. The principal under the Letter of Credit shall be reduced every month or three months, as agreed between AKBN and the Company during the First Exploration Period, as defined under the PSC, by an amount equal to the sum spent by the Company on its Work Program obligations, as defined under the PSC, during such month or three months, such reductions to be effected in accordance with monthly or quarterly written statements issued by AKBN to the Company. As of March 29, 2013 the Letter of Credit had expired and the restricted cash was relieved.


42




Note 5 - Stockholders' Equity

Preferred Stock

We have authorized 10 million shares of $0.001 par value Series A Preferred Stock. There were no shares of Series A Preferred Stock outstanding as of December 31, 2012 and December 31, 2011, respectively.

On October 8, 2010, pursuant to the terms of the Orsett Agreement, dated May 18, 2010, as amended September 29, 2010 and October 3, 2010, by and between the Company and Orsett, the Company filed a Certificate of Designation with the Secretary of State for the State of Nevada to designate 5,000,000 shares of the Company's preferred stock as shares of Series B Preferred Stock (the "Series B Preferred Shares").

The Series B Preferred Shares are participating with no preferences or voting rights, and shall not be converted by any holder, in whole or in part for a period of twelve months from the date of initial issuance. Each Series B Preferred Share is convertible into 4.4 shares of common stock of the Company, however, the shares may not be converted into more than 4.99% of beneficial ownership unless the holder waives the beneficial ownership limitation with 61 days notice.

In connection with the Series B designation and the Consultant Agreement, the Company issued 3,863,636 shares, with a fair value of $7,820,000. These shares were issued to the Consultant for expertise provided to the Company in acquiring and negotiating the acquisition of oil and gas properties in Albania. As of December 31, 2012 and December 31, 2011, 3,863,636 shares of Series B Preferred Stock were outstanding.

On June 25, 2012, the Company issued a stop order notice to its transfer agent under which the transfer agent was instructed to: not to remove the restrictive legends from the share certificates representing the Orsett Shares; not to effect or facilitate the transfer, assignment, conveyance or sale of any of the Orsett Shares; and not to effect the conversion of the Series B Preferred Stock into shares of common stock of the Corporation, unless the transfer agent receives the expressed written instructions of the Secretary of the Registrant. The Company has determined that Orsett breached numerous terms of the Consulting Agreement and committed other actions that resulted in substantial harm and damage to the Company and its shareholders.

Common Stock and Stock Options

On July 26, 2005, the Company adopted the Sky Petroleum, Inc. Non-U.S. Stock Option Plan (the “Non-U.S. Plan”), effective as of April 1, 2005. The Non-U.S. Plan authorizes the issuance of stock options to acquire up to 10% of the Company's issued and outstanding shares of common stock.

On August 25, 2005, the Company adopted the Sky Petroleum, Inc. 2005 U.S. Stock Incentive Plan (the “U.S. Plan”). The U.S. Plan authorizes the issuance of stock options and other awards to acquire up to a maximum of 3,321,600 shares of the Company's common stock (less the number of shares issuable upon exercise of options granted by the Company under all other stock incentive plans on the date of any grant under the U.S. Plan). The U.S. Plan provides for the grant of incentive stock options (within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended), options that are not incentive stock options, stock appreciation rights and various other stock-based grants.

On June 1, 2012, the Company granted 150,000 shares to an employee. These common shares were valued at $22,500 based on the quoted market price at that date.

On August 19, 2012, the Company granted 150,000 common shares valued at $24,000 to a new Advisory board member. Additonally, on October 11, 2012, the Company granted 100,000 common shares valued at $17,000 to a second Advisory board member. The common shares were all valued based on the quoted market price at date the shares were approved by the Board. The share certificates have been issued. On August 7, 2012, the Company granted 300,000 stock options under the Non-US Plan. The options are exercisable at $0.25 per share with vesting over the next three years and were valued at $56,767.

The 2012 and 2011 stock options fair value was determined using the following attributes and assumptions for each separate issuance: share prices ranging from $0.18 to $0.25, risk-free interest rates of approximately 1.55%, expected dividend yields of 0%, expected life of 4 years, and expected volatility of 207% to 291%.  The Company estimates forfeitures based on historical experience.


43



For the twelve months ended December 31, 2012, the Company recorded $29,802 of compensation expense based on its use of the Black Scholes model to estimate the grant-date fair value of these stock option awards. No options were exercised for the year ended December 31, 2012. Compensation expense is based upon straight-line amortization of the grant-date fair value over the vesting period of the underlying stock option. In accordance with FASB ASC Topic No. 718 and No. 505, the fair value of each stock option grant was estimated on the date of the grant, using the Black-Scholes option-pricing model. As of December 31, 2012, there was approximately $90,646 of unrecognized compensation expenses related to non-vested stock option agreements.

A summary of stock options outstanding as of December 31, 2012, is as follows:
Shares Underlying Options Outstanding
 
Shares Underlying Options Exercisable
Range of
Exercise Prices
 
Shares
Underlying
Options
Outstanding
 
Weighted
Average
Remaining
Contractual
Life (Years)
 
Weighted
Average
Exercise
Price
 
Shares
Underlying
Options
Exercisable
 
Weighted
Average
Exercise
Price
$
0.18

 
 
750,000

 
 
5.46

 
 
$
0.18

 
 
500,000

 
 
$
0.18

$
0.25

 
 
550,000

 
 
5.75

 
 
$
0.25

 
 
250,000

 
 
$
0.25

$
0.50

 
 
200,000

 
 
3.85

 
 
$
0.50

 
 
200,000

 
 
$
0.50

$
1.29
 
 
600,000

 
 
2.74

 
 
$
1.29

 
 
600,000

 
 
$
1.29



The aggregate intrinsic value of exercisable options as of December 31, 2012 is $0.  The aggregate intrinsic value of options outstanding as of December 31, 2012 is $0.

The following is a summary of stock option activity for the twelve months ended December 31, 2012 and for the year ended December 31, 2011:

 
 
Number
Of Shares
 
Weighted
Average
Exercise Price
 
Weighted Average
Remaining Contract Life (Years)
Balance, December 31, 2010
 
2,450,000

 
$
0.85
 
 
 
 
Options canceled
 
(300,000
)
 
 
(0.85
)
 
 
 
Options granted
 
350,000

 
 
0.23
 
 
 
 
Balance, December 31, 2011
 
2,500,000

 
 
0.76
 
 
 
4.35

 
Options canceled
 
(700,000
)
 
 
(1.18
)
 
 
 
 
Options granted
 
300,000

 
 
0.25
 
 
 
 
 
Balance, December 31, 2012
 
2,100,000

 
 
0.55
 
 
 
4.61

 
 
 
 
 
 
 
 
 
 
 
Exercisable,December 31, 2012
 
1,550,000

 
$
0.66
 
 
 
4.27

 


Class A Units and Class A Warrants and Class B Units and Class B Warrants

In October 2011, the Company initiated subscriptions agreements for a non-brokered private placement to raise $1,000,000. Upon receipt of proceeds the Company issued 4,000,000 Class A Units at $0.25 per unit to investors. Each Class A Unit consisted of one share of common stock of the Company, par value $0.001and one Class A Warrant.  Each Class A Warrant is exercisable to acquire one Class B Unit of the Company at an exercise price of $0.35 per Class B Unit until January 20, 2013, which have expired subsequent to year-end. Each Class B Unit consists of one share of common stock of the Company, par value $0.001 and one Class B Warrant.  Each Class B Warrant is exercisable to acquire one common share of the Company, par value $0.001 at an exercise price of $0.60 per Class B Warrant Share until January 20, 2014. The Company received $860,000 in proceeds prior to the year ended December 31, 2011 for the offering, and received $140,000 in 2012.The Company had received all $1,000,000 in proceeds as of December 31, 2012. As of December 31, 2012, 4,000,000 common shares and 4,000,000 Class A Warrants were also issued.


