-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, VlS9qwEYe3NNpKdZ4B6Zh+qIWjPdUa1vfWy5TtgmACtBz+D6sidTwYawDzls7mNr dXm3dMdlfRdJDq9Fv9wTQw== 0000950150-99-000709.txt : 19990520 0000950150-99-000709.hdr.sgml : 19990520 ACCESSION NUMBER: 0000950150-99-000709 CONFORMED SUBMISSION TYPE: S-1/A PUBLIC DOCUMENT COUNT: 7 FILED AS OF DATE: 19990519 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CANARGO ENERGY CORP CENTRAL INDEX KEY: 0000310316 STANDARD INDUSTRIAL CLASSIFICATION: CRUDE PETROLEUM & NATURAL GAS [1311] IRS NUMBER: 910881481 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-1/A SEC ACT: SEC FILE NUMBER: 333-72295 FILM NUMBER: 99630130 BUSINESS ADDRESS: STREET 1: 1400 BROADFIELD BLVD STREET 2: SUITE 100 CITY: HOUSTON STATE: TX ZIP: 77084-5163 BUSINESS PHONE: 7134926992 MAIL ADDRESS: STREET 1: 1400 BROADFIELD BLVD STREET 2: SUITE 100 CITY: HOUSTON STATE: TX ZIP: 777084-516 FORMER COMPANY: FORMER CONFORMED NAME: FOUNTAIN OIL INC DATE OF NAME CHANGE: 19950119 FORMER COMPANY: FORMER CONFORMED NAME: ELECTROMAGNETIC OIL RECOVERY INC DATE OF NAME CHANGE: 19920703 FORMER COMPANY: FORMER CONFORMED NAME: ORS CORP /OK/ DATE OF NAME CHANGE: 19910515 S-1/A 1 AMENDMENT #1 TO FORM S-1 1 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MAY 19, 1999 FILE NO. 333-72295 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------------------ Amendment No. 1 to Form S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 ------------------------------------ CANARGO ENERGY CORPORATION (Exact name of Registrant as specified in its charter) DELAWARE 1311 91-0881481 (State or other jurisdiction of (Primary Standard Industrial (IRS Employer Identification incorporation or organization) Classification Code Number) No.)
SUITE 1580, 727 - 7TH AVENUE S.W., CALGARY, ALBERTA T2P 0Z5 TELEPHONE (403) 777-1185 (Address and telephone number of principal executive offices) ------------------------------------ SUSAN E. PALMER CANARGO ENERGY CORPORATION 1400 BROADFIELD BOULEVARD, SUITE 100, HOUSTON, TEXAS 77084 TELEPHONE (281) 492-6992 (Name, address and telephone number of agent for service) ------------------------------------ Please forward a copy of all correspondence to: ALAN D. JACOBSON, ESQ. KELLY LYTTON MINTZ & VANN LLP 1900 AVENUE OF THE STARS, SUITE 1450, LOS ANGELES, CALIFORNIA 90067 TELEPHONE (310) 277-5333 ------------------------------------ Approximate date of commencement of proposed sale to the public: As soon as practicable after this Registration Statement becomes effective. If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. [X] If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If this form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration for the same offering. [ ] If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. [ ] ------------------------------------ The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 SUBJECT TO COMPLETION, DATED MAY 19, 1999 The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state or jurisdiction where the offer or sale is not permitted. CANARGO ENERGY CORPORATION COMMON STOCK MINIMUM -- 10,000,000 SHARES MAXIMUM -- 21,264,643 SHARES CanArgo Energy Corporation is offering a minimum of 10,000,000 shares and a maximum of 21,264,643 shares of its common stock at a price of $ per share. The common stock is traded in the over-the-counter market (symbol: GUSH). On May 12, 1999, the high and low bid prices of the common stock on the OTC Bulletin Board were $0.25 and $0.25 per share, respectively. The common stock is also traded on the Oslo Stock Exchange (symbol: CNR). YOU SHOULD CAREFULLY CONSIDER THE INFORMATION REGARDING RISKS ASSOCIATED WITH A PURCHASE OF THE COMMON STOCK THAT ARE DESCRIBED UNDER THE CAPTION "RISK FACTORS" BEGINNING ON PAGE 6.
PROCEEDS TO PRICE SALES CANARGO TO PUBLIC COMMISSIONS BEFORE EXPENSES ----------------- ----------------- ----------------- Per Share................................. $ $ $ Minimum Offering: 10,000,000 shares....... $ $ $ Maximum Offering: 21,264,643 shares....... $ $ $
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY OTHER REGULATORY BODY HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE ADEQUACY OR ACCURACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. All subscription payments will be deposited into an escrow account and no funds will be disbursed to CanArgo until at least 10,000,000 shares are sold. If the minimum number of shares is not sold by the termination of the offering, all proceeds deposited in the escrow account will be promptly refunded to subscribers in full, without interest and without any deduction of any kind. CanArgo will accord priority to subscriptions received by , 1999, from existing holders of CanArgo common stock and of exchangeable shares issued by CanArgo's subsidiary, CanArgo Oil & Gas Inc., who are located in jurisdictions in which this offering may be made. Each holder will have the priority right to purchase a number of shares in the offering up to the number of shares held of record on the third business day after the date of this prospectus. The minimum subscription is 1,000 shares, unless the subscriber is an existing holder who is subscribing for a number of shares that does not exceed the number of shares owned of record on the third business day after the date of this prospectus. The offering will terminate on the earliest of (a) the date that all the shares are sold; (b) June 30, 1999, unless CanArgo extends this date to not later than August 6, 1999; or (c) the date CanArgo terminates the offering. PROSPECTUS DATED , 1999 3 You should rely only on the information contained in this prospectus. We have not authorized anyone to provide you with information that is different. The information in this prospectus is current only as of the date of this prospectus, regardless of the time this prospectus is delivered to you or the time you purchase the common stock. This information could change and be different as of a later date. This prospectus is not an offer to sell, nor is it seeking an offer to buy, the common stock in any jurisdiction where the offer or sale is not permitted. TABLE OF CONTENTS
PAGE ---- Summary..................................................... 3 Risk Factors................................................ 6 Forward-looking Statements.................................. 14 The Offering................................................ 16 Use of Proceeds............................................. 20 Market for Common Stock and Dividend Policy................. 21 Capitalization.............................................. 24 Selected Consolidated Financial Data........................ 25 Management's Discussion and Analysis of Financial Condition and Results of Operations................................. 26 Business.................................................... 38 Management.................................................. 55 Related Transactions........................................ 62 Ownership of Voting Securities.............................. 64 Description of Capital Stock................................ 68 Shares Eligible for Future Resale........................... 71 Legal Matters............................................... 72 Experts..................................................... 72 Available Information....................................... 73 Index to Financial Statements............................... 74
2 4 SUMMARY This summary highlights information contained elsewhere in this prospectus. This summary is not complete and does not contain all of the information that you should consider before investing in the common stock. You should read the entire prospectus carefully. Unless otherwise indicated by the context, the term "CanArgo" refers to CanArgo Energy Corporation and its consolidated subsidiaries. All share and per share amounts in this prospectus have been adjusted to reflect a 1-for-2 reverse stock split of CanArgo's common stock effected in July 1998. THE COMPANY CanArgo Energy Corporation, a Delaware corporation, is an oil and gas exploration and production company that owns interests in oil and gas properties located in the Republic of Georgia and elsewhere in Eastern Europe. CanArgo's principal activity involves the rehabilitation and development of oil and gas fields with a productive history that indicate the potential for increased production through the application of modern production techniques. CanArgo is producing crude oil at the Ninotsminda field in Georgia through a 68.5% owned subsidiary, Ninotsminda Oil Company Limited. CanArgo is currently directing most of its efforts and resources to the development of the Ninotsminda field and needs the proceeds of this offering to continue that development. To the extent that it has the financial and other resources to do so, CanArgo intends to rehabilitate and develop, or engage in exploratory drilling on, other oil and gas fields in which it has an interest. CanArgo's principal executive offices are located at Suite 1580, Guinness House, 727 - 7th Avenue, S.W., Calgary, Alberta, Canada T2P 0Z5, and its telephone number is (403) 777-1185. THE OFFERING MINIMUM OFFERING............. 10,000,000 shares, or $3,000,000 based on an assumed offering price of $0.30 per share. MAXIMUM OFFERING............. 21,264,643 shares, or $6,379,393 based on an assumed offering price of $0.30 per share. PRIORITY TO EXISTING STOCKHOLDERS................. CanArgo will accord priority to subscriptions received by , 1999, from existing holders of CanArgo common stock and CanArgo Oil & Gas Inc. exchangeable shares who are located in jurisdictions in which this offering may be made. Each holder will have the priority right to purchase a number of shares in the offering up to the number of shares held of record on the third business day after the date of this prospectus. SHARES OF COMMON STOCK TO BE OUTSTANDING AFTER THIS OFFERING, BASED ON SHARES OUTSTANDING AT APRIL 30, 1999......................... Minimum offering: 29,526,324 shares Maximum offering: 40,790,967 shares 3 5 ESCROW ACCOUNT............... All subscription payments will be deposited into an escrow account, and no funds will be disbursed to CanArgo until the minimum number of shares is sold. OFFERING PERIOD.............. The offering will terminate on the earliest of: - the sale of all shares offered; - June 30, 1999 or, if extended, not later than August 6, 1999; or - the date CanArgo terminates the offering. USE OF PROCEEDS.............. CanArgo will use the net proceeds of the offering to make a $2,000,000 loan to Ninotsminda Oil Company to be used to develop the Ninotsminda field and as general working capital. OTC BULLETIN BOARD SYMBOL.... GUSH OSLO STOCK EXCHANGE SYMBOL... CNR RISKS........................ An investment in the common stock is very risky. CanArgo has experienced significant losses and has generated minimal revenues. CanArgo needs the proceeds of this offering to continue development of the Ninotsminda field and to develop its other oil and gas properties. Numerous other risks are associated with an investment in CanArgo common stock. You should carefully consider the risks that are detailed under "Risk Factors" beginning at page 6. SUMMARY CONSOLIDATED FINANCIAL DATA Since 1994, CanArgo's operations have generated minimal revenues and CanArgo has had substantial operating losses. The following table summarizes CanArgo's operating results for the year ended December 31, 1998 and the quarter ended March 31, 1999. On July 15, 1998, CanArgo acquired CanArgo Oil and Gas Inc., which owns 68.5% of Ninotsminda Oil Company, and the operating results of those subsidiaries are included from that date.
YEAR ENDED QUARTER ENDED DECEMBER 31, 1998 MARCH 31, 1999 ----------------- -------------- (UNAUDITED) Revenues....................................... $ 820,952 $ 113,667 Operating loss................................. (6,487,758) (926,330) Net loss....................................... (6,110,323) (971,223) Net loss per common share...................... (0.39) (0.05)
4 6 The following table summarizes CanArgo's balance sheet at March 31, 1999 on an actual basis and as adjusted to reflect (a) the sale of a minimum of 10,000,000 shares and a maximum of 21,264,643 shares of common stock at an assumed offering price of $0.30 per share, after deducting estimated sales commissions and offering expenses, and (b) the full disbursement of a $6,000,000 loan to Ninotsminda Oil Company. This loan and $2,000,000 of the net proceeds are treated as restricted funds because they may only be used for the development of the Ninotsminda oil field.
MARCH 31, 1999 ----------------------------------------- AS ADJUSTED -------------------------- MINIMUM MAXIMUM ACTUAL OFFERING OFFERING ----------- ----------- ----------- Working capital (deficit)............ $ (744,161) $ (294,161) $ 2,747,293 Restricted funds..................... -- 8,000,000 8,000,000 Total assets......................... 46,317,321 54,767,321 57,808,775 Long-term debt....................... -- 6,000,000 6,000,000 Minority interest in subsidiaries.... 4,464,698 4,464,698 4,464,698 Total stockholders' equity........... 39,169,710 41,619,710 44,661,164
The consolidated financial data summarized above is further explained in the sections "Use of Proceeds," "Capitalization," "Selected Consolidated Financial Data," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Notes to Consolidated Financial Statements." 5 7 RISK FACTORS This offering involves a high degree of risk. You should carefully consider the risks described below, as well as all other information in this prospectus, before investing in CanArgo common stock. This prospectus contains forward-looking statements that involve risks and uncertainties. Future events and CanArgo's actual results could differ materially from those anticipated in these forward-looking statements. Some of the important factors that might cause such a difference are discussed in the various risk factors that follow and in the "Forward-Looking Statements" section of this prospectus. CANARGO HAS NOT YET ESTABLISHED PROFITABLE OPERATIONS. CanArgo has limited experience as an oil and gas production company. During the few years that CanArgo has been an oil and gas production company, its oil and gas properties have produced minimal revenues, which have been far exceeded by its expenses. As a result, CanArgo has experienced recurring operating losses, and its operations have not generated and are not generating positive cash flows. During 1998, CanArgo had revenues of $821,000 and a net loss of $6,110,000, and in the three months ended March 31, 1999, CanArgo had revenues of $113,700 and a net loss of $971,000. CanArgo has not yet operated profitably. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" for an explanation of CanArgo's operating results. TO CONTINUE OPERATING, CANARGO REQUIRES EXTERNAL FINANCING IMMEDIATELY AND THEN MUST ESTABLISH A PROFITABLE BUSINESS WITH POSITIVE CASH FLOW. CanArgo is required to provide or arrange for all capital and operating financing for its principal oil and gas properties. CanArgo had negative working capital at March 31, 1999, when current liabilities exceeded current assets by $744,000. As a result, unless CanArgo is able to obtain funds from outside sources and generate positive cash flows from its operations, CanArgo will not be able to continue its operations. CanArgo needs the proceeds of this offering to continue its planned operations significantly beyond June 30, 1999. To enable Ninotsminda Oil Company Limited, a majority-owned subsidiary of CanArgo, to receive funding of a $6,000,000 loan from the International Finance Corporation to finance development of the Ninotsminda oil field, CanArgo must make a $2,000,000 subordinated loan to Ninotsminda Oil Company and satisfy various other conditions. If that subordinated loan is not made by June 30, 1999, the IFC may terminate its loan commitment. CanArgo is conducting this offering in order to raise the funds to make the $2,000,000 subordinated loan and to generate additional working capital, as described under "Use of Proceeds." If CanArgo is unable to make the $2,000,000 loan, it may be unable to continue with the development of the Ninotsminda oil field. For a discussion of CanArgo's financial condition, liquidity and capital requirements, see "Management's Discussion and Analysis of Financial Condition and Results of Operations." CANARGO'S FINANCIAL STATEMENTS ASSUME CONTINUED OPERATIONS. CanArgo's financial statements are prepared on the assumption that it will continue to operate despite its need for external financing and its negative cash flows. As a result, the financial statements do not reflect the reduction in the value of CanArgo's assets that would be expected if CanArgo were to cease operations. The report of CanArgo's 6 8 independent accountants on CanArgo's consolidated financial statements for the year ended December 31, 1998 is qualified with respect to this assumption. For an expanded discussion of the going concern assumption that was made in connection with the preparation of CanArgo's financial statements, see Note 3 of "Notes to Consolidated Financial Statements." CANARGO'S FUTURE IS DEPENDENT ON THE SUCCESS OF THE NINOTSMINDA OIL FIELD. CanArgo is directing substantially all of its efforts and most of its available funds to the development of the Ninotsminda oil field in the Republic of Georgia and some ancillary activities closely related to the Ninotsminda field project. This decision is based on management's assessment of the promise of the Ninotsminda field. However, CanArgo cannot assure investors that its development plans for the Ninotsminda field will be successful. For example, the Ninotsminda field may not produce sufficient quantities of oil and gas to justify the investment CanArgo has made and is making in that field, and CanArgo may not be able to produce the oil and gas at a sufficiently low cost or to market the oil and gas produced at a sufficiently high price to generate a positive cash flow and a profit. See "Business -- Ninotsminda Oil Field" for a description of this development project. CANARGO'S INTEREST IN THE NINOTSMINDA FIELD COULD BE FORFEITED OR REDUCED. CanArgo currently owns 68.5% of Ninotsminda Oil Company, which has the rights to develop and produce oil and gas from the Ninotsminda field. If the International Finance Corporation makes a $6,000,000 loan to Ninotsminda Oil Company, it will have the right to convert all or part of that loan into common shares of Ninotsminda Oil Company. If the IFC were to convert all of the loan, CanArgo's interest in Ninotsminda Oil Company would be reduced from 68.5% to 54.8%. As a result, CanArgo's share in the profits, if any, generated by Ninotsminda Oil Company would be reduced. In addition, Ninotsminda Oil Company has pledged substantially all of its assets to secure the loan it expects to receive from International Finance Corporation, and CanArgo has pledged all of the shares it owns in Ninotsminda Oil Company to secure its guaranty of the repayment of a significant portion of the $6 million IFC loan. If Ninotsminda Oil Company is unable to repay its loan from the IFC, it may have to transfer its interest in the Ninotsminda field to the IFC, in which case CanArgo would lose its interest in the Ninotsminda field. Likewise, if CanArgo is called upon to satisfy its guaranty and is unable to do so, CanArgo could lose all or a portion of its stock ownership interest in Ninotsminda Oil Company. See "Business -- Ninotsminda Oil Field -- International Finance Corporation Loan" for a discussion of the principal terms of the IFC loan. CANARGO COULD BE REQUIRED TO PURCHASE NINOTSMINDA OIL COMPANY SHARES AT PRICES IN EXCESS OF FAIR MARKET VALUE. In the event the International Finance Corporation converts all or a portion of its loan to Ninotsminda Oil Company into shares of Ninotsminda Oil Company stock, it will have the right for a period that could extend until 2007 to require CanArgo to purchase a portion of those shares at a formula price. That price could exceed the fair market value of the shares at the time CanArgo is required to purchase the shares. See "Business -- Ninotsminda Oil Field -- International Finance Corporation Loan" for a more detailed discussion of CanArgo's purchase obligation. 7 9 CANARGO COULD BE REQUIRED TO WRITE OFF THE VALUE OF UNSUCCESSFUL PROPERTIES AND PROJECTS. In order to realize the carrying value of its oil and gas properties and ventures, CanArgo must produce oil and gas in sufficient quantities and then sell such oil and gas at sufficient prices to produce a profit. CanArgo has a number of unevaluated oil and gas properties and interests in ventures with similar properties having carrying values totaling $18,990,000 at March 31, 1999, that it has not actively developed. The risks associated with successfully developing unevaluated oil and gas properties are even greater than those associated with successfully continuing development of producing oil and gas properties, since the existence and extent of commercial quantities of oil and gas in unevaluated properties have not been established. During 1997, CanArgo recorded impairment charges totaling $19.4 million relating to three unsuccessful ventures. CanArgo could be required in the future to write off its investments in additional projects, including the Ninotsminda field project, if such projects prove to be unsuccessful. CANARGO MAY NOT BE ABLE TO RAISE THE ADDITIONAL FUNDS IT NEEDS FOR ITS LONG-TERM OIL AND GAS DEVELOPMENT PLANS. It will take many years and substantial cash expenditures to develop fully CanArgo's oil and gas properties. CanArgo generally has the principal responsibility to provide financing for its oil and gas properties and ventures. The minimum net proceeds of this offering, together with financing from the International Finance Corporation and funds expected to be generated by operations and the sale of assets not central to CanArgo's business plan, are expected to be sufficient to fund CanArgo's operations and current development plan for the Ninotsminda field only until mid-2000. Thereafter, CanArgo estimates that full development of the Ninotsminda oil field over an additional two to three year period will cost an additional $16,000,000. Accordingly, CanArgo may need to raise additional funds from outside sources in order to pay for project development costs beyond those currently budgeted through mid-2000. CanArgo may not be able to obtain that additional financing. If adequate funds are not available, CanArgo will be required to scale back or even suspend its operations. CANARGO'S OIL AND GAS ACTIVITIES INVOLVE RISKS, MANY OF WHICH ARE BEYOND ITS CONTROL. CanArgo's exploration, development and production activities are subject to a number of factors and risks, many of which may be beyond CanArgo's control. First, CanArgo must successfully identify commercial quantities of oil and gas. The development of an oil and gas deposit can be affected by a number of factors which are beyond the operator's control, such as: - - Unexpected or unusual geological conditions. - - The recoverability of the oil and gas on an economic basis. - - The availability of infrastructure and personnel to support operations. - - Local and global oil prices. - - Government regulation. CanArgo's activities can also be affected by a number of hazards, such as: - - Labor disputes. 8 10 - - Natural phenomena, such as bad weather and earthquakes. - - Operating hazards, such as fires, explosions, blow-outs, pipe failures and casing collapses. - - Environmental hazards, such as oil spills, gas leaks, ruptures and discharges of toxic gases. Any of these hazards could result in damage, losses or liability for CanArgo. CanArgo experiences an increased risk of some of these hazards in connection with operations that involve the rehabilitation of fields where less than optimal practices and technology were employed in the past, as was often the case in Eastern Europe. CanArgo does not purchase insurance covering all of the risks and hazards that are involved in oil and gas exploration, development and production. THE DEVELOPMENT OF CANARGO'S PROPERTIES IS AFFECTED BY CONDITIONS IN EASTERN EUROPE. CanArgo's principal oil and gas properties, including the Ninotsminda field, are located in Eastern Europe. Development of these fields is subject to a number of conditions endemic to Eastern European countries, including: - - POLITICAL INSTABILITY -- The present governmental arrangements in the Eastern European countries in which CanArgo operates were established relatively recently, when they replaced Communist regimes. If they fail to maintain the support of their citizens, these governments could themselves be replaced by other institutions, including a possible reversion to a totalitarian form of government. CanArgo's operations typically involve joint ventures or other participatory arrangements with the national government or state-owned companies. As a result, CanArgo's operations could be adversely affected by political instability, changes in government institutions, personnel or policies, or shifts in political power. There is also the risk that governments could seek to nationalize, expropriate or otherwise take over CanArgo's oil and gas properties. - - SOCIAL AND ECONOMIC INSTABILITY -- The political institutions in Eastern Europe have recently become more fragmented, and the economic institutions of Eastern European countries have recently converted to a market economy from a planned economy. Social and economic instability have accompanied these changes due to many factors which include: - Low standards of living. - High unemployment. - Undeveloped legal and social institutions. - Conflicts with neighboring countries. This instability can make continued operations difficult or impossible. - - INADEQUATE OR DETERIORATING INFRASTRUCTURE -- Countries in Eastern Europe often either have underdeveloped infrastructures or, as a result of shortages of resources, have permitted infrastructure improvements to deteriorate. The lack of necessary infrastructure improvements can adversely affect operations. For example, the lack of a reliable power supply caused Ninotsminda Oil Company to suspend drilling of one well and the testing of a second well during the 1998-99 winter season. 9 11 - - CURRENCY RISKS -- Payment to CanArgo for oil and gas products sold in Eastern European countries may be in local currencies. Although CanArgo currently sells its oil principally for U.S. dollars, it may not be able to continue to demand payment in hard currencies. Although most Eastern European currencies are presently convertible into U.S. dollars, there is no assurance that convertibility will continue. Even if currencies are convertible, the rate at which they convert into U.S. dollars is subject to fluctuation. In addition, CanArgo's ability to transfer currencies into or out of Eastern European countries may be restricted or limited in the future. CANARGO'S OPERATIONS ARE SIGNIFICANTLY AFFECTED BY CHANGES IN THE MARKET PRICE OF OIL AND GAS. Prices for oil and natural gas are subject to wide fluctuations in response to a number of factors which are beyond CanArgo's control, including: - - Changes in the supply and demand for oil and natural gas. - - Actions of the Organization of Petroleum Exporting Countries. - - Weather conditions. - - Domestic and foreign governmental regulations. - - The price and availability of alternative fuels. - - Political conditions in the Middle East and elsewhere. - - Overall economic conditions. A reduction in oil prices can affect the economic viability of CanArgo's operations. For example, the significant decline in oil prices during 1998 adversely affected CanArgo's results of operations and increased its operating loss in 1998. There can be no assurance that oil prices will be at a level that will enable CanArgo to operate at a profit. CANARGO'S ACTUAL OIL AND GAS PRODUCTION COULD VARY SIGNIFICANTLY FROM ITS RESERVE ESTIMATES. Estimates of oil and natural gas reserves and their values by petroleum engineers are inherently uncertain. These estimates are based on professional judgments about a number of elements including: - - The amount of recoverable crude oil and natural gas present in a reservoir. - - The costs that will be incurred to produce the crude oil and natural gas. - - The rate at which production will occur. Reserve estimates are also based on evaluations of geological, engineering, production and economic data. The data can change over time due to, among other things: - - Additional development activity. - - Evolving production history. - - Changes in production costs, market prices and economic conditions. As a result, the actual amount, cost and rate of production of CanArgo's oil and gas reserves and the revenues derived from sale of the oil and gas produced in the future will vary from those anticipated in the most recent report on CanArgo's oil and gas reserves prepared by AMH Group Ltd. as of December 31, 1998. The magnitude of those 10 12 variations may be material. Some elements of the reserve report are discussed in the "Business -- Ninotsminda Oil Field -- Reserves" section of this prospectus. CANARGO'S OIL AND GAS OPERATIONS ARE SUBJECT TO EXTENSIVE GOVERNMENTAL REGULATION. Governments at all levels -- national, regional and local -- regulate oil and gas activities extensively. CanArgo must comply with laws and regulations which govern many aspects of its oil and gas business, including - - Exploration. - - Development. - - Production. - - Occupational health and safety. - - Labor standards. - - Environmental matters. CanArgo expects the trend towards more burdensome regulation of its business to result in increased costs and operational delays. This trend is particularly applicable in developing economies, such as those in Eastern Europe where CanArgo has its principal operations. In these countries, the evolution towards a more developed economy is often accompanied by a move towards the more burdensome regulations that typically exist in the more developed economies. CANARGO IS INVOLVED IN LITIGATION AND SUBJECT TO THREATENED CLAIMS. CanArgo is involved in a significant lawsuit which is described under "Business -- Legal Proceedings." CanArgo could incur significant costs to defend this or other lawsuits. The lawsuits could divert the attention and efforts of management from normal business operations. In addition, CanArgo's business, financial condition, results of operations, cash flows and prospects could be materially adversely affected if it were to lose a lawsuit. CanArgo may also be subject to claims arising from its decision to cease active development on some Eastern European projects, which are discussed in "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Contingent Liabilities and Obligations." CANARGO ENCOUNTERS COMPETITION. The oil and gas industry can be highly competitive. CanArgo's competitors include integrated oil and gas companies, independent oil and gas companies, drilling and income programs, and individuals. Many of its competitors are large, well-established, well-financed companies. Because of its small size and lack of financial resources, CanArgo may not be able to compete effectively with these companies. A more complete discussion of competition is contained in this prospectus under the heading "Business -- Competition." CANARGO'S OPERATIONS ARE DEPENDENT ON ITS CHIEF EXECUTIVE. David Robson, CanArgo's Chairman and Chief Executive Officer, does not have an employment agreement with CanArgo and could leave at will. He is the CanArgo executive who has the most experience in the oil and gas industry and who has the most 11 13 extensive business relationships in Eastern Europe. CanArgo's business and operations could be significantly harmed if Mr. Robson were to leave CanArgo or become unavailable to CanArgo because of illness or death. Neither Mr. Robson nor any other CanArgo employee is prohibited from competing with CanArgo after he or she leaves the employ of CanArgo. CanArgo does not carry key employee insurance on any of its employees. THE MARKETABILITY OF CANARGO COMMON STOCK IS ADVERSELY AFFECTED BY ITS CURRENT LOW PRICE. Due to its low trading price, CanArgo common stock was delisted from The Nasdaq National Market on March 29, 1999. It now trades on the OTC Bulletin Board. Some investors view low-priced stocks, even if not classified as penny stock under SEC regulations, as unduly speculative and therefore not appropriate candidates for investment. Many institutional investors have internal policies prohibiting the purchase of or maintenance of positions in low-priced stocks. This has the effect of limiting the pool of potential purchasers of CanArgo common stock at present price levels. As a result of the Nasdaq delisting, CanArgo stockholders may experience difficulty in obtaining accurate and timely price quotations for the common stock. They may also find greater percentage spreads between bid and asked prices, and more difficulty in completing transactions and higher transactions costs when buying or selling the common stock. For more information regarding the Nasdaq delisting and CanArgo's response, see "Market for Common Stock and Dividend Policy." CANARGO COULD LOSE THE LISTING FOR ITS COMMON STOCK ON THE OSLO STOCK EXCHANGE. The listing of CanArgo's common stock on the Oslo Stock Exchange has been a secondary listing, with the primary listing having been on The Nasdaq Stock Market. CanArgo common stock was delisted from The Nasdaq Stock Market on March 29, 1999. If CanArgo's common stock is not readmitted to trading on The Nasdaq Stock Market and CanArgo is not able to establish another listing acceptable to the Oslo Stock Exchange, CanArgo could not maintain a secondary listing on the Oslo Stock Exchange. Administrative requirements relating to an Oslo Stock Exchange primary listing make that not a feasible alternative for CanArgo. CANARGO'S PROPOSED 1-FOR-25 REVERSE STOCK SPLIT COULD REDUCE ITS MARKET CAPITALIZATION. At the annual meeting of CanArgo stockholders scheduled to be held on June 16, 1999, CanArgo will seek stockholder approval of a 1-for-25 reverse stock split of the outstanding shares of its common stock. The reasons for the reverse split are discussed under "Market for Common Stock and Dividend Policy." There is no assurance, however, that after the reverse split is effected one newly combined share will have a market value as great as that of 25 shares of common stock immediately before the reverse stock split. EXISTING STOCKHOLDERS WHO DO NOT PURCHASE IN THIS OFFERING WILL EXPERIENCE DILUTION. The maximum number of shares being offered is equal to the aggregate number of outstanding shares of CanArgo common stock and exchangeable shares of CanArgo Oil & Gas Inc. which can be exchanged for shares of CanArgo common stock. The public offering price is significantly less than the net tangible book value per share of the common stock, which was $1.84 at March 31, 1999. Holders of the common stock and the 12 14 exchangeable shares who are located in jurisdictions in which this offering may be made are being given priority in this offering to purchase additional shares up to the number of shares they own of record on the third business day after the date of this prospectus. Those stockholders who do not purchase shares in this offering, or who purchase less than the number of shares they own, will experience dilution in their percentage ownership in CanArgo and in the net tangible book value per share of the shares they hold. DURING THIS OFFERING, YOUR ABILITY TO SELL COMMON STOCK WILL BE IMPAIRED. This offering may continue until August 6, 1999. Until the offering is terminated, investors who wish to sell their shares will have to compete for buyers with CanArgo's offering of shares pursuant to this prospectus. It is unlikely that investors will be able to sell their shares on the open market during the offering for more than a price which together with the "spread" required by a market maker equals the price at which shares are being sold in this offering. CanArgo can give no assurance that the market price of the common stock will be at or above the public offering price during or after the offering. SUBSCRIPTIONS ARE NOT REVOCABLE. Once a subscription is delivered, it may not be revoked or altered, even if the market price for the common stock falls below the offering price of $ per share. Subscribers will have no rights as stockholders until certificates for the shares purchased are issued and delivered. For more information regarding the subscription procedures, see "The Offering." SALES OF COMMON STOCK DURING THE OFFERING COULD AFFECT ITS MARKET PRICE. Open market sales of common stock that is outstanding at the start of this offering may adversely affect the market price of the shares during or after this offering. Approximately 14,937,030 outstanding shares of common stock are freely tradeable. For additional information regarding shares that could be sold during the offering, see "Shares Eligible for Future Resale." FUTURE STOCK ISSUANCES COULD HAVE ANTI-TAKEOVER EFFECTS. CanArgo's board of directors may at any time issue additional shares of preferred stock and common stock without any prior approval by the stockholders. If the proposed 1-for-25 reverse stock split discussed earlier is effected, after completion of this offering there would be approximately 45,000,000 authorized but unissued shares of common stock and 4,999,900 authorized but unissued shares of preferred stock available for issuance at the discretion of the board of directors, assuming no significant stock issuances by CanArgo after the date of this prospectus except in this offering. Holders of outstanding shares have no right to purchase a pro rata portion of additional shares of common or preferred stock issued by CanArgo. The issuance of additional shares could have an anti-takeover effect under some circumstances as described in the section "Description of Capital Stock -- Preferred Stock." 13 15 FORWARD-LOOKING STATEMENTS The United States Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements in this prospectus. When used in this prospectus, the words "estimate," "project," "anticipate," "expect," "intend," "believe," "hope," "may" and similar expressions, as well as "will," "shall" and other indications of future tense, are intended to identify forward-looking statements. The forward-looking statements are based on CanArgo's current expectations and speak only as of the date made. These forward-looking statements involve risks, uncertainties and other factors that in some cases have affected CanArgo's historical results and could cause actual results in the future to differ significantly from the results anticipated in forward-looking statements made in this prospectus. Important factors that could cause such a difference are discussed in this prospectus, particularly in this section and the sections "Risk Factors" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." You are cautioned not to place undue reliance on the forward-looking statements. Few of the forward-looking statements in this prospectus deal with matters that are within the unilateral control of CanArgo. Joint venture, acquisition, financing and other agreements and arrangements must be negotiated with independent third parties and, in some cases, must be approved by governmental agencies. These third parties generally have interests that do not coincide with those of CanArgo and may conflict with CanArgo's interests. Unless CanArgo and the third parties are able to compromise their various objectives in a mutually acceptable manner, agreements and arrangements will not be consummated. Operating entities in various foreign jurisdictions must be registered by governmental agencies, and production licenses for development of oil and gas fields in various foreign jurisdictions must be granted by governmental agencies. These governmental agencies generally have broad discretion in determining whether to take or approve various actions and matters. In addition, the policies and practices of governmental agencies may be affected or altered by political, economic and other events occurring either within their own countries or in a broader international context. CanArgo does not have a majority of the equity in the entity that is the licensed developer of some projects, such as the Stynawske field project, that CanArgo may pursue in Eastern Europe, even though CanArgo may be the designated operator of the oil or gas field. In these circumstances, the concurrence of co-venturers may be required for various actions. Other parties influencing the timing of events may have priorities that differ from those of CanArgo, even if they generally share CanArgo's objectives. As a result of all of the foregoing, among other matters, any forward-looking statements regarding the occurrence and timing of future events may well anticipate results that will not be realized. Demands by or expectations of governments, co-venturers, customers and others may affect CanArgo's strategy regarding the various projects. Failure to meet such demands or expectations could adversely affect CanArgo's participation in such projects or its ability to obtain or maintain necessary licenses and other approvals. CanArgo's ability to finance all of its present oil and gas projects and other ventures according to present plans is dependent upon obtaining additional funding. An inability to obtain financing could require CanArgo to scale back or abandon its project development, capital expenditure, production and other plans. The availability of equity or debt financing 14 16 to CanArgo or to the entities that are developing projects in which CanArgo has interests is affected by many factors, including: - - world economic conditions; - - international relations; - - the stability and policies of various governments; - - fluctuations in the price of oil and gas and the outlook for the oil and gas industry; - - competition for funds; and - - an evaluation of CanArgo and specific projects in which CanArgo has an interest. Rising interest rates might affect the feasibility of debt financing that is offered. Potential investors and lenders will be influenced by their evaluations of CanArgo and its projects and comparisons with alternative investment opportunities. 15 17 THE OFFERING GENERAL CanArgo is offering a minimum of 10,000,000 shares and a maximum of 21,264,643 shares of its common stock at a purchase price of $ per share. CanArgo anticipates that shares of its common stock will be sold in this offering through dealers who will receive a sales commission. Shares may also be sold through officers and directors of CanArgo who will not receive commissions or other compensation in connection with those sales. Subject to a priority being accorded to holders of CanArgo common stock and of CanArgo Oil & Gas Inc. exchangeable shares, the shares will be sold to purchasers in the order in which their subscriptions are received and accepted. The offering will terminate on the earliest of: - - the date on which all 21,264,643 shares have been sold; - - June 30, 1999, unless this date is extended by CanArgo to a date not later than August 6, 1999; or - - the date on which CanArgo terminates this offering. ESCROW OF PROCEEDS Payment of the purchase price for shares being subscribed for will be delivered to Signature Stock Transfer, Inc., which will act as the subscription agent and as escrow agent in connection with this offering. Funds delivered to Signature Stock Transfer, Inc. will be deposited into an escrow account established at and will remain in that account until subscriptions relating to the funds have been accepted and certificates for the shares of common stock purchased have been issued. No subscriptions will be accepted and no shares will be issued and sold unless and until CanArgo receives and accepts subscriptions for at least 10,000,000 shares. The initial closing of the sale of shares of common stock in this offering will occur no earlier than , 1999, when the priority rights being afforded to stockholders will expire. When share certificates are issued and delivered to the subscribers, the proceeds from the sale of those shares will be disbursed to CanArgo. After the initial acceptance of subscriptions and issuance of share certificates for a minimum of 10,000,000 shares, subscriptions will be accepted, share certificates issued and proceeds disbursed from time to time during the remaining term of the offering. If at least 10,000,000 shares are not issued and sold by the date this offering is terminated, all proceeds deposited in the escrow account will be promptly refunded to the subscribers in full, without interest and without any deduction of any kind. RECORD STOCKHOLDER PRIORITY Holders of CanArgo common stock and of CanArgo Oil & Gas Inc. exchangeable shares who are resident in a state or other jurisdiction in which this offering may lawfully be made will be given preference to subscribe for the shares of common stock in this offering. Each holder will have a priority right to subscribe for a number of shares of common stock up to the number of shares of common stock or exchangeable shares held of record by that holder on the third business day after the date of this prospectus. This priority right will not be affected by a holder's sale of common stock or exchangeable shares after that date. This priority right will be recognized so long as the subscription agent receives properly 16 18 completed subscription documents and payment for the shares from the record holder no later than 5:00 p.m., Central Daylight Time, on , 1999. CanArgo will solicit subscriptions for shares from the general public during the period that the priority rights of record holders are in effect. Subject to the priority being accorded to stockholders who subscribe prior to , 1999, subscriptions will be processed in the order received and accepted until all 21,264,643 shares being sold pursuant to this prospectus are sold or this offering otherwise terminates. If you are a beneficial owner of shares held in the name of someone else who is acting as your nominee, such as a bank or brokerage firm, and you want to subscribe for shares of common stock in this offering and to have your subscription receive priority treatment, you must instruct the nominee in whose name your shares are registered to subscribe for shares on your behalf within the time period described above. If you are a broker, depository or nominee that holds shares of the common stock for the account of others, you should provide copies of this prospectus to the beneficial owners. You should carry out their intentions should they desire to purchase shares in this offering. SUBSCRIPTION PROCEDURE To subscribe for shares in the offering, you must complete, sign and return a subscription agreement and transmit full payment for the shares subscribed. You must subscribe for a minimum of 1,000 shares, unless you are a record holder subscribing for a number of shares that does not exceed the number of shares of common stock or exchangeable shares owned of record on the third business day after the date of this prospectus. Except for subscribers resident in Norway, subscribers must pay for the shares subscribed in U.S. dollars by (a) wire transfer, (b) check or bank draft drawn on a United States bank, or (c) postal, telegraphic or express money order, payable to "Signature Stock Transfer, Inc., as agent for CanArgo Energy Corporation." For subscribers resident in Norway, CanArgo or its agent will announce on each business day an exchange rate for Norwegian kroner into U.S. dollars. Subscribers who deliver Norwegian kroner in immediately available funds to CanArgo's designated agent in Norway will be deemed to have delivered the U.S. dollar equivalent of the amount of Norwegian kroners delivered based on the exchange rate announced for that day. If your subscription is solicited by a dealer who has entered into a selling agent agreement with CanArgo, you may deliver your completed subscription agreement and make payment for the shares as instructed by that dealer. That dealer has agreed in the selling agent agreement to immediately deliver the subscription agreement and payment for the shares to Signature Stock Transfer, Inc., as subscription and escrow agent. The subscription price will be considered to have been received when: - - The subscription agent receives a certified check, bank cashier's check or bank draft drawn on a United States bank; - - The subscription agent receives a postal, telegraphic or express money order; - - The subscription agent receives payment by wire transfer; or - - A check, other than a certified or bank cashier's check, received by the subscription agent has "cleared." Subscribers are urged to consider paying the subscription price by means of wire transfers or certified or bank cashier's checks or money orders. Payments made by personal or 17 19 company checks that have not been certified will be considered received only upon clearance. Even domestic checks that have not been certified may take more than five business days to clear, so subscribers intending to pay with uncertified personal or company checks are urged to make payment sufficiently in advance of the termination date or the date on which the priority being accorded the record stockholders terminates to ensure that payment is deemed received prior to such date. Wire transfers must be made in accordance with the instructions in the subscription agreement. The subscription agent must receive the completed subscription agreements and payments by 5:00 p.m., Central Daylight Time, on June 30, 1999, unless extended by CanArgo. We suggest, for your protection, that you deliver your subscription documents to the subscription agent by overnight or express mail courier. If you mail the documents, we suggest you use registered mail. Unless you deliver your subscription agreement to the dealer who has solicited it, you should deliver the subscription agreement and payment to: Signature StockTransfer, Inc., as Agent for CanArgo Energy Corporation 14675 Midway Road -- Suite 221 Dallas, Texas 75244-9651 United States of America Once delivered, you may not revoke or change your subscription, even if the market price for the common stock falls below the purchase price of $ per share during the offering. CanArgo may reject any subscription in full or in part. The subscription price paid with subscriptions that are not accepted for any reason will be promptly returned without interest or any deduction of any kind. Subscriptions accompanied by an overpayment which are otherwise in order will be accepted and a check will be mailed to the subscriber for the amount of the overpayment. The subscription agent will deliver certificates for shares subscribed promptly after the minimum offering has been sold and promptly after later subscriptions have been accepted. Subscribers will not be deemed to be holders of the shares of common stock they are purchasing until the stock certificates representing those shares are issued and delivered. At that time, subscribers will acquire all voting and other rights of holders of common stock with respect to the shares purchased in this offering. CanArgo will decide all questions as to the validity, form and eligibility of subscriptions, and CanArgo's interpretation of the terms and conditions of the offering will be final and binding. CanArgo may waive any irregularities in any subscription. CanArgo is not required to notify you of any defect or irregularity in your subscription. If you have any questions or need assistance concerning the procedures for subscribing for shares, you should call Susan E. Palmer, who is CanArgo's corporate secretary, at (281) 492-6992. DETERMINATION OF OFFERING PRICE CanArgo has determined the public offering price of the shares based on the recent trading history of the common stock on the OTC Bulletin Board and the Oslo Stock Exchange, management's assessment of CanArgo's assets and business prospects, and prevailing market conditions. Information regarding the market prices of the common stock on the OTC Bulletin Board, the Nasdaq National Market and the Oslo Stock Exchange since the beginning of 1997 can be found at "Market for Common Stock and Dividend Policy -- Market for Common Stock." On May 12, 1999, the high and low bid prices for the 18 20 common stock on the OTC Bulletin Board were $0.25 and $0.25 per share, respectively, and the high and low sale prices for the common stock on the Oslo Stock Exchange were $0.26 and $0.26 per share, respectively. The public trading price of the common stock may differ from the subscription price of $ during the offering. If the public trading price were to exceed the subscription price, persons interested in acquiring common stock would be unlikely to purchase shares on the OTC Bulletin Board or the Oslo Stock Exchange for more than the subscription price if they could purchase shares at the subscription price directly from CanArgo in this offering. For that reason, stockholders who wish to sell their shares during the offering will probably be required to ask a price that, when coupled with the "spread" required by a market maker, is no more than the subscription price. CanArgo's net tangible book value per share as of March 31, 1999 was $1.84 per share. Since this amount exceeds the public offering price of $ per share by a substantial amount, purchasers in this offering will not experience dilution of the subscription price they pay in this offering in relation to net tangible book value per share. Stockholders who do not subscribe in this offering for at least the same number of shares as they own will, however, experience dilution in the net tangible book value of the shares they hold. SOLICITATIONS BY DEALERS CanArgo intends to use the services of a limited number of securities dealers who are qualified in the jurisdictions in which this offering will be made to solicit purchasers of the common stock. As compensation for their services, CanArgo will pay the dealers a commission of 8% of the purchase price of the shares they sell, including shares sold to existing stockholders. No commissions will be paid with respect to subscriptions that are rejected, including subscriptions rejected because the minimum of 10,000,000 shares is not sold in the offering. Subscriptions solicited by dealers will remain subject to the priority afforded existing stockholders and to CanArgo's right to accept or reject any subscription. CanArgo will also reimburse the dealers' expenses in connection with the sale of common stock incurred with the consent of CanArgo in an amount not to exceed 2% of the purchase price of the shares they sell. CanArgo has entered into selling agent agreements with (a) National Securities Corporation, a member of the National Association of Securities Dealers, Inc., (b) Credifinance Securities Limited of Toronto, Ontario, Canada, (c) David Williamson Associates Limited of London, England, and (d) Orkla Finans (Fondsmegling) ASA of Oslo, Norway, in which CanArgo agrees to pay them an 8% sales commission. CanArgo may also enter into selling agent agreements with other foreign and domestic dealers. Each selling agent agreement with a dealer qualified in a jurisdiction outside the United States will prohibit that dealer from soliciting purchases of common stock from any person present in the United States or otherwise within the definition of U.S. person contained in Rule 901 under the United States Securities Act of 1933. Those selling agent agreements will also prohibit the foreign dealers from directing any selling efforts towards identifiable groups of U.S. citizens resident outside the United States. CanArgo may also sell common stock in this offering directly through its officers and directors. No commissions or expense reimbursement will be paid with respect to these sales. 19 21 USE OF PROCEEDS Based on an assumed offering price of $0.30 per share and after deducting (a) the maximum sales commissions payable, (b) the maximum dealer expense allowance payable, and (c) estimated expenses of the offering of approximately $250,000, CanArgo expects that the net proceeds from this offering will be approximately $2,450,000 if the minimum number of shares is sold and approximately $5,491,000 if the maximum number of shares is sold. CanArgo intends to use the net proceeds for the following purposes: - - $2,000,000 will be used to make a subordinated loan to Ninotsminda Oil Company. CanArgo must make this loan by June 30, 1999 so that Ninotsminda Oil Company can receive funding of a $6,000,000 loan from the International Finance Corporation. The combined $8,000,000 will be used to complete the current development program for the Ninotsminda oil field which is expected to be completed by mid-2000. Additional information regarding CanArgo's development plans for the Ninotsminda oil field and the loan from the International Finance Corporation is contained in the section "Business -- Ninotsminda Oil Field." - - The remaining net proceeds from the offering, about $450,000 in the case of a minimum offering and about $3,491,000 in the case of a maximum offering, will be used for general working capital purposes, including the reduction of outstanding accounts payable and the development of oil and gas projects. CanArgo believes that funds from (a) the net proceeds from the minimum offering, (b) the loan from the International Finance Corporation, (c) cash generated from operations, and (d) estimated proceeds of $900,000 from the planned sale of assets not central to its business plan, will be sufficient to satisfy its operating needs during the twelve month period following the offering. No assurances can be given that CanArgo will be able to complete any asset sales or that the proceeds from any asset sales will be as great as CanArgo currently anticipates. The net proceeds of this offering will be invested in short-term, investment-grade, interest-bearing securities until they are used. 20 22 MARKET FOR COMMON STOCK AND DIVIDEND POLICY MARKET FOR COMMON STOCK CanArgo's common stock traded from April 6, 1995 through March 29, 1999 on the Nasdaq National Market under the symbol "GUSH." CanArgo common stock has also been listed and traded on the Oslo Stock Exchange since May 1995 under the symbol "CNR." On March 29, 1999, CanArgo was advised by The Nasdaq Stock Market that it had delisted CanArgo's common stock effective with the close of business on March 29, 1999. On March 30, 1999, CanArgo's common stock commenced trading on the OTC Bulletin Board. The following table sets forth the high and low sales prices of the common stock on the Nasdaq National Market and the OSE for the periods indicated, and the high and low bid prices on the OTC Bulletin Board for the period after March 29, 1999. Average daily trading volume on these markets during these periods is also provided. Nasdaq National Market data is provided by The Nasdaq Stock Market; OTC Bulletin Board data is provided by Nasdaq Trading and Market Services; and OSE data is derived from published financial sources. The over-the-counter quotations reflect inter-dealer prices, without retail mark-up, mark-down or commissions, and may not represent actual transactions. Sales prices on the OSE were converted from Norwegian kroner into United States dollars on the basis of the daily 10:00 a.m. exchange rate for buying United States dollars with Norwegian kroner announced by the Central Bank of Norway.