44



In connection with the offering of the Class A Units, the Corporation issued a reservation order reserving Common Shares for issuance as follows:
Warrant Class/
Exercise Price
Number of Shares
Common Stock
(Reserved)
Aggregate Exercise
Price
Class A Warrants
(US$0.35)
4,000,000
$1,400,000
Class B Warrants
(US$0.60)
4,000,000
$2,400,000
Total
8,000,000
$3,800,000

In May 2012, the Company initiated subscriptions agreements for a non-brokered private placement to raise $500,000. The Company issued 2,000,000 Class A Units at $0.25 per unit to an investor in May 2012. Each Class A Unit consisted of one share of common stock of the Company, par value $0.001and one Class A Warrant. Each Class A Warrant is exercisable to acquire one Class B Unit of the Company at an exercise price of $0.35 per Class B Unit until May 14, 2013. Each Class B Unit consists of one share of common stock of the Company, par value $0.001 and one Class B Warrant. Each Class B Warrant is exercisable to acquire one common share of the Company, par value $0.001 at an exercise price of $0.60 per Class B Warrant Share until May 14, 2014. The Company received $500,000 in proceeds as of December 31, 2012.

In connection with the offering of the Class A Units, the Corporation issued a reservation order reserving Common Shares for issuance as follows:

Warrant Class/
Exercise Price
Number of Shares
Common Stock
(Reserved)
Aggregate Exercise
Price
Class A Warrants
(US$0.35)
2,000,000

$
700,000

Class B Warrants
(US$0.60)
2,000,000

$
1,200,000

Total
4,000,000

$
1,900,000



Note 6 - Income Taxes

For the year ended December 31, 2012 the Company had net operating losses and, accordingly, no provision for income taxes has been recorded. In addition, no benefit for income taxes has been recorded due to the uncertainty of the realization of any tax assets. At December 31, 2012, the Company has accumulated operating losses totaling approximately $34.3 million. The net operating loss carry forwards will begin to expire in 2020 if not utilized. The Company has recorded net operating losses in each year since its inception through December 31, 2012. Based upon all available objective evidence, including the Company’s loss history, management believes it is more likely than not that, the net deferred assets will not be fully realized. Therefore, the Company has provided a valuation allowance against its deferred tax assets at December 31, 2012 and December 31, 2011.

Non-current deferred tax assets were as follows for the dates ended below:
 
 
December 31,
 
 
2012
 
2011
Net operating loss carryfowards
 
12,013,183

 
11,364,870

Impairment of investment
 
350,000

 
350,000

Less: valuation allowance
 
(12,363,183
)
 
(11,714,870
)
Net non-current deferred tax asset
 

 



All of the Company’s oil and gas properties are located offshore off the coast of Sharjah, UAE and in Albania, and there are no income taxes due as no earnings or dividends were distributed or repatriated.


45



Undistributed earnings of the Company’s foreign subsidiaries are considered to be indefinitely reinvested and, accordingly, no provision for U.S. federal income taxes has been provided thereon. Upon distribution of those earnings in the form of dividends or otherwise, the Company may be subject to both U.S. income taxes (subject to an adjustment for foreign tax credits) and withholding taxes payable to the foreign countries.

The Company’s wholly owned subsidiaries have prepared the required foreign tax returns for the years ended December 31, 2005 through December 31, 2008. Foreign taxes of approximately $33,000 have been recorded for tax years 2005 through 2008, and are included in accrued expenses. Management has engaged qualified firms to identify and prepare foreign tax returns for filing for the years ended December 31, 2005 through 2011. The Company believes amounts due, if any, would not be material due to changes in Cyprus tax laws during those periods, and due to net operating losses from foreign operations carried forward.

Reconciliation between the income tax benefit determined by applying the applicable Federal statutory income tax rate to the pre-tax loss is as follows for the period indicated:

 
 
Year Ended December 31,
 
 
2012
 
2011
Tax benefit at statutory income tax rate
 
(681,258
)
 
(638,644
)
Stock based compensation
 
32,656

 
23,810

Meals and entertainment
 
289

 
1,734

Change in valuation allowance
 
648,313

 
613,100

Tax benefit reported
 

 



Note 7 - Contingencies

Leases

The Company has two leases on office facilities under operating lease agreements that expired(expires) on October 12, 2012 and October 30, 2013. Rent payments due under the lease for the next year is approximately $30,000. There are no additional amounts due after 2013. There is one other office lease on a month to month cancellable basis. Total rent expense was $109,000 in 2012, and $127,000 in 2011.

Oil and Gas Properties Commitments and Contingencies

Mubarek Field Operations:

On December 31, 2009, Sastaro received written notice from Buttes that Buttes had unilaterally and solely determined that the Mubarek Field had reached the end of its economic life. Buttes notified Sastaro that the Concession Agreement, dated December 29, 1969, between the His Highness Sheikh Sultan bin Mohamed Al-Qassimi III, The Ruler of Sharjah, UAE and Buttes with respect to the Mubarek Field was terminated. Buttes stated that it handed over the Mubarek Field operations and facilities to representatives of His Highness Sheikh Sultan bin Mohamed Al-Qassimi III on December 28, 2009.

As a result of these events, Buttes notified Sastaro that the Participation Agreement between Sastaro and Buttes was terminated.

Under the terms of the Participation Agreement, the Company, through Sastaro, contributed in drilling and completion costs related to two in-fill wells, H2 and K2-ST4, for the right for the Registrant to participate in a share of their future production revenue.

The Mubarek Field wells H2 and K2-ST4 continue to produce commercial amounts of oil, and the Company believes that there is significant residual value in H2 and K2-ST4. Consequently, the Company considers the Participation Agreement valid and in good standing.  Management is exercising its rights under the Participation Agreement and intends to protect our interest and our investment in the Mubarek Field.


46



Production Sharing Contract related to Blocks Four, Five and Dumre in Albania:

Under the terms of the PSC, Sky Petroleum has agreed to undertake exploration work on the blocks during the following three exploration periods over the next seven years commencing on the effective date of the PSC.
First Exploration Period:

The First Exploration Period is an initial period of two years in which Sky Petroleum has agreed to undertake G&G, including but not limited to acquisition of technical data, interpretation of geological, geophysical and well data, and conducting regional geological and structural studies (mapping, balanced cross sections); seismic reprocessing and seismic acquisition, with the following minimum expenditure commitments:
 
 
 
 
 
Minimum Work Program
Minimum Expenditure in USD
G&G Evaluation1, (Minimum expenditures for G&G will be split $150,000 for blocks 4 & 5 and $50,000 for Dumre block.)
$
200,000

 
Seismic Reprocessing (2D)
50,000
 
 
Seismic Acquisition (2D)2 150 km (Seismic acquisition: seismic acquisition will be split 100km in blocks 4 & 5 and 50km in Dumre block.)
1,230,000
 
 
Total Commitment
$
1,500,000

 

Any additional exploration work in excess of the minimum amounts during any exploration period (whether G&G or exploration wells) may be credited against Sky Petroleum's minimum work obligations in subsequent exploration periods.  If Sky Petroleum fails to complete the minimum work program, Sky Petroleum may elect to pay AKBN the minimum expenditure amount.

Second Exploration Period:

Provided that Sky Petroleum has completed the minimum First Exploration Period work program or paid AKBN the minimum expenditure amount, Sky Petroleum may elect to extend the exploration period into a Second Exploration Period of three years.  During the Second Exploration Period, Sky Petroleum will undertake G&G; seismic acquisition and an exploration drilling program with the following minimum expenditure commitments:
 
 
 
 
 
Minimum Work Program
Minimum Expenditure in USD
G&G Evaluation
$
150,000

 
Exploration Wells or 1 Exploration Well and 100km Seismic Acquisition 1 (Either (a) drill one well in blocks 4 & 5 and another well in Dumre block or (b) drill one well in blocks 4 & 5 and acquire 100km seismic in Dumre block.  The well(s) shall be drilled to a minimum vertical depth of 2,000 meters or until it reaches the Carbonates of the Eocene or Cretaceous, whichever first occurs.)
2,500,000
 
 
Total Commitment
$
2,650,000

 

Third Exploration Period:

Provided that Sky Petroleum has completed the minimum Second Exploration Period work program or paid AKBN the minimum expenditure amount, if, as approved by the AKBN, there are special circumstances which require more time for the contractor to perform adequate exploration activity, Sky Petroleum may elect to extend the exploration period into a Third Exploration Period of two years.  During the Third Exploration Period, Sky Petroleum will undertake G&G; seismic acquisition and an exploration drilling program with the following minimum expenditure commitments:

47



 
 
 
 
 
Minimum Work Program
Minimum Expenditure in USD
G&G Evaluation
$
150,000

 
2 Exploration Wells or 1 - 2000m (Drill one well in blocks 4 & 5 and another well in Dumre block. The wells are to be drilled to a minimum vertical depth of 2,000 meters or until it reaches the Carbonates of the Eocene or Cretaceous, whichever first occurs.)
3,000,000
 
 
Total Commitment
$
3,150,000

 

At the end of the First Exploration Period or the Second Exploration Period, Sky Petroleum has the right, subject to AKBN approval, to extend such period by one year.  In such a case, the duration of the Second Exploration Period or the Third Exploration Period shall be reduced to one year.  Sky Petroleum may terminate the PSC at the end of any exploration period.

If during the exploration periods, Sky Petroleum discovers petroleum accumulations capable of commercial production within the Concession Area (a “Discovery Area”); it can submit to AKBN a development plan and commence development of the Discovery Area.  Sky Petroleum will have production rights of 25 years for each field (a “Production Area”) from the date of initial commercial production, which may be extended, at Sky Petroleum's option, for successive periods of five years on the same conditions, subject to approval by AKBN, which approval shall not be unreasonably withheld or delayed.  Sky Petroleum and AKBN will share profits from any commercial production of oil (after cost recovery by Sky Petroleum) based on a sliding scale formula, in which Sky Petroleum's share of profits will range from 96% to 100%.  All available production is subject to a 10% royalty tax and Sky Petroleum's profits are subject to a 50% Albania tax on petroleum profits.

Sky Petroleum will relinquish to AKBN 25% of the Concession Area, as designated by Sky Petroleum, within 180 days after the end of each of the First Exploration Period and the Second Exploration Period and all remaining acreage of the Concession Area at the end of the Third Exploration Period, that is not then subject to a Discovery Area or in a Production Area.  Sky Petroleum will not be required to relinquish areas included in a Discovery Area or in a Production Area.

In addition, to the work program undertakings, Sky Petroleum has also agreed to the following:

Education and Training Program:  Sky Petroleum has agreed to allocate $100,000 for training and education during each year of the Exploration period. Sky paid $50,000 of the amount during the year ended December 31, 2011.

Bonus Payment Obligations:  Sky Petroleum paid to AKBN a signing bonus of $50,000 during the year ended December 31, 2011.

Production Bonuses:
 
$150,000 on start-up of production from the Contract Area
 
 
 
$250,000 when average daily crude oil production over any consecutive ninety-day period reaches fifteen thousand (15,000) Barrels of oil per day
 
 
 
$500,000 when average daily crude oil production over any consecutive ninety-day period reaches thirty thousand (30,000) Barrels of oil per day.

Notice of Arbitration

On November 4, 2011, AKBN delivered a letter to Sky Petroleum that was untranslated. Sky Petroleum received an English translation on November 9, 2011.  The AKBN letter alleged material breach of the PSC and providing notice of termination pursuant to Section 24.2(a) of the PSC.  AKBN alleges breaches for failures to commence its initial working program, deliver a bank guarantee, open an office in Albania and establish an Exploration Advisory Committee.  Section 24.2(a) of the PSC requires that AKBN provide 120 days notice prior to termination and provides that the PSC can be terminated only if Sky Petroleum has failed to commence to remedy such breach within a reasonable period of time.  Sky Petroleum is not in breach of any of these terms.  Management believes that the allegations are without merit and the letter was issued in bad faith.  Sky Petroleum responded to AKBN on November 10, 2011, and provided AKBN notice of its intent to institute an arbitration proceeding under the terms of the PSC against AKBN for breach of the PSC.

48



On November 18, 2011, Sky Petroleum's legal counsel delivered to the National Agency of Natural Resources of Albania notice that the alleged termination of the PSC was made in breach of the PSC and that Sky Petroleum intended to institute an arbitration proceeding in accordance with Article XXI of the PSC.
On December 23, 2011, Sky Petroleum delivered Notice of Arbitration under the Arbitration Rules of the United Nations Commission on Internal Trade Law to National Agency of Natural Resources and to the Ministry of Economy, Trade and Energy of Albania to institute an arbitration proceeding against the Ministry of Economy, Trade and Energy of Albania, acting by and through AKBN, for breach of the PSC in accordance with Article XXI of the PSC. The arbitration proceeding arises out of the alleged termination of the PSC in breach of the expressed termination provisions in Article 24 of the PSC.
Article XXI of the PSC provides that any dispute, controversy, claim or difference of opinion, arising out of or relating to the PSC or the breach, termination or validity of the PSC shall be finally and conclusively settled by arbitration in accordance with the UNCITRAL Arbitration Rules. The appointing authority for the arbitrators shall be the President of the Court of International Arbitration of the International Chamber of Commerce in Paris, France (the “Appointing Authority”).
Sky Petroleum is not in breach of any of its obligations under the PSC. Management believes that the allegations of AKBN are without merit.
The dispute will be arbitrated before a panel of three arbitrators ("Tribunal"), all of which have been appointed. The provisional budget as submitted by the Tribunal totals $350,000 (CHF 310,000).
Sky Petroleum is seeking the following relief:
an order that the PSC has not been validly terminated and that it remains in full force and effect; and
monetary damages that include, but are not limited to, the lost revenue due to Sky Petroleum under the terms of the PSC, estimated to be in excess of one billion dollars.