NASDAQ/OTC OSE -------------------------- -------------------------- AVERAGE AVERAGE DAILY DAILY QUARTER ENDED HIGH LOW VOLUME HIGH LOW VOLUME - ------------- ------ ----- ------- ------ ----- ------- March 31, 1997.......... $14.25 $8.75 49,338 $14.22 $8.96 210,918 June 30, 1997........... 10.13 7.81 21,109 9.52 7.92 103,931 September 30, 1997...... 9.13 4.84 23,603 8.86 4.96 157,173 December 31, 1997....... 7.00 1.19 62,684 6.46 1.66 284,036 March 31, 1998.......... 2.63 1.44 27,015 2.38 1.60 153,177 June 30, 1998........... 2.25 1.00 15,520 2.13 1.20 65,617 September 30, 1998...... 1.81 0.47 10,266 1.60 0.53 24,924 December 31, 1998....... 0.81 0.22 34,570 0.67 0.20 27,493 March 29, 1999.......... 0.47 0.19 25,642 0.57 0.23 16,412 June 30, 1999 (through , 1999).....
On May 12, 1999 the high and low bid prices of the common stock on the OTC Bulletin Board were $0.25 and $0.25 per share, respectively. On April 30, 1999, 19,526,324 shares of common stock were outstanding and held of record by 3,795 stockholders. In addition, 1,738,319 exchangeable shares issued by CanArgo Oil & Gas Inc., a subsidiary of CanArgo, were outstanding on that date. Each exchangeable share may be exchanged for one share of common stock, as described in the section "Description of Capital Stock." 21 23 PLANS TO SEEK READMISSION TO NASDAQ On March 29, 1999, The Nasdaq Stock Market advised CanArgo that the common stock had been delisted from The Nasdaq Stock Market because of the failure to meet Nasdaq's continued listing requirement that the bid price for a listed security be at least $1.00 per share. The bid price for CanArgo's common stock has been below $1.00 since August 1998. CanArgo had requested an exception to the minimum bid price requirement while it pursued a plan, including a reverse split of the common stock, to increase the bid price for the common stock to a level above $1.00 per share. The Nasdaq Listing Qualifications Panel that considered the request, however, rejected it, which resulted in the delisting. CanArgo has requested the Nasdaq Listing and Hearing Review Council to review and reconsider the delisting decision. Based upon discussions with members of the Nasdaq staff, CanArgo's management believes that one factor that will be taken into consideration in the review process is the bid price for the common stock at the time of the review. CanArgo believes that its prospects for a reversal of the delisting decision will be enhanced if the bid price for the common stock at the time of the review is well in excess of Nasdaq's continued listing requirement of a $1.00 per share minimum bid price and particularly if the bid price is in excess of Nasdaq's initial listing requirement of a $5.00 per share minimum bid price. On the other hand, CanArgo believes that an affirmation of the delisting decision is virtually certain if the bid price for the common stock at the time of the review remains below $1.00 per share. There can be no assurance that an elevated bid price will result in the common stock being readmitted to trading on The Nasdaq Stock Market. The Review Council is expected to begin its review of the delisting decision no earlier than July 1999. CanArgo's board of directors has proposed a 1-for-25 reverse split of the common stock in an attempt to establish a common stock structure that might achieve a bid price in excess of the $5.00 minimum bid price required under Nasdaq's initial listing requirements for the Nasdaq National Market. CanArgo's board of directors had initially considered proposing a 1-for-10 reverse split but decided to propose the 1-for-25 reverse split in order to increase the possibility that the bid price after the reverse split would be great enough to qualify the common stock for listing on The Nasdaq Stock Market or a national securities exchange. CanArgo will seek stockholder approval of this reverse stock split at the annual meeting of stockholders scheduled for June 16, 1999. On May 12, 1999, the closing bid price for the common stock on the OTC Bulletin Board was $0.25 per share. Although any increase in the bid price for the common stock resulting from the reverse split may be less than proportionate to the decrease in the number of shares outstanding, the reverse stock split, if implemented, should result in a substantially higher bid price for the shares. That price, however, may not meet the initial listing requirements of the Nasdaq National Market. If the stockholders approve the reverse stock split, CanArgo's board of directors would retain the power to delay or abandon the implementation of the reverse stock split. If the Review Council reverses the delisting decision, the common stock would be readmitted to trading on the Nasdaq National Market. CanArgo does not expect a decision from the Review Council before October 1999. 22 24 If the Review Council does not readmit CanArgo's common stock to trading on the Nasdaq National Market, CanArgo will consider applying for listing to the Nasdaq SmallCap Market or a national securities exchange, provided it then satisfies the applicable minimum initial listing requirements. CanArgo believes that securities listed on The Nasdaq Stock Market, as compared to securities traded on the OTC Bulletin Board, generally benefit from: - - smaller percentage spreads between bid and asked prices; - - greater availability of accurate and timely quotations; and - - lower transactions costs. Securities listed on the Nasdaq National Market and national securities exchanges are exempt from the registration requirements of state securities laws. This exemption reduces the time and costs associated with complying with state securities laws when raising capital. The listing of CanArgo's common stock on the Oslo Stock Exchange has been a secondary listing, with the primary listing having been on The Nasdaq Stock Market. If CanArgo's common stock is not readmitted to trading on The Nasdaq Stock Market and CanArgo is not able to establish another primary listing acceptable to the Oslo Stock Exchange, CanArgo could not maintain a secondary listing on the Oslo Stock Exchange. While CanArgo could apply for a primary listing on the Oslo Stock Exchange, administrative requirements relating to a primary listing make an Oslo Stock Exchange primary listing not a feasible alternative for CanArgo. Thus, CanArgo's ability to maintain its listing on the Oslo Stock Exchange may depend upon its ability to regain its listing on The Nasdaq Stock Market or to establish another listing in the United States. DIVIDEND POLICY CanArgo has not paid any cash dividends on its common stock. CanArgo currently intends to retain future earnings, if any, for use in its business and, therefore, does not anticipate paying any cash dividends in the foreseeable future. The payment of future dividends, if any, will depend on CanArgo's results of operations and financial condition and on such other factors as the board of directors may, in its discretion, consider relevant. Under its loan agreement with International Finance Corporation, Ninotsminda Oil Company's ability to transfer funds to CanArgo and its affiliates is severely restricted. The terms of this loan are described in the section "Business -- International Finance Corporation Loan." In addition, CanArgo may not pay dividends on its common stock unless its subsidiary, CanArgo Oil & Gas Inc., is able to pay and simultaneously pays an equivalent dividend on the exchangeable shares issued by that subsidiary. The terms of the exchangeable shares are described in the section "Description of Capital Stock." 23 25 CAPITALIZATION The following table sets forth the capitalization of CanArgo as of March 31, 1999. The table also presents the capitalization on a pro forma as adjusted basis to reflect (a) the application of the estimated net proceeds from a minimum offering of 10,000,000 shares and a maximum offering of 21,264,643 shares at an assumed offering price of $0.30 per share, and (b) the full disbursement of a $6,000,000 loan to Ninotsminda Oil Company. You should read this information together with CanArgo's consolidated financial statements.
AS OF MARCH 31, 1999 ------------------------------------------ AS ADJUSTED --------------------------- ACTUAL MINIMUM MAXIMUM ------------ ------------ ------------ Long-term debt(1).................... $ -- $ 6,000,000 $ 6,000,000 Stockholders' equity: Preferred stock -- 5,000,000 shares authorized; 100 shares issued and outstanding................... -- -- -- Common stock -- 50,000,000 shares authorized; issued and outstanding: 19,393,444 shares actual; 29,393,444 shares as adjusted for minimum offering; 40,658,087 shares as adjusted for maximum offering(2); 1,871,199 additional shares issuable without receipt of further consideration(3)...... 2,126,464 3,126,464 4,252,928 Capital in excess of par value..... 101,630,441 103,080,441 104,995,431 Accumulated deficit................ (64,587,195) (64,587,195) (64,587,195) ------------ ------------ ------------ Total stockholders' equity...... 39,169,710 41,619,710 44,661,164 ------------ ------------ ------------ Total liabilities and stockholders' equity............................. $ 46,317,321 $ 54,767,321 $ 57,808,775 ============ ============ ============
- ------------------------- (1) The "as adjusted" long-term debt reflects the full amount committed under Ninotsminda Oil Company's loan agreement with the International Finance Corporation. This loan is to be disbursed in installments through June 2000 subject to the satisfaction of various conditions at the time of each disbursement. This loan is described under "Business -- Ninotsminda Oil Field -- International Finance Corporation Loan." (2) Excludes 3,297,011 shares reserved for issuance in connection with option plans, outstanding warrants and for other purposes. (3) The 1,871,199 additional shares issuable without receipt of further consideration represent shares of CanArgo common stock issuable upon exchange of exchangeable shares issued or issuable by CanArgo Oil & Gas Inc., a CanArgo subsidiary. The exchangeable shares are described in the section "Description of Capital Stock." 24 26 SELECTED CONSOLIDATED FINANCIAL DATA The following tables set forth selected consolidated financial data taken from CanArgo's consolidated financial statements which appear in this prospectus beginning at page F-1. CanArgo acquired CanArgo Oil & Gas Inc. in July 1998. CanArgo Oil & Gas Inc. owns 68.5% of the outstanding stock of Ninotsminda Oil Company. The financial results of CanArgo Oil & Gas Inc. and Ninotsminda Oil Company are included in CanArgo's consolidated financial results from July 16, 1998. You should read the complete financial statements and related notes of these companies which begin on page F-1 of this prospectus. You should also read the section "Management's Discussion and Analysis of Financial Condition and Results of Operations" for an explanation of CanArgo's financial condition and operating results. In 1996 CanArgo changed its fiscal year end from August 31 to December 31, and in 1994 CanArgo changed its fiscal year end from October 31 to August 31.
TEN TWELVE TWELVE FOUR TWELVE TWELVE THREE MONTHS MONTHS MONTHS MONTHS MONTHS MONTHS MONTHS ENDED ENDED ENDED ENDED ENDED ENDED ENDED ----------------- 8/31/94 8/31/95 8/31/96 12/31/96 12/31/97 12/31/98 3/31/98 3/31/99 ------- ------- ------- -------- -------- -------- ------- ------- (IN $1,000 EXCEPT FOR PER SHARE AMOUNTS) Revenues............. 3 625 35 17 313 821 81 114 Operating loss....... (1,466) (7,882) (5,640) (2,983) (29,090) (6,488) (3,025) (926) Other income (expense).......... (366) 312 (854) 361 1,202 196 207 (132) Net loss............. (1,832) (7,600) (6,494) (2,604) (27,683) (6,110) (2,818) (971) Net loss per common share -- basic and diluted............ (0.90) (1.82) (1.04) (0.28) (2.47) (0.39) (0.25) (0.05) Working capital (deficit).......... 1,145 4,188 16,926 30,382 13,971 1,366 11,537 (744) Total assets......... 4,944 10,710 32,089 55,375 37,434 46,568 33,679 46,317 Notes payable and long-term debt..... 163 -- 300 -- -- -- -- -- Minority interest.... -- -- -- -- -- 4,552 -- 4,465 Stockholders' equity............. 4,181 9,608 30,505 53,245 26,779 40,031 23,961 39,170 Cash dividends per common share....... -- -- -- -- -- -- -- --
25 27 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read together with the Company's consolidated financial statements which appear in this prospectus. LIQUIDITY, CAPITAL RESOURCES AND FINANCIAL CONDITION During the fourth quarter of 1997, CanArgo commenced a program to preserve its financial resources. That program consisted of efforts to reduce general and administrative expenses and to limit CanArgo's investments in and advances to oil and gas ventures and properties in which it held interests, while CanArgo explored and pursued strategic alternatives with the assistance of investment advisors. As a result of its consideration of strategic alternatives, on February 2, 1998 CanArgo, which was then known as Fountain Oil Incorporated, entered into an agreement with CanArgo Oil & Gas Inc., which was then known as CanArgo Energy Inc. That agreement contemplated a series of transactions to effect a business combination involving those two companies. The business combination was consummated on July 15, 1998. The completion of the business combination had the following principal effects: - - CanArgo Oil & Gas Inc., which owns 68.5% of Ninotsminda Oil Company, became a subsidiary of CanArgo; - - the assets and liabilities of CanArgo Oil & Gas Inc. and the results of its operations subsequent to July 15, 1998 are included in CanArgo's consolidated financial statements, which has had a significant impact on CanArgo's consolidated financial statements; - - each previously outstanding CanArgo Oil & Gas Inc. common share was converted into the right to receive 0.8 share of CanArgo's common stock, which provided the former holders of CanArgo Oil & Gas Inc. securities with the right to receive approximately 47% of CanArgo's common stock; - - the management of CanArgo Oil & Gas Inc. succeeded to a majority of the senior management positions in CanArgo; and - - CanArgo effected a one-for-two reverse stock split and changed its name from Fountain Oil Incorporated to CanArgo Energy Corporation. Upon completion of the business combination, CanArgo resumed a more active status and has focused its business activities on the development, through Ninotsminda Oil Company, of the Ninotsminda oil field, and some associated ventures. Under the new management, CanArgo continues to attempt to control expenses and limits its investment in and advances to oil and gas properties and ventures which do not have prospects for early cash flow. CanArgo continues to incur general and administrative costs and project costs for which commitments were made prior to the business combination and which CanArgo would not choose to incur under present circumstances. These costs averaged approximately $40,000 per month during the second half of 1998 and are expected to continue on a diminishing basis through mid-1999. CanArgo's cash balance at March 31, 1999 is not sufficient to cover CanArgo's working capital requirements and capital expenditure plans for 1999. CanArgo is undertaking this offering in order to raise sufficient capital to fund its current development plans for the Ninotsminda field and to provide general working capital, a portion of which could be used 26 28 for the development of other projects. The intended use of the net proceeds from this offering is described in the section "Use of Proceeds." CanArgo's management believes that funds provided by (a) the estimated net proceeds from a minimum offering of 10,000,000 shares, (b) the International Finance Corporation loan described in the "Business" section of this prospectus, (c) cash from operations, and (d) the anticipated proceeds of approximately $900,000 from the planned disposition of assets not central to its operations, will be sufficient to satisfy its operating needs during the twelve months following this offering. No assurance can be given that: - - CanArgo will be able to complete any asset sales; - - The proceeds from any asset sales will be as great as CanArgo anticipates; - - CanArgo's operations will generate positive cash flow; or - - The funds provided by the sources enumerated above or from other sources will be sufficient to satisfy CanArgo's operating needs during the twelve months following this offering. The current development plan for the Ninotsminda field includes the drilling of a minimum of three development wells plus five major rehabilitations of existing wells, with a view towards increasing oil production. The total budgeted cost of the current development plan is $9,573,000. The current development plan is scheduled to be implemented in 1999 and the first half of 2000, but that timing is dependent upon the prompt availability of funding for the development, whether from this offering or otherwise. CanArgo's current development plan for the Ninotsminda field and the terms of a proposed loan from the International Finance Corporation to finance it are described in the "Business" section of this prospectus. Since a considerable amount of infrastructure for the Ninotsminda field has been put in place by Georgian Oil, increases in oil production are not expected to increase infrastructure costs substantially. No assurance can be given, however, that the Ninotsminda field current development plan will be funded, that the funding will be timely, that the development plan will be successfully completed, that it will increase production, or that the Ninotsminda field operating revenues after completion of the development plan will exceed operating costs. The extent, cost and timing of a full Ninotsminda field development plan are highly speculative and will depend significantly upon the results of the current development program. CanArgo currently projects that the full field development plan for oil would involve the drilling of nine additional wells, would cost an additional $16 million, and would require two to three years to complete. Should Ninotsminda Oil Company attempt to implement such a plan immediately following completion of the current development plan in approximately mid-2000, it could require substantial additional funding. It is unlikely CanArgo could provide such funding unless CanArgo itself obtained substantial additional funding. Depending upon the amount of revenue generated by operations and partial funding of CanArgo projects by third-party participants, CanArgo believes that it may be required to obtain additional debt or equity financing by the second half of 2000. No assurances can be given that CanArgo will be able to obtain such financing or that the financing that is available will be offered on terms that are attractive or even acceptable to CanArgo. Development of the oil and gas properties and ventures in which CanArgo has interests involves multi-year efforts and substantial cash expenditures. Full development of 27 29 CanArgo's oil and gas properties and ventures will require the availability of substantial additional financing from external sources. CanArgo intends where opportunities exist to transfer portions of its interests in oil and gas properties and ventures to other entities in exchange for such financing. CanArgo generally has the principal responsibility for arranging financing for the oil and gas properties and ventures in which it has an interest. There can be no assurance, however, that CanArgo or the entities that are developing the oil and gas properties and ventures will be able to arrange the financing necessary to develop the projects being undertaken or to support the corporate and other activities of CanArgo. There can also be no assurance that such financing as is available will be on terms that are attractive or acceptable to or are deemed to be in the best interest of CanArgo, such entities and their respective stockholders or participants. CanArgo's consolidated financial statements do not give effect to any further impairment in the value of its investment in oil and gas ventures and properties or other adjustments that would be necessary if financing cannot be arranged or if their operations are not profitable. Ultimate realization of the carrying value of CanArgo's oil and gas properties and ventures will require production of oil and gas in sufficient quantities and marketing such oil and gas at sufficient prices to provide positive cash flow to CanArgo. Establishment of successful oil and gas operations is dependent upon, among other factors, the following: - - mobilization of equipment and personnel to implement effectively drilling, completion and production activities; - - achieving significant production at costs that provide acceptable margins; - - reasonable levels of taxation, or economic arrangements in lieu of taxation, in host countries; and - - the ability to market the oil and gas produced at or near world prices. CanArgo has plans to mobilize resources and achieve levels of production and profits sufficient to recover the carrying value of its oil and gas properties and ventures. However, if one or more of the above factors, or other factors, are different than anticipated, these plans may not be realized, and CanArgo may not recover the carrying value of its oil and gas properties and ventures. Other risks relating to CanArgo's operations are described in the sections "Risk Factors" and "Forward-Looking Statements." CanArgo will be entitled to distributions from the various properties and ventures in which it participates in accordance with the arrangements governing the respective properties and ventures. Until the IFC loan is repaid by Ninotsminda Oil Company, CanArgo will have the limited ability to transfer funds from Ninotsminda Oil Company to CanArgo. CONTINGENT LIABILITIES AND OBLIGATIONS As a result of CanArgo's decision to cease active development of the Lelyaki, Maykop and Gorisht-Kocul field projects, CanArgo may be subject to contingent liabilities in the form of claims from the ventures developing those projects or from others participating in those projects. These projects are discussed under "Business -- Other Eastern European Projects -- Previously Impaired Projects." CanArgo was advised during the first quarter of 1998 that Intergas, the entity developing the Maykop field project, and a shareholder in Intergas were considering such claims, but no such claims have yet been asserted. CanArgo management is unable to estimate the range that such claims, if any, might total. However, if any claims were determined to be valid, they could have a material adverse 28 30 effect on CanArgo's financial position, results of operations, cash flows and prospects. Any such claims may be adjudicated in host country forums under host country law. CanArgo is involved in lawsuits which are described in the section "Business -- Legal Proceedings." CanArgo could incur significant costs in defending these lawsuits, and the loss of any of these lawsuits could have a material adverse effect on the financial condition, results of operations, cash flows and prospects of CanArgo. CanArgo has contingent obligations and may incur additional obligations, absolute or contingent, with respect to the acquisition and development of oil and gas properties and ventures in which it has interests that require or may require CanArgo to expend funds and to issue shares of its common stock. CanArgo believes that it has no further obligation to fund any operations relating to the Lelyaki and Maykop field projects. At March 31, 1999, CanArgo had a contingent obligation to issue 187,500 shares of common stock to a third party upon satisfaction of conditions relating to the achievement of specified Stynawske field project performance standards. As CanArgo develops current projects and undertakes other projects, it could incur significant additional obligations. CHANGES IN FINANCIAL POSITION As of December 31, 1998, CanArgo had working capital of $1,366,000, compared to working capital of $13,971,000 as of December 31, 1997. The $12,605,000 decrease in working capital principally reflects a reduction in cash and cash equivalents. The payment of liabilities accrued at December 31, 1997, principally those related to CanArgo's Lelyaki field oil and gas venture, resulted in a $9,165,000 reduction in accrued liabilities from December 31, 1997 to December 31, 1998, which was largely offset by the utilization of $8,567,000 of restricted cash during 1998 to pay accrued liabilities. As of March 31, 1999, CanArgo had a working capital deficit of $744,000, compared to $1,366,000 of working capital as of December 31, 1998. The $2,110,000 decrease in working capital from December 31, 1998 to March 31, 1999 principally reflects a reduction in cash and cash equivalents and an increase in accounts payable. Cash and cash equivalents decreased $12,239,000 during 1998 from $14,164,000 at December 31, 1997 to $1,925,000 at December 31, 1998, primarily as a result of expenditures on operating and investment activities and activities relating to the business combination. Cash and cash equivalents at December 31, 1998 included $819,000 held by Ninotsminda Oil Company, to which CanArgo has limited access. The utilization of cash during 1998 involved principally the following: - - the net loss of $6,110,000 incurred in 1998, most of which involved cash items; - - the investment of $5,727,000 in oil and gas properties, principally the Ninotsminda field; - - $1,652,000 of investments in and advances to oil and gas and other ventures, principally the acquisition of minority interests in a refinery and a proposed power generation project in the Republic of Georgia; and - - $1,215,000 of capitalized acquisition costs related to the business combination. The use of cash to fund 1998 expenditures was partially offset by the release of restrictions in 1998 that had applied to $1,133,000 of CanArgo's previously restricted cash. Cash and cash equivalents decreased $1,219,000 during the three months ended March 31, 1999 from $1,925,000 at December 31, 1998 to $706,000 at March 31, 1999, primarily as a 29 31 result of expenditures on operating activities. Cash and cash equivalents at March 31, 1999 included $275,000 held by Ninotsminda Oil Company, to which CanArgo has limited access. Accounts receivable increased from nil at December 31, 1997, when the minimal amount of accounts receivable were classified within other current assets, to $424,000 at December 31, 1998. The increase is primarily as a result of $257,000 of accounts receivable relating to oil sales. In addition, $88,000 of receivables which had previously been included within other current assets were reclassified as accounts receivable at December 31, 1998. Accounts receivable decreased from $424,000 at December 31, 1998 to $382,000 at March 31, 1999. The decrease is primarily as a result of an allowance for doubtful accounts related to prior oil sales. Advances to operator increased from nil at December 31, 1997 to $377,000 at December 31, 1998 as a result of advance payments made to the entity performing the operations at the Ninotsminda field on behalf and at the direction of CanArgo. Advances to operator decreased from $377,000 at December 31, 1998 to $253,000 at March 31, 1999 as a result of expenditures by the entity performing the operations at the Ninotsminda field on behalf and at the direction of CanArgo. Inventory increased from nil at December 31, 1997 to $170,000 at December 31, 1998 and to $298,000 at March 31, 1999, as result of placing a portion of CanArgo's oil produced at the Ninotsminda field in storage to be available for sale in the Georgian domestic or regional market or international markets. At March 31, 1999, 91,000 barrels of oil were in storage. Inventories are valued at the lower of cost or market. Other current assets decreased from $762,000 at December 31, 1997 to $453,000 at December 31, 1998, primarily as a result of: - - the 1998 amortization of prepaid expenses amounting to $264,000; - - the collection in 1998 of $234,000 on claims that had been included within other current assets; and - - the 1998 reclassification of $88,000 of accounts receivables previously included in other current assets. These reductions in other current assets were partly offset by the prepayment of insurance premiums amounting to $131,000 in the third quarter of 1998 and 1998 deposits of $169,000. Other current assets decreased from $453,000 at December 31, 1998 to $301,000 at March 31, 1999, primarily as a result of the amortization of prepaid expenses. The $8,671,000 decrease in current liabilities during the year ended December 31, 1998 is primarily attributable to a $9,165,000 decrease in accrued liabilities. The decrease in accrued liabilities is, in turn, primarily attributable to payment of liabilities accrued at December 31, 1997 relating to: - - bank debt and related interest incurred by Kashtan Petroleum Ltd., the entity operating the Lelyaki field project; - - Lelyaki field project closedown costs; - - employee termination costs; and - - acquisition of oil field equipment. These reductions in accrued liabilities in 1998 were partially offset by accounts payable for which CanArgo became responsible as a result of the business combination and those 30 32 arising out of active operations which resumed following completion of the business combination. Property and equipment, net, increased from $5,942,000 at December 31, 1997 to $6,202,000 at December 31, 1998 and to $6,260,000 at March 31, 1999, primarily as a result of capitalized costs associated with moving two drilling rigs and related equipment to the Republic of Georgia from Cyprus and the acquisition of property and equipment in connection with the business combination. Oil and gas properties, net increased from $1,479,000 at December 31, 1997 to $30,138,000 at December 31, 1998 primarily as a result of the business combination. The increase was partly offset by 1998 impairment write-downs of the Sylvan Lake project aggregating $900,000 as a result of the quarterly application of the full cost ceiling test in the context of a severe heavy oil price decline in 1998. See Note 2 of Notes to Consolidated Financial Statements, "Summary of Significant Accounting Policies -- Oil and Gas Properties," for a description of the full cost ceiling test. Oil and gas properties, net increased from $30,138,000 at December 31, 1998 to $31,070,000 at March 31, 1999 primarily as a result of the evaluation of seismic data with respect to the Ninotsminda and Nazvrevi fields for $400,000, capitalization of $262,000 of Ninotsminda Oil Company general and administrative expenses related to exploration and development activities and acquisition of interests with respect to the Ninotsminda field for $110,000. Investments in and advances to oil and gas and other ventures, net increased from $5,387,000 at December 31, 1997 to $6,878,000 at December 31, 1998. The increase reflects principally: - - $1,004,000 of investment in and advances to Georgian American Oil Refinery; - - $468,000 of investment in CanArgo Power Corporation, through which CanArgo is participating in a start-up private power generation project in the Republic of Georgia; and - - $155,000 of advances to Boryslaw Oil Company, the entity developing the Stynawske field project. These investments and advances were partially offset by CanArgo's $161,000 equity in the loss incurred by Boryslaw Oil Company in 1998. Investments in and advances to oil and gas and other ventures, net increased from $6,878,000 at December 31, 1998 to $7,049,000 at March 31, 1999. The increase reflects principally advances of $97,000 to CanArgo Power Corporation and advances of $96,000 to Boryslaw Oil Company. These investments and advances were partially offset by CanArgo's $22,000 equity in the loss of Boryslaw Oil Company in the three months ended March 31, 1999. As of March 31, 1999 and December 31, 1998 and 1997, CanArgo had net investments in and advances to Boryslaw Oil Company totaling $5,480,000, $5,406,000 and $5,387,000, respectively. CanArgo has the responsibility for arranging financing for this venture, and unless third-party financing can be arranged, CanArgo might have to supply the capital to finance operations until the venture generates positive cash flow, which would have the effect of increasing investments in and advances to oil and gas and other ventures. The amount of such advances may be greater than the amount of the Boryslaw Oil Company operating losses recognized by CanArgo, which would cause such net investment balances to increase. Such investments and advances at the initial stages of development are 31 33 essentially unevaluated oil and gas properties, and such costs may not be recovered if the venture is not successful. No assurance can be given that CanArgo will be able to arrange third-party financing for such venture, that CanArgo will have sufficient resources to fund the capital and operating needs of the venture, or that the venture will be successful. CanArgo has the right to acquire an additional interest in Georgian American Oil Refinery for approximately $860,000, which if acquired would result in an increase in investments in and advances to oil and gas and other ventures during 1999. Minority interest in subsidiaries at December 31, 1998 of $4,552,000, and at March 31, 1999 of $4,465,000, relates to the 31.5% interest of the non-controlling shareholder of Ninotsminda Oil Company. RESULTS OF OPERATIONS CanArgo has typically acquired its interests in oil and gas properties through interests in joint ventures, partially owned corporate and other entities and joint operating arrangements. CanArgo's interest in the assets and liabilities of unconsolidated entities is reflected on CanArgo's consolidated balance sheet on a net basis as investment in and advances to oil and gas ventures. CanArgo's share of revenue, other income and expenses of unconsolidated entities is reported in CanArgo's consolidated statement of operations as income or loss from equity investment in oil and gas ventures. CanArgo's interest in the cash flow of unconsolidated entities is reported in CanArgo's consolidated statement of cash flows as distributions from or investment in or advances to oil and gas ventures. Interests acquired in some joint ventures, partnerships and production sharing, working interest and other arrangements are proportionately consolidated. CanArgo will report the same stockholders' equity and net income or loss whether it accounts for various oil and gas ventures using the equity method or on a consolidated basis. THREE MONTH PERIODS ENDED MARCH 31, 1999 AND 1998 CanArgo recorded operating revenue of $114,000 during the three month period ended March 31, 1999 compared with $81,000 for the three month period ended March 31, 1998. Ninotsminda Oil Company generated $68,000 of revenue in the three month period ended March 31, 1999. Its net share of the 107,800 barrels of gross production from the Ninotsminda field in the period amounted to 39,000 barrels. From its share, Ninotsminda Oil Company placed 31,431 barrels of oil into storage to be held for sale into the Georgian local and regional market. Because lower transportation costs are involved, CanArgo believes that sales of Ninotsminda oil to customers in the Georgian local and regional market generally yield relatively higher net sales prices to Ninotsminda Oil Company than sales to other customers. Net sale prices for Ninotsminda oil sold during the first quarter of 1999 averaged $8.98 per barrel. Oil production from the Sylvan Lake property in Alberta, Canada, accounted for $46,000 of revenue in the three month period ended March 31, 1999 and substantially all revenue for the three month period ended March 31, 1998. The operating loss for the three month period ended March 31, 1999 amounted to $926,000 compared with $3,025,000 for the corresponding period in 1998. The decrease in the operating loss is attributable primarily to 1998 costs associated with CanArgo's involvement in some Eastern European oil and gas ventures which involvement CanArgo has effectively terminated, 1998 costs associated with CanArgo's business combination with CanArgo Oil & Gas Inc., and the impairment of oil and gas properties which amounted to $800,000 in 1998. 32 34 Lease operating expenses decreased to $67,000 for the three month period ended March 31, 1999 as compared to $100,000 for the three month period ended December 31, 1998. The decrease is primarily as a result of a lower level of operating activity with respect to the Sylvan Lake property for the three month period ended March 31, 1999, partially offset by the inclusion of Ninotsminda field expenses. Direct project costs decreased to $68,000 for the three month period ended March 31, 1999, from $539,000 for the three month period ended March 31, 1998, reflecting 1998 costs associated with CanArgo's involvement in some Eastern European oil and gas ventures which involvement CanArgo has effectively terminated, partially offset by activity related to the Ninotsminda field. General and administrative costs decreased to $859,000 for the three month period ended March 31, 1999, from $1,457,000 for the three month period ended March 31, 1998. The decrease is primarily attributable to 1998 costs associated with CanArgo's involvement in some Eastern European oil and gas ventures which involvement CanArgo has effectively terminated, and 1998 costs associated with CanArgo's business combination with CanArgo Oil & Gas Inc., partially offset by the cost of activity related to the Ninotsminda field. The decrease in depreciation, depletion and amortization expense from $118,000 for the three month period ended March 31, 1998 to $25,000 for the three month period ended March 31, 1999 is attributable principally to the write-down of the Sylvan Lake properties in 1998 and a decrease in the number of barrels of oil produced from the Sylvan Lake property for the three month period ended March 31, 1999, partially offset by depletion related to Ninotsminda field oil production. The equity loss from investments in unconsolidated subsidiaries decreased to $22,000 for the three month period ended March 31, 1999, from $91,000 for the three month period ended March 31, 1998 as a result of the substantially lower level of activity conducted through unconsolidated subsidiaries in 1998, reflecting the termination of CanArgo's involvement in the development activities of some Eastern European oil and gas ventures conducted through unconsolidated subsidiaries. During the three months ended March 31, 1998, CanArgo wrote down its oil and gas properties in the Sylvan Lake project by an aggregate $800,000 as a result of a substantial decline of heavy oil prices and the quarterly application of the full cost ceiling test. There was no comparable write down during the three months ended March 31, 1999. CanArgo recorded net other expenses of $132,000 for the three months ended March 31, 1999, as compared to net other income of $207,000 during the three months ended March 31, 1998. The principal reason for the decrease is lower interest income as a result of lower cash balances for the three months ended March 31, 1999 compared to the same period for the previous year and the payment of a facility fee pursuant to Ninotsminda Oil Company's $6,000,000 loan agreement with the International Finance Corporation. The net loss of $971,000 or $0.05 per share for the three month period ended March 31, 1999 compares to a net loss of $2,818,000, or $0.25 per share for the three month period ended March 31, 1998. As a result of the issuance of shares in connection with the business combination, the weighted average number of common shares outstanding was substantially higher during the three month period ended March 31, 1999 than during the three month period ended March 31, 1998. 33 35 YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997 CanArgo recorded operating revenue of $821,000 during the year ended December 31, 1998, compared with $313,000 for the year ended December 31, 1997. Ninotsminda Oil Company generated $603,000 of 1998 revenue subsequent to the consummation of the business combination in July 1998. Its net share of the 275,300 barrels of gross production from the Ninotsminda field subsequent to the business combination amounted to 92,400 barrels of oil. From its share, Ninotsminda Oil Company placed 41,700 barrels of oil into storage to be held for sale into the Georgian local and regional market. Because lower transportation costs are involved, CanArgo believes that sales of Ninotsminda oil to customers in the Georgian local and regional market generally yield relatively higher net sales prices to Ninotsminda Oil Company than sales to other customers. Sale prices for Ninotsminda oil sold during the second half of 1998 averaged $10.63 per barrel. Oil production from the Sylvan Lake property in Alberta, Canada accounted for $202,000 of 1998 revenue and substantially all of 1997 revenue. CanArgo also recorded a nominal amount of revenue during the year ended December 31, 1998 from the sale of electrically enhanced oil recovery equipment; there was no revenue from the sale of such equipment for the year ended December 31, 1997. CanArgo expects that revenue for 1999 should be substantially higher than in 1998, since Ninotsminda field operating results will be included for the full twelve months and CanArgo has plans to increase Ninotsminda field production substantially during 1999. Prices for crude oil are subject to wide fluctuations in response to changes in supply and demand and additional political, economic and other factors. The significant decline in oil prices during 1998 adversely affected the results of CanArgo's operations for that year. World oil prices are likely to have a significant impact on CanArgo's revenue and operating profit or loss in 1999 and subsequent years. The operating loss for 1998 amounted to $6,488,000, compared with $29,090,000 for 1997. The decrease in the operating loss is attributable primarily to the impairment in 1997 of oil and gas ventures, oil and gas properties, property and equipment and other assets which aggregated $19,424,000, as well as a $3,778,000 loss in 1997 representing CanArgo's equity in the loss of oil and gas ventures. Both are associated with CanArgo's decision in 1997 to effectively terminate its involvement in some Eastern European oil and gas ventures and write off its investment related to them. Lease operating expenses increased to $843,000 during 1998, as compared to $200,000 for 1997, primarily as a result of the inclusion of Ninotsminda field expenses subsequent to the business combination. Direct project costs decreased to $1,157,000 in 1998 from $1,753,000 for 1997, reflecting the 1997 termination of CanArgo's involvement in some Eastern European oil and gas ventures, partially offset by activity related to the Ninotsminda field subsequent to the business combination. The decrease in depreciation, depletion and amortization expense from $345,000 for 1997 to $239,000 during 1998 is attributable principally to the write-down of proved properties in the Sylvan Lake area in the first and second quarter of 1998 as a result of a severe decline in the price of heavy oil and the quarterly application of the full cost ceiling test. These write-downs had the effect of reducing the per barrel depletion expense for oil produced at the Sylvan Lake field. The decrease in 1998 depreciation, depletion and amortization expense related to the Sylvan Lake write-downs was partially offset by depletion related to Ninotsminda field oil production subsequent to the business 34 36 combination and to a 1998 increase in the number of barrels of oil produced from the Sylvan Lake property. The equity loss from investments in unconsolidated subsidiaries decreased to $161,000 during 1998, from $3,778,000 for 1997, as a result of the substantially lower level of activity conducted through unconsolidated subsidiaries in 1998, reflecting the 1997 termination of development activities of some Eastern European oil and gas ventures conducted through unconsolidated subsidiaries. During 1998, CanArgo wrote down its oil and gas properties in the Sylvan Lake project by an aggregate $900,000 as a result of a substantial decline of heavy oil prices and the quarterly application of the full cost ceiling test. If oil prices decline further, CanArgo may experience additional impairments of these or other properties. In 1998 CanArgo also wrote down the carrying value of oil field camp equipment by $113,000 to its estimated recoverable amount. The $1,013,000 in 1998 impairment expense compares to an aggregate of $19,424,000 of impairment expense recorded in 1997. CanArgo recorded net other income of $196,000 for 1998, as compared to $1,202,000 during 1997. The principal reason for the decrease is CanArgo's 1998 payment of interest expense related to the Lelyaki field project. This was partially offset by a reduction in the loss that CanArgo recorded on the disposition of miscellaneous equipment and property, which dropped from $271,000 in 1997 to $30,000 in 1998. The net loss of $6,110,000, or $0.39 per share, for 1998 compares to a net loss of $27,683,000, or $2.47 per share, for 1997. As a result of the issuance of shares in connection with the business combination, the weighted average number of common shares outstanding was substantially higher during 1998 than during 1997. YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED AUGUST 31, 1996 CanArgo recorded operating revenue of $313,000 during the year ended December 31, 1997 compared with $35,000 for the year ended August 31, 1996. Revenue in both years was related to a modest amount of oil and gas production from property in Alberta, Canada in which CanArgo has interests. The 1997 production was generated primarily at the Sylvan Lake property in which CanArgo acquired an interest in 1997. CanArgo incurred an operating loss of $29,090,000 for the year ended December 31, 1997, compared to an operating loss of $5,640,000 for the year ended August 31, 1996. The increase in the operating loss is attributable primarily to the impairment of oil and gas ventures, oil and gas properties, and property and equipment and other assets which aggregated $19,424,000 in 1997, as well as a $3,778,000 loss representing CanArgo's equity in the loss of oil and gas ventures. There were no comparable impairment charges in fiscal 1996, and in that year, CanArgo's equity in the loss of oil and gas ventures was $13,000. Lease operating expenses increased to $200,000 in 1997, as compared to $11,000 in fiscal 1996, primarily as a result of CanArgo's acquisition of an interest in the Sylvan Lake property in early 1997. 1997 direct project costs increased $485,000 from the $1,268,000 experienced during the fiscal year ended August 31, 1996, reflecting principally the higher level of project activity and the inability of CanArgo to recoup from Kashtan some expenses related to the Lelyaki field project incurred during December 1997. General and administrative expenses in the years ended December 31, 1997 and August 31, 1996 were comparable. The level of general and administrative expense is expected to decrease during 1998, at least prior to the consummation of the business combination with CanArgo Oil & Gas Inc. The increase in depreciation and amortization 35 37 expense from $77,000 in the year ended August 31, 1996 to $345,000 in the year ended December 31, 1997 is attributable principally to the increased production of oil. During the year ended December 31, 1997, CanArgo recognized an aggregate of $19,237,000 in losses as a result of the impairment of long-lived assets, as compared to an impairment loss of $420,000 for the year ended August 31, 1996. Impairment of the ventures operating the Lelyaki, Maykop and Gorisht-Kocul field projects resulted in a combined loss of $15,736,000. The impairment of drilling rigs and related equipment originally intended to be utilized in the Maykop field project and some office furniture, fixtures and equipment resulted in a loss of $3,244,000. The remaining investment in the Rocksprings property, which was carried in CanArgo's December 31, 1996 balance sheet as a $257,000 unevaluated oil and gas property, was recognized as impaired in 1997. The remaining assets impaired during 1997 were notes receivable from the entity that sold to CanArgo its principal interest in the Lelyaki field project, as to which there were doubts regarding collectability. In 1997, CanArgo recorded total other income of $1,202,000, as compared to total other expense of $854,000 in the year ended August 31, 1996. Interest income increased to $1,615,000 for the year ended December 31, 1997 from $332,000 for the year ended August 31, 1996 due to higher average cash and cash equivalent investments. Interest expense decreased from $1,016,000 for the year ended August 31, 1996, when CanArgo recorded amortization of financing costs, discount and interest related to CanArgo's 8% Convertible Subordinated Debentures, to $69,000 for calendar 1997. In both 1997 and fiscal 1996, CanArgo recorded losses from the sale of miscellaneous equipment and property amounting to $271,000 and $182,000, respectively. The net loss of $27,683,000, or $2.47 per share, in 1997 compares to a net loss of $6,494,000, or $1.04 per share, in the fiscal year ended August 31, 1996. The disproportionate losses per share are attributable to CanArgo's issuance of additional shares subsequent to August 31, 1996, resulting in a substantially higher weighted average number of common shares outstanding during the year ended December 31, 1997. FOUR MONTHS ENDED DECEMBER 31, 1996 COMPARED WITH FOUR MONTHS ENDED DECEMBER 31, 1995 CanArgo recorded an operating loss of $2,983,000 during the four month period ended December 31, 1996 compared with $1,470,000 for the same 1995 period. The increased loss resulted from an increase of approximately $1,357,000 of equity loss from investments in unconsolidated subsidiaries primarily associated with the activities of the oil and gas ventures in Eastern Europe in which CanArgo has interests. General and administrative expenses for the four month period ended December 31, 1996 amounted to $1,282,000, reflecting a modest decrease from the $1,303,000 for the comparable 1995 period. For the 1995 period, general and administrative costs included a charge for external services for public relations activities of a non-recurring nature. The decrease in the 1996 period for such expense was substantially offset by increases in salaries and other administrative costs related to the build-up of staff associated with the projects in Eastern Europe. General and administrative expense is net of $1,220,000 and $320,000 capitalized pursuant to full cost accounting rules during the four month period ended December 31, 1996 and 1995, respectively. Interest income increased to $424,000 for the four month period ended December 31, 1996 from $55,000 in the comparable period for the prior year due to higher average cash 36 38 investments. Interest expense increased to $13,000 for the four month period ended December 31, 1996 from $3,000 in the comparable period for the prior year due to the amortization of financing costs and interest related to CanArgo's debentures and financing of insurance premiums. YEAR 2000 COMPLIANCE The Year 2000 problem is the result of computer programs being written using two digits to define the applicable year. If not corrected, any programs or equipment that have time sensitive components could fail or produce erroneous results. CanArgo has completed a review of its existing information technology and non-information technology systems and has upgraded its accounting information systems to software that the developer represents to be Year 2000 compliant. Except for a limited number of desktop computers utilized by CanArgo which CanArgo intends to replace, CanArgo believes that the software and hardware currently used by CanArgo, including oil field production equipment is Year 2000 compliant. The cost of replacing the desktop computers is expected not to exceed $25,000. Although CanArgo does not expect to incur significant additional expenditures to address Year 2000 issues, there can be no assurance that this will be the case. CanArgo has identified several significant suppliers of goods and services, primarily in the banking, transportation, refining and communication sectors, whose inability or failure to become Year 2000 compliant in a timely manner could have a material adverse effect on CanArgo's business, financial condition, results of operations or cash flows. CanArgo has reviewed information from these suppliers, where available, with respect to their Year 2000 compliance status and continues to monitor their progress. While disruptions to the local power grid as a result of the Year 2000 problem and other problems could interfere with CanArgo's ability to produce oil and continue development activities at the Ninotsminda field, CanArgo anticipates that the planned addition later this year of independent power generation capability at the Ninotsminda field, if accomplished, will substantially mitigate that risk and enable CanArgo to at least produce and store oil. Because of uncertainties, however, the actual effects of the Year 2000 problem on CanArgo may be different from its current assessment. Should remedial efforts be required, the inability of CanArgo or its principal suppliers to become Year 2000 compliant in a timely manner could impact CanArgo's ability to produce, sell and receive payment for its crude oil on a timely basis and could have a material adverse effect on CanArgo's business, financial condition, results of operations or cash flows. NEW ACCOUNTING STANDARDS In 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income, and SFAS No. 131, Disclosure about Segments of an Enterprise and Related Information, both of which were adopted in 1998 without having any material effect on CanArgo's financial statements. In 1998, FASB issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, which will be adopted in the 1999 annual financial statements and based on present circumstances would not have any material effect on CanArgo's financial statements. 