On January 10, 2012, Sky Petroleum filed a complaint (Case No.: A-12-CA-023-SS) with the United States District Court, Western District of Texas, Austin Division (the “Court”) for declaratory and injunctive relief against the Ministry of Economy, Trade, and Energy of Albania, acting by and through AKBN (collectively, the “Defendants”). The action for declaratory and injunctive relief under the Foreign Sovereign Immunities Act and the Albania-America Bilateral Investment Treaty sought to compel arbitration of the dispute between Sky Petroleum and the Defendants (collectively, the “Parties”) under the PSC and to preserve the status quo ante between the Parties pending completion of arbitration under the United Nations Commission on International Trade Law.
On January 19, 2012, Sky Petroleum, through legal counsel and a corporate representative, appeared before the Court to argue the merits of Sky Petroleum's Motion for Preliminary Injunction and on January 20, 2012, the Court delivered an Order and Preliminary Injunction (i) granting Sky Petroleum's preliminary injunction to maintain the status quo between the Parties pending arbitration, (ii) enjoining the Defendants and all persons acting in concert with them from awarding, transferring, or otherwise disposing of any rights to explore, develop and/or produce petroleum on the Contract Area until a final arbitration award is issued, (iii) ordering the Defendants to remove from their website or other publicly available documents all references to the Contract Area being “free” or otherwise available for new contractors until a final arbitration award is issued, and (iv) ordering the Parties to arbitrate their dispute with the United Nations Commission on International Trade Law according to the terms of the PSC. Additionally, the Court ordered that Sky Petroleum only be required to post a surety bond of $50,000 in lieu of the $500,000 surety bond that the Court had previously requested. On January 25, 2012, the Company deposited $50,000 to the Registry of the Court for the Austin Division of the United States District Court for a required surety bond related to the Order.
On February 28, 2012, Sky Petroleum petitioned the Albanian Appeal Court, Tirana, to seek to enforce the Order and Preliminary Injunction granted by the United States District Court, Western District of Texas, Austin Division. On March 1, 2012, the Appeal Court refused to recognize the Order in Albania.
Accordingly, Sky Petroleum intends to continue to vigorously pursue its rights and remedies against the Defendants under the mandatory arbitration provision in Article 21 of the PSC.
A Statement of Claim was filed with the Tribunal on April 24, 2012, by the Company.

On April 30, 2012, the Company paid approximately $112,000 (CHF 100,000) to the Tribunal for the first tranche of the provisional budget which are included in other current assets on the Consolidated Balance Sheets as of December 31, 2012. Both Sky and AKBN were required to pay the advances, however AKBN failed to deliver its portion of the advance. Subsequent to the year end, AKBN again failed to deliver its portion of the balance of the provisional budget, therefore the Company paid $238,000 (CHF 210,000) to the Tribunal.


49



A procedural calender was issued by the Tribunal for Arbitration proceedings. The Statement of Defense was filed by AKBN on June 22, 2012. Sky Petroleum filed its Statement of Reply on August 3, 2012. Sky Petroleum filed its Request for Documents in connection with the Arbitration on October 31, 2012.

Subsequent to December 31, 2012, the Arbitration took place before the Tribunal at the International Dispute Resolution Centre in London, UK between February 18th and February 22nd, 2013.  At the conclusion of the arbitration hearing, the Chairman of the Tribunal indicated the Tribunal expected to produce a written decision in three months.  

Sky Petroleum intends to continue to vigorously pursue its rights and remedies against the Defendants under the mandatory arbitration provision in Article 21 of the PSC.

The Company's investment in the Albania exploration blocks as of December 31, 2012, was $10,205,220. This investment consisted of acquisition costs related to the PSC totaling $50,000, and $850,000 for fees to consultants for locating and negotiating the Company's investment in the Albania exploration blocks; $265,220 for fees related to evaluations and assessments of the concession area, and $50,000 towards the $100,000 allocation for training and education for the first year exploration period. In addition, 3 million shares of common stock with a fair value of $1,170,000, plus 3,863,636 Preferred Shares Series B with a value of $7,820,000, were issued to Orsett for expertise provided to the Company in acquiring and negotiating the acquisition of oil and gas properties.
 
The Arbitration took place before the Tribunal at the International Dispute Resolution Centre in London, UK between February 18th and February 22nd, 2013.  At the conclusion of the arbitration hearing, the Chairman of the Tribunal indicated the Tribunal expected to produce a written decision in three months.  

Note 8 - Supplemental Financial Information for Oil and Gas Producing Activities (unaudited)

The Company follows the guidelines prescribed in ASC Topic No. 932 for computing a standardized measure of future net cash flows and changes therein relating to estimated proved reserves. Future cash inflows and future production and development costs are determined by applying prices and costs, including transportation, quality, and basis differentials, to the year-end estimated quantities of oil and gas to be produced in the future. The resulting future net cash flows are reduced to present value amounts by applying a ten percent annual discount factor. Future operating costs are determined based on estimates of expenditures to be incurred in producing the proved oil and gas reserves in place at the end of the period using year-end costs and assuming continuation of existing economic conditions, plus Company overhead incurred. Future development costs are determined based on estimates of capital expenditures to be incurred in developing proved oil and gas reserves.

The assumptions used to compute the standardized measure are those prescribed by the FASB and the SEC. These assumptions do not necessarily reflect the Company's expectations of actual revenues to be derived from those reserves, nor their present value. The limitations inherent in the reserve quantity estimation process, as discussed previously, are equally applicable to the standardized measure computations since these reserve quantity estimates are the basis for the valuation process. The Company emphasizes that reserve estimates are inherently imprecise and that estimates of new discoveries and undeveloped locations are more imprecise than estimates of established proved producing oil and gas properties. Accordingly, these estimates are expected to change as future information becomes available.

The were no producing wells as of December 31, 2012 or 2011, related to the Blocks Four, Five and Dumre in Albania.

Mubarek Field Operations:

The Company's operations are directly related to oil and gas producing activities located offshore in the Arabian Gulf off of the
coast of Sharjah, UAE.

Our proved oil reserves have been estimated by petroleum reserve engineers in Dubai as of December 31, 2008, whom were affiliated with the Company through a mutual director until May 2008. On December 31, 2009, Sastaro received written notice from Buttes that Buttes had unilaterally and solely determined that the Mubarek Field had reached the end of its economic life. Buttes also notified Sastaro that the Concession Agreement, dated December 29, 1969, between the His Highness Sheikh Sultan bin Mohamed Al-Qassimi III, The Ruler of Sharjah, UAE and Buttes with respect to the Mubarek Field was terminated. Buttes have stated that it handed over the Mubarek Field operations and facilities to representatives of His Highness Sheikh Sultan bin Mohamed Al-Qassimi III on December 28, 2009.

As a result of these events the investment in the wells was impaired to zero, and therefore, the Company did not obtain estimated petroleum reserves as of December 31, 2012 or 2011.


50



Capitalized Costs Relating to Oil and Gas Producing Activities:

 
 
2012
 
2011
Evaluated Properties:    
 
 
 
 
Mubarek K2-ST4 Well
 
$
13,173,901

 
 
$
13,173,901

 
Mubarek H2 Well
 
13,457,501
 
 
 
13,457,501
 
 
Accumulated Depletion
 
(11,163,034
)
)
 
(11,163,034
)
)
Impairment
 
(15,468,368
)
)
 
(15,468,368
)
)
Total
 
$

 
 
$

 

Costs Incurred in Oil and Gas Producing Activities:

For the Years Ended December 31:
 
2012
 
2011
Acquisition of proved properties
 
$

 
 
$

 
Acquisition of unproved properties-Albania project
 
 
 
 
 
 
Development costs
 
 
 
 
 
 
Exploration costs
 
 
 
 
90,000
 
 
Total Costs Incurred
 
$

 
 
$
90,000

 

Results of Operations from Oil and Gas Producing Activities:
 
 
 
 
 
 
 
 
 
 
 
Year Ended December 31,
 
 
2012
 
2011
Oil and gas revenues-Mubarek Field
 
$

 
 
$

 
Production costs-Mubarek Field
 
 
 
 
 
 
Exploration expenses
 
 
 
 
 
 
Depletion and depreciation
 
 
 
 
 
 
Impairment
 
 
 
 
 
 
Results of oil and gas producing operations before income taxes
 
 
 
 
 
 
Provision for income taxes
 
 
 
 
 
 
Results of Oil and Gas Producing Operations
 
$

 
 
$

 

Proved Developed and Undeveloped Reserves

Our proved oil reserves have been estimated by petroleum reserve engineers in Dubai as of December 31, 2008, whom were affiliated with the Company through a mutual director until May 2008. Proved reserves are the estimated quantities that geologic and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions. Proved developed reserves are the quantities expected to be recovered through existing wells with existing equipment and operating methods. Due to the inherent uncertainties and the limited nature of reservoir data, such estimates are subject to change as additional information becomes available. The reserves actually recovered and the timing of
production of these reserves may be substantially different from the original estimate. Revisions result primarily from new information obtained from development drilling and production history, and changes in economic factors.

There were no proved undeveloped or proved developed reserves as of December 31, 2011.

As of December 31, 2011, pursuant to the Participation Agreement, the Company is not liable for estimated well abandonment costs or net of salvage for the Mubarek field. Therefore, no abandonment costs are considered as part of the calculation of the full cost pool at December 31, 2011.

Price and cost revisions are primarily the net result of changes in year-end prices, based on beginning of year reserve estimates. Quantity estimate revisions are primarily the result of the extended economic life of proved reserves and proved undeveloped reserve additions attributable to increased development activity. The standardized measure of the Company's proved crude oil and

51



natural gas reserves at December 31, 2011 and 2010 is not provided as the wells were impaired to zero.

No income taxes have been provided above as future net cash flows are expected to be less than the Company's tax basis in the properties.

Changes in the Standardized Measure

There were no changes in the standardized measure of discounted future net cash flows for the years ended December 31, 2011 and 2010.

Note 9 - Subsequent Events

On January 8, 2013 the Company agreed to obtain loans through the offer of 8% Convertible Promissory Notes due January 8, 2014 (the “Notes”) in the aggregate amount of up to US$1,000,000 (the “Offering”). The Notes are convertible into shares of common shares of the Company (“Common Shares”) at a conversion price of US$0.25 per share (the “Conversion Price”) and interest on the Notes is payable in cash or, at the option of the Company, in-kind in Common Shares at the Conversion Price.

The Note proceeds will be primarily used for the development of the Production Sharing Contract (“PSC”) with respect to the three exploration blocks, Four, Five and Dumre and to pay certain fees, expenses and obligations in connection with the arbitration related to the dispute with the Ministry of Economy, Trade, and Energy of Albania, acting by and through AKBN regarding the Company's PSC.

On January 18, 2013 the Company entered into a Note Purchase Agreement with one accredited investor outside the United States in connection with the Notes, in the principal amount of US$150,000. The Notes are convertible into Common Shares at the Conversion Price and interest on the Notes is payable in cash or, at the option of the Company, in-kind in shares of common stock of the Company at the Conversion Price. The Note Purchase Agreement contained customary representations and warranties. The offer and sale of the Note is the first part of an offer of Notes outside the United States to raise up to US$1,000,000.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

There have been no disagreements between the Company and its accountants regarding any matter or accounting principles or practice or financial statement disclosures.


ITEM 9A. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

At the end of the period covered by this Annual Report an evaluation was carried out under the supervision of and with the participation of the Company’s management, including the Interim Chief Executive Officer (“CEO”) and Interim Chief Financial Officer (“CFO”), of the effectiveness of the design and operations of the Company’s disclosure controls and procedures (as defined in Rule 13a - 15(e) and Rule 15d - 15(e) under the Exchange Act). Based on that evaluation the CEO and CFO have concluded that the Company’s disclosure controls and procedures are adequately designed and effective in ensuring that: (i) information required to be disclosed by the Company in reports that it files or submits to the SEC under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in applicable rules and forms and (ii) material information required to be disclosed in our reports filed under the Exchange Act is accumulated and communicated to our management, including our CEO and CFO, as appropriate, to allow for accurate and timely decisions regarding required disclosure.

Management’s Report on Internal Control over Financial Reporting

The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation and fair presentation of financial statements for external purposes in accordance with generally accepted accounting principles.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness in 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.

52




Management conducted an evaluation of the design and operation of the Company’s internal control over financial reporting as of December 31, 2012 based on the criteria set forth in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. This evaluation included review of the documentation of controls, evaluation of the design effectiveness of controls, testing of the operating effectiveness of controls and a conclusion on this evaluation. Based on this evaluation, management has concluded that the Company’s internal control over financial reporting was effective as of December 31, 2012.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting identified in connection with the above-referenced evaluation by management of the effectiveness of our internal control over financial reporting that occurred during the fourth quarter ended December 31, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 
Attestation Report of the Registered Public Accounting Firm 

This Annual Report does not include an attestation report of the Company's independent registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to attestation by the Company's independent registered public accounting firm pursuant to Section 404(c) of the Sarbanes-Oxley Act.  Section 404(c) of the Sarbanes-Oxley Act exempts issuers that are neither accelerated filers nor large accelerated filers from the auditor attestation requirements of Section 404(b) of the Sarbanes-Oxley Act.  Accordingly the Company, as a smaller reporting company, is only required to provide management's report on internal control over financial reporting in this annual report.

ITEM 9B. OTHER INFORMATION
 
None.


53




PART III



ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE

The Company’s Board of Directors consists currently of four directors. Directors are elected for one-year terms and serve until their successors are elected and qualified. All of the executive officers of the Company are contractors of the Company. Executive officers of the Company are appointed for a one-year term and serve until their respective successors have been selected and qualified; provided, however, such officers are subject to removal at any time by the affirmative vote of a majority of the Board of Directors. The ages of the directors, executive officers and key employees are shown as of December 31, 2012.
Name
 
Position
 
Director/Officer
Since
 
Age
Michael D. Noonan(1)
 
Interim Chief Financial Officer, Vice President, Corporate, Secretary and Director
 
August 25, 2005
 
53
Shafiq Ur Rahman
 
Manager of Finance and Administration
 
May 29, 2006
 
60
Karim Jobanputra(3)
 
Director (Principal Executive Officer)
 
November 2, 2005
 
48
Robert Curt(2)
 
Director
 
July 31, 2009
 
61
Mark Rachovides(4)
 
Director
 
August 8, 2012
 
49

(1)
Mr. Noonan was appointed as director on November 16, 2005. Mr. Noonan was appointed Secretary effective May 30, 2006. Mr. Noonan was appointed Interim Chief Financial Officer on August 11, 2008.
(2)
Mr. Curt was appointed as director on July 31, 2009 pursuant to its powers under the Company’s bylaws to fill vacant seats on the Board.
(3)
Mr. Jobanputra was appointed Interim Chief Executive Officer on September 12, 2007 until his resignation on December 1, 2011. He continues to serve as a director and Chairman of the Board.
(4)
Mr. Rachovides was appointed as director on August 8, 2012, pursuant to its powers under the Company’s bylaws to fill vacant seats on the Board.
(5)

The following is a description of the principal occupations and other employment during the past five years and their directorships in certain companies of the directors of the Company. This information is as reported by the respective directors and executive officers.