37 39 BUSINESS GENERAL DEVELOPMENT OF CANARGO'S BUSINESS CanArgo Energy Corporation was formed in 1994 to continue, through reincorporation in Delaware, the business of a predecessor Oklahoma corporation which was formed in 1980. CanArgo changed its name from Fountain Oil Incorporated to CanArgo Energy Corporation in connection with a business combination with CanArgo Oil & Gas Inc. completed on July 15, 1998. CanArgo conducts its principal operations through subsidiaries, and unless otherwise indicated by the context, the term CanArgo refers to CanArgo Energy Corporation and its consolidated subsidiaries. CanArgo initially operated as an oil and gas exploration and production company. It altered its principal focus to the application of electrically enhanced heavy oil recovery technology in 1988, and that focus continued through 1994. In early 1995, CanArgo shifted its principal activities to acquiring and developing interests in Eastern European oil and gas properties. From 1995 to 1997, CanArgo established significant ownership interests in four Eastern European oil and gas development projects. As a result of disappointing results and other negative indications, CanArgo during the fourth quarter of 1997 wrote off its entire investments in three of those four projects and began actively to seek a business combination or similar transaction with another oil and gas company. As a result of this effort, CanArgo entered into a business combination with CanArgo Oil & Gas Inc. Upon completion of the business combination in July 1998, CanArgo Oil & Gas Inc. became a subsidiary of CanArgo, the management of CanArgo Oil & Gas Inc. assumed the senior management positions in CanArgo, and CanArgo changed its name from Fountain Oil Incorporated to CanArgo Energy Corporation. At the time of the business combination, the principal operations and assets of CanArgo Oil & Gas Inc. were associated with the producing Ninotsminda oil field in the Republic of Georgia. CanArgo's principal activity is the rehabilitation and development of oil and gas fields with a productive history that indicate the potential for increased production through the application of modern production techniques. CanArgo is producing crude oil at the Ninotsminda field in Georgia through a 68.5% owned subsidiary, Ninotsminda Oil Company Limited. CanArgo is currently directing most of its efforts and resources to the development of the Ninotsminda field. CanArgo also has interests in other oil and gas fields in Georgia and Ukraine that it intends to rehabilitate and develop, provided sufficient resources are available to support these efforts. In addition, CanArgo has interests in properties at which it may engage in exploratory drilling in an effort to establish the existence of oil and gas fields which CanArgo could then develop. CanArgo also owns interests in other Eastern European oil and gas projects which CanArgo is not actively pursuing, and holds interests in small oil and gas properties in North America, some of which are producing modest amounts of oil and gas. CanArgo's principal product is crude oil, and the sale of that oil is its principal source of revenue. CanArgo's oil and gas development and production activities are subject to various risks and uncertainties which are discussed under "Risk Factors" and "Forward-Looking Statements." NINOTSMINDA OIL FIELD Since completion of the business combination with CanArgo Oil & Gas Inc., CanArgo's resources have been focused on the development of the Ninotsminda oil field and some associated activities. The Ninotsminda oil field covers some 2,500 acres and is located 38 40 forty kilometers east of the Georgian capital, Tbilisi. It is adjacent to and west of the Samgori oil field, which is Georgia's most productive oil field. The Ninotsminda field was discovered later than the Samgori field and has experienced substantially less development activity. The state oil company, Georgian Oil, and others including CanArgo have drilled sixteen wells in the Ninotsminda field, of which seven are currently classified as producing. Three of the seven wells classified as producing are presently shut-in while undergoing or awaiting rehabilitation, and production from the remaining four wells currently is approximately 1,200 barrels of oil per day. BUSINESS STRUCTURE CanArgo's activities at the Ninotsminda oil field are conducted through Ninotsminda Oil Company Limited, a 68.5% owned subsidiary. In November 1998, CanArgo increased its percentage ownership of Ninotsminda Oil Company from 55.9% to 68.5% when the other shareholder of Ninotsminda Oil Company chose not to subscribe for its pro rata portion of shares being offered to increase Ninotsminda Oil Company's capital. During 1998, CanArgo invested $6,394,000 of cash in Ninotsminda Oil Company and, in addition, capitalized an aggregate of $1,164,000 in loans and accrued interest. If the other shareholder of Ninotsminda Oil Company declines to provides its pro rata share of required capital in the future, CanArgo may have to provide a disproportionate share of the capital Ninotsminda Oil Company requires, if those capital requirements are to be met. This would result in an increase in CanArgo's percentage ownership of Ninotsminda Oil Company. At the present time, Ninotsminda Oil Company does not have any plans to increase its capital. Ninotsminda Oil Company obtained its rights to the Ninotsminda field and two other fields under a 1996 production sharing contract with Georgian Oil. Ninotsminda Oil Company's rights under the agreement expire in December 2019, subject to the possibility of extending such rights with regard to producing areas. Under the production sharing contract, Ninotsminda Oil Company is required to relinquish at least half of the area then covered by the production sharing contract, but not any portions being actively developed, at five year intervals commencing December 1999. CanArgo is discussing a possible deferral of the initial relinquishment to 2004 with the Georgian authorities. No assurance can be given that a deferral will be granted. Under the production sharing contract, Georgian Oil has a priority right to receive oil representing a projection of what the Ninotsminda field would have yielded through 2001 based upon the wells and equipment in use at the time the contract was entered into. The priority right amounts to approximately: - - 542 barrels of oil per day during 1999; - - 280 barrels of oil per day during 2000; and - - 93 barrels of oil per day during 2001. Of the remaining production, up to 50% will be allocated to Ninotsminda Oil Company for the recovery of the cumulative capital and operating costs associated with the Ninotsminda field, which Ninotsminda Oil Company initially pays. The balance of production is allocated on a 70/30 basis between Georgian Oil and Ninotsminda Oil Company. Thus, while Ninotsminda Oil Company continues to have unrecovered costs, it will receive 65% of production in excess of the oil allocated to Georgian Oil on a priority basis with respect to projected base production. The allocation of a share of production to Georgian Oil relieves Ninotsminda Oil Company of all obligations it would otherwise have 39 41 to pay taxes and similar levies to the Republic of Georgia with respect to Ninotsminda field operations. Georgian Oil and Ninotsminda Oil Company take their respective shares of production in kind, and they market their oil separately. Pursuant to the terms of the production sharing contract, a local, Georgian company must be appointed as field operator. The field operator provides the operating personnel and is responsible for day-to-day operations. Ninotsminda Oil Company pays the operating company's expenses associated with the development of the Ninotsminda field, and the operating company performs on a non-profit basis. The Georgian company serving as Ninotsminda field operator has eighty-eight full time employees, and substantially all of its activities relate to the development of the Ninotsminda field. The use of the Georgian company as field operator gives Ninotsminda Oil Company less control of operations than it might have if it were conducting operations directly. Ninotsminda field operations are determined by a governing body composed of members designated by Georgian Oil and Ninotsminda Oil Company, with the deciding vote allocated to Ninotsminda Oil Company. If Georgian Oil believes that action proposed by Ninotsminda Oil Company with which Georgian Oil disagrees would result in permanent damage to a field or reservoir or in a material reduction in production over the life of a field or reservoir, it may refer the disagreement to an independent expert for binding resolution. OIL FIELD DEVELOPMENT Ninotsminda Oil Company assumed developmental responsibility for the Ninotsminda field in 1996, when production was minimal. CanArgo believes that the development and productivity of the Ninotsminda field had in the past been hampered by, among other factors, a lack of funding, civil strife and utilization of non-optimal technology. Ninotsminda Oil Company's initial approach to Ninotsminda field development involved rehabilitating and adding additional perforations to existing wells, and this program is continuing. In 1997, Ninotsminda Oil Company commenced a drilling program, which has involved three wells thus far. The first was completed in October 1997. Under normal production conditions, this well has been producing at the rate of 400 to 600 barrels of oil per day but is currently shut-in for maintenance activities. The second well was completed in October 1998. While further testing and stimulation of this well are planned prior to placing it on production, CanArgo believes that the second well will be less productive than the first based on preliminary test data. The drilling of the third well was suspended in December 1998 at a depth of 700 meters as a result of undependable electrical supply and is expected to resume in the spring or summer of 1999 when the electrical supply is expected to improve. The lack of a reliable power supply during the winter has also caused delays in the testing of the second well and in the continuing field rehabilitation program. Ninotsminda Oil Company expects that the electrical supply problem will be resolved or mitigated if and when a planned gas-fired, electric generating power plant near Ninotsminda commences operations. See "Ancillary Ninotsminda Area Projects -- Electrical Power Generation," which discusses CanArgo's investment in a private power generation project in the Ninotsminda area which, when operational, should increase the supply of power available to the Ninotsminda field development program. During 1997 and 1998, Ninotsminda Oil Company acquired additional seismic data about the Ninotsminda field, which CanArgo believes will be useful in selecting additional 40 42 drilling sites. Drilling sites tentatively selected by Ninotsminda Oil Company must be approved by Georgian regulatory authorities before drilling may commence. To date, exploration and production at the Ninotsminda field have focused on one zone. There is, however, a second zone, from which oil has been produced in one well, that Ninotsminda Oil Company intends to examine. In addition, the Ninotsminda field has a gas cap above the principal producing zone, which could be a natural gas reservoir from which commercial production could be established if there were a market for Ninotsminda field natural gas. See "Potential Gas Development" for a discussion of the possible creation of a market for Ninotsminda field natural gas and the possible evaluation by CanArgo of the prospects for natural gas production from the Ninotsminda field. Since a gas cap can, under some circumstances, aid in the production of crude oil, any evaluation of the possibility of commencing production from the gas cap would have to take into consideration the expected impact of natural gas production on the production of crude oil. Ninotsminda Oil Company's current development program for oil is defined in a schedule to Ninotsminda Oil Company's loan agreement with the International Finance Corporation discussed below. The program described in the schedule covers a period that began in 1998 and will extend into 2000. The principal elements of the current development program include: - - Drilling and testing five new wells, of which one has been completed and a second has been started; one or more of the wells are expected to be drilled as horizontal wells; - - An extensive program for rehabilitating and maintaining existing wells, including major rehabilitations of at least five additional wells; major rehabilitations involve such actions as gas and water isolation procedures, reperforation of existing casings and application of stimulation techniques; - - Acquisition and analysis of additional seismic data, which has largely been completed; and - - Installation of additional facilities designed to support increased production to at least the level of 4,500 barrels of oil per day. The current development program is expected to cost approximately $18.9 million, of which CanArgo estimates approximately one-half had been expended prior to March 31, 1999. CanArgo believes that the $6 million loan from the International Finance Corporation and the $2 million subordinated loan from CanArgo to Ninotsminda Oil Company, both of which are discussed below, will provide most of the funds required to complete the current development program. Completion is anticipated by mid-2000, provided that funding through the IFC loan and the subordinated loan from CanArgo is made available to Ninotsminda Oil Company by June 30, 1999. A principal use of the proceeds of this offering is to fund the subordinated loan, which must be in place before disbursements will be made under the IFC loan. The objective of the current development plan for the Ninotsminda field is to increase the field's production level to 4,500 barrels of oil per day. Ninotsminda Oil Company's ability to complete the program successfully and reach that production level is subject to many risks, including those described in "Risk Factors." No assurances can be given that the current development program for the Ninotsminda field will be successfully completed or that the 4,500 barrels of oil per day production level will be achieved. The extent, cost and timing of a full Ninotsminda field development plan are highly speculative and will depend significantly upon the results of the current development 41 43 program. CanArgo currently projects that the full Ninotsminda field development plan for oil would involve the drilling of nine additional wells, would cost an additional $16 million, and would require two to three years to complete. Ninotsminda Oil Company could require substantial additional funding to be able to implement this plan immediately following completion of the current development plan. It is unlikely CanArgo could provide this funding unless CanArgo itself obtained substantial additional funding. INTERNATIONAL FINANCE CORPORATION LOAN In December 1998, Ninotsminda Oil Company entered into a convertible loan agreement with International Finance Corporation, an affiliate of the World Bank. Pursuant to the loan agreement, IFC agreed under specified conditions to lend $6 million to Ninotsminda Oil Company primarily to fund the Ninotsminda field current development program. The first disbursement under the loan agreement must be made before July 1, 1999, and IFC has no obligation to disburse funds after June 29, 2000. Ninotsminda Oil Company is required to repay the loan in five semi-annual payments of $1.2 million each commencing December 2001. Ninotsminda Oil Company has pledged substantially all of its assets to IFC to secure the loan. The loan will bear interest at LIBOR plus 3%. LIBOR is currently approximately 5% per year. In addition, Ninotsminda Oil Company has paid to IFC a facility fee of $60,000 and will pay a commitment fee equal to 1/2 of 1% per annum on the portion of the $6 million that has not been disbursed. Both the initial disbursement of the loan and each subsequent disbursement are subject to a large number of conditions. The conditions applicable to all disbursements include: - - The maintenance of specified financial ratios by Ninotsminda Oil Company, including: -- a debt-to-equity ratio that does not exceed 1:1; and -- a ratio of the present value of projected future cash flows from proved reserves to outstanding long-term indebtedness that exceeds 1.6:1; - - The absence of any material adverse changes in Ninotsminda Oil Company's financial condition or business prospects; and - - Ninotsminda Oil Company's reaffirmance of various representations and warranties on and as of the date of disbursement. Before IFC will advance the initial funds to Ninotsminda Oil Company, additional significant conditions must be satisfied. Among the important conditions to the first disbursement are: - - The shareholders of Ninotsminda Oil Company must provide a $2 million subordinated loan to Ninotsminda Oil Company; since the other shareholder has indicated that it will not participate in such a loan, this is effectively a condition that CanArgo provide the $2 million loan; - - Evidence has been presented to IFC that Ninotsminda Oil Company has received at least $10 million from its shareholders since the beginning of 1998 in the form of equity contributions and the $2 million subordinated loan, which either has been expended on the Ninotsminda field current development program or is held in a cash account; and - - IFC has received favorable legal opinions on a variety of matters relating to the loan. 42 44 No assurances can be given that the conditions to disbursement will be satisfied or, if not satisfied, waived, or that the IFC will fund all or any part of the $6,000,000 loan. The IFC has the right under the loan agreement to convert all or part of the loan into common shares of Ninotsminda Oil Company. If the entire $6,000,000 loan were converted, IFC would receive shares representing 20% of the equity of Ninotsminda Oil Company. This would reduce CanArgo's percentage ownership of Ninotsminda Oil Company from 68.5% to 54.8% but would leave Ninotsminda Oil Company as a consolidated subsidiary of CanArgo. The conversion right remains in effect until approximately three months after: - - The completion of the current development program for the Ninotsminda field; - - The achievement of sustained production of at least 4,500 barrels of oil per day; and - - The completion of various procedural requirements. CanArgo has provided a partial guaranty of the IFC loan to Ninotsminda Oil Company and has pledged the shares of Ninotsminda Oil Company stock that it owns to secure its guaranty obligation. Under the guaranty, CanArgo will be responsible for the first $4.1 million of guaranteed indebtedness and related monetary obligations of Ninotsminda Oil Company to IFC under the loan agreement and 68.5% of any such guaranteed obligations in excess of $6 million. If IFC converts the loan into Ninotsminda Oil Company stock, it has the right to require CanArgo and the other shareholder of Ninotsminda Oil Company to purchase a portion of the shares IFC acquires through conversion. The purchase price for those shares shall be based on the greater of the cost of those shares to IFC plus interest and the portion of Ninotsminda Oil Company net asset value attributable to those shares. CanArgo is obligated to purchase all shares that IFC is requiring the existing shareholders of Ninotsminda Oil Company to purchase until it has spent $4,100,000 on such purchases, and then CanArgo must purchase 68.5% of all shares that IFC is requiring the existing shareholders of Ninotsminda Oil Company to purchase after an aggregate of $6 million has been spent on such purchases. The repurchase obligation will terminate no later than December 31, 2007. PROCESSING, SALE AND CUSTOMERS Georgian Oil built a considerable amount of infrastructure in and adjacent to the Ninotsminda field prior to entering into the production sharing contract with Ninotsminda Oil Company, and those infrastructure improvements, including initial processing equipment, are now used by Ninotsminda Oil Company. The mixed oil and water fluid produced from the Ninotsminda field wells flows into a two-phase separator located at the Ninotsminda field, where gas associated with the oil is separated. The oil and water mixture is then transported eleven kilometers in a pipeline to Georgian Oil's central processing facility at Sartichala for further treatment. The gas is transported to Sartichala in a separate pipeline where some of the gas is used for fuel and the rest is currently flared. At Sartichala, the water is separated from the oil. Ninotsminda Oil Company then sells this oil to buyers at Sartichala, and the buyers at that point assume responsibility for the oil. The buyers, at their own risk and cost, generally transport the oil 20 kilometers by pipeline to a railhead at Ghaciani. At the railhead, the oil is loaded into railcars for 43 45 transport directly to the buyers or their customers or to the Black Sea port of Batumi, Georgia, where oil can be loaded onto tankers for international shipment. Ninotsminda Oil Company sells its oil directly to local and international buyers. Ninotsminda Oil Company sold all of its 1997 production to one buyer, Glencore International AG, an international trading company. In 1998, Ninotsminda Oil Company sold its production to three customers as follows:
CUSTOMER PERCENTAGE OF PRODUCTION - -------- ------------------------ Sis Plus 7 Ltd........................................... 35.9 % Glencore International AG................................ 34.4 Navtobi Ltd.............................................. 29.7
The price received for oil by Ninotsminda Oil Company has generally been negotiated on the basis of the European spot price for Brent grade crude oil, less discounts for transportation and related charges. The price received by Ninotsminda Oil Company has ranged from the full Brent price to Brent minus $5.83 per barrel. The average discount from Brent prices was less in 1998 than 1997, as buyers have begun to purchase oil from Ninotsminda Oil Company for use in Georgia and neighboring countries and have accordingly faced smaller transportation costs. Ninotsminda Oil Company now maintains an inventory of oil available for local, regional and international buyers principally on cash payment terms. International trading companies have been generally been willing to purchase Ninotsminda field crude oil at a net price based on the formula of the then current Brent price less a discount for transportation and related charges, without regard to shifts in the absolute level of the Brent spot price. CanArgo has observed, however, that as the Brent price has risen substantially during March and April 1999, local and regional buyers have resisted paying the net price based on that formula and have sought a greater discount. Local and regional buyers generally incur small transportation charges and at relatively low Brent prices have been offering the highest net price for Ninotsminda field oil. During the three months ended January 1999, the average per barrel discount from the spot price for Brent grade crude oil granted by CanArgo was approximately $1.50, as sales were made principally to local and regional buyers during a period of relatively low Brent prices. CanArgo expects that it will experience a higher average discount from the Brent spot price while the spot price remains at levels well above recent lows, because it expects that it will be selling crude oil either to local and regional buyers who will demand a discount greater than their actual transportation and related charges or to international buyers who will be facing higher transportation charges than the local and regional buyers. CanArgo believes that the loss of one or more of its current customers would not result in any significant delay in the sale of the crude oil produced from the Ninotsminda field, but could result in lower selling prices. In order for Ninotsminda Oil Company to cover production and depletion expenses under its production sharing contract at its current production level of approximately 1,200 barrels per day, it needs to realize a net price of approximately $10.00 per barrel. The Brent spot price was $14.65 per barrel on May 12, 1999, but very recently it was substantially below that level. The highest discount Ninotsminda Oil Company has granted is $5.83 per barrel. No assurances can be given that oil prices will be at a level that will enable Ninotsminda Oil Company to cover its production and depletion expenses. See "Risk Factors" for information about the effects of fluctuations in oil prices. 44 46 PRODUCTION HISTORY The Ninotsminda field was discovered, and initial development began, in 1979. Ninotsminda field is currently producing approximately 1,200 barrels per day of oil, plus associated gas, primarily from four wells. Gross production from the Ninotsminda field for the past three years was as follows:
YEAR ENDED DECEMBER 31 OIL - GROSS BARRELS - ---------------------- ------------------- 1998........................................................ 554,633 1997........................................................ 639,910 1996........................................................ 515,000
RESERVES The following table summarizes net hydrocarbon reserves for the Ninotsminda oil field, which are the only significant reserves for CanArgo. This information is derived from a report as of December 31, 1998 prepared by AMH Group Ltd., independent petroleum consultants. This report is available for inspection at CanArgo's principal executive offices, Suite 1580, 727 - 7th Avenue, S.W., Calgary, Alberta T2P 0Z5 during regular business hours.
PSC ENTITLEMENT VOLUMES(1) -------------------------------------- OIL RESERVES NINOTSMINDA OIL CANARGO SHARE OF ---------------- COMPANY NINOTSMINDA OIL GROSS NET(2) ENTITLEMENT COMPANY ENTITLEMENT ------ ------ --------------- ------------------- (IN THOUSANDS OF BARRELS) Proved Producing......... 2,404 1,647 1,340 918 Proved Non-Producing..... 1,379 945 890 610 Proved Undeveloped....... 15,200 10,412 8,783 6,016 ------ ------ ------ ----- Total Proven............. 18,983 13,004 11,013 7,544 ====== ====== ====== =====
- ------------------------- (1) PSC Entitlement Volumes are those produced volumes which, through the production sharing contract, accrue to the benefit of Ninotsminda Oil Company and, as a result of CanArgo's interest in Ninotsminda Oil Company, accrue to the benefit of CanArgo for the recovery of capital, repayment of operating costs and share of profit. (2) Net Oil Reserves represent CanArgo's 68.5% share of Ninotsminda Oil Company's interest under the production sharing contract in the gross reserves, before taking into account the interest of Georgian Oil. Proved reserves are those reserves estimated as recoverable under current technology and existing economic conditions from that portion of a reservoir which can be reasonably evaluated as economically productive on the basis of analysis of drilling, geological, geophysical and engineering data, including the reserves to be obtained by enhanced recovery processes demonstrated to be economically and technically successful in the subject reservoir. Proved reserves includes proved producing reserves, proved non-producing reserves and proved undeveloped reserves. Proved producing reserves are those proved reserves that are actually on production or, if not producing, that could be recovered from existing wells or facilities and where the reasons for the current non-producing status is the choice of the owner rather than the lack of markets or some other involuntary reason. An illustration of such a situation is where a 45 47 well or zone is capable but is shut-in because its deliverability is not required to meet commitments. 1998 production was 554,633 barrels. Proved non-producing reserves are reserves that are expected to be recovered from producing zones in existing well bores open at the time of the reserve estimate, but production is not occurring for mechanical reasons or the lack of maintenance-type rehabilitation. Although these reserves are currently not producing, they are expected to be producing in the short-term. For example, due to general well rehabilitation program delays, several wells were shut-in or remained shut-in during 1998, and reserves expected to be produced from these wells are classified as proved non-producing reserves. Proved undeveloped reserves are proven reserves that are expected to be recovered from new wells on undrilled acreage, or from existing wells where relatively major expenditures are required for the completion of these wells or for installation of processing and gathering facilities prior to the production of these reserves. Reserves on undrilled acreage are limited to those drilling units offsetting productive wells that are reasonably certain of production when drilled. The evaluation by AMH represents the efforts of AMH to predict the performance of the oil recovery project using their expertise and the available data at the effective date of their report. There has been no material change in the available data since that date. Considerable uncertainty exists in the interpretation and extrapolation of existing data for the purposes of projecting the ultimate production of oil from underground reservoirs and the corresponding future net cash flows associated with that production. The process of estimating quantities of proved crude oil, and the subcategories thereof, is very complex. The estimating process requires significant subjective decisions relating to the evaluation of all available geological, engineering and economic data for each reservoir. The data for a given reservoir may change substantially over time as a result of such factors as additional development activity, evolving production history and changing economic conditions. No assurance can be given that the projections included in the report by AMH will be realized. POTENTIAL GAS DEVELOPMENT CanArgo has recently become involved in three-party discussions involving the electric utility serving the Tbilisi region, which was recently purchased by an American utility company, and an entity that generates electricity in the Tbilisi region. The transactions being discussed would involve the sale of natural gas by CanArgo to the generator of the electricity, the sale of electricity by the generator to the utility, the payment by the utility directly to CanArgo of the price of the natural gas utilized to generate the electricity, and the payment by the utility to the generator of the balance of the price for the electricity provided. The subjects being discussed include the volume of gas required and the price to be paid for it. No assurances can be given that these discussions will result in the development of the Ninotsminda field gas reserves or that CanArgo will sell any natural gas in connection with these potential transactions. CanArgo has not yet fully evaluated the Ninotsminda field gas reserves or the economics of producing that gas. Most of the gas that is now produced incidentally with Ninotsminda field oil is currently being flared. CanArgo expects that in the near future the gas being produced incidentally with the oil will be utilized by a private power generation operation to be established at Ninotsminda. 46 48 OTHER FIELDS AND PROSPECTS UNDER 1996 PRODUCTION SHARING CONTRACT Ninotsminda Oil Company has rights to one other field, West Rustavi, and one prospect, Manavi, in addition to the Ninotsminda field, under the 1996 production sharing contract. The West Rustavi field is located some 40 km southeast of Ninotsminda. Ten wells were drilled by Georgian Oil in the West Rustavi field, two of which produced oil. Ninotsminda Oil Company has initiated an appraisal program and commenced test production from one of the wells. The appraisal program, which includes acquiring further seismic data and performing rehabilitation work on some of the wells, is aimed at assessing Georgian Oil's original reserve estimates and ultimately initiating an appropriate development program. No assurances can be given that the West Rustavi field will be developed by Ninotsminda Oil Company. The Manavi prospect is located east of Ninotsminda. Ninotsminda Oil Company has seismic data regarding the Manavi prospect from both work it commissioned and earlier efforts by Georgian Oil. Georgian Oil's attempt to drill in the Manavi prospect was thwarted by logistical problems and did not reach the reservoir. CanArgo's management believes Manavi is a promising exploration prospect. ANCILLARY NINOTSMINDA AREA PROJECTS Electrical Power Generation CanArgo has an effective 42.5% interest in a Georgian stock company that intends to produce electricity. This company is planning to install and operate a pilot 3.0 megawatt gas fired power plant to be located adjacent to the Ninotsminda field. The plant would utilize as its principal fuel gas produced in conjunction with oil from Ninotsminda field wells. Most of this gas is presently being flared, with no economic benefit to Ninotsminda Oil Company. The Georgian power generation company would sell the electricity generated to Ninotsminda Oil Company for the Ninotsminda field project and to other local purchasers. The basic equipment, a refurbished Rolls Royce Proteus single cycle gas turbine with attached Siemens electrical generating equipment, is expected to be in Georgia and operational before the 1999-2000 winter season begins. No assurance can be given that the turbine and equipment will arrive in Georgia or prove to be operational within the time period contemplated. Once operational, this project would be one of the first private sector power producers in Georgia. Privatization of the Georgian power sector is well underway. The 1997 Electricity Law is causing a restructuring of the Georgian power sector to facilitate competition through provisions having the following effects, among others: - - unbundling the generation, transmission and distribution functions; - - increasing tariffs substantially; and - - establishing an independent regulatory commission to grant licenses and regulate tariffs. Ninotsminda Oil Company expects that the private power company will supply electricity for Ninotsminda field operations on a priority basis. If this happens, Ninotsminda Oil Company should be able to avoid or mitigate the electrical supply problems it has encountered, which forced a suspension of drilling activity on its third well and interfered with other operations during the 1998-1999 winter season. 47 49 CanArgo is actively seeking to expand its involvement in the Georgian power sector. It is, among other things, seeking to attract financial partners to join CanArgo in pursuing opportunities for private sector power production in Georgia. Refinery In 1998, CanArgo purchased for $1,000,000 a 12.9% equity interest in a company which owns a small refinery located at Sartichala, Georgia. The proceeds were used to upgrade and expand the refinery. CanArgo has the right through September 30, 1999 to purchase an additional 11.1% interest in the refinery company for $860,000. The refinery, which primarily utilizes refurbished American equipment, began operations in July 1998 and has a current capacity of approximately 2,000 barrels per day. It is the only refinery in Georgia employing Western technology. It is able to produce naphtha, diesel fuel, fuel oil, kerosene and jet fuel. Refinery expansion plans envision capacity of over 4,000 barrels per day, with further capacity expansion and product extension possible in the future. The refinery has not purchased crude oil from, or processed crude oil for the account of, Ninotsminda Oil Company, although it may do so in the future. Sartichala is the primary processing center for east Georgian oil production, including production from Ninotsminda. Refined products are sold on both the local and export markets. Although the refinery receives some revenue from the sale of its products in the Georgian currency, the Lari, most pricing is related to dollar based world market prices. To mitigate the currency exchange risk, the refinery has established some export sales contracts denominated in United States dollars. CanArgo believes that its involvement in Georgian refining activity strengthens its position in the Georgian energy sector and provides specific support for Ninotsminda Oil Company's activities in Ninotsminda. The refinery suspended operations in early 1999 while it evaluates the impact on its business of recently enacted tax legislation in Georgia which imposes a substantial excise tax on many refined oil products sold into the local Georgian market. The excise tax amounts to 60% of the cost of the goods being sold. Among the options being considered by the refinery is shifting a greater portion of its output to the export market. While CanArgo does not believe that the suspension of refinery operations will remain in effect for an extended period of time, no assurances can be given about when or whether the refinery will resume operations. OTHER GEORGIAN PROJECT -- NAZVREVI/BLOCK XIII In February 1998, CanArgo entered into a second production sharing contract with Georgian Oil. This contract covers the Nazvrevi and Block XIII areas of East Georgia, a 2,100 square kilometer exploration area adjacent to the Ninotsminda and West Rustavi fields which contains existing infrastructure for oil and gas production. The contract term is for twenty-five years. CanArgo is required to relinquish at least half of the area then covered by the production sharing contract, but not any portions being actively developed, at five year intervals commencing in 2003. Under the production sharing contract, CanArgo pays all operating and capital costs. CanArgo first recovers its cumulative operating costs from production. After deducting production attributable to operating costs, 50% of the remaining production, considered on an annual basis, is applied to reimburse CanArgo for its cumulative capital costs. While cumulative capital costs remain unrecovered, the other 50% of remaining production is allocated on a 50/50 basis between Georgian Oil and CanArgo. After all cumulative capital costs have been recovered by CanArgo, remaining production, after deduction of 48 50 operating costs, is allocated on a 70/30 basis between Georgian Oil and CanArgo. The allocation of a share of production to Georgian Oil relieves CanArgo of all obligations it would otherwise have to pay the Republic of Georgia for taxes and similar levies related to activities covered by the production sharing contract. Both Georgian Oil and CanArgo will take their respective shares of production under this production sharing contract in kind. The first phase of the preliminary work program under the Nazvrevi/Block XIII production sharing contract involves primarily a seismic survey of a portion of the exploration area and the processing and interpretation of the data collected. The seismic survey has been completed, and the results of those studies are currently being interpreted, with a view towards defining possible oil and gas prospects and exploration drilling locations. The cost of the seismic program is approximately $1,200,000. In October 1998, XCL Ltd., a Louisiana based oil exploration company, agreed to pay $650,000 for shares representing 11.5% of the outstanding equity of CanArgo's subsidiary holding the Nazvrevi/Block XIII production sharing contract. The proceeds will be applied by the subsidiary to fund a portion of the cost of the seismic acquisition, processing and interpretation program. Most of the $650,000 has not yet been paid. The second phase of the preliminary work program under the Nazvrevi/Block XIII production sharing agreement involves the drilling of one well at an estimated cost of $4 million. CanArgo can terminate the production sharing contract if it decides not to proceed with drilling. OTHER EASTERN EUROPEAN PROJECTS STYNAWSKE FIELD, WESTERN REGION, UKRAINE In November 1996, CanArgo entered into a joint venture arrangement with the Ukrainian state oil company, Ukranafta, for the development of the 6,000 acre Stynawske field, located in Western Ukraine near the town of Stryv. CanArgo has a 45% interest in the joint venture entity, with Ukranafta holding the remaining 55% interest. Ukranafta receives on a declining basis through 2001 an allotment of oil equal to what the field was projected to produce based on the physical plant and technical processes in use in 1996. The joint venture will be entitled to all incremental production above that declining base. The Stynawske field is a relatively tight sandstone reservoir containing light sweet oil. The production from the field commenced in 1967 but was substantially terminated after a few years of production due to environmental considerations. The field is located underneath the main water supply for Western Ukraine, and leakage from producing wells some 20 years ago threatened to pollute this aquifer. Four wells that are located away from the water supply have been allowed to continue production. New wells which would pose a threat to the aquifer are prohibited. In preparation for the commencement of development activities, the joint venture has carried out the following activities: - - An environmental audit of the Stynawske field; - - A technical and economic evaluation of the project; and - - The selection of drilling sites. CanArgo expects that the initial phase of the project will consist of the rehabilitation of a number of existing wells, with a view towards increasing production and gathering data for 49 51 the preparation of a full field development program. The feasibility of the initial phase is currently being considered, including financing and ultimate recovery of funds invested. CanArgo has concluded on a preliminary basis that the full field development plan for the rehabilitation of the Stynawske field will probably be based on deviated drilling, in which the drilling sites for the wells would be located a safe distance from the water supply and the wells would enter the reservoir at angles avoiding the aquifer. Additional measures would be taken with the drilling mud and otherwise to protect the environmental integrity of the project. Reservoir pressure support through gas or water injection may be necessary to optimize recovery. The full field development plan for the Stynawske field will, however, depend upon data developed during an initial rehabilitation phase. CanArgo is actively seeking to establish arrangements under which oil and gas production companies or other investors would acquire a portion of CanArgo's interest in the Stynawske field joint venture in return for supplying financing or services to implement the initial phase of the project. If CanArgo does not proceed with the Stynawske field development program, it may be in breach of obligations it has with regard to the joint venture. This could place CanArgo's rights to the Stynawske field at risk and could subject CanArgo to possible liability. POTENTIAL CASPIAN EXPLORATION PROJECT In May 1998, CanArgo led a consortium which was the successful bidder in a tender for two large exploration blocks in the Caspian Sea, located off the shore of the autonomous Russian republic of Dagestan. Licenses for the blocks were issued in February 1999 to a majority-owned subsidiary of CanArgo. The licenses impose substantial commitments on the licensee, and CanArgo is assessing its options for meeting such commitments in light of CanArgo's limited resources and existing commitments. If CanArgo determines that it cannot assume the commitments, CanArgo will relinquish its rights under the licenses. PREVIOUSLY IMPAIRED PROJECTS Gorisht-Kocul Field, Albania CanArgo and the Albanian state oil company, Albpetrol, are partners in a 50/50 joint venture to rehabilitate and develop the 16.5 square kilometer Gorisht-Kocul field, which is located 35 kilometers east of the Adriatic port, Vlora. The Albanian government granted the joint venture a 25 year production license covering the Gorisht-Kocul field. Production at the Gorisht-Kocul field commenced in 1966. The field, which contains relatively heavy oil, has reportedly produced approximately 69 million barrels to date. CanArgo was named operator of the Gorisht-Kocul field with responsibility for implementing the development plan and arranging financing for the project. In March 1997, CanArgo declared the political unrest in Albania to be a force majeure, and the joint venture suspended activities. The suspension of activities continues. In light of the extended period that the force majeure condition had continued and the absence of any indication of an imminent termination of the condition, CanArgo recorded during the fourth quarter of 1997 an impairment for the entire amount of its investment in and advances to the Albanian joint venture. Albpetrol has requested that the joint venture recommence activities at the Gorisht-Kocul field. CanArgo is evaluating that request and seeking others who may want to participate in this project. If it is unsuccessful in attracting others to participate in this project, CanArgo may relinquish this project. 50 52 Lelyaki Field, Pryluki Region, Ukraine CanArgo holds an effective 45% interest in a joint venture company formed to develop the Lelyaki field in eastern Ukraine. CanArgo's partner in this joint venture is Ukranafta, which holds a 55% interest. In 1996, the joint venture received a 20 year oil and gas production license for a 67 square kilometer portion of the Lelyaki field, as well as a five year exploration license for 327 square kilometer area surrounding the production area. Based on its analysis of initial development efforts including consulting with independent petroleum engineers, CanArgo concluded that the Lelyaki field would not support a successful commercial development. On the basis of that conclusion, CanArgo recorded during the fourth quarter of 1997 an impairment for the entire amount of its remaining investment in and advances to the Lelyaki joint venture and advised the joint venture that CanArgo would not provide it with any further financial support. The joint venture continues to produce a modest amount of oil from wells recompleted by the joint venture, which is sold in the Ukrainian market. Maykop Field, Adygea CanArgo holds a 37% interest in Intergas, a Russian joint stock company with a license for the Maykop gas field. In 1994, Intergas was granted an exclusive 25 year exploration and production license covering specified zones in the 12,500 acre Maykop gas condensate field in the southern Russian autonomous republic of Adygea, located approximately 185 kilometers from the Black Sea. In 1996 through 1997, CanArgo experienced delays and difficulty in resolving operating arrangements and other matters relating to Intergas. This caused CanArgo to conclude that it could not effectively pursue commercial activities and develop the Maykop field as planned. As a result, CanArgo recorded during the fourth quarter of 1997 an impairment for the entire amount of its investment in and advances to Intergas. CanArgo is currently in discussions with the other shareholders regarding the future of Intergas. CanArgo believes that it has no further obligation to fund any operations of Intergas, but Intergas and other shareholders of Intergas and other parties may assert claims against CanArgo. NORTH AMERICAN OIL AND GAS PROPERTIES AND VENTURES CanArgo has interests in several small oil and gas properties located in Alberta, Canada and Texas. These properties either are non-producing or are producing modest amounts of oil and gas. CanArgo intends to offer one or more of these properties for sale in order to raise additional working capital. COMPETITION The oil and gas industry can be highly competitive. CanArgo encounters competition from other oil and gas companies in all phases of its operations, including: - - The acquisition of producing properties; - - Obtaining scarce resources and services including oil field services; and - - The sale of crude oil. CanArgo's competitors include integrated oil and gas companies, independent oil and gas companies, individuals and drilling and income programs. Many of these competitors are large, well-established companies with substantially larger operating staffs and greater capital resources than CanArgo and which, in many instances, have been engaged in the 51 53 energy business for a much longer time than CanArgo. Such competitors may be able to outperform CanArgo on a number of dimensions, including: - - Development of information; - - Analysis of available information; - - Ability to pay for productive oil and gas properties and exploratory prospects; and - - Commitment of resources to define, evaluate, bid for and purchase oil and gas properties and prospects. In the competition to acquire oil and gas properties, CanArgo has relied substantially on the relationships its officers and directors have developed in the international oil and gas industry and in its areas of operation and interest. As a result of the termination of employment of various former officers, CanArgo's ability to benefit from such relationships outside of Georgia has been significantly reduced. CanArgo's management believes that CanArgo's relatively small size has enabled it to consider projects that would be deemed to be too small for consideration by many larger competitors. Most crude oil is sold at prices related to published world prices for various grades of crude oil. The sale price generally reflects the world price less an allowance for the cost of delivering the crude oil to a location identified by the customer. Accordingly, the most desirable market for Ninotsminda field oil would appear to be the local and regional Georgian markets, although customers in these markets have recently shown some resistance to price increases based on movement in world prices. CanArgo has encountered little competition for sales to the local and regional Georgian markets for crude oil, although Georgian Oil is a potential competitor as would be any other production company that establishes crude oil production in or near Georgia. No assurance can be given that the local and regional Georgian markets for crude oil will not become more competitive on the sellers' side, yielding relatively lower selling prices. TECHNOLOGY FOR ENHANCED RECOVERY OF HEAVY OIL CanArgo has rights to a technology based upon heating heavy oil in the reservoir with electric current. Heavy oil is very viscous at reservoir temperatures and normally needs to be heated in order to flow easily. Several pilot projects involving the technology have been implemented during the past ten years, and while results have varied, CanArgo believes that they suggest the validity of the technology. CanArgo, however, has not successfully commercialized this technology, and during the past several years CanArgo has not devoted any significant resources to the development or commercialization of this technology. CanArgo hopes to fund further development of its enhanced oil recovery technology through direct third-party equity financing of the subsidiary holding the rights to the technology. No assurances can be given that the subsidiary will be able to attract purchasers for its shares, that adequate funding will be generated, or that any funding will result in the successful development or commercialization of the enhanced oil recovery technology. GOVERNMENTAL AUTHORIZATIONS CanArgo's business in Eastern Europe operates pursuant to licenses, concession agreements or other authorizations granted by the local governmental authorities. These authorizations impose various requirements upon CanArgo, either directly or indirectly. The failure to satisfy the requirements of any authorization could result in its termination or cancellation. In addition, as sovereign agencies, the governmental authorities that have granted 52 54 authorizations may have greater power than private parties to terminate such authorizations arbitrarily. Loss of such authorizations could have a material adverse effect upon the financial condition, results of operations, cash flows and prospects of CanArgo. ENVIRONMENTAL AND REGULATORY MATTERS The development of oil and gas fields and the production of hydrocarbons inherently involve environmental risks. These risks can be minimized, but not eliminated, through use of various engineering and other technological methods, and CanArgo intends to employ such methods to industry standards. The potential environmental problems are enhanced when the oil and gas development and production activities involve the rehabilitation of fields where the practices and technologies employed in the past have not embodied the highest standards then in effect, which has been the case in the Eastern European oil fields in which CanArgo operates. CanArgo's business is subject to various national, provincial, state and local laws and regulations relating to the exploration for and the development, production and transportation of oil and natural gas, as well as environmental and safety matters. Many of these laws and regulations have become more stringent in recent years, imposing greater liability on a larger number of potentially responsible parties. CanArgo believes it has complied in all material respects with these laws and regulations. Because the requirements imposed by such laws and regulations are frequently changed, CanArgo is unable to predict the ultimate cost of compliance with these requirements or their effect on its operations. EMPLOYEES As of April 30, 1999, CanArgo had 12 full time employees. The non-affiliated entity acting as operator of the Ninotsminda oil field for Ninotsminda Oil Company has 88 full time employees, and substantially all of that company's activities relate to the development of the Ninotsminda field. PROPERTIES CanArgo does not have outright ownership of any real property. Its real property interests are limited to leasehold and mineral interests. The following table summarizes the number of productive oil wells and the total developed acreage for the Ninotsminda field on March 31, 1999. This information has been presented on a gross basis, representing the interest of Ninotsminda Oil Company, and on a net basis, representing the interest of CanArgo based on its 68.5% interest in Ninotsminda Oil Company.