Michael D. Noonan - Interim Chief Financial Officer, Vice President, Corporate Secretary and Director. Michael D. Noonan has been the Company’s Vice President, Corporate since August 25, 2005 and was appointed interim Chief Financial Officer on August 11, 2008, and was appointed as Corporate Secretary on April 19, 2006. Mr. Noonan has more than 20 years of corporate finance, corporate governance and investor relations experience. Prior to joining the Company, Mr. Noonan worked for Forgent Networks from May 2002 to February 2006, where he most recently served as the Senior Director of Investor Relations.  Prior to working at Forgent, Mr. Noonan was employed for two years from March 2000 to March 2002, by Pierpont Communications, an investor and public relations firm, where he was a Senior Vice President. Mr. Noonan has also served as director of investor relations and corporate communications at Integrated Electrical Services, an electrical services company, and manager of investor relations and public affairs for Sterling Chemicals, a manufacturer of commodity chemicals. He received a Bachelor of Business Administration degree in Business Administration and Economics from Simon Fraser University in British Columbia, Canada; a Master of Business Administration degree from Athabasca University in Alberta, Canada; and an Executive Juris Doctorate from Concord School of Law in Los Angeles, California.

Shafiq Ur Rahman - Manager of Finance and Administration. Shafiq  Rahman has more than 30 years experience in the oil and gas industry. Prior to joining the Company he served as Chief Accountant and Director of Finance and Administration for several companies, including in the past, Huston Oil and Minerals, Tenneco Oil, Lundin Oil (formerly International Petroleum Inc.), Arabex Petroleum, and Coplex Resources. From 1993-2003 Mr. Rahman worked as Chief Accountant to Resource Petrochemical Consultants. From October 2003- December 2005, Mr. Rahman was employed by Tanganyika Oil Company as Chief Accountant for its subsidiary Dublin International Petroleum (Syria). Mr. Rahman took an extended vacation prior to joining us on a part-time basis in February and full-time beginning in May of 2006. Mr. Rahman’s global experience includes working in various countries in the Middle East, North and West Africa, and Asia. Mr. Rahman has a Bachelor in Commerce degree from Karachi University.
 

54



Karim Jobanputra - Director/Principal Executive Officer. Karim Jobanputra is an entrepreneur and owns companies that do business mostly in the Middle East and Europe. Mr. Jobanputra has experience in the areas of corporate finance and international business development.  Mr. Jobanputra is an entrepreneur and dedicates less than 100% of his business efforts to the business of Sky.  Mr. Jobanputra has other business interests, some of which may be in the oil and gas industry, and serves on the board of directors and as an officer for private companies.  Mr. Jobanputra also works as a self-employed consultant based in the United Kingdom and has provided consulting services to companies in the areas of corporate finance and business development in the Asian and Middle East markets, including Indonesia, Qatar, Saudi Arabia, India and China.

Robert Curt – Director. Robert P. Curt has over thirty years of experience, primarily as an executive in marine transportation and supply related functions. He is currently a Director, Projects at Mallory, Jones, Lynch, Flynn and Assoc., an independent consultant to the marine industry. Mr. Curt retired from ExxonMobil in 2007 after assignments in a variety of positions up to and including General Manager Marine Transportation for ExxonMobil Refining & Supply Company and Managing Director, Qatar Gas Transport Company. He is also a Trustee of the US Merchant Marine Academy and a member of the American Bureau of Shipping’s Advisory Council and Nominating Committee and serves on the boards of two publicly traded shipping and ship building companies. Mr. Curt is a 1972 graduate of the U.S. Merchant Marine Academy and holds an MBA in Finance from Iona College.
 
Mark Rachovides - Director. Mark Rachovides is currently the Chairman of Deva Gold in Romania and is a well-known specialist in Eastern Europe and the Former Soviet Union (“FSU”) region. Mark served for over 11 years at the European Bank for Reconstruction and Development (“EBRD”). He is a member of Euromines Board and the Chairman of the Euromines Gold Group. Euromines is recognized as the representative body of the European metals and minerals mining industry. Previously he was Executive Vice President and Director of European Goldfields, a Gold Mining company listed in London and Toronto, as well as Vice President, Europe at Dundee Resources Limited. Mark has been involved in a wide variety of projects in Eastern Europe and the FSU. He was also a director of Uzhuralzoloto, one of Russia’s largest gold producers until recently and remains on the Board of Eurogas International, a company developing oil and gas projects in Tunisia. He has been involved with a number of public companies and natural resource projects in the region both as a company director and a financier. He has also written a number of articles and conference presentations for Euromines, the LBMA, the World Gold Council, PDAC, the Mining Journal, the Russia-Canada mining group and other bodies.

Relationships between Directors and Officers

None of our executive officers or directors or key employees are related by blood, marriage or adoption to any other director or executive officer.

Arrangements between Directors and Officers

To our knowledge, there is no arrangement or understanding between any of our officers and any other person pursuant to which the officer was selected to serve as an officer.

Legal Proceedings, Cease Trade Orders and Bankruptcy

As of the date of this Annual Report, no director or executive officer of the Company and no shareholder holding more than 5% of any class of voting securities in the Company, or any associate of any such director, officer or shareholder is a party adverse to the Company or any of our subsidiaries or has an interest adverse to the Company or any of our subsidiaries.

No director or executive officer of the Company is, as at the date of this Annual Report, or was within 10 years before the date of this Annual Report, a director, chief executive officer or chief financial officer of any company (including the Company), that:
 
(a)
was subject to a cease trade order, an order similar to a cease trade order or an order that denied the relevant company access to any exemption under securities legislation, for a period of more than 30 consecutive days, that was issued while the director or executive officer was acting in the capacity as director, chief executive officer or chief financial officer; or
(b)
was subject to a cease trade order, an order similar to a cease trade order or an order that denied the relevant company access to any exemption under securities legislation, for a period of more than 30 consecutive days, that was issued after the director or executive officer ceased to be a director, chief executive officer or chief financial officer and which resulted from an event that occurred while that person was acting in the capacity as director, chief executive officer or chief financial officer.


55



No director or executive officer of the Company, and no shareholder holding a sufficient number of securities of the Company to affect materially the control of the Company:
 
(a)
is, as at the date of this Annual Report, or has been within the 10 years before the date of this Annual Report, a director or executive officer of any company (including the Company) that, while that person was acting in that capacity, or within a year of that person ceasing to act in that capacity, became bankrupt, made a proposal under any legislation relating to bankruptcy or insolvency or was subject to or instituted any proceedings, arrangement or compromise with creditors or had a receiver, receiver manager or trustee appointed to hold its assets;
(b)
has, within 10 years before the date of this Annual Report, become bankrupt, made a proposal under any legislation relating to bankruptcy or insolvency, or become subject to or instituted any proceedings, arrangement or compromise with creditors, or had a receiver, receiver manager or trustee appointed to hold the assets of the director, executive officer or shareholder;
(c)
has, within 10 years before the date of this Annual Report, been the subject of, or a party to, any U.S. federal or state judicial or administrative order, judgment, decree, or finding, not subsequently reversed, suspended or vacated, relating to an alleged violation of: (i) any U.S. federal or state securities or commodities law or regulation; or (ii) any law or regulation respecting financial institutions or insurance companies including, but not limited to, a temporary or permanent injunction, order of disgorgement or restitution, civil money penalty or temporary or permanent cease-and-desist order, or removal or prohibition order; or (iii) any law or regulation prohibiting mail or wire fraud or fraud in connection with any business entity; or
(d)
has, within 10 years before the date of this Annual Report, been the subject of, or a party to, any sanction or order, not subsequently reversed, suspended or vacated, of any self-regulatory organization (as defined in Section 3(a)(26) of the Exchange Act (15 U.S.C.78c(a)(26))), any registered entity (as defined in Section 1(a)(29) of the Commodity Exchange Act (7 U.S.C.1(a)(29))), or any equivalent exchange, association, entity or organization that has disciplinary authority over its members or persons associated with a member.

No director or executive officer of the Company, and no shareholder holding a sufficient number of securities of the Company to affect materially the control of the Company has been subject to:
 
(a)
any penalties or sanctions imposed by a court relating to securities legislation or by a securities regulatory authority or has entered into a settlement agreement with a securities regulatory authority; or
(b)
any other penalties or sanctions imposed by a court or regulatory body that would likely be considered important to a reasonable investor in making an investment decision.

Corporate Governance

The Company’s Board of Directors is responsible for the Company’s Corporate Governance policies and has separately designated standing Compensation, Nominating, and Audit Committees. During 2012, the full Board handled the responsibilities of the designated committees until such time as qualified independent directors could be nominated and appointed to the Board and assigned to the committees. The Company’s Board determines independence based on the criteria for independence and un-relatedness prescribed by the Sarbanes-Oxley Act of 2002, and section 803A of the NYSE Amex Company Guide.

Compensation Committee

Compensation of the Company’s Chairman and other officers is recommended to the Board for determination by the Compensation Committee. The Compensation Committee develops reviews and monitors director and executive compensation and policies. The Compensation Committee is also responsible for annually reviewing the adequacy of compensation for directors and others and the composition of compensation packages. The Company’s Chairman cannot be present during the Committee’s deliberations or vote.

During 2012 the Compensation Committee had no members.  Accordingly, the members of the Company’s Board of Directors, as a whole, performed the functions and responsibilities of the Compensation Committee.

Nominating Committee

Nominees for the election to the Board of Directors are recommended by the Nominating Committee. The Company has adopted a formal written Board resolution addressing the nomination process and such related matters as may be required under federal securities laws. During 2012, the Corporate Governance and Nominating Committee had no members.  Accordingly, the members of the Company’s Board of Directors, as a whole, performed the functions and responsibilities of the Nominating Committee.


56



There have been no material changes to the procedures by which security holders may recommend nominees to the Company’s Board of Directors.

Audit Committee

The Company’s Audit Committee Charter designated an Audit Committee established in accordance with section 3(a)(58)(A) of the Exchange Act.

During 2012, the Company’s Audit Committee had no members.  Accordingly, the members of the Company’s Board of Directors, as a whole, performed the functions and responsibilities of the Audit Committee. The Company has not identified an independent financial expert our its Board of Directors.

Diversity of the Board

The Company does not have a formal policy regarding diversity in the selection of nominees for directors. The Board does however consider diversity as part of its overall selection strategy. In considering diversity of the Board as a criteria for selecting nominees, the Corporate Board takes into account various factors and perspectives, including differences of viewpoint, professional experience, education, skills and other individual qualities and attributes that contribute to Board heterogeneity, as well as race, gender and national origin. The Board seeks persons with leadership experience in a variety of contexts and, among public company leaders, across a variety of industries. The Board believes that this expansive conceptualization of diversity is the most effective means to implement Board diversity. The Board will assess the effectiveness of this approach as part of its annual assessment of the performance of the Board.

Code of Ethics

We have adopted a corporate code of ethics administered by our corporate secretary, Michael D. Noonan. We believe our code of ethics is reasonably designed to deter wrongdoing and promote honest and ethical conduct, to provide full, fair, accurate, timely and understandable disclosure in public reports, to comply with applicable laws, to ensure prompt internal reporting of code violations, and to provide accountability for adherence to the code. Our code of ethics provides written standards that are reasonably designed to deter wrongdoing and to promote:
Honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships;
Full, fair, accurate, timely and understandable disclosure in reports and documents that are filed with, or submitted to, the Commission and in other public communications made by an issuer;
Compliance with applicable governmental laws, rules and regulations;
The prompt internal reporting of violations of the code to an appropriate person or persons identified in the code; and
Accountability for adherence to the code.

Our Code of Ethics is available at our website at www.skypetroleum.com. We intend to disclose any waiver from a provision of our code of ethics that applies to any of our principal executive officer, principal financial officer, principal accounting officer or controller or persons performing similar functions that relates to any element of our code of ethics on our website. No waivers were granted from the requirements of our Code of Ethics during the year ended December 31, 2012, or during the subsequent period from January 1, 2013, through the date of this Annual Report.

Section 16(a) Beneficial Ownership Reporting Compliance

Section 16(a) of the Exchange Act, as amended, requires the Company’s officers, directors, and persons who beneficially own more than 10% of the Company’s common stock (“10% stockholders”), to file reports of ownership and changes in ownership with the SEC. Such officers, directors and 10% stockholders are also required by SEC rules to furnish us with copies of all Section 16(a) forms that they file. Based solely upon our review of the copies of such forms received by us, or written representations from certain reporting persons, we believe that all of these filing requirements were satisfied by our officers, directors, and 10% stockholders in fiscal 2012.


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ITEM 11. EXECUTIVE COMPENSATION

A summary of cash and other compensation paid in accordance with management consulting contracts for our Principal Executive Officer and other executives for the fiscal year ended December 31, 2012 is as follows:
Name and
 
Year
 
Salary
 
Bonus
 
Stock Awards
 
Option
Awards
 
Non-Equity
Incentive Plan
 
Nonqualified Deferred
 
All other
 
Total
Principal Position
 
 
 
 
 
 
 
 
 
 
 
Compensation
 
Compensation Earnings
 
Comp.
 
 
 
 
 
 
($)
 
($)
 
($)
 
($)
 
($)
 
($)
 
($)
 
($)
(a)
 
(b)
 
(c)
 
(d)
 
(e)
 
(f)
 
(g)
 
(h)
 
(i)
 
(j)
Michael D. Noonan
Corporate Secretary, Vice President Corporate, and Director(1)
 
2012 2011
 
  72,500 152,400
 
 
 
 
 
 
 
 
 
 
 
 
 
72,500 152,400
Tobias Gondorf Interim Chief Executive Officer
 
2012 2011 
 
60,000 15,000
 
 
 
 
 
 
 
 
 
 
 
 
 
60,000 15,000
Karim Jobanputra
Chairman and Director(2)
 
2012 2011
 
    7,500 266,400
 
 
 
 
 
 
 
 
 
 
 
 
 
    7,500 266,400
Shafiq Ur Rahman
Manager of Finance and Admin (3)
 
2012 2011
 
83,840 107,844
 
 
 
 
 
 
 
 
 
 
 
 
 
83,840 107,884

(1)
Includes $120,000 paid in consulting fees for services as VP Corporate, Corporate Secretary, and $30,000 in director fees. As of December 31, 2012 the amount due to Mr. Noonan in deferred and unpaid fees was $77,500
(2)
Mr. Jobanputra received $19,500 per month in compensation for his services as Chief Executive Officer for eleven months in 2011 and includes $30,000 in director fees. Mr. Jobanputra did not receive compensation for services in 2012 and $7,500 in directors fees. As of December 31, 2012 the amount due to Mr. Jobanputra is $22,500.
(3)
As of December 31, 2012 the amount due to Mr. Rahman was $24,000.