GROSS NET -------------------------- -------------------------- NUMBER OF WELLS ACREAGE NUMBER OF WELLS ACREAGE --------------- ------- --------------- ------- Ninotsminda field.......... 7 2,500 4.8 1,713
On March 31, 1999, there were no productive wells or developed acreage on any of CanArgo's other Georgian properties, except for one well on the West Rustavi field which was shut-in at that date. 53 55 The following table summarizes the gross and net undeveloped acreage held under the Ninotsminda and Nazvrevi/Block XIII production sharing contracts on March 31, 1999. The information regarding gross acreage represents the interest of Ninotsminda Oil Company under the Ninotsminda contract and the interest of a majority-owned subsidiary of CanArgo under the Nazvrevi/Block XIII contract. The information regarding net acreage represents the interest of CanArgo based on its 68.5% interest in Ninotsminda Oil Company and on an anticipated 88.5% interest in the subsidiary holding the Nazvrevi/ Block XIII contract following the expected sale to XCL Ltd. of stock representing 11.5% of that subsidiary.
GROSS ACREAGE NET ACREAGE ------------- ----------- Ninotsminda field.................................... 24,000 16,440 Nazvrevi/Block XIII.................................. 518,500 458,873 ------- ------- Total.............................................. 542,500 475,313 ======= =======
CanArgo leases office space in Calgary, Alberta; Houston, Texas; Tbilisi, Republic of Georgia; and Maidenhead, England. The leases have remaining terms varying from one to two years. CanArgo has subleased its Maidenhead offices. LEGAL PROCEEDINGS On February 20, 1998, Zhoda Corporation filed suit against CanArgo in the District Court of Harris County, Texas. In 1997, Zhoda sold to CanArgo shares in a company through which CanArgo acquired most of its interest in the Lelyaki field project. Part of the consideration which CanArgo paid to Zhoda consisted of shares of a CanArgo subsidiary which were exchangeable for shares of CanArgo common stock only upon the achievement of specified Lelyaki field operating objectives. CanArgo believes that these objectives were not achieved. In the litigation, Zhoda asserts that it was wrongfully deprived of the value of the CanArgo shares it believes it should have received, based upon claims of breach of contract, breach of fiduciary duty and duty of good faith and fair dealing, fraud and constructive fraud, fraud in the inducement, negligent misrepresentation, civil conspiracy, breach of trust, unjust enrichment and rescission. Zhoda is seeking more than $7,500,000 in damages, return of the shares transferred to CanArgo, and other relief. The Harris County District Court has stayed the litigation pending completion of arbitration proceedings, which are being held in Calgary, Alberta. The arbitration proceedings are still in the preliminary procedural stage. CanArgo believes it has meritorious defenses to Zhoda's claims which it intends to assert vigorously. A judgment in favor of Zhoda could have a material adverse effect on CanArgo's financial condition, results of operations, cash flows and prospects. On March 24, 1998, CanArgo filed an action against Zhoda in the Court of Queen's Bench of Alberta, Judicial Centre of Calgary, in which CanArgo seeks to recover $190,000, plus interest, which CanArgo asserts Zhoda owes CanArgo pursuant to promissory notes and loan agreements. On March 31, 1998, Zhoda filed a statement of defense and a counterclaim in which it asserted essentially the same claims as were asserted in the Texas action described above. On the basis of its counterclaim, Zhoda seeks relief similar to that sought in the Texas action. CanArgo's claim against Zhoda in the Alberta action is not within the scope of the arbitration proceeding being conducted in Calgary. 54 56 On March 9, 1998, Ribalta Holdings, Inc., which sold to CanArgo shares in a company through which CanArgo acquired most of its interest in the Maykop field project, filed suit against CanArgo in the Third Judicial District Court of Salt Lake County, Utah. Ribalta, however, has not yet served the complaint on CanArgo. In its complaint, Ribalta alleges breach by CanArgo of the contract governing the sale of the shares it transferred to CanArgo and failure of a condition in that contract that should have resulted in the termination of the contract. Ribalta seeks the return of all benefits conferred on CanArgo pursuant to the contract or damages equal to the value of such benefits, as well as other relief. Under that contract, as amended, the maximum consideration to which Ribalta might have been entitled was $800,000 and 350,000 shares of CanArgo common stock. CanArgo believes that no consideration is payable under that contract because conditions to payment specified in the contract were not satisfied. A judgment in favor of Ribalta in this proceeding could have a material adverse impact on CanArgo's financial condition, results of operations, cash flows and prospects. CanArgo believes it has meritorious defenses to Ribalta's claims which it intends to assert vigorously. MANAGEMENT EXECUTIVE OFFICERS AND DIRECTORS The executive officers, directors and a significant employee of CanArgo are as follows:
NAME AGE POSITION - ---- --- -------- David Robson 41 Chairman of the Board and Chief Executive Officer Michael R. Binnion 38 Director, President and Chief Financial Officer Robert A. Halpin 63 Director J.F. Russell Hammond 57 Director Peder Paus 53 Director Nils N. Trulsvik 50 Director Ron Gerlitz 44 Vice President, Technology Anthony J. Potter 34 Vice President, Finance Niko Tevzadze 34 Vice President (Significant Employee)
The members of the audit committee are Robert A. Halpin and Peder Paus. The members of the compensation committee are J.F. Russell Hammond and Nils N. Trulsvik. DAVID ROBSON was elected a Director, Chairman of the Board and Chief Executive Officer on July 15, 1998. He has also served as a Director, Chairman of the Board and Chief Executive Officer of CanArgo's subsidiary, CanArgo Oil & Gas Inc., since July 1997, and as President of Ninotsminda Oil Company since 1996. Dr. Robson provides his services to CanArgo through Vazon Energy Limited, a company that he owns. From April 1992 until February 1997, Dr. Robson held several senior officer positions at JKX Oil & Gas plc, including Managing Director and Chief Executive Officer. A subsidiary of JKX Oil & Gas plc is the minority shareholder of Ninotsminda Oil Company. Dr. Robson holds a B.Sc. (Hon) in Geology and a Ph.D. in Geochemistry from the University of Newcastle upon Tyne, and an MBA from the University of Strathclyde. He is the energy sector representative on the United Kingdom government's East European Trade Council. 55 57 MICHAEL R. BINNION was elected a Director, President and Chief Financial Officer on July 15, 1998. He has also served as a Director, Chief Financial Officer and Secretary of CanArgo Oil & Gas Inc. since March 1997. Mr. Binnion is also President and a director of Terrenex Acquisition Corporation, an Alberta Stock Exchange listed investment company which is CanArgo's largest stockholder. He is sole owner and director of Rupert's Crossing, a private investment company, and a director of NRI Online Inc., Fintech Services Ltd. and Smartor Products Inc. Prior to April 1997, he served as Chief Financial Officer and a director of Trans-Dominion Energy Company, a Toronto Stock Exchange listed international exploration and production company, for four years. ROBERT A. HALPIN was elected a Director on March 4, 1995. Mr. Halpin is not standing for reelection and will retire as a director at the annual meeting of stockholders to be held in June 1999. He served as Chairman of the Board from November 14, 1995 to February 4, 1997 and as Vice Chairman of the Board from February 4, 1997 to July 15, 1998. Mr. Halpin has long experience in the oil and gas industry. Mr. Halpin has been a director of TransGlobe Energy Corporation, Synerseis Technologies Inc. and Pacific Tiger Energy Ltd., all Canadian companies, since 1997. From 1989 to his retirement in September 1993, he served as Vice President for International Exploration and Production with Petro-Canada. In October 1993, Mr. Halpin became President of Halpin Energy Resources Ltd., a firm which provides advisory services to energy companies. J.F. RUSSELL HAMMOND was elected a Director on July 15, 1998. He has also served as a Director of CanArgo Oil & Gas Inc. since June 1997. For over five years, Mr. Hammond has been an investment advisor to Provincial Securities Ltd., a private investment company which is the beneficial owner of 7.86% of CanArgo's voting securities. Mr. Hammond has been Chairman of Terrenex Acquisition Corporation, since 1992. PEDER PAUS was elected a Director on July 15, 1998 and is an independent businessman based in Oslo, Norway. Since 1995, he has been a consultant on investor relations for various companies. From 1981 to 1995, Mr. Paus was Chief Executive Officer of North Venture Ltd., a shipping and offshore consulting firm based in London, England. NILS N. TRULSVIK was elected a Director on August 17, 1994. He served CanArgo as President and Chief Executive Officer from February 4, 1997 to July 15, 1998 and from November 21, 1994 to March 9, 1995; and as Executive Vice President from March 9, 1995 to February 4, 1997 and from September 8, 1994 until November 21, 1994. In August 1998, Mr. Trulsvik became a partner in a consulting company, The Bridge Group, located in Norway. Mr. Trulsvik is a petroleum explorationist with extensive experience in petroleum exploration and development throughout the world. Prior to joining CanArgo, he held various positions with Nopec a.s., a Norwegian petroleum consultant group of companies of which he was a founder, including Managing Director from 1987 to 1993 and Special Advisor from 1993 to August 1994. RON GERLITZ was elected Vice President, Technology on November 1, 1998. From 1997 to September 1998, he was Manager of Engineering for First Calgary Petroleums. From 1992 until 1997 he was an independent petroleum consultant in Calgary, Alberta, Canada. From 1983 to 1992, Mr. Gerlitz worked as an engineer in various capacities and positions with a number of corporations, including Mobil Oil. In 1983, he graduated from the University of Calgary with a Bachelor of Science in Engineering. ANTHONY J. POTTER was elected Vice President, Finance on July 15, 1998. He also serves CanArgo as Group Controller. He has served as Vice President, Finance and Group Controller of CanArgo Oil & Gas Inc., since May 1998. From September 1986 to 56 58 April 1998, Mr. Potter was employed with Coopers & Lybrand Chartered Accountants. In 1986, he graduated from the University of Calgary with a Bachelor of Commerce in Accounting. NIKO TEVZADZE was elected Vice President on July 15, 1998. He has been the General Director of Georgian British Oil Company, which operates the Ninotsminda field on behalf of CanArgo, since October 1993. From 1991 to 1993, Mr. Tevzadze was general director of the joint venture Georgia Makoil. From 1986 to 1991, he worked at the East Georgia Drilling Office of Georgian Oil as foreman, drilling engineer and chief technologist. Directors hold office until the next annual meeting of stockholders and until their successors are duly elected and qualified. Officers serve at the pleasure of the board of directors. INDEMNIFICATION AND INSURANCE CanArgo's Bylaws require CanArgo to indemnify its officers and directors to the full extent permitted by Delaware law. The Bylaws also require CanArgo to advance payment of expenses to an indemnified party so long as he agrees to repay the amount advanced if it is later determined that he is not entitled to indemnification. CanArgo carries directors' and officers' liability insurance covering losses arising from claims based on breaches of duty, negligence, error and other wrongful acts. EXECUTIVE COMPENSATION SUMMARY COMPENSATION TABLE The following table summarizes the compensation paid during the periods indicated to the current and former executive officers named below.
ANNUAL COMPENSATION LONG-TERM COMPENSATION ------------------ -------------------------------------- SECURITIES NAME AND YEAR UNDERLYING ALL OTHER PRINCIPAL POSITION ENDED SALARY ($) OPTIONS/SARS (#) COMPENSATION(5) ($) - ------------------ ----- ---------- ---------------- ------------------- David Robson(1)......... 12/98 82,500 390,000 0 Nils N. Trulsvik(2)..... 12/98 87,376 0 3,681 12/97 140,333 0 6,653 12/96* 51,834 50,000 5,679 8/96 161,241 0 8,635 Rune Falstad(3)......... 12/98 112,852 25,000 3,786 12/97 82,952 15,000 3,825 Alfred Kjemperud(4)..... 12/98 133,338 50,000 3,124 12/97 101,296 5,000 5,014 12/96* 38,875 10,000 2,342
- ------------------------- * Four month period ended December 31, 1996. (1) Mr. Robson has served as Chief Executive Officer since July 15, 1998 and provides services to CanArgo through Vazon Energy Limited. 57 59 (2) Mr. Trulsvik served as President and Chief Executive Officer from February 4, 1997 to July 15, 1998 and as Executive Vice President from March 9, 1995 to February 4, 1997. Included in his 1998 salary is $1,671 paid as non-employee directors' fees subsequent to July 31, 1998. Mr. Trulsvik's current compensation arrangements are described below under "Employment Contracts." (3) Mr. Falstad served as Vice President from June 1997 through March 1999. Included in his 1998 salary are payments for consulting services rendered to CanArgo subsequent to July 31, 1998 under a contract with FinCom AS, of which Mr. Falstad is a partner, which is described below under "Employment Contracts." (4) Mr. Kjemperud resigned as Vice President on September 3, 1998. Included in his 1998 salary are payments for consulting services rendered to CanArgo subsequent to September 3, 1998 under a contract with The Bridge Group which is described below under "Employment Contracts." (5) Represents CanArgo's contributions to individual retirement and pension plans. OPTION GRANTS DURING FISCAL YEAR 1998 The following table sets forth information concerning options granted during 1998 to the persons named in the summary compensation table.
NUMBER OF % OF TOTAL SECURITIES OPTIONS GRANT DATE UNDERLYING GRANTED TO PRESENT VALUE(2) OPTIONS EMPLOYEES EXERCISE EXPIRATION -------------------- NAME GRANTED(1) IN FY 12/98 PRICE DATE PER SHARE TOTAL - ---- ---------- ----------- -------- ---------- --------- -------- David Robson........... 120,000 16.58% $0.69 10/6/08 $0.3233 $ 38,796 270,000 37.30 1.25 7/16/08 0.5874 158,598 Nils N. Trulsvik....... 0 -- -- -- -- -- Rune Falstad........... 25,000 3.45 0.70 12/16/00 0.1225 3,063 Alfred Kjemperud....... 50,000 6.91 0.70 12/16/00 0.1225 6,125
- ------------------------- (1) The options granted to Mr. Robson vest in three equal annual installments commencing on the first anniversary of the grant date and were granted at an exercise price equal to the fair market value of the common stock on the date of grant. The options granted to Messrs. Falstad and Kjemperud are exercisable only from November 16, 2000 through December 16, 2000, at an exercise price equal to 124% of the fair market value of the common stock on the date of grant. CanArgo's stock option plans allow the compensation committee to modify the terms of outstanding options, including their exercise price and vesting schedule. (2) These values were derived using the Black-Scholes option pricing model applying the following assumptions:
EXERCISE RISK FREE PRICE DIVIDEND YIELD VOLATILITY INTEREST RATE EXPECTED TERM -------- -------------- ---------- ------------- ------------- $0.69 0% 44.76% 5.72% 5 years 1.25 0 44.76 5.72 5 years 0.70 0 44.76 5.69 2.1 years
58 60 These values are not intended to forecast future appreciation of CanArgo's stock price. The actual value, if any, that an executive officer may realize from his options, assuming that they are exercised, will depend solely on the increase in the market price of the shares acquired through option exercises over the exercise price, as measured when the shares are sold. OPTION VALUES AT DECEMBER 31, 1998 The following table summarizes information at December 31, 1998 concerning the number and hypothetical value of stock options held by the persons named in the summary compensation table.
NUMBER OF SHARES UNDERLYING UNEXERCISED VALUE OF UNEXERCISED OPTIONS HELD IN-THE-MONEY OPTIONS AT FISCAL YEAR END AT FISCAL YEAR END(1) ---------------------------- ---------------------------- NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE - ---- ----------- ------------- ----------- ------------- David Robson............... 75,000 495,000 $0 $0 Nils N. Trulsvik........... 30,000 0 0 0 Rune Falstad............... 0 25,000 0 0 Alfred Kjemperud........... 0 50,000 0 0
- ------------------------- (1) As of December 31, 1998, none of the options was "in-the-money" because their exercise price exceeded the market value of the common stock on that date. DIRECTORS' COMPENSATION CanArgo does not currently pay cash compensation to its directors for their services as directors, but does reimburse them for their ordinary out-of-pocket expenses for attending board and committee meetings or otherwise in connection with activities as directors. From July 15, 1998 until October 1, 1998, CanArgo paid non-employee directors fees at the rate of $10,000 per year. From January 1, 1998 until July 15, 1998, CanArgo paid non-employee directors other than Robert A. Halpin fees at the rate of $14,000 per year plus a fee of $3,000 per year for each committee on which the non-employee director served. During that period, CanArgo also paid non-employee directors a fee of $1,000 per day, other than a day on which the board met, for each day a non-employee director spent on the business of board committees which exceeded one day per year with respect to the compensation committee and three days per year with respect to the audit committee and the petroleum committee. From January 1998 through July 15, 1998, CanArgo paid Robert A. Halpin for his services as Vice Chairman of the board and a member of board committees at the rate of $45,000 per year. During that period, CanArgo also provided Mr. Halpin with an office at CanArgo's offices located in Calgary, Alberta, Canada, and reimbursed Mr. Halpin for his out-of-pocket expenses in connection with services on behalf of CanArgo. Nils N. Trulsvik may provide consulting services to CanArgo at the rate of $1,200 per day plus expenses, through The Bridge Group, of which Mr. Trulsvik is a partner, pursuant to a work order dated August 1, 1998 between CanArgo and Mr. Trulsvik. Mr. Trulsvik did not provide any consulting services to CanArgo during 1998. 59 61 From January 1, 1996 to July 15, 1998, Eugene Meyers, who was a non-employee director of CanArgo during that period, provided financial relations consulting services to CanArgo at the rate of $15,000 per year for 22 days of service, and thereafter at the rate of $100 per hour, subject to a $1,000 maximum per day. CanArgo also reimbursed him for his out-of-pocket expenses associated with those services. CanArgo provides automatic grants of non-qualified options to non-employee directors pursuant to the 1995 Long-Term Incentive Plan. The plan provides that each non-employee director will receive a non-qualified option to purchase 3,750 shares of common stock on (1) the date of each meeting of stockholders at which he is elected or re-elected as a director or, if in any fiscal year directors are not elected at a meeting of stockholders, on the last date of that fiscal year and (2) the date he is first elected as a director, if not at a meeting of stockholders. In addition, a non-employee director will automatically be granted a non-qualified option to purchase 3,750 shares of common stock on each date on which he is elected or re-elected by the board of directors as chairman of the board of directors, or, if the chairman of the board is then an employee of CanArgo, as vice chairman of the board of directors. The exercise price of each option is equal to 100% of the fair market value of the common stock on the date of grant. Each option is 100% vested six months after the date of grant. Options expire on the earlier of three years from the date of grant or the first anniversary of the date the director ceases to be a director. Non-employee directors are not eligible to receive other options under the 1995 Long-Term Incentive Plan. The following table shows the compensation paid to all persons who were non-employee directors of CanArgo, during the year ended December 31, 1998:
DIRECTORS FEES AND OTHER CONSULTING OPTIONS NAME COMPENSATION PAYMENTS GRANTED - ---- -------------- ---------- ------- Robert A. Halpin............................ $26,293 $ 0 3,750(3) J.F. Russell Hammond........................ 2,137 0 3,750(4) Stanley D. Heckman(1)....................... 10,685 0 -- Eugene J. Meyers(1)......................... 7,537 43,100(2) -- Peder Paus.................................. 2,137 0 3,750(4) Nils N. Trulsvik............................ 1,671 0 --
- ------------------------- (1) Messrs. Heckman and Meyers served as non-employee directors until July 15, 1998. (2) Includes $35,600 for services rendered during 1997. (3) The options were granted on December 31, 1998 at an exercise price of $0.313 per share, expire on December 30, 2001 and will be 100% vested at June 30, 1999. (4) The options were granted on July 15, 1998 at an exercise price of $1.00 per share, expire on July 14, 2001 and were 100% vested at January 15, 1999. EMPLOYMENT CONTRACTS CanArgo had employment contracts with Nils N. Trulsvik, Rune Falstad and Alfred Kjemperud which were terminated effective July 31, 1998. The contracts provided for annual salaries of approximately $150,000 in the case of Mr. Trulsvik, approximately $125,000 in the case of Mr. Falstad and approximately $100,000 in the case of 60 62 Mr. Kjemperud. In addition, each person received an allowance equal to 12.5% of his base salary, a portion of which was used to provide minimum life and disability insurance coverage for each such person. The remainder of the allowance was used by each person for additional life, medical or accident insurance and to fund individual pension and retirement plans. Mr. Falstad provided consulting services to CanArgo through FinCom AS under an agreement from August 1, 1998 through March 31, 1999 at the rate of $7,000 per month plus expenses. Mr. Kjemperud provides consulting services to CanArgo through The Bridge Group pursuant to a one-year work order commencing August 1, 1998 at the rate of $13,000 per month plus expenses. Mr. Trulsvik may provide consulting services through the Bridge Group pursuant to a work order dated August 1, 1998 at the rate of $1,200 per day plus expenses. STOCK OPTION PLANS CanArgo has adopted the 1995 Long-Term Incentive Plan pursuant to which it has awarded and may in the future award stock options, including re-load options, and stock appreciation rights, to employees, directors, consultants and advisors of CanArgo or any subsidiary of CanArgo. Non-employee directors of CanArgo are only eligible to receive annual automatic option grants under the incentive plan as described above under "Directors' Compensation." The incentive plan currently authorizes the issuance of up to 750,000 shares of CanArgo common stock. At the annual meeting of stockholders scheduled for June 16, 1999, CanArgo will seek stockholder approval of an amendment of the incentive plan to increase the number of shares which may be issued thereunder from 750,000 shares to 4,000,000 shares, subject to the limitation that CanArgo may not grant awards that would increase the number of shares subject to outstanding awards under this plan at any time to an amount that would exceed 10% of the number of then outstanding shares of common stock. At March 31, 1999, there were 695,084 shares subject to outstanding options and 54,916 shares available for future grants under the incentive plan. There are no stock appreciation rights outstanding. In connection with the July 1998 combination with CanArgo Oil and Gas Inc., CanArgo assumed the CanArgo Oil and Gas Inc. Stock Option Plan under which 988,000 shares may be issued. There are currently outstanding options covering 888,000 shares and 100,000 shares are available for future option grants. Persons who are eligible to receive options under this stock option plan are full time employees and consultants of CanArgo or any 50% or more owned subsidiary of CanArgo (including a director of any subsidiary) who are not officers or directors of CanArgo. CanArgo's stock option plans are administered by the Compensation Committee of the board of directors. The exercise price and vesting schedule of awards under these plans are determined by the Compensation Committee when the award is granted, provided that the option price for any incentive stock option or any option granted under the CanArgo Oil and Gas Inc. stock option plan may not be less than 100% of the fair market value of CanArgo common stock on the date of grant. The term of options granted under these plans may not exceed ten years from the date of grant. In the case of an incentive option granted to a person who owns 10% or more of CanArgo's common stock, the exercise price of the option may not be less than 110% of the fair market value on the date of grant and the term of the option may not exceed five years. 61 63 The Compensation Committee may modify or amend the terms of outstanding awards, including a change or acceleration of the vesting of an award, and it may exchange, cancel or substitute awards, subject to the consent of the holders of the awards. Unless a surviving or acquiring entity agrees to assume the outstanding awards, each outstanding award under these plans will terminate on the date of: - - CanArgo's liquidation or dissolution, - - a reorganization, merger or consolidation in which CanArgo is not the survivor, - - the sale of substantially all of the assets of CanArgo, or - - the sale of more than 80% of the then outstanding stock of CanArgo to another corporation or entity. No awards may be granted under the incentive plan after November 2005. The board of directors may discontinue either plan at any time and may amend either plan without stockholder approval unless the amendment would increase the total number of shares issuable under that plan or, with respect to the CanArgo Oil and Gas Inc. stock option plan, would change the manner of determining the minimum exercise price of options. Under Section 162(m) of the Internal Revenue Code of 1986, CanArgo may be precluded from claiming a federal income tax deduction for total remuneration in excess of $1,000,000 for its chief executive officer or any of its other four highest paid officers. Based on the current market price of CanArgo's common stock and the number of options held by such persons, CanArgo does not believe that any compensation derived from the exercise of awards granted under these plans, together with other compensation to CanArgo's executive officers, will exceed $1,000,000 in any year for any such officer. Neither of the stock option plans, however, meets the requirements of an exception from Section 162(m) for "performance-based compensation." RELATED TRANSACTIONS Nicholas G. Dobrotwir served as Vice President of CanArgo from September 1997 until January 26, 1998. Since then he has provided consulting services to CanArgo. In 1997, CanArgo paid $500,000 and issued 87,500 shares of common stock having a value on the date of issuance of $1,060,938 to Fielden Management Services Pty, Ltd. in connection with CanArgo obtaining the right to develop and operate the Stynawske field project. Mr. Dobrotwir has indirect beneficial ownership of the 87,500 shares of common stock owned by Fielden. Fielden also has the contingent right to receive up to an additional 187,500 shares of common stock if the Stynawske field project satisfies specified performance standards. During 1997, CanArgo paid Fielden consulting fees and expenses related to the Stynawske field project. Mr. Dobrotwir was the President and Chief Executive Officer of Fielden until his resignation on May 5, 1997. Mr. Dobrotwir's consulting services to CanArgo were provided through Fielden from January 1997 through April 1997. After April 30, 1997, Mr. Dobrotwir's services were provided pursuant to a management service agreement between CanArgo and Trident Petroleum Inc. During 1997, CanArgo paid a total of $288,065.20 to Fielden, including $111,562.50 for consulting services provided by Mr. Dobrotwir, and paid $100,000 to Trident Petroleum Inc. for Mr. Dobrotwir's services. Orest Senkiw served as a Vice President of CanArgo from February 4, 1997 to December 1, 1997. Mr. Senkiw and his family own the corporation that holds 10.3% of the 62 64 outstanding shares of Zhoda Corporation. Mr. Senkiw was the CanArgo executive who had the principal operating responsibilities for the Lelyaki field project during 1997. On April 26, 1997, Zhoda transferred an effective 36% ownership interest in the Lelyaki field project to CanArgo. In consideration for the transfer, a subsidiary of CanArgo assumed a $450,000 obligation owed by Zhoda to CanArgo and issued to Zhoda special non-voting common shares of that subsidiary which could be exchanged for 500,000 shares of CanArgo common stock if various conditions relating to performance by the Lelyaki field were achieved. CanArgo believes that all of Zhoda's rights to exchange the special shares terminated during 1997 because the conditions were not satisfied. Zhoda has filed a suit against CanArgo in connection with this transaction which is described in the section "Business -- Legal Proceedings." CanArgo is a 50% shareholder of CanArgo Power Corporation, which in turn owns 85% of a Georgian private power company. The other 50% of CanArgo Power is owned by Terrenex Acquisition Corporation. Terrenex is the beneficial owner of 11.8% of CanArgo's voting securities. Michael R. Binnion is President and a director of both CanArgo and Terrenex. J.F. Russell Hammond is a director of CanArgo and Chairman of Terrenex. Peder Paus is a director of CanArgo and a 12% stockholder of Terrenex. During the first half of 1998, Terrenex, on behalf of both itself and CanArgo, provided all of the funds required by CanArgo Power. After the July 1998 business combination with CanArgo Oil & Gas Inc. was completed, CanArgo reimbursed Terrenex $398,000, representing half of the amount that had been advanced through that time. CanArgo and Terrenex have funded CanArgo Power equally since that time. In May 1998, Terrenex agreed to lend CanArgo Oil & Gas Inc. up to $1,000,000 through August 31, 1998 and subsequently advanced the $1,000,000. CanArgo Oil & Gas Inc. paid Terrenex a $10,000 commitment fee, $50,000 in draw down fees and interest at the rate of 1/2% per month. In addition, CanArgo Oil & Gas Inc. granted Terrenex two options, each exercisable until December 31, 1998. One option entitled Terrenex to acquire 12 1/2% of the stock of the CanArgo subsidiary that holds the Nazvrevi/Block XIII production sharing contract. Under the second option, Terrenex could purchase 15% of CanArgo Oil & Gas Inc.'s position in any licenses received as a result of a consortium submission in response to the Dagestan tender for offshore drilling and production rights. The terms of the loan were negotiated and approved by those directors of CanArgo Oil & Gas Inc. who had no affiliation with Terrenex. CanArgo repaid the Terrenex loan following completion of the business combination in July 1998. CanArgo subsequently extended the options through March 31, 1999 in consideration of the efforts of Terrenex in attempting to arrange financing for CanArgo. The options could be exercised by Terrenex paying the percentage of the amount spent by CanArgo on the relevant project through the exercise date as equaled the percentage of the project being acquired through the exercise of the option. In light of the relationship between Terrenex and CanArgo, Terrenex decided that any investment related to CanArgo that it would make at this time should be in the entity CanArgo Energy Corporation and not in specific CanArgo projects and, accordingly, Terrenex allowed the options to expire unexercised. On July 14, 1998, CanArgo Oil & Gas Inc. issued to Peder Paus, but retained in escrow, 225,000 of its common shares. The shares were issued to Mr. Paus for financial services rendered in connection with CanArgo's 1998 business combination with CanArgo Oil & Gas Inc. Upon the consummation of the business combination, Mr. Paus became a director of CanArgo, and the 225,000 common shares of CanArgo Oil & Gas Inc. were converted into 180,000 CanArgo Oil & Gas Inc. exchangeable shares, each of which could be exchanged for a share of CanArgo common stock. The shares were issued to Mr. Paus 63 65 subject to the condition that the financial services rendered by Mr. Paus result in completed transactions. Although the business combination closed, post-combination financing that had been contemplated did not take place. As a result, Mr. Paus and CanArgo Oil & Gas Inc. agreed in September 1998 that since the condition had not been satisfied, the shares were not earned and should be cancelled. The 180,000 exchangeable shares were subsequently cancelled. OWNERSHIP OF VOTING SECURITIES DESCRIPTION OF VOTING SECURITIES The voting securities of CanArgo consist of common stock and special voting stock. Generally, the common stock and special voting stock are voted together as a single class on all matters. The common stock is entitled to one vote per share. The special voting stock is entitled generally to a number of votes equal to the number of outstanding exchangeable shares issued by CanArgo Oil & Gas Inc., a subsidiary of CanArgo. The special voting stock is held of record by Montreal Trust Company of Canada, which holds the stock in trust for the benefit of the holders of the exchangeable shares. The special voting stock is voted in the manner directed by the holders of the exchangeable shares. The exchangeable shares may be exchanged for shares of common stock on a share-for-share basis. For purposes of the following tables, the term "voting securities" refers to the common stock and the exchangeable shares as though they were a single class of voting securities. These securities are described in the section "Description of Capital Stock." SECURITY OWNERSHIP BY MANAGEMENT The following table sets forth information as of April 30, 1999 regarding the beneficial ownership of the voting securities by each director, by the persons named in the summary compensation table, and by all directors and current executive officers of CanArgo as a group. This information is also provided to give effect to the sale of a minimum 10,000,000 shares and a maximum 21,264,643 shares of common stock in this offering, on the assumption that these persons do not purchase shares in this offering. Unless otherwise noted, each stockholder has sole voting and investment power as to the shares shown.