Executive Compensation Agreements and Summary of Executive Compensation

Report of the Board of Directors on Executive Compensation

During the year ended December 31, 2012, our Board of Directors was responsible for establishing compensation policy and administering the compensation programs of our executive officers.

The amount of compensation paid by us to each of our directors and officers and the terms of those persons’ employment is determined solely by the Board of Directors. We believe that the compensation paid to its directors and officers is fair to the Company.

The Board of Directors reviewed the compensation and benefits of all our executive officers and established and reviewed general policies relating to compensation and benefits of our employees. Directors do not participate in approving or authorizing their own salaries as executive officers.

Our Board of Directors believes that the use of direct stock awards is at times appropriate for employees, and in the future intends to use direct stock awards to reward outstanding service or to attract and retain individuals with exceptional talent and credentials.

58



The use of stock options and other awards is intended to strengthen the alignment of interests of executive officers and other key employees with those of our stockholders.

Appointment and Resignation of Karim Jobanputra - Director/Principal Executive Officer

Mr. Karim Jobanputra was appointed as our Chief Executive Officer on September 5, 2007. On November 22, 2011 Karim Jobanputra submitted his resignation as CEO of the Company, effective December 1, 2011. Mr. Jobanputra's resignation was not the result of any disputes, claims or issues with the Company. Mr. Jobanputra will continue serving the Company as Chairman of the Board of Directors and Principal Executive Officer.

Consulting Agreement with Michael Noonan - Interim Chief Financial Officer and Corporate Secretary

In connection with the appointment of Mr. Michael Noonan as our Vice President Corporate on August 25, 2005, we entered into an Independent Contractor Services Agreement, subsequently amended, and a Confidentiality Agreement for the services of Mr. Noonan as our Vice President, Corporate.  We entered into a new Independent Contractor Services Agreement, as amended for the services of Mr. Noonan as our Vice President Corporate effective February 1, 2009.  Under these agreements, Mr. Noonan serves as our Vice President Corporate at a consulting fee of $10,000 per month until the Independent Contractor Services Agreement is terminated by either party. Under the terms of the Confidentiality Agreement, Mr. Noonan is prohibited from disclosing certain confidential information with respect to Sky Petroleum for a period of five years following the termination of the Independent Contractor Services Agreement. 

On April 19, 2006, the Board of Directors appointed Michael Noonan to become Secretary to the Company following the resignation of Daniel Meyer from that office. During the transition period from April 19, 2006 to May 30, 2006, Mr. Noonan aided Mr. Meyer and the Company in carrying out the rights and responsibilities of the office. Following the end of the transition period, Mr. Meyer’s resignation was approved by the Board, effective May 30, 2006. On May 30, 2006, the Board approved the appointment of Mr. Noonan to the office of Secretary to the Company and ratified and approved all previous actions taken by Mr. Noonan with respect to the rights and responsibilities of the office. Mr. Noonan continues to serve as Vice President, Corporate, a position he had held since August 25, 2005, and Director, to which he was appointed November 16, 2005. Mr. Noonan was appointed Interim Chief Financial Officer on August 11, 2008.

Appointment of Shafiq Ur Rahman - Manager of Finance and Administration

Mr. Rahman was appointed Manager of Finances and Administration and the Principal Financial and Accounting Officer to the Company, effective May 29, 2006. Mr. Rahman currently works as a consultant for the Company at a fixed rate of $6,000 per month and an educational stipend of approximately $8,962 per quarter. We have no written agreement with Mr. Rahman in connection with this consulting arrangement.


59



Equity Awards

The following table sets forth certain information concerning our outstanding options for our named executive officers and directors at December 31, 2012. Under our U.S. and non-U.S. Employee Stock Option Plans there is 1/3 vesting on the first anniversary of the grant and 1/3 vested each anniversary thereafter with terms between 7 and 10 years.

Option Awards
Stock Awards
Name
Number of Securities Underlying Unexercised Options(1)
(#) Exercisable

Number of Securities Underlying Unexercised Options
(#) Unexercisable
Equity Incentive Plan Awards: Number of Securities Unexercised Unearned Options 
(#)
Option Exercise Price
($)
Option Expiration Date
Number of Shares or Units of Stock That Have Not Vested
(#)
Market Value of Shares or Units of Stock That Have Not Vested
($)
Equity Incentive Plan Awards: Number of Unearned Shares, Units or Other Rights That Have Not Vested
(#)
Equity Incentive Plan Awards: Market or Payout Value of Unearned Shares, Units or Other Rights That Have Not Vested
($)
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
(j)
Michael D. Noonan
600,000

 
 
1.29

9/28/2015
 
 
 
 
 
50,000

100,000

 
0.18

6/28/2020
 

 
 
Tobias Gondorf
 
250,000

 
0.25

12/1/2018
 

 
 
Shafiq Ur Rahman
50,000

100,000

 
0.18

6/28/2017
 
 
 
 
Karim Jobanputra
100,000

200,000

 
0.18

6/28/2017
 
 
 
 
Robert Curt
100,000

50,000

 
0.50

8/17/2016
 
 
 
 
 
16,667

33,333

 
0.18

6/28/2020
 
 
 
 
Oliver J Whittle
50,000

 
 
0.50

8/17/2017
 
 
 
 
Mark Rachovides
 
300,000

 
0.25

8/8/2019
 
 
 
 


Director Compensation Agreements and Summary of Director Compensation Policies

Board Compensation

On January 11, 2006, our Board of Directors approved a compensation plan, effective November 16, 2005, pursuant to which each director would receive the following compensation:

annual director fees of $30,000 per year, payable quarterly in arrears;
director compensation options consisting of between 150,000 and 300,000 options exercisable to acquire shares of common stock between $0.25 and $1.00 per share for non-U.S. directors and at fair market value on the date of grant for U.S. directors;
meeting fees of $1,200 per meeting and $600 per teleconference meeting, including committee meetings; and
reimbursement of expenses related to service in the capacity of a member of the Board.

Compensation Interlocks and Insider Participation

There were no compensation committee or board interlocks among the members of our Board of Directors.


60



ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERS MATTERS

The following table sets forth certain information regarding the beneficial ownership of shares of our common stock as of March 29, 2013, by each person who is known by us to beneficially own more than 5% of our issued and outstanding shares of common stock; our named executive officers; our directors; and all of our executive officers and directors as a group.

Name of Stockholder
 
Address
 
Amount and Nature of
Beneficial Ownership
 
Percent of Class
Directors and Officers:
 
 
 
 
 
 
Michael Noonan, Interim Chief Financial Officer,
Vice President, Corporate, Director
 
401 Congress Avenue
Suite 1540
Austin, Texas USA 78701
 
314,687

 
0.01
%
Karim Jobanputra, Chairman, Director
 
P.O. Box 82
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