PERCENTAGE OWNERSHIP ------------------------------------------ NUMBER OF BEFORE AFTER MINIMUM AFTER MAXIMUM NAME SHARES OWNED OFFERING OFFERING OFFERING - ---- ------------ -------- ------------- ------------- Michael Binnion......... 439,852(1) 2.06% 1.40% 1.03% Peder Paus.............. 365,894(2) 1.72% 1.17% * Nils N. Trulsvik........ 103,700(3) * * * David Robson............ 90,000(4) * * * J.F. Russell Hammond.... 33,750(5) * * * Robert A. Halpin........ 13,500(6) * * * Rune Falstad............ 10,500 * * * Alfred Kjemperud........ 0 0 0 0 All executive officers and directors as a group (8 persons)..... 1,073,362(7) 4.98% 3.40% 2.51%
- ------------------------- 64 66 * Less than 1%. (1) Includes 70,000 shares underlying presently exercisable options; also includes 137,218 shares, but excludes 2,403,853 shares, beneficially owned by Terrenex Acquisition Corporation of which Mr. Binnion is President, a director and an approximately 5.4% shareholder. Mr. Binnion disclaims beneficial ownership of all shares beneficially owned by Terrenex, other than the 137,218 shares which represent his 5.4% proportionate interest. For information about the holdings of Terrenex, see "Top 20 Holders of Voting Securities" below. (2) Includes 15,715 shares underlying presently exercisable warrants to acquire exchangeable shares and 3,750 shares underlying presently exercisable options. (3) Includes 30,000 shares underlying presently exercisable options. (4) Represents 90,000 shares underlying presently exercisable options. (5) Represents 33,750 shares underlying presently exercisable options. Excludes 2,541,071 shares owned by Terrenex Acquisition Corporation of which Mr. Hammond is Chairman, and 1,671,250 shares owned by Provincial Securities Limited for which Mr. Hammond is an investment advisor, as to which shares Mr. Hammond disclaims beneficial ownership. For information about the holdings of Terrenex and Provincial Securities, see "Top 20 Holders of Voting Securities" below. (6) Includes 7,500 shares underlying presently exercisable options. (7) See Notes 1 through 6; also includes 26,666 shares underlying presently exercisable options held by an executive officer not named in the foregoing table. 65 67 TOP 20 HOLDERS OF VOTING SECURITIES Except as noted with respect to Terrenex Acquisition Corporation, Provincial Securities Limited, Michael R. Binnion, Peder Paus and Nils N. Trulsvik, who are known by CanArgo to beneficially own the shares indicated, the following table sets forth information regarding the top 20 record holders of the voting securities as shown on the stock records of CanArgo and CanArgo Oil & Gas Inc. as of April 30, 1999. Only Terrenex Acquisition Corporation and Provincial Securities Limited are known to CanArgo to be the beneficial owners of more than 5% of the voting securities.
RECORD OWNERSHIP PRIOR TO OFFERING ------------------------------ NAME NUMBER OF SHARES PERCENTAGE - ---- ---------------- ---------- Terrenex Acquisition 2,541,071(1) 11.80% Corporation........... 1580, 727 - 7th Avenue, S.W. Calgary, Alberta T2P 0Z5 Canada Provincial Securities 1,671,250(2) 7.86% Limited................ 607 Gilbert House, Barbican London EC2Y 8BD United Kingdom Independent Oilfield............................... 750,000 3.53% B.A.S.E............................................ 708,750 3.33% Michael R. Binnion................................. 439,852(3) 2.06% Gjensidige Kapital v/Gjensidige Fondsfo............ 412,000 1.94% Peder Paus......................................... 365,894(4) 1.72% Unibank A/S S/A Collective Client.................. 263,950 1.24% Makoil Inc......................................... 250,000 1.18% Part Invest AS..................................... 200,000 0.94% Eurosecurities Limited............................. 189,200 0.89% Arnfred Alvestad................................... 134,000 0.63% G-Fondspar 2020 v/Gjensidige Fondsfo............... 120,000 0.56% Southwest Capital Group Inc........................ 119,444 0.56% Vestmo AS.......................................... 119,000 0.56% A. Hellesto A/S.................................... 106,800 0.50% Nils N. Trulsvik................................... 103,700(5) 0.49% Ingebrigt Breistol................................. 101,800 0.48% Tom Henning Slethei................................ 100,000 0.47% G&J Holding AS v/Jon T. Marthinsen................. 100,000 0.47%
- ------------------------- (1) Includes 261,680 shares underlying presently exercisable warrants to acquire exchangeable shares. Michael Binnion is President, a director and an approximately 5.4% shareholder, and J.F. Russell Hammond is Chairman, of Terrenex Acquisition Corporation. Assuming it does not purchase any shares in this offering, after giving effect to a minimum and a maximum offering, Terrenex would be the beneficial owner of 8.06% and 5.94%, respectively, of the voting securities then outstanding. 66 68 (2) J.F. Russell Hammond is an investment advisor to Provincial Securities Ltd. Assuming it does not purchase any shares in this offering, after giving effect to a minimum and a maximum offering, Provincial Securities would be the beneficial owner of 5.35% and 3.93%, respectively, of the voting securities then outstanding. (3) See Note 1 -- "Security Ownership by Management" above. (4) See Note 2 -- "Security Ownership by Management" above. (5) See Note 3 -- "Security Ownership by Management" above. 67 69 DESCRIPTION OF CAPITAL STOCK CanArgo's certificate of incorporation authorizes CanArgo to issue 50,000,000 shares of common stock, $.10 par value per share, and 5,000,000 shares of preferred stock, $.10 par value per share. CanArgo has authorized a class of preferred stock, "Series Voting Preferred Stock," which we refer to in this prospectus as "special voting stock." As of April 30, 1999, there were 19,526,324 shares of common stock and 100 shares of special voting stock outstanding. At the annual meeting of stockholders scheduled to be held on June 16, 1999 CanArgo will seek stockholder approval of a 1-for-25 reverse stock split of its common stock. If approved, CanArgo does not expect to implement the reverse split until after this offering is completed. The reverse stock split would affect the outstanding shares and options, warrants and other obligations to issue shares of common stock, but would not proportionately reduce the number of authorized shares of common stock. Accordingly, if the reverse stock split is implemented, after completion of this offering there will be at least 45,000,000 authorized but unissued shares of common stock available for future issuance at the discretion of the board of directors. See "Market for Common Stock and Dividend Policy" for additional information regarding the proposed reverse stock split. COMMON STOCK Holders of common stock have no preferences or preemptive, conversion or exchange rights. Subject to any preferential rights of any shares of preferred stock which may be outstanding, holders of common stock are entitled to receive dividends approved by the board of directors and to share ratably in CanArgo's assets legally available for distribution to its stockholders in the event of its liquidation, dissolution or winding-up. CanArgo may not pay dividends on its common stock unless its subsidiary, CanArgo Oil & Gas Inc., simultaneously pays an equivalent dividend on the exchangeable shares described below. Holders of common stock are entitled to one vote per share on all matters voted on generally by the stockholders, including the election of directors. Cumulative voting for the election of directors is not permitted. Except as otherwise required by law or except as any series or class of preferred stock, such as the special voting stock, may provide, the holders of common stock possess all voting power. The shares of common stock to be issued in this offering, when issued and paid for, will be fully paid and non-assessable. PREFERRED STOCK The board of directors is authorized to issue, without stockholder approval, shares of preferred stock in one or more classes or series. The board of directors may set the terms and provisions of each class or series by resolution, including provisions regarding voting, liquidation preference, redemption, conversion and the right to receive dividends. The board of directors has authorized one class of preferred stock, "Series Voting Preferred Stock," which we refer to in this prospectus as "special voting stock." The board of directors has no present plans to issue any additional shares of preferred stock. The ability to issue preferred stock provides CanArgo with flexibility in connection with possible acquisitions, financings and other corporate transactions. The issuance of preferred stock may also, however, have the effect of discouraging, delaying or preventing a change in control of CanArgo. For example, the board of directors can create a series of preferred stock with disproportionate voting power or with the right to vote separately as a class on 68 70 important corporate matters, like mergers or the election of directors. The preferred stock could also be convertible into a large number of shares of common stock or have other terms which could make it more difficult or costly for a third party to acquire a significant interest in CanArgo. Also, shares of preferred stock could be privately placed with purchasers who might side with the management of CanArgo in opposing a hostile tender offer or other attempt to obtain control. As a result, the issuance of preferred stock as an anti-takeover device might preclude stockholders from taking advantage of a situation which might be favorable to their interests. SPECIAL VOTING STOCK In connection with the July 1998 business combination with CanArgo Oil & Gas Inc., the board of directors authorized a class of preferred stock, "Series Voting Preferred Stock," referred to as "special voting stock", consisting of 100 shares. The shares of special voting stock were issued to Montreal Trust Company of Canada, which is holding the shares as trustee for the benefit of the holders of the exchangeable shares described below. Except as otherwise required by law or CanArgo's certificate of incorporation, each share of special voting stock is entitled to a number of votes equal to the quotient (rounded down to the nearest whole number) obtained by dividing the number of outstanding exchangeable shares by the number of outstanding shares of special voting stock. The special voting stock may be voted in the election of directors and on all other matters submitted to a vote of stockholders of CanArgo. The holders of common stock and the holder of the special voting stock vote together as a single class on all matters, except to the extent voting as a separate class is required by applicable law or CanArgo's certificate of incorporation. In the event of any liquidation, dissolution or winding up of CanArgo, the holder of the special voting stock will be entitled to receive the sum of $1.00 per share of special voting stock from any assets of CanArgo available for distribution to its stockholders. The holder of the special voting stock is not entitled to receive dividends. The special voting stock may be redeemed by CanArgo for a price of $1.00 per share at any time when there are no exchangeable shares outstanding and none which are issuable under options, warrants or other obligations. EXCHANGEABLE SHARES In connection with the July 1998 business combination, the outstanding common shares of CanArgo Oil & Gas Inc. were exchanged for exchangeable shares issued by that corporation. The holders of the exchangeable shares may exchange them at any time for CanArgo common stock on a share-for-share basis. As of April 30, 1999, there were 1,738,319 exchangeable shares outstanding and 933,503 exchangeable shares issuable upon exercise of warrants, which may be exchanged for an aggregate of 2,671,822 shares of CanArgo's common stock. If the proposed 1-for-25 reverse split of CanArgo's common stock is implemented, then each 25 exchangeable shares may be exchanged for one share of CanArgo common stock. The following is a summary of the principal terms and rights of the exchangeable shares. DIVIDENDS. Holders of exchangeable shares are entitled to receive dividends equal to the dividends paid by CanArgo on shares of its common stock. VOTING RIGHTS. The holders of exchangeable shares are entitled to provide directions to the holder of the special voting stock as to the manner in which the special voting stock should be voted with respect to any matter on which holders of the common stock are entitled to vote, as described under "Special Voting Stock" above. 69 71 EXCHANGE EVENTS. Exchangeable shares must be exchanged for shares of common stock on a share-for-share basis, plus an amount equal to all declared and unpaid dividends on the exchangeable shares, whenever: - - The holder requests CanArgo Oil & Gas Inc. to redeem his exchangeable shares; - - CanArgo Oil & Gas Inc. is liquidated, dissolved or wound-up; - - Requested by the holder of the special voting stock, in the event CanArgo Oil & Gas Inc. becomes insolvent or bankrupt, has a receiver appointed or similar event occurs; - - CanArgo Energy Corporation becomes involved in voluntary or involuntary liquidation, dissolution or winding-up proceedings; - - Either CanArgo Oil & Gas Inc. or CanArgo Energy Corporation elects to redeem all of the exchangeable shares, provided the election is made after January 30, 2004 or at the time of the election the number of outstanding exchangeable shares in less than 853,071; or - - A holder of exchangeable shares instructs the holder of the special voting stock to require CanArgo to purchase his exchangeable shares. PROTECTION RIGHTS. Without the prior approval of CanArgo Oil & Gas Inc. and the holders of the exchangeable shares, CanArgo may not (1) distribute additional shares of its common stock, subscription rights or other property or assets to all or substantially all holders of its common stock, or (2) subdivide, combine, reclassify or otherwise change the common stock, unless the same or an economically equivalent action is taken with respect to the exchangeable shares. The CanArgo Oil & Gas Inc. board of directors decides in its sole discretion whether the exchangeable shares are being treated on an economically equivalent basis with the common stock. In the event of any proposed tender offer, share exchange offer, issuer bid, take-over bid or similar transaction affecting the common stock, CanArgo must use reasonable efforts to enable holders of exchangeable shares to be treated the same as the holders of the common stock. CanArgo has also agreed to protect the rights of the holders of the exchangeable shares to receive the same dividends as are paid on the common stock and to exchange shares of common stock for exchangeable shares. LIMITATION ON LIABILITY CanArgo's certificate of incorporation limits or eliminates the liability of CanArgo's directors or officers to CanArgo or its stockholders for monetary damages to the fullest extent permitted by the Delaware General Corporation Law. Delaware law provides that a director of CanArgo will not be personally liable to CanArgo or its stockholders for monetary damages for a breach of fiduciary duty as a director, except for liability: (1) for any breach of the director's duty of loyalty; (2) for acts or omissions not in good faith or involving intentional misconduct or a knowing violation of law; (3) for the payment of unlawful dividends and some other actions prohibited by Delaware corporate law; and (4) for any transaction resulting in receipt by the director of an improper personal benefit. SECTION 203 OF DELAWARE GENERAL CORPORATION LAW Section 203 of the Delaware General Corporation Law, which is applicable to CanArgo as a Delaware corporation, prohibits various business combinations between a Delaware corporation and an "interested stockholder," that is, anyone who beneficially owns, alone or with other related parties, at least 15% of the outstanding voting shares of a Delaware 70 72 corporation. Business combinations subject to Section 203 include mergers, consolidations, sales or other dispositions of assets having an aggregate value in excess of 10% of the consolidated assets of the corporation, and some transactions that would increase the interested stockholder's proportionate share ownership in the corporation. Section 203 prohibits this type of business combination for three years after a person becomes an interested stockholder, unless: - - the business combination is approved by the corporation's board of directors prior to the date the person becomes an interest stockholder; - - the interested stockholder acquired at least 85% of the voting stock of the corporation, other than stock held by directors who are also officers or by specified employee stock plans, in the transaction in which it becomes an interested stockholder; or - - the business combination is approved by a majority of the board of directors and by the affirmative vote of two-thirds of the outstanding voting stock that is not owned by the interested stockholder. TRANSFER AGENT AND REGISTRAR The transfer agent and registrar for the common stock is Signature Stock Transfer, Inc., Dallas, Texas, and the Norwegian sub-registrar for the common stock is Den norske Bank ASA, Oslo, Norway. SHARES ELIGIBLE FOR FUTURE RESALE Based on the number of shares outstanding on April 30, 1999, upon completion of this offering, CanArgo will have outstanding 29,526,324 shares of common stock if the minimum number of shares is sold and 40,790,967 shares of common stock if the maximum number of shares is sold. Of these shares, approximately 24,937,030 shares if the minimum number of shares is sold, and approximately 36,201,673 shares if the maximum number of shares is sold, will be freely tradable without restriction or further registration under the Securities Act unless purchased by "affiliates" of CanArgo, as that term is defined in Rule 144 under the Securities Act described below. An "affiliate" is generally considered to be an executive officer, director or holder of enough of the equity securities of a company to be able to influence the policies of that company. The only material restriction on the approximately 4,251,794 of the shares of common stock outstanding prior to this offering which are held by affiliates is the limitation on the number of shares that may be sold in any three-month period under Rule 144. In general, under Rule 144 any person, including an affiliate, who has beneficially owned restricted shares for at least one year, and an affiliate with respect to all of his non-restricted shares, is entitled to sell, within any three-month period, a number of shares at least equal to 1% of the number of then outstanding shares of common stock. In addition, a person who has not been an affiliate of CanArgo at any time during the 90 days preceding the sale and who has beneficially owned the shares proposed to be sold for at least two years, is entitled to sell an unlimited number of restricted shares. 71 73 In addition to the outstanding shares, at April 30, 1999 CanArgo had reserved the following shares for possible future issuance: - - 2,671,822 shares issuable upon exchange of exchangeable shares which are now outstanding and which may become outstanding upon exercise of warrants to purchase exchangeable shares; - - 1,635,084 shares issuable upon exercise of outstanding stock options; - - 154,916 shares that may be issued upon exercise of options available for future grant under CanArgo's stock option plans; - - 181,250 shares issuable for services rendered; and - - 187,500 shares issuable in connection with an oil and gas project. Of the foregoing shares, all but 368,750 shares will be freely tradeable without restriction or further registration under the Securities Act, except for shares which may be acquired by affiliates of CanArgo which would be subject to Rule 144 as described above. LEGAL MATTERS Kelly Lytton Mintz & Vann LLP, special securities counsel to CanArgo, has provided an opinion concerning the validity of the shares of common stock offered by this prospectus. Alan D. Jacobson, a partner in that firm, owns 25,972 shares of common stock, representing less than 1% of the outstanding shares. EXPERTS The consolidated financial statements of CanArgo for the years ended December 31, 1998 and 1997 and August 31, 1996 and the four month period ended December 31, 1996, included in this prospectus have been audited by PricewaterhouseCoopers LLP, independent accountants, as set forth in their report which appears in this prospectus. Those financial statements have been included in this prospectus in reliance upon the report of that firm, which is given upon the authority of that firm as experts in accounting and auditing. The consolidated financial statements of CanArgo Oil & Gas Inc. for the six month period ended December 31, 1997 included in this prospectus have been audited by Ernst & Young, Chartered Accountants, as set forth in their report which appears in this prospectus. Those financial statements have been included in this prospectus in reliance upon the report of that firm, which is given upon the authority of that firm as experts in accounting and auditing. The financial statements of Ninotsminda Oil Company Limited for the periods ended June 30, 1997 and December 31, 1996, included in this prospectus have been audited by Ernst & Young, Chartered Accountants, as set forth in their report which appears in this prospectus. Those financial statements have been included in this prospectus in reliance upon the report of that firm, which is given upon the authority of that firm as experts in accounting and auditing. Information from a report prepared by AMH Group Ltd., a firm of independent petroleum consultants, has been included in this prospectus in reliance on the fact that AMH Group Ltd. is an expert in the evaluation of oil and gas reserves. 72 74 AVAILABLE INFORMATION This prospectus is part of a registration statement on Form S-1 (file no. 333-72295) filed by CanArgo with the SEC. This prospectus does not contain all of the information set forth in the registration statement. Additional information about CanArgo and its common stock is contained in the registration statement and its exhibits. This prospectus contains summary descriptions of some of the documents that are filed as exhibits to the registration statement. You should read the entire document filed as an exhibit and not rely solely on the summaries in this prospectus. CanArgo files reports with the SEC such as annual and quarterly reports, proxy and information statements, and other information. The public may read and copy any materials CanArgo files with the SEC, including the registration statement and its exhibits, at the SEC's Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers, such as CanArgo, that file electronically with the SEC. The address of that site is: http:// www.sec.gov. 73 75 INDEX TO FINANCIAL STATEMENTS CANARGO ENERGY CORPORATION: Report of Independent Accountants......................... F-1 Consolidated Balance Sheet as of December 31, 1998 and December 31, 1997...................................... F-2 Consolidated Statement of Operations for the years ended December 31, 1998 and 1997 and August 31, 1996......... F-3 Consolidated Statement of Operations for the four month periods ended December 31, 1996 and 1995............... F-4 Consolidated Statement of Stockholders' Equity for the period August 31, 1996 through December 31, 1998....... F-5 Consolidated Statement of Cash Flows for the years ended December 31, 1998 and 1997 and August 31, 1996......... F-6 Consolidated Statement of Cash Flows for the four month periods ended December 31, 1996 and 1995............... F-7 Notes to Consolidated Financial Statements................ F-8 Supplemental Financial Information: Supplemental Oil and Gas Disclosures -- Unaudited........................... F-40 Consolidated Condensed Balance Sheet as of March 31, 1999 and December 31, 1998 (Unaudited)...................... F-45 Consolidated Condensed Statements of Operations for the three months ended March 31, 1999 and March 31, 1998 (Unaudited)............................................ F-46 Consolidated Condensed Statements of Cash Flows for the three months ended March 31, 1999 and March 31, 1998 (Unaudited)............................................ F-47 Notes to Unaudited Consolidated Condensed Financial Statements for the three months ended March 31, 1999 and March 31, 1998..................................... F-48 CANARGO OIL & GAS INC.: Consolidated Balance Sheet as of June 30, 1998 (Unaudited)............................................ F-59 Consolidated Statement of Operations and Deficit for the six months ended June 30, 1998 (Unaudited)............. F-60 Consolidated Statement of Cash Flows for the six months ended June 30, 1998 (Unaudited)........................ F-61 Notes to Unaudited Consolidated Financial Statements for the six months ended June 30, 1998 (Unaudited)......... F-62 Auditors' Report.......................................... F-68 Consolidated Balance Sheet as of December 31, 1997........ F-69 Consolidated Statement of Operations and Deficit for the six months ended December 31, 1997..................... F-70 Consolidated Statement of Cash Flows for the six months ended December 31, 1997................................ F-71 Notes to Consolidated Financial Statements................ F-72 Supplemental Disclosures about Oil and Gas -- Production Activities............................................. F-79
74 76 NINOTSMINDA OIL COMPANY LIMITED: Auditors' Report.......................................... F-82 Balance Sheet for the periods ended June 30, 1997 and December 31, 1996...................................... F-83 Statement of Operations and Retained Earnings for the six months ended June 30, 1997 and the period October 24, 1995 to December 31, 1996.............................. F-84 Statement of Cash Flows for the six months ended June 30, 1997 and the period October 24, 1995 to December 31, 1996................................................... F-85 Notes to Financial Statements............................. F-86
75 77 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders of CanArgo Energy Corporation: We have audited the accompanying consolidated balance sheets of CanArgo Energy Corporation (formerly Fountain Oil Incorporated) and subsidiaries (the "Company") as of December 31, 1998 and 1997 and the related consolidated statements of operations, stockholders' equity and cash flows for the years ended December 31, 1998, 1997 and August 31, 1996 and the four month period ended December 31, 1996. 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 generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe 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 consolidated financial position of the Company as of December 31, 1998 and 1997 and the consolidated results of their operations and their cash flows for the years ended December 31, 1998, 1997 and August 31, 1996 and the four month period ended December 31, 1996, in conformity with generally accepted accounting principles. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As more fully described in Notes 3 and 8 to the consolidated financial statements, the Company will require substantial capital in order to finance the development of its oil and gas interests. In addition, the Company and its oil and gas ventures must produce and market oil and gas in sufficient quantities and at sufficient prices to provide positive cash flow to the Company. As a result, there is substantial doubt about the Company's ability to continue as a going concern. Management's plans in regards to these matters are also described in Note 8 to the consolidated financial statements. The consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties. Houston, Texas /S/ PRICEWATERHOUSECOOPERS LLP March 5, 1999 (except for PricewaterhouseCoopers LLP note 20 which is as of March 29, 1999)
F-1 78 CANARGO ENERGY CORPORATION CONSOLIDATED BALANCE SHEET AS OF DECEMBER 31, 1998 AND DECEMBER 31, 1997
DECEMBER 31, DECEMBER 31, 1998 1997 ------------ ------------ ASSETS Cash and cash equivalents......................... $ 1,924,908 $ 14,164,177 Restricted cash................................... -- 9,700,000 Accounts receivable............................... 424,367 -- Advances to operator.............................. 376,890 -- Inventory......................................... 170,405 -- Other current assets.............................. 453,476 761,904 ------------ ------------ Total current assets......................... 3,350,046 24,626,081 Property and equipment, net....................... 6,201,936 5,942,273 Oil and gas properties, net, full cost method (including unevaluated amounts of $13,266,368 and $324,500 respectively)...................... 30,137,573 1,478,974 Investments in and advances to oil and gas and other ventures -- net........................... 6,877,974 5,386,707 ------------ ------------ TOTAL ASSETS...................................... 46,567,529 37,434,035 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Accounts payable.................................. $ 821,761 $ 328,171 Accrued liabilities............................... 1,162,050 10,326,608 ------------ ------------ Total current liabilities.................... $ 1,983,811 $ 10,654,779 Minority interest in subsidiaries................. 4,552,285 -- Commitments and contingencies (Notes 8 and 11).... -- -- Stockholders' equity: Preferred stock, par value $0.10 per share, 5,000,000 shares authorized: 100 shares issued and outstanding....................... -- -- Common Stock, par value $0.10 per share, 50,000,000 shares authorized: 15,157,868 and 11,223,744 shares issued and outstanding respectively; 5,856,775 additional shares issuable on demand at December 31, 1998 without receipt of further consideration..... 2,101,464 1,122,374 Capital in excess of par value.................. 101,545,941 83,162,531 Accumulated deficit............................. (63,615,972) (57,505,649) ------------ ------------ Total stockholders' equity................... $ 40,031,433 $ 26,779,256 ------------ ------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY........ $ 46,567,529 $ 37,434,035 ============ ============
The accompanying notes are an integral part of the consolidated financial statements F-2 79 CANARGO ENERGY CORPORATION CONSOLIDATED STATEMENT OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 AND AUGUST 31, 1996
1998 1997 1996 ----------- ------------ ----------- Operating Revenues: Oil and gas sales.................. $ 804,552 $ 313,301 $ 26,562 Other.............................. 16,400 -- 8,615 ----------- ------------ ----------- TOTAL REVENUES....................... 820,952 313,301 35,177 ----------- ------------ ----------- Operating expenses: Lease operating expenses........... 843,169 200,321 10,988 Cost of sales...................... 7,888 -- 31,991 Direct project costs............... 1,157,163 1,753,166 1,267,555 General and administrative......... 3,887,386 3,903,446 3,853,972 Depreciation, depletion and amortization.................... 238,924 344,666 77,253 Equity loss from investments in unconsolidated subsidiaries..... 161,180 3,778,287 13,272 Impairment of notes receivable..... -- 186,611 -- Impairment of property and equipment....................... 113,000 3,243,997 -- Impairment of oil and gas properties...................... 900,000 257,407 419,835 Impairment of oil and gas ventures........................ -- 15,735,592 -- ----------- ------------ ----------- TOTAL OPERATING EXPENSES............. 7,308,710 29,403,493 5,674,866 ----------- ------------ ----------- OPERATING LOSS....................... (6,487,758) (29,090,192) (5,639,689) ----------- ------------ ----------- Other (expense) income: Interest income.................... 782,596 1,615,066 332,071 Interest expense................... (479,932) (69,286) (1,016,465) Other.............................. (76,540) (72,714) 12,551 Loss on disposition of equipment and property.................... (30,333) (271,205) (182,020) ----------- ------------ ----------- TOTAL OTHER (EXPENSE) INCOME......... 195,791 1,201,861 (853,863) ----------- ------------ ----------- Net loss before income tax expense... (6,291,967) (27,888,331) (6,493,552) Income tax expense................... -- -- -- ----------- ------------ ----------- NET LOSS BEFORE MINORITY INTEREST.... (6,291,967) (27,888,331) (6,493,552) Minority interest in loss of consolidated subsidiaries.......... 181,644 205,380 -- ----------- ------------ ----------- NET LOSS............................. $(6,110,323) $(27,682,951) $(6,493,552) ----------- ------------ ----------- NET LOSS PER COMMON SHARE -- BASIC... $ (0.39) $ (2.47) $ (1.04) ----------- ------------ ----------- NET LOSS PER COMMON SHARE --DILUTED.. $ (0.39) $ (2.47) $ (1.04) ----------- ------------ ----------- Weighted average number of common shares outstanding................. 15,783,889 11,206,506 6,247,568 ----------- ------------ -----------
The accompanying notes are an integral part of the consolidated financial statements F-3 80 CANARGO ENERGY CORPORATION CONSOLIDATED STATEMENT OF OPERATIONS -- CONTINUED FOR THE FOUR MONTH PERIODS ENDED DECEMBER 31, 1996 AND 1995
1996 1995 ----------- ----------- UNAUDITED Operating Revenues: Oil and gas sales............................... $ 16,980 $ 6,440 Other income.................................... -- 1,908 ----------- ----------- TOTAL REVENUES.................................... 16,980 8,348 ----------- ----------- Operating expenses: Cost of sales................................... 4,052 4,581 Lease operating expenses........................ 1,550 2,536 Direct project costs............................ 314,100 120,268 General and administrative...................... 1,281,821 1,303,048 Loss from investments in unconsolidated subsidiaries................................. 1,359,246 4,424 Depreciation, depletion and amortization........ 39,578 43,643 ----------- ----------- TOTAL OPERATING EXPENSES.......................... 3,000,347 1,478,500 ----------- ----------- OPERATING LOSS.................................... (2,983,367) (1,470,152) ----------- ----------- Other (expense) income: Interest income................................. 423,681 54,992 Interest expense................................ (12,744) (3,006) Other........................................... (49,995) (24,016) ----------- ----------- TOTAL OTHER (EXPENSE) INCOME...................... 360,942 27,970 ----------- ----------- Net loss before income tax expense................ (2,622,425) (1,442,182) Income tax expense................................ -- -- ----------- ----------- NET LOSS BEFORE MINORITY INTEREST................. (2,622,425) (1,442,182) Minority interest in loss of consolidated subsidiaries.................................... 17,970 -- ----------- ----------- NET LOSS.......................................... $(2,604,455) $(1,442,182) ----------- ----------- NET LOSS PER COMMON SHARE -- BASIC................ $ (.28) $ (.27) ----------- ----------- NET LOSS PER COMMON SHARE -- DILUTED.............. $ (.28) $ (.27) ----------- ----------- Weighted average number of common shares outstanding..................................... 9,348,106 5,417,032 ----------- -----------
The accompanying notes are an integral part of the consolidated financial statements F-4 81 CANARGO ENERGY CORPORATION CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY FOR THE PERIOD AUGUST 31, 1996 THROUGH DECEMBER 31, 1998
COMMON STOCK ------------------------ NUMBER OF ADDITIONAL TOTAL SHARES PAID-IN ACCUMULATED STOCKHOLDERS' ISSUED PAR VALUE CAPITAL DEFICIT EQUITY ---------- ---------- ------------ ------------ ------------- BALANCE, AUGUST 31, 1996.................. 8,688,304 $ 868,830 $ 56,854,403 $(27,218,243) $30,504,990 ---------- ---------- ------------ ------------ ----------- Issuance of common stock upon conversion of debentures............ 29,563 2,956 277,438 -- 280,394 Issuance of common stock upon exercise of warrants and options............... 2,366,377 236,638 24,827,704 -- 25,064,342 Net loss................ -- -- -- (2,604,455) (2,604,455) ---------- ---------- ------------ ------------ ----------- BALANCE, DECEMBER 31, 1996.................. 11,084,244 $1,108,424 $ 81,959,545 $(29,822,698) $53,245,271 ---------- ---------- ------------ ------------ ----------- Issuance of common stock for purchase of interest in oil and gas venture........... 87,500 8,750 1,052,186 -- 1,060,936 Issuance of common stock upon exercise of options............... 52,000 5,200 150,800 -- 156,000 Net loss................ -- -- -- (27,682,951) (27,682,951) ---------- ---------- ------------ ------------ ----------- BALANCE, DECEMBER 31, 1997.................. 11,223,744 $1,122,374 $ 83,162,531 $(57,505,649) $26,779,256 ---------- ---------- ------------ ------------ ----------- Issuance of common stock upon exchange of CanArgo Oil & Gas Inc. Exchangeable Shares... 3,934,124 393,412 7,386,718 -- 7,780,130 Net loss................ -- -- -- (6,110,323) (6,110,323) ---------- ---------- ------------ ------------ ----------- BALANCE, DECEMBER 31, 1998.................. 15,157,868 $1,515,786 $ 90,549,249 $(63,615,972) $28,449,063 ---------- ---------- ------------ ------------ ----------- Common shares issuable upon exchange of CanArgo Oil & Gas Inc. Exchangeable Shares without receipt of further consideration......... 5,856,775 585,678 10,996,692 -- 11,582,370 ---------- ---------- ------------ ------------ ----------- TOTAL, DECEMBER 31, 1998.................. 21,014,643 $2,101,464 $101,545,941 $(63,615,972) $40,031,433 ---------- ---------- ------------ ------------ -----------
The accompanying notes are an integral part of the consolidated financial statements F-5 82 CANARGO ENERGY CORPORATION CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 AND AUGUST 31, 1996
1998 1997 1996 ------------ ------------ ----------- Operating activities: Net loss........................................... $ (6,110,323) $(27,682,951) $(6,493,552) Depreciation and amortization...................... 238,924 344,666 77,253 Loss on disposition of equipment and property...... 30,333 271,205 182,020 Impairment of notes receivable..................... -- 186,611 -- Impairment of property and equipment............... 113,000 3,243,997 -- Impairment of oil and gas properties............... 900,000 257,407 419,835 Impairment of oil and gas ventures................. -- 15,735,592 -- Amortization of debt issuance costs and discount... -- -- 866,666 Equity loss in investments in unconsolidated subsidiaries..................................... 161,180 3,778,287 13,272 Minority interest in loss of unconsolidated subsidiaries..................................... (181,644) (205,380) -- Changes in assets and liabilities: Accounts receivable.............................. 649,671 259,040 53,905 Advance to operator.............................. 665,358 -- -- Inventory........................................ (150,000) -- -- Other assets..................................... 331,936 (139,493) (211,222) Accounts payable................................. (2,202,203) (471,814) 62,638 Accrued liabilities.............................. (9,164,558) 246,920 (116,766) ------------ ------------ ----------- NET CASH USED IN OPERATING ACTIVITIES................ (14,718,326) (4,175,913) (5,145,951) ------------ ------------ ----------- Investing activities: Restricted cash.................................... 9,700,000 (4,300,000) -- Acquisition costs.................................. (1,214,948) -- -- Investments in oil and gas properties.............. (5,727,029) (1,318,492) (155,938) Investments in and advances to oil and gas and other ventures................................... (1,652,447) (6,280,613) (2,644,837) Capital expenditures............................... -- (1,573,507) (3,728,770) Proceeds from disposition of assets................ 438,033 232,638 104,000 Issuance of notes receivable....................... -- -- (135,186) ------------ ------------ ----------- NET CASH USED IN INVESTING ACTIVITIES................ 1,543,609 (13,239,974) (6,560,731) ------------ ------------ ----------- Financing activities: Cash acquired...................................... 935,448 -- -- Proceeds from issuance of debentures, net of expenses......................................... -- -- 3,346,723 Proceeds from sales of common stock, net of expenses......................................... -- -- 21,103,189 Proceeds from exercise of options.................. -- 156,000 -- Proceeds from issuance of short-term borrowings.... -- -- 4,848,476 Principal payments on short-term borrowings........ -- -- (5,054,114) ------------ ------------ ----------- NET CASH PROVIDED BY FINANCING ACTIVITIES............ 935,448 156,000 24,244,274 ------------ ------------ ----------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS........................................ (12,239,269) (17,259,887) 12,537,592 CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR......... 14,164,177 31,424,064 4,791,645 ------------ ------------ ----------- CASH AND CASH EQUIVALENTS, END OF YEAR............... $ 1,924,908 $ 14,164,177 $17,329,237 ------------ ------------ -----------
The accompanying notes are an integral part of the consolidated financial statements F-6 83 CANARGO ENERGY CORPORATION CONSOLIDATED STATEMENT OF CASH FLOWS -- CONTINUED FOR THE FOUR MONTH PERIODS ENDED DECEMBER 31, 1996 AND 1995
1996 1995 ----------- ----------- UNAUDITED Operating activities: Net loss.......................................... $(2,604,455) $(1,442,182) Depreciation and amortization..................... 39,578 43,643 Amortization of debt issuance costs and discount....................................... 1,375 -- Loss in investments in unconsolidated subsidiaries................................... 1,359,246 4,424 Minority interest in loss of unconsolidated subsidiaries................................... (17,970) -- Changes in assets and liabilities: Accounts receivable............................ (251,828) (114,236) Other assets................................... 26,687 88,344 Accounts payable............................... 68,453 (305,580) Accrued liabilities............................ 149,069 (242,037) ----------- ----------- NET CASH USED IN OPERATING ACTIVITIES............... (1,229,845) (1,967,624) ----------- ----------- Investing activities: Restricted cash................................... (5,400,000) -- Investments in and advances to oil and gas and other ventures................................. (3,108,472) (1,369,767) Capital expenditures.............................. (1,200,042) (746,810) Proceeds from disposition of assets............... -- (73,900) ----------- ----------- NET CASH USED IN INVESTING ACTIVITIES............... (9,708,514) (2,190,477) Financing activities: Proceeds from exercise of warrants and options.... 25,064,342 -- Proceeds from issuance of short-term borrowings... -- 122,153 Principal payments on short-term borrowings....... (31,156) (25,108) ----------- ----------- NET CASH PROVIDED BY FINANCING ACTIVITIES........... 25,033,186 97,045 ----------- ----------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS....................................... 14,094,827 (4,061,056) CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR........ 17,329,237 4,791,645 ----------- ----------- CASH AND CASH EQUIVALENTS, END OF YEAR.............. $31,424,064 $ 730,589 ----------- -----------
The accompanying notes are an integral part of the consolidated financial statements F-7 84 CANARGO ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. NATURE OF OPERATIONS On July 15, 1998, the Company completed the purchase of CanArgo Energy Inc., changed its name to CanArgo Energy Corporation and effected a one-for-two reverse split of its common stock. See Note 4, Business Combination, of Notes to Consolidated Financial Statements. The reverse split has been reflected retroactively in the accompanying financial statements and notes thereto. The principal activities of CanArgo Energy Corporation and its consolidated subsidiaries (collectively the "Company") have involved the acquisition of interests in and development of oil and gas fields with a productive history that indicate the potential for increased production through rehabilitation and utilization of modern production techniques and enhanced oil recovery processes. The Company has typically acquired its interests in oil and gas properties through interests in joint ventures, partially owned corporate and other entities, and joint operating arrangements. While the Company has acquired interests representing 50% or less of the equity in various oil and gas projects, it has generally sought operational responsibility for the substantial oil and gas projects in which it has interests. Accordingly, certain activities in which the Company has interests are conducted through unconsolidated entities. The Company has acquired less than majority interests in entities developing or seeking to develop oil and gas properties in Eastern Europe including the Russian Federation. These entities are accounted for as unconsolidated subsidiaries. The Company elected to change its fiscal year from August 31 to December 31 effective December 31, 1996 to conform to the calendar year accounting which is required for most of the significant oil and gas projects in which the Company participates. Accordingly, the accompanying consolidated financial statements include information for the four-month transition period ended December 31, 1996. The comparable statements of operations and cash flows for the four month period ended December 31, 1995 and all related footnote disclosures are unaudited. Such unaudited information includes all adjustments necessary in the opinion of the management of the Company for a fair statement of the results of operations and cash flows. Results for the four month period may not be indicative of results for the full year. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION -- The consolidated financial statements and notes thereto are prepared in accordance with U.S. generally accepted accounting principles. All amounts are in U.S. dollars. CONSOLIDATION -- The consolidated financial statements include the accounts of CanArgo Energy Corporation and its majority owned subsidiaries. The majority owned subsidiaries at December 31, 1998 are CanArgo Oil & Gas Inc. (formerly CanArgo Energy Inc.), Ninotsminda Oil Company Limited, CanArgo Limited, CanArgo Nazvrevi Limited, CanArgo (Kaspi) Limited, CanArgo Petroleum Products Limited, Novara Limited, CaspArgo Limited, Electromagnetic Oil Recovery International Inc., Focan Ltd., Fountain Oil Adygea Incorporated, Fountain Oil Boryslaw Incorporated, Fountain Oil Boryslaw Ltd., Fountain Oil Norway AS, Fountain Oil Production Incorporated, Fountain Oil Services Ltd., Fountain Oil Ukraine Ltd., Fountain Oil F-8 85 CANARGO ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED) U.S. Inc., Gastron International Limited, Uentech Corporation and UK-RAN Oil Corporation. All significant intercompany transactions and accounts have been eliminated. Investments in less than majority-owned corporations and corporate-like entities are accounted for using the equity method of accounting. USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS -- 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 revenues and expenses during the reporting period. Actual results could differ from those estimates. RECLASSIFICATION -- Certain items in the Consolidated Financial Statements have been reclassified to conform to the current year presentation. There was no effect on net loss as a result of these reclassifications. CASH AND CASH EQUIVALENTS -- The Company considers unrestricted short-term, highly liquid investments with maturities of three months or less at the time of purchase to be cash equivalents. INVENTORIES -- Inventories are valued at lower of cost or market. PROPERTY AND EQUIPMENT -- Property and equipment is stated at cost unless the carrying amount is viewed as not recoverable in which case the carrying value of the assets is reduced to the estimated recoverable amount. See "Impairment of Long-Lived Assets" below. Expenditures for major renewals and betterments, which extend the original estimated economic useful lives of applicable assets, are capitalized. Expenditures for normal repairs and maintenance are charged to expense as incurred. The cost and related accumulated depreciation of assets sold or retired are removed from the accounts and any gain or loss thereon is reflected in operations. Depreciation of property and equipment is computed using the straight-line method over the estimated useful lives of the assets ranging from three to ten years. OIL AND GAS PROPERTIES -- The Company and the unconsolidated entities for which it accounts using the equity method account for oil and gas properties and interests under the full cost method. Under this accounting method, costs, including a portion of internal costs associated with property acquisition and exploration for and development of oil and gas reserves, are capitalized within cost centers established on a country-by-country basis. Capitalized costs within a cost center, as well as the estimated future expenditures to develop proved reserves and estimated net costs of dismantlement and abandonment, are amortized using the unit-of-production method based on estimated proved oil and gas reserves. All costs relating to production activities are charged to expense as incurred. Capitalized oil and gas property costs, less accumulated depreciation, depletion and amortization and related deferred income taxes, are limited to an amount (the ceiling limitation) equal to (a) the present value (discounted at 10%) of estimated future net revenues from the projected production of proved oil and gas reserves, calculated at prices in effect as of the balance sheet date (with consideration of price changes only to the F-9 86 CANARGO ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED) extent provided by fixed and determinable contractual arrangements), plus (b) the lower of cost or estimated fair value of unproved and unevaluated properties, less (c) income tax effects related to differences in the book and tax basis of the oil and gas properties. REVENUE RECOGNITION -- The Company recognizes revenues when goods have been delivered, when services have been performed, or when hydrocarbons have been produced and delivered. FOREIGN CURRENCY TRANSLATION -- The U.S. dollar is the functional currency for all of the Company's operations. Accordingly, all monetary assets and liabilities denominated in foreign currency are translated into U.S. dollars at the rate of exchange in effect at the balance sheet date and the resulting unrealized translation gains or losses are reflected in operations. Non-monetary assets are translated at historical exchange rates. Revenue and expense items (excluding depreciation and amortization which are translated at the same rates as the related assets) are translated at the average rate of exchange for the year. Foreign currency translation amounts recorded in operations for years ended December 31, 1998 and 1997, the year ended August 31, 1996 and the four months ended December 31, 1996 and 1995 were not material. INCOME TAXES -- The Company follows the provisions of Statement of Financial Accounting Standards ("SFAS") No. 109, Accounting for Income Taxes, which requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax liabilities and assets are determined based on the difference between the financial statement and the tax bases of assets and liabilities using enacted rates in effect for the years in which the differences are expected to reverse. Valuation allowances are established, when appropriate, to reduce deferred tax assets to the amount expected to be realized. IMPAIRMENT OF LONG-LIVED ASSETS -- The Company reviews all of its long-lived assets except its oil and gas assets, for impairment in accordance with SFAS No. 121 Accounting for the Impairment of Long-Lived Assets and Assets to be Disposed Of. The Company evaluates its oil and gas properties and its carrying value of investments in unconsolidated entities conducting oil and gas operations in accordance with the full cost ceiling limitation. STOCK-BASED COMPENSATION PLANS -- The Company has adopted only the disclosure requirements of SFAS No. 123, Accounting for Stock-Based Compensation, and has elected to continue to record stock-based compensation expense using the intrinsic-value approach prescribed by Accounting Principles Board ("APB") Opinion 25. Accordingly, the Company computes compensation cost for each employee stock option granted as the amount by which the quoted market price of the Company's Common Stock on the date of grant exceeds the amount the employee must pay to acquire the stock. The amount of compensation costs, if any, is charged to operations over the vesting period. F-10 87 CANARGO ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED) RECENTLY ISSUED PRONOUNCEMENTS -- In 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No. 130, Reporting Comprehensive Income, and SFAS No. 131, Disclosure about Segments of an Enterprise and Related Information both of which were adopted in 1998 without having any material effect on the Company's financial statements. In 1998, FASB issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities which will be adopted in the 1999 annual financial statements. The Company is currently evaluating the impact of SFAS No. 133 on its financial statements. 3. GOING CONCERN ASSUMPTION The Company has incurred recurring operating losses, and its current operations are not generating positive cash flows. The ability of the Company to continue as a going concern and to pursue its principal activities of acquiring interests in and developing oil and gas fields is highly dependent upon generating funds from external sources and, ultimately, achieving sufficient positive cash flows from operating activities. Without sufficient cash from external sources, the Company's ability to finance its ongoing operations and continue as a going concern is doubtful. However, the Company's management believes that it will be able to generate funds from external sources including quasi-governmental financing agencies such as the International Finance Corporation, conventional lenders, equity investors and other oil and gas companies that may decide to participate in the Company's oil and gas projects. See Note 8, Oil and Gas Properties and Investments, of Notes to Consolidated Financial Statements. The consolidated financial statements do not give effect to any additional impairment of its investments in oil and gas properties and ventures or other adjustments which would be necessary should the Company be unable to obtain sufficient funds from external sources or continue as a going concern. 4. BUSINESS COMBINATION On July 15, 1998, the Company completed the acquisition of all of the common stock of CanArgo Oil & Gas Inc. ("CAOG") for Common Stock consideration valued at $19,362,500. CAOG is an oil and gas exploration, development and production company whose principal operations are located in the Republic of Georgia. On completion of the acquisition, CAOG became a subsidiary of the Company, and each previously outstanding share of CAOG common stock was converted into the right to receive 0.8 shares of the Company's Common Stock, giving the former shareholders of CAOG the right to receive approximately 47% of the Company's Common Stock. In addition, the former management of CAOG now holds most of the Company's senior management positions. F-11 88 CANARGO ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED 4. BUSINESS COMBINATION -- (CONTINUED) The purchase price was allocated to the net assets of CAOG as follows: Cash........................................................ $ 935,448 Other Current Assets........................................ 2,160,199 Property and Equipment...................................... 841,029 Oil and Gas Properties...................................... 22,855,546 Current Liabilities......................................... (3,096,293) Long Term Liabilities....................................... (895,500) Minority Interest........................................... (3,437,929) ----------- Consideration given -- common shares...................... $19,362,500 -----------
Under purchase accounting, CAOG's results have been included in the Company's consolidated financial statements since the date of acquisition. The following pro forma statements of operations give effect to the business combination as if such business combination had occurred on January 1, 1997; however, as CAOG commenced operations in June of 1997, the pro forma financial statements of operations have been adjusted to reflect the results of operations of Ninotsminda Oil Company Limited ("NOC"), a 68.5% (prior to November 30, 1998 -- 55.9%) subsidiary of CAOG and now the Company, from January 1, 1997 to June 30, 1997. The historical results of operations have been adjusted to reflect (i) revenues and expenses attributable to the Ninotsminda field and (ii) the difference between the properties, historical depletion, depreciation and amortization and such expenses calculated based on the value allocated to the acquired assets. Management does not believe the pro forma amounts are indicative of the results of operations that would have been reported had the business combination occurred prior to January 1, 1997 or that may be reported in the future.
PRO FORMA (UNAUDITED) ---------------------------- YEAR YEAR ENDED ENDED DECEMBER 31, DECEMBER 31, 1998 1997 ------------ ------------ Revenues........................................... $ 1,813,904 $ 3,137,415 Operating expenses................................. 9,235,690 32,742,737 ----------- ------------ Operating loss..................................... (7,421,786) (29,605,322) Other income (loss)................................ 203,750 1,131,532 Minority interest in loss of unconsolidated subsidiary....................................... 449,066 402,654 ----------- ------------ Net loss........................................... $(6,768,970) $(28,071,136) ----------- ------------ Basic and diluted net loss per common share........ $ (0.32) $ (1.33) =========== ============ Weighted average number of common shares outstanding...................................... 21,014,643 21,177,425 =========== ============
F-12 89 CANARGO ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED 4. BUSINESS COMBINATION -- (CONTINUED) The business combination will result in the issuance of 9,790,900 shares of the Company's Common Stock without receipt of additional consideration by the Company. At December 31, 1998, 3,934,124 of these shares had been issued. Giving effect to the full issuance of such shares, the number of shares of the Company's Common Stock outstanding as at December 31, 1998 would be 21,014,643. 5. RESTRICTED CASH At December 31, 1997 and 1996, the Company pledged an aggregate of $9,700,000 and $5,400,000, respectively, to collateralize bank letters of credit issued to assure repayment of borrowings under a line of credit established by Kashtan Petroleum Ltd. ("Kashtan"), the entity through which the Lelyaki field project was being developed. At December 31, 1997 and 1996, letters of credit of $8,150,000 and $1,400,000 were outstanding, respectively. In 1997 the Company concluded that the Lelyaki field could not support a successful commercial development and as a result, wrote off its remaining investments relating to the Lelyaki field project and accrued a liability of $8,280,000 with respect to Kashtan indebtedness supported by the Company's restricted cash deposits. The liability is included within accrued liabilities on the Company's balance sheet as of December 31, 1997. In January 1998, $350,000 of restricted cash, which had been used to collateralize a bank letter of credit relating to the Gorisht-Kocul field project, was released. In April 1998, restricted cash totaling $8,567,000 was applied to repay such bank borrowings and related interest. The remaining portion of restricted cash, totaling $783,000, was released to the Company free of restrictions in May 1998. 6. PROPERTY AND EQUIPMENT, NET Property and equipment and the related accumulated depreciation at December 31, 1998 included the following:
ACCUMULATED COST DEPRECIATION IMPAIRMENT NET ----------- ------------ ----------- ---------- Electrically enhanced oil recovery ("EEOR") equipment............... $ 562,953 $(290,855) $ -- $ 272,098 Oil and gas related equipment............... 8,363,505 -- (2,710,024) 5,653,481 Office furniture, fixtures and equipment and other................... 1,090,352 (413,995) (400,000) 276,357 ----------- --------- ----------- ---------- Property and Equipment, Net..................... $10,016,810 $(704,850) $(3,110,024) $6,201,936 ----------- --------- ----------- ----------
F-13 90 CANARGO ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED 6. PROPERTY AND EQUIPMENT, NET -- (CONTINUED) Property and equipment and the related accumulated depreciation at December 31, 1997 included the following:
ACCUMULATED COST DEPRECIATION IMPAIRMENT NET ---------- ------------ ----------- ---------- Electrically enhanced oil recovery ("EEOR") equipment................ $ 562,953 $(284,909) $ -- $ 278,044 Oil and gas related equipment................ 8,348,309 -- (2,843,997) 5,504,312 Office furniture, fixtures and equipment and other.................... 1,014,263 (454,346) (400,000) 159,917 ---------- --------- ----------- ---------- Property and Equipment, Net...................... $9,925,525 $(739,255) $(3,243,997) $5,942,273 ---------- --------- ----------- ----------
Oil and gas related equipment includes new or refurbished drilling rigs and related equipment, substantially all of which has been transported to the Republic of Georgia for use by the Company in the development of the Ninotsminda field. Much of the equipment was originally planned to be used in the Maykop field, Republic of Adygea, Russian Federation, but following extended delays in resolving operating arrangements with the entity developing that project, the Company recorded an impairment of $2,844,000 at December 31, 1997, which represented the difference between the book value of the rigs and related equipment and their estimated fair value. As a result of the Company's decision to close down or significantly reduce its various corporate offices, the Company recorded in 1997 an impairment of $400,000 to reduce the carrying value of furniture, fixtures and equipment to their estimated fair value. 7. OIL AND GAS PROPERTIES The Company has acquired interests in oil and gas properties through joint ventures and other joint operating arrangements. A summary of the Company's oil and gas properties as of December 31, 1998 and 1997 are set out below:
DECEMBER 31, DECEMBER 31, 1998 1997 ---------------------------------------------------------------- ------------ REPUBLIC OF GEORGIA CANADA USA OTHER TOTAL TOTAL ----------- ----------- ----------- -------- ----------- ------------ Proved properties......... $16,743,816 $ 1,612,308 $ 1,174,734 $ -- $19,530,858 $ 2,650,327 Unproved properties....... 12,707,912 324,500 -- 233,956 13,266,368 324,500 Less: accumulated depletion and impairment.............. (174,421) (1,310,498) (1,174,734) -- (2,659,653) (1,495,853) ----------- ----------- ----------- -------- ----------- ----------- Total Oil and Gas Properties, Net......... $29,277,307 $ 626,310 $ -- $233,956 $30,137,573 $ 1,478,974 =========== =========== =========== ======== =========== ===========
Oil and gas properties obtained in connection with the acquisition of CAOG includes $15,120,000 of properties in the full cost pool and $10,550,500 of unevaluated properties. F-14 91 CANARGO ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED OIL AND GAS PROPERTIES -- (CONTINUED) The Ninotsminda field includes seven producing wells and since February 1996 has been operated under the terms of a production sharing contract ("PSC") between NOC and the Republic of Georgia represented by the state oil company, Georgian Oil. Unproved properties in the Republic of Georgia include other license areas covered by the Ninotsminda PSC as well as an other exploration area referred to as the Nazvrevi block operated under the terms of a PSC between the Company's subsidiary, CanArgo Nazvrevi Limited, and the Republic of Georgia. At December 31, 1997 and 1996, the Company held oil and gas properties in the United States and Canada. During the fiscal years ended December 31, 1997 and August 31, 1996, the Company recognized impairments of $257,407 and $419,835 respectively, on these oil and gas properties as a result of applying the full cost ceiling limitation. The impairments related to previously unproved properties. During the first quarter of 1997, the Company purchased a 60% interest in a heavy oil property in the Sylvan Lake area in Alberta, Canada for approximately $1,009,000. One new well was successfully drilled during the 1997 third quarter. The Sylvan Lake project includes a total of four producing wells. During the year ended December 31, 1998, the Company recognized impairments aggregating $900,000 on its oil and gas properties in the Sylvan Lake project as a result of a decline of heavy oil prices and the application of the quarterly full cost ceiling limitation. The impairments relate to proved properties. Unproved properties and associated costs not currently being amortized and included in oil and gas properties were $13,266,368 and $324,500 at December 31, 1998 and 1997 respectively. Unproved oil and gas properties at December 31, 1998 include costs of $12,854,368 with respect to properties in Eastern Europe. These properties are expected to be evaluated over the next five years. Remaining costs of $324,500 (December 31, 1997 -- $324,500) relate to the Sylvan Lake field which are expected to be evaluated over the next 12 months. If no proved reserves are added, these properties could result in additional impairment. F-15 92 CANARGO ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED 8. INVESTMENT IN AND ADVANCES TO OIL AND GAS AND OTHER VENTURES The Company has acquired interests in oil and gas and other ventures through less than majority interests in corporate and corporate-like entities. A summary of the Company's net investment in and advances to oil and gas and other ventures as of December 31, 1998 and 1997 is set out below:
DECEMBER 31, DECEMBER 31, 1998 1997 ------------ ------------ Investments in and Advances to Oil and Gas and Other Ventures Ukraine -- Stynawske Field, Boryslaw Through 45% ownership of Boryslaw Oil Company.................................... $ 5,980,613 $ 5,800,407 Republic of Georgia -- Sartichala Through 12.9% ownership of Georgian American Oil Refinery............................... 1,004,445 -- Republic of Georgia -- Ninotsminda Through an effective 42.5% ownership Sagarego Power Corporation.......................... 467,796 -- Ukraine -- Lelyaki Field, Pryluki Region Through an effective 40.5% ownership of Kashtan Petroleum Ltd...................... 2,435,725 $ 2,435,725 Adygea, Russian Federation -- Maykop Field Through 37% ownership in Intergas JSC........ 6,710,874 6,710,874 Canada -- Inverness Unit Through 50% ownership in Focan Ltd........... -- -- Albania -- Gorisht-Kocul Field Through 50% ownership of the joint venture... 2,202,922 2,202,922 ----------- ----------- Total Investments in and Advances to Oil and Gas and Other Ventures.............................. $18,802,375 $17,149,928 ----------- -----------
F-16 93 CANARGO ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED 8. INVESTMENT IN AND ADVANCES TO OIL AND GAS AND OTHER VENTURES -- (CONTINUED)
DECEMBER 31, DECEMBER 31, 1998 1997 ------------ ------------ Equity in Profit (Loss) of Oil and Gas and Other Ventures Ukraine -- Stynawske Field, Boryslaw............ (574,880) (413,700) Ukraine -- Lelyaki Field, Pryluki Region........ $(2,435,725) $(2,435,725) Adygea, Russian Federation -- Maykop Field...... (1,452,510) (1,452,510) Canada -- Inverness Unit........................ -- -- Albania -- Gorisht-Kocul Field.................. (833,191) (833,191) ----------- ----------- Cumulative Equity in Profit (Loss) of Oil and Gas and Other Ventures.............................. $(5,296,306) $(5,135,126) ----------- ----------- Impairment -- Maykop Field...................... $(5,258,364) $(5,258,364) Impairment -- Gorisht-Kocul Field............... (1,369,731) (1,369,731) ----------- ----------- Total Impairment.................................. $(6,628,095) $(6,628,095) ----------- ----------- Total Investments in and Advances to Oil and Gas and Other Ventures, Net of Equity Loss and Impairment...................................... $ 6,877,974 $ 5,386,707 ----------- -----------
As of December 31, 1998, the Company had net investments in and advances to oil and gas ventures totaling $5,405,733 which relate to Boryslaw Oil Company ("BOC"), the entity holding the license to develop the Stynawske field, for which development operations have not yet begun. Included are advances to BOC totaling $1,665,000 and $1,508,000 at December 31, 1998 and 1997 respectively. Such advances may be recoverable only from future revenue of or payments from future participants in the venture, if any. In 1998, the Company acquired a 12.9% interest in Georgian American Oil Refinery ("GAOR") for investments and advances totaling $1,004,445. The Company has the right to purchase an additional 11.1% interest in GAOR for investment and advances totaling $860,000. As of December 31, 1998, the Company has an effective 42.5% interest in Sagarego Power Corporation, a Georgian joint stock company, for which operations have not yet begun. Based on its analysis of initial Lelyaki field development efforts completed in the fourth quarter of 1997, the Company concluded that the Lelyaki field would not support a successful commercial development. As a result, the Company recorded an impairment charge totaling $9,108,000 of which $8,280,000 represented debt and accrued interest of Kashtan on which Kashtan defaulted and which was effectively guaranteed by the Company through restricted cash deposits and $691,000 related to estimated liabilities for severance and related costs associated with closing down Kashtan's operations. In addition, the Company recognized a loss in 1997 of $2,080,000 reflecting its equity in the loss of Kashtan. The Company believes that it has no further obligation to fund any operations of Kashtan. F-17 94 CANARGO ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED 8. INVESTMENT IN AND ADVANCES TO OIL AND GAS AND OTHER VENTURES -- (CONTINUED) Because of extended delays in resolving operating arrangements and other matters associated with Intergas JSC ("Intergas"), the entity developing the Maykop field project, the Company during the fourth quarter of 1997 recorded an impairment for the entire amount of its investment in and advances to Intergas of $5,258,000. In addition, the Company recognized a loss in 1997 of $851,000, reflecting its equity in the loss of Intergas. The Company believes that it has no further obligation to fund any operations of Intergas. In March 1997, the Company declared the political unrest in Albania to be a force majeure with respect to the Gorisht-Kocul project and suspended development activities. Due to the extended period that the force majeure condition has continued and the absence of any indication of an imminent termination of that condition, the Company during the fourth quarter of 1997 recorded an impairment for the entire amount of its investment in and advances to the Gorisht-Kocul joint venture of $1,370,000. The Company also recognized a $433,000 loss in 1997 as its equity in the loss of that joint venture. At December 31, 1998, the force majeure condition remained in effect. The Company's investment in and advances to BOC are essentially unevaluated properties. At December 31, 1998 and 1997, there were no material operations or assets (other than unevaluated properties) of entities being accounted for using the equity method. Accordingly, no other separate financial information has been presented. As a result of the events associated with the impairment of the Company's investment in and advances to and other assets related to Kashtan, Intergas and the Gorisht-Kocul joint venture, the Company may be subject to contingent liabilities in the form of claims from those ventures and other participants therein. The Company was advised early in 1998 that Intergas and another shareholders of Intergas were considering asserting such claims, but no such claims have yet been asserted. Management is unable to estimate the range that such claims, if any, might total. However, if any claims were determined to be valid, they could have a material adverse effect on the financial position, results of operations and cash flows of the Company. Development of the oil and gas properties and ventures in which the Company has interests involves multi-year efforts and substantial cash expenditures. The Company had working capital of $1,366,235 at December 31, 1998, which it considered inadequate to proceed with full implementation of its program of developing its principal oil and gas properties and ventures. Full development of these properties and ventures would require the availability of substantial funds from external sources. The Company believes that it will be able to generate funds from external sources including quasi-governmental financing agencies such as the International Finance Corporation, conventional lenders, equity investors and other oil and gas companies that may desire to participate in the Company's oil and gas projects. The Company generally has the principal responsibility for arranging financing for the oil and gas properties and ventures in which it has an interest. There can be no assurance, however, that the Company or the entities that are developing the oil and gas properties and ventures will be able to arrange the financing necessary to develop the projects being F-18 95 CANARGO ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED 8. INVESTMENT IN AND ADVANCES TO OIL AND GAS AND OTHER VENTURES -- (CONTINUED) undertaken or to support the corporate and other activities of the Company or that such financing as is available will be on terms that are attractive or acceptable to or are deemed to be in the best interests of the Company, such entities or their respective stockholders or participants. As of December 31, 1998 the Company had remaining net investments in oil and gas properties and other ventures totaling $37,015,547. Of this amount, $5,405,733 relates to the Stynawske field in the Ukraine for which development operations have not yet begun. Ultimate realization of the carrying value of the Company's oil and gas properties and ventures will require production of oil and gas in sufficient quantities and marketing such oil and gas at sufficient prices to provide positive cash flow to the Company, which is dependent upon, among other factors, achieving significant production at costs that provide acceptable margins, reasonable levels of taxation from local authorities, and the ability to market the oil and gas produced at or near world prices. In addition, the Company must mobilize drilling equipment and personnel to initiate drilling, completion and production activities. The Company expects that the initial phase of development of the Stynawske field will consist of the workover of a number of existing wells, with a view towards increasing production and gathering data for the preparation of a full field development program. The Company is actively seeking to establish arrangements under which oil and gas production companies or other investors would acquire a portion of the Company's interest in the Stynawske field in return for supplying financing or services to implement the initial phase of the project. However, if one or more of the above factors, or other factors, are different than anticipated, these plans may not be realized, and the Company may not recover its carrying value. The Company will be entitled to distributions from the various properties and ventures in accordance with the arrangements governing the respective properties and ventures. The consolidated financial statements of the Company do not give effect to any additional impairment in the value of the Company's investment in oil and gas properties and ventures or other adjustments that would be necessary if financing cannot be arranged for the development of such properties and ventures or if they are unable to achieve profitable operations. The Company's consolidated financial statements have been prepared under the assumption of a going concern. Failure to arrange such financing on reasonable terms or failure of such properties and ventures to achieve profitability would have a material adverse effect on the financial position, including realization of assets, results of operations, cash flows and prospects of the Company and ultimately its ability to continue as a going concern. F-19 96 CANARGO ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED 9. ACCRUED LIABILITIES Accrued liabilities at December 31, 1998 and 1997 included the following:
DECEMBER 31, DECEMBER 31, 1998 1997 ------------ ------------ Compensation, including related taxes............... $ -- $ 337,767 Professional fees................................... 280,000 276,500 Termination costs................................... -- 405,833 Effective guarantee of Kashtan obligations (Note 8)................................................ -- 8,280,000 Close down costs -- Kashtan project (Note 8)........ -- 690,622 Seismic acquisition................................. 771,207 -- Taxes payable....................................... 61,000 -- Oilfield related equipment.......................... -- 268,000 Other............................................... 49,843 67,886 ---------- ----------- $1,162,050 $10,326,608 ---------- -----------
In 1997, the Company accrued termination costs for employees who received contractually required termination notices during the fourth quarter of 1997. The costs involved represent salaries and related taxes and were reflected as general and administrative expenses. The accrual included the termination costs for 11 employees, who were located in the Company's offices in Calgary, Canada and Asker, Norway. 10. CONVERTIBLE SUBORDINATED DEBENTURES During the quarter ended February 29, 1996, the Company completed an offering of its 8% Convertible Subordinated Debentures (the "Debentures") due December 31, 1997. The Company issued $3,750,000 principal amount of Debentures at par and received net proceeds of $3,346,723 after commissions and expenses. The Debentures were convertible into shares of the Company's Common Stock at a price equal to 82 1/2% of the average closing price of such shares on the five trading days preceding the date of conversion. A maximum of 154,750 shares of the Company's Common Stock was issuable upon conversion of each $1,000,000 principal amount of the Debentures. At August 31, 1996, $3,450,000 principal amount of the Debentures had been converted into 498,662 shares of Common Stock. During the four months ended December 31, 1996, the remaining $300,000 principal amount of Debentures was converted into 29,563 shares of Common Stock. In accordance with Securities and Exchange Commission guidance published in early 1997, the August 31, 1996 Consolidated Statement of Operations was restated to reflect a $795,500 charge to interest expense related to the discount feature of the Debentures. The discount was amortized from the date of issuance to the earliest conversion dates. F-20 97 CANARGO ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED 11. COMMITMENTS AND CONTINGENCIES OIL AND GAS PROPERTIES AND INVESTMENTS IN OIL AND GAS VENTURES The Company has contingent obligations and may incur additional obligations, absolute and contingent, with respect to acquiring and developing oil and gas properties and ventures. At December 31, 1998, the Company had the contingent obligation to issue an aggregate of 187,500 shares of its Common Stock, subject to the satisfaction of conditions related to the achievement of specified performance standards by the Stynawske field project. The Company believes that it has no further obligation to fund operations of Kashtan or Intergas. Also see Note 8, Oil and Gas Properties and Investments, of Notes to Consolidated Financial Statements. LEGAL PROCEEDINGS AND POTENTIAL CLAIMS On February 20, 1998, Zhoda Corporation ("Zhoda") filed suit against the Company in the District Court of Harris County, Texas. Zhoda had sold to the Company shares in a subsidiary through which the Company acquired most of its interest in the Lelyaki field project. Substantially all of the consideration payable to Zhoda was contingent upon achievement of specified Lelyaki field operating objectives, and because these objectives were not achieved, the Company did not pay the consideration. In the litigation, Zhoda asserts that it was wrongfully deprived of the value of the shares it transferred to the Company and of the contingent consideration it might have received, based upon claims of breach of contract, breach of fiduciary duty and duty of good faith and fair dealing, fraud and constructive fraud, fraud in the inducement, negligent misrepresentation, civil conspiracy, breach of trust, unjust enrichment and rescission. Zhoda is seeking more than $7,500,000 in damages, return of the shares transferred to the Company, and other relief. The Company believes it has meritorious defenses to Zhoda's claims which it intends to assert vigorously. The Harris County District Court has stayed the litigation pending completion of arbitration proceedings, which are being held in Calgary, Alberta. On March 24, 1998, the Company filed an action against Zhoda in the Court of Queen's Bench of Alberta, Judicial Centre of Calgary, in which the Company seeks to recover $190,000, plus interest, which the Company asserts Zhoda owes the Company pursuant to promissory notes and loan agreements. On March 31, 1998, Zhoda filed a statement of defense and a counterclaim in which it asserted essentially the same claims as were asserted in the Texas action described above. On the basis of its counterclaim, Zhoda seeks relief similar to that sought in the Texas action. The Company's claim against Zhoda in the Alberta action is not within the scope of the arbitration proceeding being conducted in Calgary. A judgement in favor of Zhoda on its claims could have a material adverse effect on the Company's financial condition, results of operations and cash flows. On March 9, 1998, Ribalta Holdings, Inc. ("Ribalta"), which sold to the Company shares in a subsidiary through which the Company acquired most of its interest in the Maykop field project, filed suit against the Company in the Third Judicial District Court of Salt Lake County, Utah. Ribalta, however, has not yet served the complaint on the Company. F-21 98 CANARGO ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED 11. COMMITMENTS AND CONTINGENCIES -- (CONTINUED) In its complaint, Ribalta alleges breach by the Company of the contract governing the sale of the shares it transferred to the Company and failure of a condition in that contract that should have resulted in the termination of the contract. Ribalta seeks the return of all benefits conferred on the Company pursuant to the contract or damages equal to the value of such benefits, as well as other relief. Under that contract, as amended, the maximum consideration to which Ribalta might have been entitled was $800,000 and 350,000 shares of Company Common Stock. The Company believes that no consideration is payable under that contract because conditions to payment specified in the contract were not satisfied. An outcome of this proceeding unfavorable to the Company could have a material adverse impact on the Company's financial condition, results of operations and cash flows. The Company believes it has meritorious defenses to Ribalta's claims which it intends to assert vigorously. As a result of the Company's decision to cease active development of the Lelyaki, Maykop and Gorisht-Kocul projects, the Company may be subject to contingent liabilities in the form of claims from the joint ventures developing such projects or from others participating in those projects. The Company was advised during the first quarter of 1998 that Intergas and another shareholder of Intergas were considering asserting such claims in relation to the Maykop project, but no such claims have yet been asserted. The Company is unable to estimate the range that such claims, if made, might total. However, if one or more such claims were asserted and determined to be valid, they could have a material adverse effect on the Company's financial position, results of operations and cash flows. Such claims may be adjudicated in the host country forum under host country laws. LEASE COMMITMENTS -- The Company leases office space under non-cancellable operating lease agreements. Rental expense for the years ended December 31, 1998 and 1997 and August 31, 1996 and for the four months ended December 31, 1996 and 1995 was $170,795, $293,855, $186,444, $119,133 and $87,872 respectively. Future minimum rental payments for the Company's lease obligations as of December 31, 1998, are as follows: 1999........................................................ $119,800 2000........................................................ 57,600 2001........................................................ 28,800 -------- $206,200 --------
The Company has sublet office space representing $76,800 and $59,000 of the future minimum rental payments in 1999 and 2000, respectively. 12. CONCENTRATIONS OF CREDIT RISK The Company's financial instruments that are exposed to concentrations of credit risk consist primarily of cash and cash equivalents, accounts receivable and advances to oil and gas and other ventures. The Company places its temporary cash investments with high credit quality financial institutions. Accounts receivable relates primarily to other entities F-22 99 CANARGO ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED 12. CONCENTRATIONS OF CREDIT RISK -- (CONTINUED) active in the oil and gas industry. The concentration of credit risk associated with accounts receivable is limited as the Company's debtors are spread across several countries. 13. STOCKHOLDERS' EQUITY On July 8, 1998, at a Special Meeting of Stockholders, the stockholders of the Company approved the acquisition of all of the common stock of CAOG for Common Stock of the Company pursuant to the terms of an Amended and Restated Combination Agreement between those two companies (the "Combination Agreement"). Upon completion of the acquisition on July 15, 1998, CAOG became a subsidiary of the Company, and each previously outstanding share of CAOG common stock was converted into the right to receive 0.8 shares (the "Exchangeable Shares") of CAOG which are exchangeable generally at the option of the holders for shares of the Company's Common Stock on a share-for-share basis. The stockholders of the Company also approved the issuance of 100 shares (the "Voting Preferred Shares") of Series Voting Preferred Stock to the Montreal Trust Company of Canada (the "Trustee") under the Voting, Support and Exchange Trust Agreement entered into among the Company, CAOG and the Trustee. The Voting Preferred Shares embody the right to (i) the voting power the holders of unexchanged Exchangeable Shares would have following the exchange thereof for shares of the Company's Common Stock and (ii) the right to receive an aggregate of $100 upon redemption at the rate of $1.00 per Voting Preferred Share following the exchange of all outstanding Exchangeable Shares. The Voting Preferred Shares are stripped of their voting power proportionately as Exchangeable Shares are exchanged for shares of the Company's Common Stock. When fully divested of voting rights through the exchange of all Exchangeable Shares, the Voting Preferred Shares can be redeemed by the Company for nominal consideration. The stockholders also approved a 1-for-2 reverse stock split of the outstanding shares of Common Stock which took effect on July 15, 1998 and has been given effect through restatement in these Consolidated Financial Statements and notes thereto. As of December 31, 1998, 15,157,168 shares of Common Stock, 5,856,775 Exchangeable Shares and 100 shares of Voting Preferred Shares were issued and outstanding. No other shares of the Company's preferred stock have been issued. On February 12, 1996, at an Annual Meeting of Stockholders, the stockholders of the Company approved an increase in the number of authorized shares of Common Stock from 25,000,000 to 50,000,000 having $0.10 par value per share. The number of authorized shares of preferred stock of 5,000,000, also having a par value of $0.10 per share, remained unchanged. During the year ended August 31, 1996, the four-month period ended December 31, 1996 and the years ended December 31, 1997 and 1998, the following transactions regarding the Company's Common Stock and warrants and options to purchase the Company's Common Stock were consummated pursuant to authorization by the Company's Board of Directors or duly constituted committees thereof. F-23 100 CANARGO ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED 13. STOCKHOLDERS' EQUITY -- (CONTINUED) FISCAL YEAR ENDED AUGUST 31, 1996 - - The issuance to investors of 2,500,000 shares for aggregate proceeds of $20,960,354 net of $1,539,646 of related offering costs. - - The following are included in the issuance of Common Stock for purchase of interests in oil and gas ventures: - The issuance of 75,000 shares at a price of $9.125 per share, along with other consideration, in exchange for 10% of the equity of UK-RAN Oil Corporation and 33% of the equity of UK-RAN Energy Corporation - The issuance of 150,000 shares at a price of $11.125 per share in exchange for 6% of the equity of Intergas JSC, a joint stock company incorporated in the Russian Federation. - - The following are included in the issuance of Common Stock upon conversion of debentures: - The issuance of 498,662 shares in a series of conversions of an aggregate of $3,450,000 principal amount of debentures convertible at various prices based on 82 1/2% of market price at the time of conversion. - The adjustment to capital in excess of par in the amount of $311,088 related to deferred costs incurred in the issuance of debentures and $795,500 related to the discount feature of the debentures. - - The following are included in the issuance of Common Stock upon warrant and option exercises: - The issuance of 26,000 shares at a price of $3.00 per share in a series of option exercises. - The issuance of 21,611 shares at a price of $3.00 per share in a series of warrant exercises. - - The issuance of options exercisable at $7.6875 per share to purchase 15,000 shares granted to non-employee directors at February 12, 1996 pursuant to the Company's 1995 Long-Term Incentive Plan. FOUR MONTH PERIOD ENDED DECEMBER 31, 1996 - - The following are included in the issuance of Common Stock upon conversion of debentures: - The issuance of 29,563 shares upon conversion of $300,000 principal amount of debentures convertible at 82 1/2% of market price at the time of conversion. - The adjustment to capital in excess of par in the amount of $19,599 related to deferred costs incurred in the issuance of debentures. F-24 101 CANARGO ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED 13. STOCKHOLDERS' EQUITY -- (CONTINUED) - - The following are included in the issuance of Common Stock upon warrant and option exercises: - The issuance of 6,000 shares at a price of $3.00 per share in a series of option exercises. - The issuance of 243,334 shares at a price of $3.00 per share in a series of warrant exercises. - The issuance of 7,143 shares at a price of $3.50 per share in a warrant exercise. - The issuance of 569,900 shares at a price of $10.20 per share in a series of warrant exercises. - The issuance of 1,540,000 shares at a price of $12.00 per share in a series of warrant exercises. - - The issuance of options exercisable at $14.50 per share to purchase 190,750 shares granted to employees at December 31, 1996 pursuant to the Company's 1995 Long-Term Incentive Plan. - - The issuance of options exercisable at $17.98 per share to purchase 222,500 shares granted to employees at December 31, 1996 pursuant to the Company's 1995 Long-Term Incentive Plan. YEAR ENDED DECEMBER 31, 1997 - - The issuance of 87,500 shares at a price of $12.125 per share in connection with the acquisition of an interest in the Stynawske field, Ukraine. - - The issuance of 52,000 shares at a price of $3.00 per share in a series of option exercises. - - The issuance of options exercisable at $9.00 per share to purchase 15,000 shares granted to non-employee directors at June 3, 1997 pursuant to the Company's 1995 Long-Term Incentive Plan. - - The issuance of options exercisable at $8.50 per share to purchase 3,500 shares granted to employees at June 30, 1997 pursuant to the Company's 1995 Long-Term Incentive Plan. - - The issuance of options exercisable at $10.54 per share to purchase 77,500 shares granted to employees at June 30, 1997 pursuant to the Company's 1995 Long-Term Incentive Plan. - - The cancellation of options to purchase an aggregate 63,084 shares which had been granted to employees pursuant to the Company's 1995 Long-Term Incentive Plan. Of the options cancelled, 59,584 were exercisable at $14.50, 2,500 were exercisable at $17.98, and 1,000 were exercisable at $8.50. F-25 102 CANARGO ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED 13. STOCKHOLDERS' EQUITY -- (CONTINUED) YEAR ENDED DECEMBER 31, 1998 - - The issuance of 3,934,124 shares upon exchange by holders of Exchangeable Shares. - - The issuance of options exercisable at $1.00 per share to purchase 7,500 shares granted to non-employee directors at July 15, 1998 pursuant to the Company's 1995 Long-Term Incentive Plan. - - The conversion at July 15, 1998 of options granted to employees of CAOG under its stock option plan to purchase shares of CAOG into options exercisable at $1.85 per share to purchase 988,000 shares of Company Common Stock. The Company has adopted CAOG's Stock Option Plan covering the existing converted options and providing for additional grants under the plan. - - The conversion of CAOG Stock Purchase Warrants into warrants to purchase an aggregate 1,097,511 Exchangeable Shares that are exchangeable at the option of the holder for shares of the Company's Common Stock on a share-for-share basis. Of the 1,097,511 warrants, 164,008 are exercisable at C$2.75, 32,000 are exercisable at C$2.875 and 901,503 are exercisable at C$3.25. - - The issuance of options exercisable at $1.25 per share to purchase 440,000 shares granted to employees at July 17, 1998 pursuant to the Company's 1995 Long-Term Incentive Plan. - - The cancellation at July 31, 1998 of options to purchase 140,000 shares of Company Common Stock which had been granted pursuant to the CAOG Stock Option Plan exercisable at $1.85 per share. - - The issuance of options exercisable at $0.688 per share to purchase 192,000 shares of Company Common Stock granted to employees on October 7, 1998 pursuant to the Company's 1995 Long-Term Incentive Plan. - - The issuance of options exercisable at $0.563 per share to purchase 21,834 shares of Company Common Stock granted to employees on November 17, 1998 pursuant to the Company's 1995 Long-Term Incentive Plan. - - The issuance of options exercisable at $0.563 per share to purchase 90,000 shares of Company Common Stock granted to employees at November 17, 1998 pursuant to the CAOG Stock Option Plan. - - The issuance of options exercisable at $0.70 per share to purchase 25,000 shares of Company Common Stock granted to a consultant at November 17, 1998 pursuant to the Company's 1995 Long-Term Incentive Plan. - - The issuance of options exercisable at $0.70 per share to purchase 50,000 shares of Company Common Stock granted to a consultant at November 17, 1998 pursuant to the CAOG Stock Option Plan. - - The issuance of options exercisable at $0.313 per share to purchase 3,750 shares of Company Common Stock granted to a non-employee director at December 31, 1998 pursuant to the Company's 1995 Long-Term Incentive Plan. F-26 103 CANARGO ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED 13. STOCKHOLDERS' EQUITY -- (CONTINUED) - - The cancellation of options to purchase an aggregate 42,000 shares of Company Common Stock exercisable at $3.00 which had been granted to various individuals in August 1994 who were serving or were expected in the future to serve the Company as officers, directors, employees, consultants and advisors. - - The cancellation of options to purchase an aggregate 414,834 shares of Company Common Stock which had been granted to employees pursuant to the Company's 1995 Long-Term Incentive Plan. Of the options cancelled, 1,667 were exercisable at $8.50, 75,000 were exercisable at $10.54, 118,167 were exercisable at $14.50 and 220,000 were exercisable at $17.98. - - The cancellation of options at December 31, 1998 to purchase 80,000 shares of Company Common Stock which had been granted pursuant to the CAOG Stock Option Plan exercisable at $1.85 per share. Pursuant to the terms of the Combination Agreement, holders of CAOG Stock Purchase Warrants have the right to purchase Exchangeable Shares which are exchangeable generally at the option of the holder for shares of the Company's Common Stock on a share-for-share basis. The following table summarizes warrants to purchase the Company's Common Stock, which were outstanding:
NUMBER OF EXERCISE EXPIRATION OUTSTANDING AT: WARRANTS PRICE DATE - --------------- ---------- --------------- ------------------ August 31, 1995............. 2,463,988 $ 3.00 - $12.00 2/28/97 to 11/3/97 ---------- Exercised................. (21,611) $ 3.00 11/3/97 ---------- August 31, 1996............. 2,442,377 $ 3.00 - $12.00 2/28/97 to 11/3/97 ---------- Exercised................. (2,360,377) $ 3.00 - $12.00 2/28/97 to 11/3/97 Redeemed.................. (82,000) $ 12.00 2/28/97 to 11/3/97 ---------- December 31, 1997 and 1996...................... 0 ---------- CAOG Stock Purchase Warrants............... 1,097,511 $C2.75 - $C3.25 4/30/99 to 11/1/99 ---------- December 31, 1998........... 1,097,511 $C2.75 - $C3.25 4/30/99 to 11/1/99 ----------
During the four month period ended December 31, 1996, an aggregate of 2,191,900 warrants were called for redemption by the Company. If the average closing price of the Company's Common Stock exceeded $12.20 and $14.00 per share for 10 consecutive trading days, upon election of the Company and notice to the warrant holders, the holders of 569,900 warrants and 1,622,000 warrants, respectively, were required either to exercise their warrants within a specified period or to have the warrants redeemed by the Company for a nominal redemption price. All but 82,000 of the 2,191,900 warrants called for redemption were exercised during the four month period ended December 31, F-27 104 CANARGO ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED 13. STOCKHOLDERS' EQUITY -- (CONTINUED) 1996; the 82,000 warrants were redeemed. During the same period, an additional 250,477 warrants were also exercised by their holders. There were no outstanding warrants at December 31, 1996 and 1997. As of December 31, 1998, there were outstanding 164,008 CAOG Stock Purchase Warrants exercisable at $C2.75 expiring April 30, 1999, 32,000 CAOG Stock Purchase Warrants exercisable at $C2.875 expiring July 31, 1999 and 901,503 CAOG Stock Purchase Warrants exercisable at $C3.25 expiring November 1, 1999. 14. NET LOSS PER COMMON SHARE Effective December 31, 1997 the Company adopted SFAS No. 128 Earnings Per Share, for all periods presented. Basic and diluted net loss per common share for the years ended December 31, 1998 and 1997, the year ended August 31, 1996 and the four month periods ended December 31, 1996 and 1995 were based on the weighted average number of common shares outstanding during those periods. The weighted average number of shares used was 15,783,889, 11,206,586, 6,247,568, 9,348,106 and 5,417,032 respectively. The Debentures, which were convertible into a maximum of 154,750 shares of the Company's Common Stock per $1,000,000 principal amount of the Debentures, were not included in the computation of diluted net loss per common share for the four month period ended December 31, 1996 and the fiscal year ended August 31, 1996 because the effect of such inclusion would have been anti-dilutive. Additionally, options to purchase the Company's Common Stock were outstanding during the years ended December 31, 1998 and 1997, the four month period ended December 31, 1996 and the fiscal year ended August 31, 1996 and warrants to purchase the Company's Common Stock were outstanding during the year ended December 31, 1998, the four month period ended December 31, 1996, and the fiscal year ended August 31, 1996 but were not included in the computation of diluted net loss per common share because the effect of such inclusion would have been anti-dilutive. F-28 105 CANARGO ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED 15. INCOME TAXES The Company and its domestic subsidiaries file U.S. consolidated income tax returns. No benefit for U.S. income taxes has been recorded in these consolidated financial statements because of the Company's inability to recognize deferred tax assets under provisions of SFAS 109. Due to the implementation of the quasi-reorganization as of October 31, 1988, future reductions of the valuation allowance relating to those deferred tax assets existing at the date of the quasi-reorganization, if any, will be allocated to capital in excess of par value. The provision for income taxes for the year ended August 31, 1995 consisted of taxes applicable to foreign operations. A reconciliation of the differences between income taxes computed at the U.S. federal statutory rate (34%) and the Company's reported provision for income taxes is as follows:
FOUR MONTH FOUR MONTH YEAR ENDED YEAR ENDED PERIOD ENDED PERIOD ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, AUGUST 31, 1998 1997 1996 1995 1996 ------------ ------------ ------------ ------------ ----------- Income tax benefit at statutory rate..... $(2,077,510) $(9,412,203) $(885,515) (490,342) $(2,207,808) Benefit of losses not recognized......... 2,077,510 9,412,203 876,629 490,342 2,197,879 Foreign tax provision.......... -- -- -- -- -- Other, net........... -- -- 8,886 -- 9,929 ----------- ----------- --------- --------- ----------- Provision for income taxes.............. $ 0 $ 0 $ 0 $ 0 $ 0 ----------- ----------- --------- --------- ----------- Effective tax rate... 0% 0% 0% 0% 0%
The components of the deferred tax assets as of December 31, 1998 and 1997 were as follows:
DECEMBER 31, DECEMBER 31, 1998 1997 ------------ ------------ Net operating loss carryforwards................... 13,105,000 $13,372,000 Foreign net operating loss carryforwards........... 5,892,000 4,972,000 Impairments........................................ 7,161,000 6,817,000 Patent rights and related equipment................ 180,378 225,473 ------------ ----------- 26,338,378 25,386,473 Valuation allowance................................ (26,338,378) (25,386,473) ------------ ----------- Net deferred tax asset recognized in balance sheet............................................ $ -- $ -- ------------ -----------
On August 1, 1991, and subsequently on August 17, 1994, the Company experienced changes in the Company's ownership as defined in Section 382 of the Internal Revenue Code ("IRC"). The effect of these changes in ownership is to limit the utilization of certain existing net operating loss carryforwards for income tax purposes to approximately F-29 106 CANARGO ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED 15. INCOME TAXES -- (CONTINUED) $1,375,000 per year on a cumulative basis. As of December 31, 1997, total U.S. net operating loss carryforwards were approximately $38,543,000. Of that amount, approximately $17,208,000 was incurred subsequent to the ownership change in 1994, $16,635,000 was incurred prior to 1994 and therefore is subject to the IRC Section 382 limitation and $4,700,000 is subject to the separate return limitation rules. See Note 1 of Notes to Consolidated Financial Statements. The net operating loss carryforwards expire from 1999 to 2013. The net operating loss carryforwards limited under the separate return limitation rules may only be offset against the separate income of the respective subsidiaries. The Company has also generated approximately $17,330,000 of foreign net operating loss carryforwards. A significant portion of the foreign net operating loss carryforwards are subject to limitations similar to IRC Section 382. The Company's available net operating loss carryforwards may be used to offset future taxable income, if any, prior to their expiration. The Company may experience further limitations on the utilization of net operating loss carryforwards and other tax benefits as a result of additional changes in ownership. 16. SEGMENTS During the years ended December 31, 1998 and 1997 and the four months ended December 31, 1996, the Company operated through one business segment, oil and gas exploration and production, reflecting its decision to use its electrically enhanced oil recovery ("EEOR") technology primarily internally as a competitive advantage to obtain and exploit interests in heavy oil fields and not to pursue external sales of goods and services related to the EEOR technology. Since oil and gas exploration and production activities were at a preliminary stage, revenues for the periods ended December 31, 1997 and 1996 were minimal. For the fiscal year ended August 31, 1996, EEOR activities were reported as a separate business segment. For the fiscal year ended August 31, 1996, EEOR revenues related to a contract with one customer in Canada. F-30 107 CANARGO ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED 16. SEGMENTS -- (CONTINUED) Operating revenues for the years ended December 31, 1998 and 1997, the year ended August 31, 1996 and the four months ended December 31, 1996 by business segment and geographical area were as follows:
DECEMBER 31, DECEMBER 31, AUGUST 31, DECEMBER 31, 1998 1997 1996 1996 ------------ ------------ ---------- ------------ Oil and Gas Exploration, Development and Production Eastern Europe............. $602,724 $ -- $ -- $ -- United States.............. -- -- 2,624 -- Canada..................... 201,828 313,301 23,938 16,980 -------- -------- ------- ------- Total........................ $804,552 $313,301 $26,562 $16,980 -------- -------- ------- ------- EEOR Process Sales and Service United States.............. $ -- $ -- $ -- $ -- Canada..................... -- -- 8,615 -- -------- -------- ------- ------- Total........................ $ 0 $ 0 $ 8,615 $ 0 -------- -------- ------- -------
In 1998, the Company sold its production in Eastern Europe to two customers. Sales to each customer represented 57% and 43% of operating revenue, respectively. F-31 108 CANARGO ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED 16. SEGMENTS -- (CONTINUED) Operating profit (loss) for the years ended December 31, 1998 and 1997, the year ended August 31, 1996 and the four months ended December 31, 1996 by business segment and geographical area were as follows:
DECEMBER 31, DECEMBER 31, AUGUST 31, DECEMBER 31, 1998 1997 1996 1996 ------------ ------------ ----------- ------------ Oil and Gas Exploration, Development and Production Eastern Europe.......... $(2,408,968) $(24,831,798) $(1,770,434) $(1,712,924) United States........... -- (257,407) (3,262) -- Canada.................. (1,258,506) (97,541) 18,836 11,378 ----------- ------------ ----------- ----------- Total..................... $(3,667,474) $(25,186,746) $(1,754,860) $(1,701,546) ----------- ------------ ----------- ----------- EEOR Process Sales and Service United States........... $ -- $ -- $ -- $ -- Canada.................. -- -- (30,857) -- ----------- ------------ ----------- ----------- Total..................... $ -- $ -- $ (30,857) $ -- ----------- ------------ ----------- ----------- Corporate Expenses........ $(2,820,284) $ (3,903,446) $(3,853,972) $(1,281,821) ----------- ------------ ----------- ----------- Total..................... $(6,487,758) $(29,090,192) $(5,639,689) $(2,983,367) ----------- ------------ ----------- -----------
The Company's loss from investments in unconsolidated subsidiaries pertains primarily to operations in Eastern Europe. F-32 109 CANARGO ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED 16. SEGMENTS -- (CONTINUED) Identifiable assets as of December 31, 1998, 1997 and 1996 by business segment and geographical area were as follows:
DECEMBER 31, DECEMBER 31, DECEMBER 31, 1998 1997 1996 ------------ ------------ ------------ Corporate United States..................... $ 3,319 $ 212,536 $ 7,580,219 Canada............................ 2,304,690 -- -- Western Europe.................... 196,304 24,263,223 29,049,022 ----------- ----------- ----------- Total............................... $ 2,504,313 $24,475,759 $36,629,241 ----------- ----------- ----------- Oil and Gas Exploration, Development and Production Eastern Europe.................... $41,644,701 $ 5,386,707 $11,127,176 United States..................... -- -- 6,786,714 Canada............................ 1,001,733 2,067,257 831,930 Western Europe.................... 13,769 5,504,312 -- ----------- ----------- ----------- Total............................... $42,660,203 $12,958,276 $18,745,820 ----------- ----------- ----------- Other Energy Projects Eastern Europe.................... 1,403,013 -- -- ----------- ----------- ----------- Identifiable Assets -- Total........ $46,567,529 $37,434,035 $55,375,061 ----------- ----------- -----------
The percentage of operating revenues for the years ended December 31, 1998 and 1997, the year August 31, 1996 and the four months ended December 31, 1996 by business segment and geographical area are as follows:
DECEMBER 31, DECEMBER 31, AUGUST 31, DECEMBER 31, 1998 1997 1996 1996 ------------ ------------ ---------- ------------ Oil and Gas Exploration, Development and Production Eastern Europe............. 75% -- -- -- United States.............. -- -- 10% -- Canada..................... 25% 100% 90% 100% EEOR Process Sales and Service United States.............. -- -- 100% -- Canada..................... -- -- -- --
F-33 110 CANARGO ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED 17. SUPPLEMENTAL CASH FLOW INFORMATION AND NONMONETARY TRANSACTIONS The following represents supplemental cash flow information for the years ended December 31, 1998 and 1997, the year ended August 31, 1996 and for the four-month periods ended December 31, 1996 and 1995:
YEARS ENDED 4 MONTHS ENDED ------------------------------- -------------------- 12/31/98 12/31/97 8/31/96 12/31/96 12/31/95 -------- -------- ------- -------- -------- (ALL AMOUNTS IN 000'$) Supplemental disclosures of cash flow information: Interest paid during the year.......... $-- $ -- $ 146 $ 17 $ 3 -- ------ ------ ---- ------ Supplemental schedule of non-cash activities: Acquisition of common stock of subsidiaries resulting in elimination upon consolidation and cancellation of notes receivable of $2,450,000 and $530,000, respectively............... $-- $ -- $2,980 $ -- $2,450 -- ------ ------ ---- ------ Issuance of Common Stock upon conversion of convertible debentures and notes............................ $-- $ -- $3,934 $280 $ -- -- ------ ------ ---- ------ Issuance of Common Stock in connection with investments in oil and gas ventures............................. $-- $1,060 $2,353 $ -- $ -- -- ------ ------ ---- ------ Issuance of Common Stock in connection with compensation earned and third party services provided.............. $-- $ -- $ -- -- ------ ------ ---- Accruals recorded applicable to effective guaranty of Kashtan obligation and Lelyaki field close-down costs..................... $-- $8,971 $ -- $678 -- ------ ------ ----
18. STOCK-BASED COMPENSATION PLANS On August 17, 1994, options to purchase 200,000 shares of the Company's Common Stock were issued to various individuals who were serving or were expected in the future to serve the Company as officers, directors, employees, consultants and advisors (the "1994 Plan"). The options are exercisable at an exercise price of $3.00 and are only exercisable at the time or within six months after services are rendered by such individuals. All of these options expire August 16, 1999. Under the 1994 Plan, 74,000 options were outstanding at December 31, 1998. Pursuant to the 1995 Long-Term Incentive Plan (the "1995 Plan") adopted by the Company in February 1996, 750,000 shares of the Company's Common Stock have been authorized for possible issuance under the 1995 Plan. Stock options granted under the 1995 Plan may be either incentive stock options or non-qualified stock options. Options expire on such date as is determined by the committee administering the 1995 Plan, except that incentive stock options may expire no later than 10 years from the date of grant. Pursuant to the 1995 Plan, a specified number of stock options exercisable at the then market price are granted annually to non-employee directors of the Company, which become 100% vested six months from the date of grant. Stock appreciation rights entitle F-34 111 CANARGO ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED 18. STOCK-BASED COMPENSATION PLANS -- (CONTINUED) the holder to receive payment in cash or Common Stock equal in value to the excess of the fair market value of a specified number of shares of Common Stock on the date of exercise over the exercise price of the stock appreciation right. No stock appreciation rights have been granted through December 31, 1998. The exercise price and vesting schedule of stock appreciation rights are determined at the date of grant. Under the 1995 Plan, 736,416 options were outstanding at December 31, 1998. Pursuant to the terms of the Combination Agreement, on July 15, 1998 each stock option granted under CAOG's existing Stock Option Plan (the "CAOG Plan") to purchase a CAOG common share was converted into an option to purchase 0.8 shares of the Company's Common Stock. Pursuant to the CAOG Plan, which has been adopted by the Company, a total of 988,000 shares of the Company's Common Stock have been authorized for issuance. Stock options granted under the CAOG Plan expire on such date as is determined by the committee administering the CAOG Plan, except that the term of stock options may not exceed 10 years from the date of grant. Under the CAOG Plan, 908,000 options were outstanding at December 31, 1998. The purpose of the Company's stock option plans is to further the interest of the Company by enabling officers, directors, employees, consultants and advisors of the Company to acquire an interest in the Company by ownership of its stock through the exercise of stock options and stock appreciation rights granted under its various stock option plans. F-35 112 CANARGO ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED 18. STOCK-BASED COMPENSATION PLANS -- (CONTINUED) A summary of the status of stock options granted under the 1994 Plan, the 1995 Plan and the CAOG Plan is as follows:
SHARES SHARES ISSUABLE WEIGHTED AVAILABLE UNDER OUTSTANDING AVERAGE FOR ISSUE OPTIONS EXERCISE PRICE --------- ----------------- -------------- Balance at August 31, 1995.......... 0 200,000 $ 3.00 1995 Plan Authorization........... 750,000 Options (1994 & 1995 Plans): Granted at market.............. (15,000) 15,000 $ 7.68 Exercised (1994 Plan).......... -- (26,000) $ 3.00 -------- --------- Balance at August 31, 1996.......... 735,000 189,000 $ 3.38 Options (1994 & 1995 Plans): Granted at market.............. (190,750) 190,750 $14.50 Granted at a premium........... (222,500) 222,500 $17.98 Exercised (1994 Plan).......... -- (6,000) $ 3.00 -------- --------- Balance at December 31, 1996........ 321,750 596,250 $12.38 Options (1994 & 1995 Plans): Granted at market.............. (18,500) 18,500 $ 8.90 Granted at a premium........... (77,500) 77,500 $10.54 Exercised (1994 Plan).......... -- (52,000) $ 3.00 Canceled....................... 63,084 (63,084) $14.54 -------- --------- Balance at December 31, 1997........ 288,834 577,166 $12.64 -------- --------- Options (1994 & 1995 Plans): Granted at market.............. (665,084) 665,084 $ 1.06 Granted at a premium........... (25,000) 25,000 $ 0.70 Canceled (1994 Plan)........... -- (42,000) $ 3.00 Canceled....................... 414,834 (414,834) $15.59 CAOG Plan Authorization:.......... 988,000 Converted Options.............. (988,000) 988,000 $ 1.85 Granted at market.............. (90,000) 90,000 $0.563 Granted at a premium........... (50,000) 50,000 $ 0.70 Canceled....................... 220,000 (220,000) $ 1.85 -------- --------- Balance at December 31, 1998........ 93,584 1,718,416 $ 1.70 -------- ---------
F-36 113 CANARGO ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED 18. STOCK-BASED COMPENSATION PLANS -- (CONTINUED) The shares issuable upon exercise of vested options and the corresponding weighted average exercise price are as follows:
SHARES ISSUABLE UNDER WEIGHTED EXERCISABLE AVERAGE OPTIONS EXERCISE PRICE --------------- -------------- August 31, 1995................................... 172,000 $3.00 August 31, 1996................................... 171,000 $3.42 December 31, 1996................................. 165,000 $3.42 December 31, 1997................................. 177,832 $7.12 December 31, 1998................................. 413,661 $2.82
The weighted average fair value of options granted at market was $0.61, $2.92, $7.30 and $2.02 for the years ended December 31, 1998 and 1997, the four month period ended December 31, 1996 and the fiscal year ended August 31, 1996, respectively. The weighted average fair value of options granted at a premium was $0.13, $1.85 and $3.46 for the years ended December 31, 1998 and 1997 and the four month period ended December 31, 1996, respectively; no options were granted at a premium for the fiscal year ended August 31, 1996. The weighted average fair value of all options granted during the years ended December 31, 1998 and 1997, the four month period ended December 31, 1996 and the fiscal year ended August 31, 1996 was $0.59, $2.05, $5.04 and $2.02, respectively. The following table summarizes information about stock options outstanding at December 31, 1998:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE - ------------------------------------------------------------------- ----------------------------- NUMBER WEIGHTED NUMBER OF SHARES AVERAGE WEIGHTED OF SHARES WEIGHTED RANGE OF OUTSTANDING REMAINING AVERAGE EXERCISABLE AVERAGE EXERCISE PRICES AT 12/31/98 TERM EXERCISE PRICE AT 12/31/98 EXERCISE PRICE - --------------- ----------- --------- -------------- ----------- -------------- $0.31 to $1.85....... 1,598,084 9.64 $ 1.39 299,997 $ 1.85 $3.00 to $7.69....... 89,000 8.31 $ 3.79 89,000 $ 3.79 $9.00 to $14.50...... 31,332 7.84 $11.55 24,664 $11.16 --------- ------- $0.31 to $14.50...... 1,718,416 413,661 --------- -------
As discussed in Note 2, Summary of Significant Accounting Policies, under "Stock-Based Compensation Plans," of Notes to Consolidated Financial Statements, the Company accounts for its stock-based compensation plans under APB Opinion 25. Accordingly, no compensation cost has been recognized for those stock options with exercise prices equal to F-37 114 CANARGO ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED 18. STOCK-BASED COMPENSATION PLANS -- (CONTINUED) or greater than the market price of the stock on the date of grant. Under SFAS No. 123, compensation cost is measured at the grant date based on the fair value of the awards and is recognized over the service period, which is usually the vesting period. Had compensation cost for those stock options been determined consistent with SFAS No. 123, the Company's net loss and net loss per common share after plan forfeitures would have been approximately $5,750,000 and $0.36, respectively, for the year ended December 31, 1998, $28,600,000 and $2.56, respectively, for the year ended December 31, 1997 and approximately $6,500,000 and $1.04, respectively, for the fiscal year ended August 31, 1996. Stock options had no effect on net loss for the four months ended December 31, 1996. This effect is not likely to be representative of future pro forma amounts because of the exclusion of costs of grants before 1995 and the addition of awards to be granted in future years. The fair value of each stock option granted by the Company was calculated using the Black-Scholes option-pricing model applying the following weighted-average assumptions for the years ended December 31, 1998 and 1997, the four month period ended December 31, 1996 and the fiscal year ended August 31, 1996: dividend yield of 0.00%; risk-free interest rates are different for each grant and range from 5.69% to 5.72% for the year ended December 31, 1998, 6.08% to 6.36% for the year ended December 31, 1997, 5.79% to 6.16% for the four month period ended December 31, 1996, and during the fiscal year ended August 31, 1996, only one grant was made with a risk-free interest rate of 4.79%; the average expected lives of options of 4.0 years, 2.1 years, 3.1 years and 1.5 years, respectively; and volatility of 44.8% for the year ended December 31, 1998, 44.7% for the year ended December 31, 1997 and 49% for the four month period ended December 31, 1996 and the fiscal year ended August 31, 1996. 19. RELATED PARTY TRANSACTIONS The Company is a 50% shareholder of CanArgo Power Corporation, which in turn owns 85% of a Georgian private power company. The other 50% of CanArgo Power Corporation is owned by Terrenex Acquisition Corporation, an entity that is affiliated with two of the Company's directors and is itself a principal stockholder of the Company. During the first half of 1998, Terrenex, on behalf of both itself and the Company, provided all of the funds required by CanArgo Power. After the July 1998 business combination with CAOG was completed, the Company reimbursed Terrenex $398,000, representing half of the amount that had been advanced through that time. In May 1998, Terrenex agreed to lend CAOG up to $1,000,000 through August 31, 1998 and subsequently advanced the $1,000,000. CAOG paid Terrenex a $10,000 commitment fee, $50,000 in draw down fees and interest at the rate of 1/2% per month. In addition, CAOG granted Terrenex options exercisable until December 31, 1998 to acquire 12 1/2% of the stock of the subsidiary holding the Nazvrevi/Block XIII production sharing contract and 15% of CAOG's position in any license received as a result of a consortium submission in response to the Dagestan tender for offshore drilling and production rights. The terms of the loan were negotiated and approved by directors of CAOG who had no affiliation with Terrenex. The Company subsequently extended the options through F-38 115 CANARGO ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED RELATED PARTY TRANSACTIONS -- (CONTINUED) March 31, 1999 in consideration of the efforts of Terrenex in attempting to arrange financing for the Company. Terrenex can exercise either option by paying the percentage of the amounts expended on such projects through the exercise date as equals the percentage of the project being acquired through the exercise of the option. The Company repaid the Terrenex loan following completion of the business combination July 1998. 20. SUBSEQUENT EVENTS On February 12, 1999, the Company filed, subject to completion, a Registration Statement on Form S-1 with the Securities and Exchange Commission with respect to the offering of 21,264,643 shares of its Common Stock. On March 29, 1999, CanArgo was advised by The Nasdaq Stock Market that it had delisted CanArgo's common stock effective with the close of business on March 29, 1999. On March 30, 1999, CanArgo's common stock commenced trading on the OTC Bulletin Board. F-39 116 CANARGO ENERGY CORPORATION SUPPLEMENTAL FINANCIAL INFORMATION SUPPLEMENTAL OIL AND GAS DISCLOSURES -- UNAUDITED ESTIMATED NET QUANTITIES OF OIL AND GAS RESERVES Users of this information should be aware that the process of estimating quantities of "proved" and "proved developed" natural gas and crude oil reserves is very complex, requiring significant subjective decisions in the evaluation of all available geological, engineering and economic data for each reservoir. The data for a given reservoir may also change substantially over time as a result of numerous factors including, but not limited to, additional development activity, evolving production history and continual reassessment of the viability of production under varying economic conditions. Consequently, material revisions to existing reserve estimates occur from time to time. Although every reasonable effort is made to ensure that reserve estimates reported represent the most accurate assessments possible, the significance of the subjective decisions required and variances in available data for various reservoirs make these estimates generally less precise than other estimates presented in connection with financial statement disclosures. Proved reserves are estimated quantities of natural gas, crude oil and condensate that geological and engineering data demonstrate, with reasonable certainty, to be recoverable in future years from known reservoirs with existing equipment under existing economic and operating conditions. Proved developed reserves are proved reserves that can be expected to be recovered through existing wells with existing equipment and under existing economic and operating conditions. No major discovery or other favorable or adverse event subsequent to December 31, 1998 is believed to have caused a material change in the estimates of proved or proved developed reserves as of that date. The following table sets forth the Company's net proved reserves, including the changes therein, and proved developed reserves at December 31, 1998, as estimated by the independent petroleum engineering firm, AMH Group Ltd.: F-40 117 CANARGO ENERGY CORPORATION SUPPLEMENTAL FINANCIAL INFORMATION -- CONTINUED SUPPLEMENTAL OIL AND GAS DISCLOSURES -- UNAUDITED
REPUBLIC OF NET PROVED RESERVES -- OIL GEORGIA CANADA TOTAL - -------------------------- ----------- ------ ----- (IN THOUSANDS OF BARRELS) December 31, 1996 Purchase of properties........................ -- 116 116 Revisions of previous estimates............... -- (33) (33) Extension, discoveries, other additions....... -- 267 267 Production.................................... -- (16) (16) ----- ---- ----- December 31, 1997............................... -- 334 334 Purchase of properties........................ 6,050 -- 6,050 Revisions of previous estimates............... 198 (155) 43 Extension, discoveries, other additions....... 1,388 -- 1,388 Production.................................... (92) (21) (113) ----- ---- ----- December 31, 1998............................... 7,544 158 7,702 ----- ---- ----- Net Proved Developed Reserves December 31, 1998.......................................... 1,528 158 1,686 ----- ---- -----
Net proved reserves in the Republic of Georgia as at December 31, 1998 were as follows:
PSC ENTITLEMENT VOLUMES(1) --------------------------- OIL RESERVES COMPANY ---------------- NOC SHARE OF NOC GROSS NET(2) ENTITLEMENT ENTITLEMENT ------ ------ ----------- ------------ (IN THOUSANDS OF BARRELS) Proved Developed Producing........ 2,404 1,647 1,340 918 Proved Developed Non-Producing.... 1,379 945 890 610 Proved Undeveloped................ 15,200 10,412 8,783 6,016 ------ ------ ------ ----- Total Proven...................... 18,983 13,004 11,013 7,544 ------ ------ ------ -----
- ------------------------- (1) PSC (production sharing contract) Entitlement Volumes are those produced volumes which, through the production sharing contract, accrue to the benefit of NOC and, as a result of the Company's interest in NOC, accrue to the benefit of the Company for the recovery of capital, repayment of operating costs and share of profit. (2) Net Oil Reserves represent the Company's 68.5% share of NOC's interest under the production sharing contract in the gross reserves, before taking into account the interest of Georgian Oil. F-41 118 CANARGO ENERGY CORPORATION SUPPLEMENTAL FINANCIAL INFORMATION -- CONTINUED SUPPLEMENTAL OIL AND GAS DISCLOSURES -- UNAUDITED Costs incurred for oil and gas property acquisition, exploration and development activities for the years ended December 31, 1998 and 1997, the four months ended December 31, 1996 and the year ended August 31, 1996 are as follows:
EASTERN EUROPE CANADA TOTAL -------------- ------------- ---------- December 31, 1998 Property Acquisition Unproved*........................ $ -- $ -- $ -- Proved........................... -- -- -- Exploration......................... 684,056 136,715 820,771 Development......................... 4,390,495 4,390,495 ---------- ---------- ---------- Total costs incurred............. $5,074,551 $ 136,715 $5,211,266 ---------- ---------- ---------- December 31, 1997 Property Acquisition Unproved*........................ $ -- $ 324,500 $ 324,500 Proved........................... -- 684,500 684,500 Exploration......................... -- -- -- Development......................... -- 680,974 680,974 ---------- ---------- ---------- Total costs incurred............. $ -- $1,689,974 $1,689,974 ---------- ---------- ----------
UNITED STATES ------------- December 31, 1996 Property acquisition: Unproved*........................ $ -- $ 259,338 $ 259,338 Proved........................... -- -- -- Exploration......................... -- -- -- Development......................... -- -- -- ---------- ---------- ---------- Total costs incurred............. $ -- $ 259,338 $ 259,338 ---------- ---------- ----------
F-42 119 CANARGO ENERGY CORPORATION SUPPLEMENTAL FINANCIAL INFORMATION -- CONTINUED SUPPLEMENTAL OIL AND GAS DISCLOSURES -- UNAUDITED
UNITED STATES ------------- August 31, 1996 Property acquisition: Unproved*........................ $ -- $ 287,788 $ 287,788 Proved........................... -- -- -- Exploration......................... -- -- -- Development......................... -- -- -- ---------- ---------- ---------- Total costs incurred............. $ -- $ 287,788 $ 287,788 ---------- ---------- ----------
- --------------- * These amounts represent costs incurred by the Company and excluded from the amortization base until proved reserves are established or impairment is determined. STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS RELATING TO PROVED OIL AND GAS RESERVES The following information has been developed utilizing procedures prescribed by SFAS No. 69 Disclosure about Oil and Gas Producing Activities ("SFAS 69") and based on crude oil reserve and production volumes estimated by the Company's engineering staff. It may be useful for certain comparative purposes, but should not be solely relied upon in evaluating the Company or its performance. Further, information contained in the following table should not be considered as representative of realistic assessments of future cash flows, nor should the Standardized Measure of Discounted Future Net Cash Flows be viewed as representative of the current value of the Company. The Company believes that the following factors should be taken into account in reviewing the following information: (1) future costs and selling prices will probably differ from those required to be used in these calculations; (2) actual rates of production achieved in future years may vary significantly from the rate of production assumed in the calculations; (3) selection of a 10% discount rate is arbitrary and may not be reasonable as a measure of the relative risk inherent in realizing future net oil and gas revenues; and (4) future net revenues may be subject to different rates of income taxation. Under the Standardized Measure, future cash inflows were estimated by applying period-end oil prices adjusted for fixed and determinable escalations to the estimated future production of period-end proven reserves. Future cash inflows were reduced by estimated future development, abandonment and production costs based on period-end costs in order to arrive at net cash flow before tax. Future income tax expenses has been computed by applying period-end statutory tax rates to aggregate future pre-tax net cash flows, reduced by the tax basis of the properties involved and tax carryforwards. Use of a 10% discount rate is required by SFAS No. 69. Management does not rely solely upon the following information in making investment and operating decisions. Such decisions are based upon a wide range of factors, including estimates of probable as well as proven reserves and varying price and cost assumptions F-43 120 CANARGO ENERGY CORPORATION SUPPLEMENTAL FINANCIAL INFORMATION -- CONTINUED SUPPLEMENTAL OIL AND GAS DISCLOSURES -- UNAUDITED considered more representative of a range of possible economic conditions that may be anticipated. The standardized measure of discounted future net cash flows relating to proved oil and gas reserves is as follows:
REPUBLIC OF DECEMBER 31, 1998 (IN THOUSANDS) GEORGIA CANADA TOTAL - -------------------------------- ----------- ------ ------- Future cash inflows............................. $70,464 $1,905 $72,369 Less related future: Production costs........................... 15,051 1,176 16,227 Development and abandonment costs.......... 26,304 37 26,341 Income taxes............................... -- -- -- ------- ------ ------- Future net cash flows........................... 29,109 692 29,801 10% annual discount for estimating timing of cash flows.................................... 13,838 255 14,093 ------- ------ ------- Standardized measure of discounted future net cash flows before income taxes............. $15,271 $ 437 $15,708 ------- ------ -------
A summary of the changes in the standardized measure of discounted future net cash flows applicable to proved oil and gas reserves is as follows:
YEAR ENDED DECEMBER 31, 1998 -------------- (IN THOUSANDS) Beginning of period......................................... $ 1,243 Purchase of reserves in place............................... 14,088 Revisions of previous estimates............................. 115 Development costs incurred during the period................ 4,642 Sales of oil and gas, net of production costs............... 38 Production timing and other................................. (4,418) ------- Net increase................................................ 14,465 ------- End of the period........................................... $15,708 =======
F-44 121 CANARGO ENERGY CORPORATION AND SUBSIDIARIES CONSOLIDATED CONDENSED BALANCE SHEET AS OF MARCH 31, 1999 AND DECEMBER 31, 1998 (UNAUDITED)
MARCH 31, DECEMBER 31, 1999 1998 ------------ ------------ UNAUDITED ASSETS Cash and cash equivalents....................... $ 705,807 $ 1,924,908 Accounts receivable............................. 381,699 424,367 Advances to operator............................ 252,588 376,890 Inventory....................................... 298,149 170,405 Other current assets............................ 300,509 453,476 ------------ ------------ Total current assets....................... $ 1,938,752 $ 3,350,046 Property and equipment, net..................... 6,259,741 6,201,936 Oil and gas properties, net, full cost method (including unevaluated amounts of $13,510,157 and $13,266,368 respectively)................. 31,069,646 30,137,573 Investments in and advances to oil and gas and other ventures -- net......................... 7,049,182 6,877,974 ------------ ------------ TOTAL ASSETS.................................... $ 46,317,321 $ 46,567,529 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Accounts payable................................ $ 1,427,139 $ 821,761 Accrued liabilities............................. 1,255,774 1,162,050 ------------ ------------ Total current liabilities.................. $ 2,682,913 $ 1,983,811 Minority interest in subsidiaries............... 4,464,698 4,552,285 Stockholders' equity: Preferred stock, par value $0.10 per share.... -- -- Common stock, par value $0.10 per share....... 2,126,464 2,101,464 Capital in excess of par value................ 101,630,441 101,545,941 Accumulated deficit........................... (64,587,195) (63,615,972) ------------ ------------ Total stockholders' equity................. $ 39,169,710 $ 40,031,433 ------------ ------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY...... $ 46,317,321 $ 46,567,529 ============ ============
See accompanying notes to unaudited consolidated condensed financial statements. F-45 122 CANARGO ENERGY CORPORATION AND SUBSIDIARIES CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND MARCH 31, 1998 (UNAUDITED)
THREE MONTHS ENDED -------------------------- MARCH 31, MARCH 31, 1999 1998 ----------- ----------- UNAUDITED Operating Revenues: Oil and gas sales............................... $ 113,667 $ 80,614 ----------- ----------- 113,667 80,614 ----------- ----------- Operating Expenses: Lease operating expense......................... 66,718 99,517 Direct project costs............................ 68,068 539,406 General and administrative...................... 858,630 1,457,352 Depreciation, depletion and amortization........ 25,000 117,824 Equity loss from investments in unconsolidated subsidiaries................................. 21,581 91,431 Impairment of oil and gas properties............ -- 800,000 ----------- ----------- 1,039,997 3,105,530 ----------- ----------- OPERATING LOSS.................................... (926,330) (3,024,916) ----------- ----------- Other Income (Expense): Interest, net................................... (48,259) 203,574 Other........................................... (84,221) 3,225 ----------- ----------- TOTAL OTHER INCOME (EXPENSE)...................... (132,480) 206,799 ----------- ----------- Minority interest in loss of consolidated subsidiary...................................... 87,587 -- ----------- ----------- NET LOSS AND COMPREHENSIVE LOSS................... $ (971,223) $(2,818,117) =========== =========== Weighted average number of common shares outstanding..................................... 21,222,976 11,223,744 ----------- ----------- Net Loss Per Common Share -- Basic................ $ (0.05) $ (0.25) ----------- ----------- Net Loss Per Common Share -- Diluted.............. $ (0.05) $ (0.25) ----------- -----------
See accompanying notes to unaudited consolidated condensed financial statements. F-46 123 CANARGO ENERGY CORPORATION AND SUBSIDIARIES CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND MARCH 31, 1998 (UNAUDITED)
THREE MONTHS ENDED -------------------------- MARCH 31, MARCH 31, 1999 1998 ----------- ----------- UNAUDITED Operating activities: Net loss........................................ $ (971,223) $(2,818,117) Depreciation, depletion and amortization........ 25,000 117,824 Impairment of oil and gas properties............ -- 800,000 Equity loss from investments in unconsolidated subsidiaries................................. 21,581 91,431 Minority interest in loss of consolidated subsidiary................................... (87,587) -- Changes in assets and liabilities: Accounts receivable............................. 42,668 -- Advances to operator............................ 124,302 -- Inventory....................................... (127,744) -- Other current assets............................ 152,967 172,315 Accounts payable................................ 605,378 (164,835) Accrued liabilities............................. 93,724 (772,399) ----------- ----------- NET CASH USED IN OPERATING ACTIVITIES............. (120,934) (2,573,781) ----------- ----------- Investing activities: Restricted cash................................. -- (200,000) Investments in oil and gas properties........... (842,573) (73,904) Purchase of property and equipment.............. (62,805) (1,321) Investments in and advances to oil and gas and other ventures............................... (192,789) -- ----------- ----------- NET CASH USED IN INVESTING ACTIVITIES............. (1,098,167) (275,225) ----------- ----------- NET DECREASE IN CASH AND CASH EQUIVALENTS......... (1,219,101) (2,849,006) CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD.... 1,924,908 14,164,177 ----------- ----------- CASH AND CASH EQUIVALENTS, END OF PERIOD.......... $ 705,807 $11,315,171 =========== =========== Non cash investing and financing activities: Issuance of common stock in connection with acquisition of oil and gas properties........ $ 109,500 $ -- =========== ===========
See accompanying notes to unaudited consolidated condensed financial statements. F-47 124 CANARGO ENERGY CORPORATION AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS THREE MONTHS ENDED MARCH 31, 1999 AND MARCH 31, 1998 (UNAUDITED) (1) BASIS OF PRESENTATION The interim consolidated condensed financial statements and notes thereto of CanArgo Energy Corporation and its subsidiaries (collectively, the Company) have been prepared by management without audit. In the opinion of management, the consolidated condensed financial statements include all adjustments, consisting of normal recurring adjustments, necessary for a fair statement of the results for the interim period. The accompanying consolidated condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 1998 filed with the Securities and Exchange Commission. On July 15, 1998 the Company filed with the Delaware Secretary of State amendments to its Certificate of Incorporation to effect a one-for-two reverse split of the shares of the Company's Common Stock (the "Reverse Split") and to change the Company's name from Fountain Oil Incorporated to CanArgo Energy Corporation. The Reverse Split has been reflected retroactively in the accompanying financial statements. Oil and Gas Properties -- The Company and the unconsolidated entities for which it accounts using the equity method account for oil and gas properties and interests under the full cost method. Under this accounting method, costs, including a portion of internal costs associated with property acquisition and exploration for and development of oil and gas reserves, are capitalized within cost centers established on a country-by-country basis. Capitalized costs within a cost center, as well as the estimated future expenditures to develop proved reserves and estimated net costs of dismantlement and abandonment, are amortized using the unit-of-production method based on estimated proved oil and gas reserves. All costs relating to production activities are charged to expense as incurred. Capitalized oil and gas property costs, less accumulated depreciation, depletion and amortization and related deferred income taxes, are limited to an amount (the ceiling limitation) equal to (a) the present value (discounted at 10%) of estimated future net revenues from the projected production of proved oil and gas reserves, calculated at prices in effect as of the balance sheet date (with consideration of price changes only to the extent provided by fixed and determinable contractual arrangements), plus (b) the lower of cost or estimated fair value of unproved and unevaluated properties, less (c) income tax effects related to differences in the book and tax basis of the oil and gas properties. (2) BUSINESS COMBINATION On July 15, 1998, the Company completed the acquisition of all of the common stock of CanArgo Oil & Gas Inc. ("CAOG") for Common Stock consideration valued at $19,362,500. CAOG is an oil and gas exploration, development and production company whose principal operations are located in the Republic of Georgia. On completion of the acquisition, CAOG became a subsidiary of the Company, and each previously outstanding share of CAOG Common Stock was converted into the right to receive 0.8 shares of the Company's Common Stock, giving the former shareholders of CAOG the right to receive F-48 125 CANARGO ENERGY CORPORATION AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS -- CONTINUED (2) BUSINESS COMBINATION -- (CONTINUED) approximately 47% of the Company's Common Stock. In addition, the former management of CAOG now holds a majority of the Company's senior management positions. The transaction was accounted for as a purchase. Under purchase accounting, CAOG's results have been included in the Company's consolidated financial statements since the date of acquisition. The business combination will result in the issuance of 9,790,900 shares of the Company's Common Stock without receipt of additional consideration by the Company. At March 31, 1999, 7,919,701 of these shares had been issued. Giving effect to the full issuance of such shares, the number of shares of the Company's Common Stock outstanding as at March 31, 1999 would be 21,264,643. (3) NEED FOR SIGNIFICANT ADDITIONAL CAPITAL, POSSIBLE IMPAIRMENT OF ASSETS As described in notes 4, 5 and 6 to the condensed consolidated financial statements, the Company has oil and gas related assets totaling $44,107,212. In order to recover the carrying value of the proved properties (principally the Ninotsminda field), among other things, the Company will be required to raise significant additional capital to develop the proved properties in order to increase production to a level that provides positive cash flow and to recover the proved reserves associated with those properties. Budgeted costs for this development are approximately $9.5 million to be incurred prior to mid-2000 and approximately $16 million thereafter. To partially fund this further development cost, Ninotsminda Oil Company received a $6 million loan commitment from the International Finance Corporation. However, the commitment is essentially contingent on the Company providing $2 million to NOC in the form of a subordinated loan. There is no assurance that the Company will be able to raise the required funds and therefore that NOC will be able to draw on the loan. If the Company cannot successfully raise the required funds to develop the Ninotsminda field, it may not be able to recover its carrying value. In addition to the funds needed to develop the Ninotsminda field, significant additional capital will be required to explore and, if appropriate develop, the Company's unproved properties and its investment in oil and gas ventures. This requirement could be met by raising additional capital, partnering with other industry participants who would fund all or part of the exploration or development activities in exchange for an interest in the properties or interests or outright sale of the properties or interests. The Company is actively seeking industry partners in connection with its interests in the Stynawske field as well as its other unproved properties in Eastern Europe. No adjustment to the carrying value of these properties or interests have been made as of March 31, 1999, pending the outcome of the Company's capital raising or joint venture activities. However, it substantive joint venture partners are not obtained or significant capital is not raised the Company may not recover all or any of the carrying value of those assets. In addition, even if the Company obtains the means or identifies an industry partner to explore those properties, there is no assurance that proved reserves will be found in sufficient quantities to permit the Company to recover its investment. F-49 126 CANARGO ENERGY CORPORATION AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS -- CONTINUED (3) NEED FOR SIGNIFICANT ADDITIONAL CAPITAL, POSSIBLE IMPAIRMENT OF ASSETS -- (CONTINUED) The Company has mobilized oil and gas related equipment to Georgia principally for use in the development of the Ninotsminda field and ultimately for the exploration and development of certain other unproved properties in Eastern Europe. If the Ninotsminda field and certain unproved properties are not successfully developed, the Company may not recover the remaining carrying value of this equipment. The Company's investments in Georgian American Oil Refinery and Sagarego Power Corporation are part of the Company's strategy to successfully develop the Ninotsminda field and accordingly, ultimate realization of those investments is tied to the successful development and operation of that field. The consolidated financial statements of the Company do not give effect to any additional impairment in the value of the Company's investment in oil and gas properties and ventures or other adjustments that would be necessary if financing cannot be arranged for the development of such properties and ventures or if they are unable to achieve profitable operations. The Company's consolidated financial statements have been prepared under the assumption of a going concern. Failure to arrange such financing on reasonable terms or failure of such properties and ventures to achieve profitability would have a material adverse effect on the financial position, including realization of assets, results of operations, cash flows and prospects of the Company and ultimately its ability to continue as a going concern. (4) PROPERTY AND EQUIPMENT, NET Property and equipment, net of accumulated depreciation and impairment at March 31, 1999 and December 31, 1998 included the following:
DECEMBER 31, MARCH 31, 1999 1998 ------------------------------------------------------ ------------ ACCUMULATED COST DEPRECIATION IMPAIRMENT NET NET ----------- ------------ ----------- ----------- ------------ Electrically enhanced oil recovery ("EEOR") equipment............. $ 562,953 $ (290,855) $ -- $ 272,098 $ 272,098 Oil and gas related equipment............. 8,426,310 -- (2,710,024) 5,716,286 5,653,481 Office furniture, fixtures and equipment and other............. 1,090,352 (418,995) (400,000) 271,357 276,357 ----------- ----------- ----------- ----------- ----------- Property and Equipment............. $10,079,615 $ (709,850) $(3,110,024) $ 6,259,741 $ 6,201,936 =========== =========== =========== =========== ===========
Oil and gas related equipment includes new or refurbished drilling rigs and related equipment, substantially all of which has been transported to the Republic of Georgia for use by the Company in the development of the Ninotsminda field. F-50 127 CANARGO ENERGY CORPORATION AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS -- CONTINUED (5) OIL AND GAS PROPERTIES, NET The Company has acquired interests in oil and gas properties through share ownership, joint ventures and joint operating arrangements. A summary of the Company's oil and gas properties at March 31, 1999 and December 31, 1998 is set out below:
MARCH 31, 1999 DECEMBER 31, ------------------------------------------------------------------- 1998 REPUBLIC OF ------------ GEORGIA CANADA USA OTHER TOTAL TOTAL ----------- ----------- ----------- ----------- ----------- ------------ Proved properties.... $17,426,461 $ 1,637,947 $ 1,174,734 $ -- $20,239,142 $19,530,858 Unproved properties......... 12,951,701 324,500 -- 233,956 13,510,157 13,266,368 Less: accumulated depletion and impairment......... (194,421) (1,310,498) (1,174,734) -- (2,679,653) (2,659,653) ----------- ----------- ----------- ----------- ----------- ----------- Total Oil and Gas Properties, Net.... $30,183,741 $ 651,949 $ -- $ 233,956 $31,069,646 $30,137,573 =========== =========== =========== =========== =========== ===========
Oil and gas properties obtained in connection with the acquisition of CAOG includes $15,120,000 of properties in the full cost pool and $10,550,500 of unevaluated properties. The Ninotsminda field includes seven producing wells and since February 1996 has been operated under the terms of a production sharing contract ("PSC") between Ninotsminda Oil Company Limited ("NOC") and the Republic of Georgia represented by the state oil company, Georgian Oil. Unproved properties in the Republic of Georgia include other license areas within the Ninotsminda PSC, as well as other exploration areas referred to as the Nazvrevi block and Block XIII operated under the terms of a PSC between the Company's wholly owned subsidiary, CanArgo Nazvrevi Limited, and the Republic of Georgia. During the first quarter of 1997, the Company purchased a 60% interest in a heavy oil property in the Sylvan Lake area in Alberta, Canada for approximately $1,009,000. During the three months ended March 31, 1998, the Company recognized impairments aggregating $800,000 on its oil and gas properties in the Sylvan Lake project as a result of a decline of heavy oil prices and the quarterly application of the full cost ceiling test. The impairment relates to proved properties. Unproved properties and associated costs not currently being amortized and included in oil and gas properties were $13,510,157 and $13,266,368 at March 31, 1999 and December 31, 1998 respectively. Unproved oil and gas properties at March 31, 1999 include costs of $13,185,657 (December 31, 1998 -- $12,941,868) with respect to properties in Eastern Europe. These properties are expected to be evaluated over the next five years. Remaining costs of $324,500 (December 31, 1998 -- $324,500) relate to the Sylvan Lake field which are expected to be evaluated over the next 12 months. If no proved reserves are added, these properties could result in additional impairment. F-51 128 CANARGO ENERGY CORPORATION AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS -- CONTINUED (6) INVESTMENTS IN AND ADVANCES TO OIL AND GAS AND OTHER VENTURES The Company has acquired interests in oil and gas and other ventures through less than majority interests in corporate and corporate-like entities. A summary of the Company's net investment in and advances to oil and gas ventures as of March 31, 1999 and December 31, 1998 is set out below:
MARCH 31, DECEMBER 31, INVESTMENTS IN AND ADVANCES TO OIL AND GAS AND OTHER VENTURES 1999 1998 - ------------------------------------------------------------- ----------- ------------ Ukraine -- Stynawske Field, Boryslaw Through 45% ownership of Boryslaw Oil Company........ $ 6,076,233 $ 5,980,613 Republic of Georgia -- Sartichala Through 12.9% ownership of Georgian American Oil Refinery.......................................... 1,004,445 1,004,445 Republic of Georgia -- Ninotsminda Through an effective 42.5% ownership Sagarego Power Corporation....................................... 564,965 467,796 Ukraine -- Lelyaki Field, Pryluki Region Through an effective 40.5% ownership of Kashtan Petroleum Ltd............................................... 2,435,725 2,435,725 Adygea, Russian Federation -- Maykop Field Through 37% ownership in Intergas JSC................ 6,710,874 6,710,874 Albania -- Gorisht-Kocul Field Through 50% ownership of the joint venture........... 2,202,922 2,202,922 ----------- ----------- Total Investments in and Advances to Oil and Gas and Other Ventures............................................. $18,995,164 $18,802,375 ----------- -----------
MARCH 31, DECEMBER 31, EQUITY IN PROFIT (LOSS) OF OIL AND GAS AND OTHER VENTURES 1999 1998 - --------------------------------------------------------- ----------- ------------ Ukraine -- Stynawske Field, Boryslaw................. $ (596,461) $ (574,880) Ukraine -- Lelyaki Field, Pryluki Region............. (2,435,725) (2,435,725) Adygea, Russian Federation -- Maykop Field........... (1,452,510) (1,452,510) Albania -- Gorisht-Kocul Field....................... (833,191) (833,191) ----------- ----------- Cumulative Equity in Profit (Loss) of Oil and Gas and Other Ventures..................................... $(5,317,887) $(5,296,306) ----------- -----------
F-52 129 CANARGO ENERGY CORPORATION AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS -- CONTINUED (6) INVESTMENTS IN AND ADVANCES TO OIL AND GAS AND OTHER VENTURES -- (CONTINUED)
MARCH 31, DECEMBER 31, EQUITY IN PROFIT (LOSS) OF OIL AND GAS AND OTHER VENTURES 1999 1998 - --------------------------------------------------------- ----------- ------------ Impairment -- Maykop Field........................... $(5,258,364) $(5,258,364) Impairment -- Gorisht-Kocul Field.................... (1,369,731) (1,369,731) ----------- ----------- Total Impairment..................................... $(6,628,095) $(6,628,095) ----------- ----------- Total Investments in and Advances to Oil and Gas and Other Ventures, Net of Equity Loss and Impairment... $ 7,049,182 $ 6,877,974 =========== ===========
As of March 31, 1999, the Company had net investments in and advances to oil and gas ventures totaling $5,479,772 (December 31, 1998 -- $5,405,733) which relate to Boryslaw Oil Company, the entity holding the license to develop the Stynawske field, for which development operations have not yet begun. Included are advances to Boryslaw Oil Company totaling $1,715,000 and $1,665,000 at March 31, 1999 and December 31, 1998, respectively. Such advances are recoverable only from future revenue of or payments from future participants in the venture, if any. The Company's investment in and advances to Boryslaw Oil Company are essentially unevaluated properties. At March 31, 1999 and December 31, 1998, there were no material operations or assets (other than unevaluated properties) of entities being accounted for using the equity method. Accordingly, no other separate financial information has been presented. As of March 31, 1999 the Company had remaining net investments in oil and gas properties and other ventures totaling $38,118,828 (December 31, 1998 -- $37,015,547). Of this amount, $5,479,772 (December 31, 1998 -- $5,405,733) relates to the Stynawske field in the Ukraine for which development operations have not yet begun. Ultimate realization of the carrying value of the Company's oil and gas properties and ventures will require production of oil and gas in sufficient quantities and marketing such oil and gas at sufficient prices to provide positive cash flow to the Company, which is dependent upon, among other factors, achieving significant production at costs that provide acceptable margins, reasonable levels of taxation from local authorities, and the ability to market the oil and gas produced at or near world prices. In addition, the Company must mobilize drilling equipment and personnel to initiate drilling, completion and production activities. The Company expects that the initial phase of development of the Stynawske field will consist of the workover of a number of existing wells, with a view towards increasing production and gathering data for the preparation of a full field development program. The Company is actively seeking to establish arrangements under which oil and gas production companies or other investors would acquire a portion of the Company's interest in the Stynawske field in return for supplying financing or services to implement the initial phase of the project. However, if one or more of the above factors, or other factors, are different than anticipated, these plans may not be realized, and the Company may not recover its carrying value. The Company will be entitled to distributions from the various properties F-53 130 CANARGO ENERGY CORPORATION AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS -- CONTINUED (6) INVESTMENTS IN AND ADVANCES TO OIL AND GAS AND OTHER VENTURES -- (CONTINUED) and ventures in accordance with the arrangements governing the respective properties and ventures. (7) ACCRUED LIABILITIES Accrued liabilities at March 31, 1999 and December 31, 1998 included the following:
MARCH 31, DECEMBER 31, 1999 1998 ---------- ------------ Professional fees.................................. $ 330,000 $ 280,000 Seismic acquisition................................ 814,931 771,207 Taxes payable...................................... 61,000 61,000 Other.............................................. 49,843 49,843 ---------- ---------- $1,255,774 $1,162,050 ========== ==========
F-54 131 CANARGO ENERGY CORPORATION AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS -- CONTINUED (8) STOCKHOLDERS' EQUITY
COMMON STOCK ----------------------- NUMBER OF SHARES ADDITIONAL TOTAL ISSUED AND PAID-IN ACCUMULATED STOCKHOLDERS' ISSUABLE PAR VALUE CAPITAL DEFICIT EQUITY ---------- ---------- ------------ ------------ ------------- BALANCE, DECEMBER 31, 1998................ 15,157,868 $1,515,786 $ 90,549,249 $(63,615,972) $28,449,063 Issuance of common stock upon exchange of CanArgo Oil & Gas Inc. Exchangeable Shares... 3,985,576 398,558 7,483,326 -- 7,881,884 Issuance of common stock in connection with acquisition of oil and gas properties.......... 250,000 25,000 84,500 -- 109,500 Net loss.............. -- -- -- (971,223) (971,223) ---------- ---------- ------------ ------------ ----------- 19,393,444 1,939,344 98,117,075 (64,587,195) 35,469,224 Shares issuable upon exchange of CanArgo Oil & Gas Inc. Exchangeable Shares without payment of additional consideration....... 1,871,199 187,120 3,513,366 -- 3,700,486 ---------- ---------- ------------ ------------ ----------- BALANCE, MARCH 31, 1999................ 21,264,643 2,126,464 $101,630,441 $(64,587,195) $39,169,710 ========== ========== ============ ============ ===========
CanArgo's Board of Directors has adopted resolutions proposing, subject to stockholder approval, a 1-for-25 reverse stock split of its outstanding shares of common stock. (9) NET LOSS PER COMMON SHARE Effective December 31, 1997, the Company adopted SFAS No. 128 Earnings Per Share. Basic and diluted net loss per common share for the periods ended March 31, 1999 and March 31, 1998 are based on the weighted average number of common shares outstanding during those periods. The weighted average numbers of shares issued and issuable without receipt of additional consideration for the three month periods ended March 31, 1999 and 1998 are 21,222,976 and 11,223,744, respectively. The weighted average number of shares outstanding at March 31, 1999 excludes 2,754,595 shares issuable upon exercise of options and warrants because they are anti-dilutive. F-55 132 CANARGO ENERGY CORPORATION AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS -- CONTINUED (10) COMMITMENTS AND CONTINGENCIES OIL AND GAS PROPERTIES AND INVESTMENTS IN OIL AND GAS VENTURES The Company has contingent obligations and may incur additional obligations, absolute and contingent, with respect to acquiring and developing oil and gas properties and ventures. At March 31, 1999, the Company had the contingent obligation to issue an aggregate of 187,500 shares of its Common Stock, subject to the satisfaction of conditions related to the achievement of specified performance standards by the Stynawske field project. The Company believes that it has no further obligation to fund operations of Kashtan Petroleum Ltd. or Intergas JSC. LEGAL PROCEEDINGS AND POTENTIAL CLAIMS On February 20, 1998, Zhoda Corporation ("Zhoda") filed suit against CanArgo in the District Court of Harris County, Texas. In 1997, Zhoda sold to CanArgo shares in a company through which CanArgo acquired most of its interest in the Lelyaki field project. Part of the consideration which CanArgo paid to Zhoda consisted of shares of a CanArgo subsidiary which were exchangeable for shares of CanArgo common stock only upon the achievement of specified Lelyaki field operating objectives. CanArgo believes that these objectives were not achieved. In the litigation, Zhoda asserts that it was wrongfully deprived of the value of the CanArgo shares it believes it should have received, based upon claims of breach of contract, breach of fiduciary duty and duty of good faith and fair dealing, fraud and constructive fraud, fraud in the inducement, negligent misrepresentation, civil conspiracy, breach of trust, unjust enrichment and rescission. Zhoda is seeking more than $7,500,000 in damages, return of the shares transferred to CanArgo, and other relief. The Harris County District Court has stayed the litigation pending completion of arbitration proceedings, which are being held in Calgary, Alberta. The arbitration proceedings are still in the preliminary procedural stage. CanArgo believes it has meritorious defenses to Zhoda's claims which it intends to assert vigorously. A judgment in favor of Zhoda could have a material adverse effect on CanArgo's financial condition, results of operations, cash flows and prospects. On March 24, 1998, CanArgo filed an action against Zhoda in the Court of Queen's Bench of Alberta, Judicial Centre of Calgary, in which CanArgo seeks to recover $190,000, plus interest, which CanArgo asserts Zhoda owes CanArgo pursuant to promissory notes and loan agreements. On March 31, 1998, Zhoda filed a statement of defense and a counterclaim in which it asserted essentially the same claims as were asserted in the Texas action described above. On the basis of its counterclaim, Zhoda seeks relief similar to that sought in the Texas action. CanArgo's claim against Zhoda in the Alberta action is not within the scope of the arbitration proceeding being conducted in Calgary. On March 9, 1998, Ribalta Holdings, Inc. ("Ribalta"), which sold to CanArgo shares in a company through which CanArgo acquired most of its interest in the Maykop field project, filed suit against CanArgo in the Third Judicial District Court of Salt Lake County, Utah. Ribalta, however, has not yet served the complaint on the CanArgo. F-56 133 CANARGO ENERGY CORPORATION AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS -- CONTINUED In its complaint, Ribalta alleges breach by CanArgo of the contract governing the sale of the shares it transferred to CanArgo and failure of a condition in that contract that should have resulted in the termination of the contract. Ribalta seeks the return of all benefits conferred on CanArgo pursuant to the contract or damages equal to the value of such benefits, as well as other relief. Under that contract, as amended, the maximum consideration to which Ribalta might have been entitled was $800,000 and 350,000 shares of CanArgo Common Stock. CanArgo believes that no consideration is payable under that contract because conditions to payment specified in the contract were not satisfied. A judgment in favor of Ribalta in this proceeding could have a material adverse impact on CanArgo's financial condition, results of operations, cash flows and prospects. CanArgo believes it has meritorious defenses to Ribalta's claims which it intends to assert vigorously. POTENTIAL CLAIMS RELATING TO PREVIOUSLY IMPAIRED PROJECTS As a result of CanArgo's decision to cease active development of the Lelyaki, Maykop and Gorisht-Kocul projects, CanArgo may be subject to contingent liabilities in the form of claims from the joint ventures developing such projects or from others participating in those projects. CanArgo was advised during the first quarter of 1998 that Intergas and another shareholder of Intergas were considering asserting such claims in relation to the Maykop project, but no such claims have yet been asserted. CanArgo is unable to estimate the range that such claims, if made, might total. However, if one or more such claims were asserted and determined to be valid, they could have a material adverse effect on CanArgo's financial position, results of operations, cash flows and prospects. Such claims may be adjudicated in the host country forum under host country laws. (11) SEGMENT INFORMATION For the three month periods ended March 31, 1999 and 1998, the Company operated through one business segment, oil and gas exploration and production, reflecting its decision to use its electrically enhanced oil recovery ("EEOR") technology primarily internally as a competitive advantage to obtain and exploit interests in heavy oil fields and not to pursue external sales of goods and services related to the EEOR technology. Operating revenues for the three month periods ended March 31, 1999 and 1998 by geographical area were as follows:
MARCH 31, MARCH 31, 1999 1998 --------- --------- Oil and Gas Exploration, Development and Production Eastern Europe....................................... $ 68,000 $ -- Canada............................................... 45,667 80,614 -------- -------- Total.................................................. $113,667 $ 80,614 ======== ========
F-57 134 CANARGO ENERGY CORPORATION AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS -- CONTINUED (11) SEGMENT INFORMATION -- (CONTINUED) Operating profit (loss) for the three month periods ended March 31, 1999 and 1998 by geographical area were as follows:
MARCH 31, MARCH 31, 1999 1998 ----------- ----------- Oil and Gas Exploration, Development and Production Eastern Europe.................................. $ (336,194) $(1,592,777) Canada.......................................... (85,503) (142,985) ----------- ----------- Total............................................. $ (421,697) $(1,735,762) Corporate Expenses................................ $ (504,633) $(1,289,154) Total............................................. $ (926,330) $(3,024,916) =========== ===========
Identifiable assets as of March 31, 1999 and December 31, 1998 by business segment and geographical area were as follows:
MARCH 31, DECEMBER 31, 1999 1998 ----------- ------------ Corporate United States................................... $ 154,756 $ 3,319 Canada.......................................... 1,117,817 2,304,690 Western Europe.................................. 93,632 196,304 ----------- ----------- Total............................................. $ 1,366,205 $ 2,504,313 ----------- ----------- Oil and Gas Exploration, Development and Production Eastern Europe.................................. $42,413,878 $41,644,701 Canada.......................................... 956,513 1,001,733 Western Europe.................................. 11,315 13,769 ----------- ----------- Total............................................. $43,381,706 $42,660,203 ----------- ----------- Other Energy Projects Eastern Europe.................................. $ 1,569,410 $ 1,403,013 ----------- ----------- Identifiable Assets -- Total...................... $46,317,321 $46,567,529 =========== ===========
F-58 135 CANARGO OIL & GAS INC. CONSOLIDATED BALANCE SHEET (SEE BASIS OF PRESENTATION -- NOTE 1) (STATED IN U.S. DOLLARS)
JUNE 30, 1998 ----------- (UNAUDITED) ASSETS Current Cash...................................................... $ 935,443 Accounts receivable....................................... 2,116,286 Prepaid expenses.......................................... 23,511 Inventory................................................. 20,405 ----------- $ 3,095,645 Oil and gas properties [note 5]............................. 9,061,436 ----------- $12,157,081 =========== LIABILITIES AND SHAREHOLDERS' EQUITY Current Accounts payable and accrued liabilities.................. $ 3,051,742 Taxes payable............................................. 61,000 ----------- $ 3,112,742 Long term debt [note 6]..................................... 895,500 Non-controlling interest.................................... 3,437,929 ----------- $ 7,446,171 ----------- CONTINGENCIES [NOTES 7 AND 8] SHAREHOLDERS' EQUITY Share capital and special warrants [note 7]................. $ 5,701,384 Deficit..................................................... (990,474) ----------- $ 4,710,910 ----------- $12,157,081 ===========
See accompanying notes F-59 136 CANARGO OIL & GAS INC. CONSOLIDATED STATEMENT OF OPERATIONS AND DEFICIT (STATED IN U.S. DOLLARS)
SIX MONTHS ENDED JUNE 30, 1998 ----------- (UNAUDITED) REVENUE Oil......................................................... $ 992,952 Interest.................................................... 46,979 ----------- $ 1,039,931 ----------- EXPENSES Operating costs............................................. $ 771,652 General and administration.................................. 703,652 Depletion................................................... 527,676 Interest.................................................... 39,020 ----------- $ 2,042,000 ----------- Loss before non-controlling interest........................ $(1,002,069) Non-controlling interest.................................... 267,422 ----------- LOSS FOR THE PERIOD......................................... $ (734,647) DEFICIT -- BEGINNING OF PERIOD.............................. $ (255,827) ----------- DEFICIT -- END OF PERIOD.................................... $ (990,474) =========== BASIC AND FULLY DILUTED LOSS PER SHARE...................... $ (0.07) ----------- WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING DURING PERIOD.................................................... 10,438,391 ===========
See accompanying notes F-60 137 CANARGO OIL & GAS INC. CONSOLIDATED STATEMENT OF CASH FLOWS (STATED IN U.S. DOLLARS)
SIX MONTHS ENDED JUNE 30, 1998 ----------- (UNAUDITED) CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES Loss for the period......................................... $ (734,647) Items not requiring cash Depletion................................................. 527,676 Non-controlling interest.................................. (267,422) ----------- Funds from operations....................................... $ (474,393) Net change in non-cash working capital related to operating activities................................................ 522,401 ----------- $ 48,008 ----------- INVESTING ACTIVITIES Additions to capital assets................................. $(2,527,655) ----------- $(2,527,655) ----------- FINANCING ACTIVITIES Contribution from non-controlling interest.................. $ 1,820,000 Share issue costs........................................... (238,358) ----------- $ 1,581,642 ----------- INCREASE (DECREASE) IN CASH................................. $ (898,005) Cash position, beginning of period.......................... $ 1,833,448 ----------- CASH POSITION, END OF PERIOD................................ $ 935,443 ===========
See accompanying notes F-61 138 CANARGO OIL & GAS INC. NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS SIX MONTHS ENDED JUNE 30, 1998 (UNAUDITED) 1. BASIS OF PRESENTATION Prior to July 1, 1997, CanArgo Oil & Gas Inc. (formerly CanArgo Energy Inc.) carried on business under the name Money Works Inc. Money Works Inc. was incorporated under the Alberta Business Corporations Act. Effective July 1, 1997, Money Works Inc. acquired all of the outstanding common shares of CanArgo Ltd. by issuing a total of 8,276,250 common shares from treasury (see note 4), and changed its name to CanArgo Energy Inc. ("the Corporation"). This resulted in the former shareholders of CanArgo Ltd. acquiring control of Money Works Inc. Accordingly, this transaction has been accounted for as a reverse takeover of the Corporation and the Consolidated Balance Sheet includes the assets and liabilities of CanArgo Ltd. at their carrying values together with the net assets of Money Works Inc. acquired at their ascribed fair values. The financial statements of the Corporation are a continuation of the financial statements of CanArgo Ltd., the acquirer, for accounting purposes. CanArgo Ltd. was incorporated on March 4, 1997 with nominal share capital for the purpose of holding certain shareholders' interest aggregating 55.9% of the shares of Ninotsminda Oil Company Limited ("NOC"). There was no change in the individual shareholders' effective interest in NOC as a result of the formation of CanArgo Ltd. NOC is a Cypriot company specializing in the exploration and development of oil and gas properties in the Republic of Georgia. NOC operates under the terms of a Production Sharing Contract ("PSC") signed February 15, 1996 between NOC and the Republic of Georgia represented by the state oil company, Georgian Oil. Under the terms of the PSC, NOC is responsible for the costs associated with the project, which is operated on behalf of NOC by the local operating company, Georgian British Oil Company ("Georgian Oil"). Georgian Oil is responsible for the costs associated with site restoration and abandonment, royalties and all state taxes. The PSC expires in December 2019 and provides for a five-year extension. While areas containing field developments are not subject to relinquishment, other areas are subject to relinquishment after 5, 10, 15 and 20 years after the date of issue of the license. Currently, the Ninotsminda field is the only producing field in this license. Production from the Ninotsminda field commenced in the early part of 1996, and during 1996 approximately 515,000 barrels of oil were produced. Under the terms of the PSC, Georgian Oil currently takes the first 96.4 tons per day ("determined production") of production, after which all production is shared. The level of determined production will change in accordance with the terms of the agreement. After determined production, NOC receives up to 50% of production for cost recovery. Remaining production after cost recovery is then allocated as to 30% to NOC and as to 70% to Georgian Oil. To date, NOC has sold all of its production to one international buyer at prices related to the world market price for Brent crude, with payment in US dollars into NOC's bank account in Cyprus. F-62 139 CANARGO OIL & GAS INC. NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED 1. BASIS OF PRESENTATION -- (CONTINUED) NOC is in an early stage of operations and is facing challenges typical of doing business in the former Soviet Union. Neither NOC nor the Corporation is currently in a position to finance all working capital or capital investment requirements through their own operations and therefore will require additional external financing. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The Corporation follows accounting principles generally accepted in Canada. The significant accounting policies are noted below. a) PRINCIPLES OF CONSOLIDATION These consolidated financial statements include the accounts of the Corporation's wholly owned subsidiaries CanArgo Ltd. and CanArgo Nazvrevi Limited and its 55.9% owned subsidiary, NOC. The Corporation's interest in NOC was contributed by the CanArgo Ltd. shareholders. As there was no substantive change in the ownership of the NOC shares arising from the transfer, the Corporation has recorded its investment at the historic costs of NOC to the shareholders. b) INVENTORY Materials, supplies and spare parts held for use in the oil field and inventories of petroleum products held for sale are recorded at the lower of average cost and net realizable value. c) OIL AND GAS PROPERTIES The Corporation follows the full cost method of accounting for exploration and development expenditures wherein all costs related to the exploration for and the development of oil and gas reserves are capitalized. These costs include lease acquisition costs, geological and geophysical expenses, carrying charges of non-producing properties, costs of drilling and completing wells and oil and gas production equipment and that portion of general and administrative expense applicable to these activities. Proceeds received from the disposal of properties are normally credited against accumulated costs unless this would result in a change in the depletion rate by more than 20%, in which case a gain or loss is computed and reflected in the statement of operations. Depletion of exploration and development costs and production equipment is provided on the unit-of-production method based upon estimated proved oil and gas reserves, as determined by independent engineers. The Corporation carries its oil and gas properties at the lower of capitalized cost and net recoverable amount. Net recoverable amount is future net revenues from proved reserves plus unproved properties at cost less any impairment. Future net revenues are determined using unit prices and production and overhead costs, financing charges and income taxes that will be incurred in earning these revenues. F-63 140 CANARGO OIL & GAS INC. NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED) d) FOREIGN CURRENCY TRANSLATION These financial statements are presented in United States dollars. Monetary amounts denominated in a foreign currency are translated to United States dollars at the exchange rate in effect at the balance sheet date. Revenue and expense items are translated at the average exchange rate for the period. Exchange gains and losses resulting from the translation of foreign currency amounts are included in or charged to income for the year. e) FINANCIAL INSTRUMENTS Financial instruments of the Corporation consist of cash, accounts receivable, accounts payable and long term debt. As at June 30, 1998 there are no significant differences between their carrying values and their estimated market values. f) INCOME TAXES Georgian Oil is responsible for all state taxes in the Republic of Georgia. The undistributed earnings of foreign investees are considered to be permanently invested for their continuing operations; accordingly, no provisions are made for taxes which would become payable upon the distribution of such earnings to the parent company. g) MEASUREMENT UNCERTAINTY The amount recorded for depletion of oil and gas properties is based on estimates. The ceiling test calculation is based on estimates of proved reserves, production rates, oil prices, future costs and other relevant assumptions. By their nature, these estimates are subject to measurement uncertainty and the effect on the financial statements of changes in such estimates in future years could be significant. 3. CONTRIBUTING OF SHARES OF NOC Effective June 30, 1997, the shareholders of CanArgo Ltd. contributed their collective 55.9% interest in NOC for shares in a common control transaction. The contribution is summarized as follows: NET ASSETS CONTRIBUTED: Current assets, including $492,295 cash..................... $ 1,291,195 Capital assets.............................................. 4,748,422 Current liabilities......................................... (777,834) Long term debt.............................................. (675,000) Non-controlling interest.................................... (1,399,783) ----------- SHARES ISSUED: 8,275,250 common shares...................... $ 3,187,000 ===========
F-64 141 CANARGO OIL & GAS INC. NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED 4. ACQUISITION OF CANARGO LTD. Effective July 1, 1997, the Corporation acquired all of the outstanding shares of CanArgo Ltd., a privately owned company. This transaction has been accounted for as a reverse takeover as described in Note 1. The acquisition is summarized as follows: NET ASSETS OF CANARGO ENERGY INC. (FORMERLY MONEY WORKS INC.) ACQUIRED: Current assets, including $2,726 cash....................... $ 44,108 Current liabilities......................................... (12,133) -------- $ 31,975 -------- CONSIDERATION: 1,708,640 common shares..................................... $ 31,975 ========
5. OIL AND GAS PROPERTIES
JUNE 30, 1998 ------------- (UNAUDITED) Oil and gas properties...................................... $10,887,172 Accumulated Depletion....................................... (1,825,736) ----------- $ 9,091,436 ===========
General and administrative expenses of $535,363 were capitalized during the six months ended June 30, 1998. 6. LONG TERM DEBT
JUNE 30, 1998 ------------- (UNAUDITED) Advance..................................................... $220,500 Loan........................................................ 675,000 -------- $895,500 ========
The advance from non-controlling interest to NOC bears no interest unless it is not repaid by June 30, 2000, at which time it would bear interest at 15% until repayment. The loan from non-controlling interest to NOC bears interest at a rate of 10% and is repayable out of surplus funds of NOC as and when available. F-65 142 CANARGO OIL & GAS INC. NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED 7. SHARE CAPITAL AND SPECIAL WARRANTS AUTHORIZED Unlimited number of voting common shares Unlimited number of first preferred shares Unlimited number of second preferred shares
ISSUED COMMON SHARES NUMBER AMOUNT - -------------------- ---------- ---------- Balance, December 31, 1997............................ 10,438,391 $3,917,465 ---------- ---------- Share issue costs..................................... (238,358) ---------- ---------- Balance, June 30, 1998................................ 3,679,107 ---------- ---------- Special Warrants Special warrants issued............................... 1,636,597 $2,520,359 Issue costs........................................... -- (498,082) ---------- ---------- Balance, December 31, 1997 and June 30, 1998.......... 1,636,597 $2,022,277 ---------- ---------- Warrants issued and balance, December 31, 1997 and June 30, 1998....................................... 681,760 $ -- ---------- ---------- Total share capital and special warrants, December 31, 1997................................................ 5,701,389 ---------- ----------
On November 3, 1997, the Corporation closed a private placement of 1,636,597 special warrants at a price of Canadian $2.20 per special warrant. Each special warrant is convertible into one common share of the Corporation and one half of one warrant. Each full warrant is exercisable into one common share at a price of Canadian $2.60 per share through to November 1, 1999. In conjunction with the special warrants placement, 681,760 warrants were issued. Each warrant is exercisable into one common share with 455,010 being exercisable at a price of Canadian $2.20, 250,000 warrants of which expire on June 30, 1998 and 205,010 warrants of which expire April 30, 1999, and 226,750 being exercisable at a price of Canadian $2.60 and expiring on November 1, 1999. If the Corporation has not obtained a receipt for a final prospectus indicating the qualification of these securities in each relevant jurisdiction by February 28, 1998 then each special warrant will entitle the holder to receive an additional 0.1 common share and 0.05 warrant without payment of additional consideration. INCENTIVE STOCK OPTION PLAN During the period ended December 31, 1997, 1,035,000 common share options were granted; none were exercised. At December 31, 1997, options exercisable between 1998 and 2002 were outstanding to purchase 1,035,000 common shares at a price of $2.20 per share. F-66 143 CANARGO OIL & GAS INC. NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED 8. SUBSEQUENT EVENTS On February 2, 1998, the Corporation entered into an agreement with Fountain Oil Incorporated ("Fountain") under which a business combination would be effected through an exchange of shares. Each common share of the Corporation is exchangeable into 0.8 (1.6 preReverse Split) common shares of Fountain. This business combination is subject to regulatory and shareholder approval. 9. GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP) IN THE UNITED STATES The Corporation's consolidated financial statements have been prepared in accordance with accounting principles generally accepted in Canada, which in the case of the Corporation at June 30, 1998, conforms in all material respects with United States GAAP. F-67 144 AUDITORS' REPORT To the Directors of CanArgo Oil & Gas Inc. We have audited the consolidated balance sheet of CanArgo Oil & Gas Inc. (formerly CanArgo Energy Inc.) as at December 31, 1997 and the consolidated statements of operations and deficit and cash flows for the six-month period then ended. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of the Corporation as at December 31, 1997 and the results of its operations and the changes in its financial position for the six month period then ended in accordance with accounting principles generally accepted in Canada. /s/ Ernst & Young Calgary, Canada Ernst & Young February 18, 1998 Chartered Accountants
F-68 145 CANARGO OIL & GAS INC. CONSOLIDATED BALANCE SHEET (SEE BASIS OF PRESENTATION -- NOTE 1) (STATED IN U.S. DOLLARS)
DECEMBER 31, 1997 ------------ ASSETS Current Cash...................................................... $1,833,448 Accounts receivable....................................... 514,513 Prepaid expenses.......................................... 53,668 Inventory................................................. 20,405 ---------- $2,422,034 Oil and gas properties [note 5]............................. 7,061,457 ---------- $9,483,491 ========== LIABILITIES AND SHAREHOLDERS' EQUITY Current Accounts payable and accrued liabilities.................. $ 957,725 Taxes payable............................................. 61,000 ---------- $1,018,725 Long term debt [note 6]..................................... 895,500 Non-controlling interest.................................... 1,885,351 ---------- $3,799,576 ---------- CONTINGENCIES [NOTES 7 AND 8] SHAREHOLDERS' EQUITY Share capital and special warrants [note 7]................. $5,939,742 Deficit..................................................... (255,827) ---------- $5,683,915 ---------- $9,483,491 ==========
See accompanying notes F-69 146 CANARGO OIL & GAS INC. CONSOLIDATED STATEMENT OF OPERATIONS AND DEFICIT (STATED IN U.S. DOLLARS)
SIX MONTHS ENDED DECEMBER 31, 1997 ----------------- REVENUE Oil......................................................... $ 1,324,114 Interest.................................................... 22,681 ----------- $ 1,346,795 ----------- EXPENSES Operating costs............................................. $ 790,287 General and administration.................................. 386,397 Depletion................................................... 555,960 Interest.................................................... 34,410 ----------- $ 1,767,054 ----------- Loss before non-controlling interest........................ $ (420,259) Non-controlling interest.................................... 164,432 ----------- LOSS FOR THE PERIOD......................................... $ (255,827) DEFICIT -- BEGINNING OF PERIOD.............................. -- ----------- DEFICIT -- END OF PERIOD.................................... $ (255,827) =========== BASIC AND FULLY DILUTED LOSS PER SHARE...................... $ (0.03) ----------- WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING DURING PERIOD.................................................... $10,210,641 ===========
See accompanying notes F-70 147 CANARGO OIL & GAS INC. CONSOLIDATED STATEMENT OF CASH FLOWS (STATED IN U.S. DOLLARS)
SIX MONTHS ENDED DECEMBER 31, 1997 ----------------- CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES Loss for the period......................................... $ (255,827) Items not requiring cash Depletion................................................. 555,960 Non-controlling interest.................................. (164,432) ----------- Funds from operations....................................... $ 135,701 Net change in non-cash working capital related to operating activities................................................ 480,454 ----------- $ 616,155 ----------- INVESTING ACTIVITIES Contribution of NOC assets, net of cash..................... $(2,694,705) Acquisition of Money Works Inc., net of cash................ (29,249) Additions to capital assets................................. (2,868,995) ----------- $(5,592,949) ----------- FINANCING ACTIVITIES Issue of share capital on contribution of NOC assets........ $ 3,187,000 Issue of share capital to acquire Money Works Inc........... 31,975 Initial share capital issued................................ 100 Contribution from non-controlling interest.................. 650,000 Long term debt.............................................. 220,500 Issue of share capital...................................... 698,390 Issuance of special warrants, net of issue costs............ 2,022,277 ----------- $ 6,810,242 ----------- INCREASE IN CASH............................................ $ 1,833,448 Cash position, beginning of period.......................... -- ----------- CASH POSITION, END OF PERIOD................................ $ 1,833,448 ===========
See accompanying notes F-71 148 CANARGO OIL & GAS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (STATED IN U.S. DOLLARS) 1. BASIS OF PRESENTATION Prior to July 1, 1997, CanArgo Oil & Gas Inc. (formerly CanArgo Energy Inc.) carried on business under the name Money Works Inc. Money Works Inc. was incorporated under the Alberta Business Corporations Act. Effective July 1, 1997, Money Works Inc. acquired all of the outstanding common shares of CanArgo Ltd. by issuing a total of 8,276,250 common shares from treasury (see note 4), and changed its name to CanArgo Energy Inc. ("the Corporation"). This resulted in the former shareholders of CanArgo Ltd. acquiring control of Money Works Inc. Accordingly, this transaction has been accounted for as a reverse takeover of the Corporation and the Consolidated Balance Sheet includes the assets and liabilities of CanArgo Ltd. at their carrying values together with the net assets of Money Works Inc. acquired at their ascribed fair values. The financial statements of the Corporation are a continuation of the financial statements of CanArgo Ltd., the acquirer, for accounting purposes. CanArgo Ltd. was incorporated on March 4, 1997 with nominal share capital for the purpose of holding certain shareholders' interest aggregating 55.9% of the shares of Ninotsminda Oil Company Limited ("NOC"). There was no change in the individual shareholders' effective interest in NOC as a result of the formation of CanArgo Ltd. These consolidated financial statements reflect the operations of the Corporation from July 1, 1997, the date of commencement of operations, which also coincides with the date of the reverse takeover, when the series of transactions resulting in achieving control over the principal operating asset was culminated. NOC is a Cypriot company specializing in the exploration and development of oil and gas properties in the Republic of Georgia. NOC operates under the terms of a Production Sharing Contract ("PSC") signed February 15, 1996 between NOC and the Republic of Georgia represented by the state oil company, Georgian Oil. Under the terms of the PSC, NOC is responsible for the costs associated with the project, which is operated on behalf of NOC by the local operating company, Georgian British Oil Company ("Georgian Oil"). Georgian Oil is responsible for the costs associated with site restoration and abandonment, royalties and all state taxes. The PSC expires in December 2019 and provides for a five-year extension. While areas containing field developments are not subject to relinquishment, other areas are subject to relinquishment after 5, 10, 15 and 20 years after the date of issue of the license. Currently, the Ninotsminda field is the only producing field in this license. Production from the Ninotsminda field commenced in the early part of 1996, and during 1996 approximately 515,000 barrels of oil were produced. Under the terms of the PSC, Georgian Oil currently takes the first 96.4 tons per day ("determined production") of production, after which all production is shared. The level of determined production will change in accordance with the terms of the agreement. After determined production, NOC receives up to 50% of production for cost recovery. Remaining production after cost recovery is then allocated as to 30% to NOC and as to 70% to Georgian Oil. To date, NOC has sold all of its production to one international buyer at prices related to the world market price for Brent crude, with payment in US dollars into NOC's bank account in Cyprus. F-72 149 CANARGO OIL & GAS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED 1. BASIS OF PRESENTATION -- (CONTINUED) NOC is in an early stage of operations and is facing challenges typical of doing business in the former Soviet Union. Neither NOC nor the Corporation is currently in a position to finance all working capital or capital investment requirements through their own operations and therefore will require additional external financing. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The Corporation follows accounting principles generally accepted in Canada. The significant accounting policies are noted below. a) PRINCIPLES OF CONSOLIDATION These consolidated financial statements include the accounts of the Corporation's wholly owned subsidiaries CanArgo Ltd. and CanArgo Nazvrevi Limited and its 55.9% owned subsidiary, NOC. The Corporation's interest in NOC was contributed by the CanArgo Ltd. shareholders. As there was no substantive change in the ownership of the NOC shares arising from the transfer, the Corporation has recorded its investment at the historic costs of NOC to the shareholders. b) INVENTORY Materials, supplies and spare parts held for use in the oil field and inventories of petroleum products held for sale are recorded at the lower of average cost and net realizable value. c) OIL AND GAS PROPERTIES The Corporation follows the full cost method of accounting for exploration and development expenditures wherein all costs related to the exploration for and the development of oil and gas reserves are capitalized. These costs include lease acquisition costs, geological and geophysical expenses, carrying charges of non-producing properties, costs of drilling and completing wells and oil and gas production equipment and that portion of general and administrative expense applicable to these activities. Proceeds received from the disposal of properties are normally credited against accumulated costs unless this would result in a change in the depletion rate by more than 20%, in which case a gain or loss is computed and reflected in the statement of operations. Depletion of exploration and development costs and production equipment is provided on the unit-of-production method based upon estimated proved oil and gas reserves, as determined by independent engineers. The Corporation carries its oil and gas properties at the lower of capitalized cost and net recoverable amount. Net recoverable amount is future net revenues from proved reserves plus unproved properties at cost less any impairment. Future net revenues are determined using unit prices and production and overhead costs, financing charges and income taxes that will be incurred in earning these revenues. F-73 150 CANARGO OIL & GAS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED) d) FOREIGN CURRENCY TRANSLATION These financial statements are presented in United States dollars. Monetary amounts denominated in a foreign currency are translated to United States dollars at the exchange rate in effect at the balance sheet date. Revenue and expense items are translated at the average exchange rate for the period. Exchange gains and losses resulting from the translation of foreign currency amounts are included in or charged to income for the year. e) FINANCIAL INSTRUMENTS Financial instruments of the Corporation consist of cash, accounts receivable, accounts payable and long term debt. As at December 31, 1997 there are no significant differences between their carrying values and their estimated market values. f) INCOME TAXES Georgian Oil is responsible for all state taxes in the Republic of Georgia. The undistributed earnings of foreign investees are considered to be permanently invested for their continuing operations; accordingly, no provisions are made for taxes which would become payable upon the distribution of such earnings to the parent company. g) MEASUREMENT UNCERTAINTY The amount recorded for depletion of oil and gas properties is based on estimates. The ceiling test calculation is based on estimates of proved reserves, production rates, oil prices, future costs and other relevant assumptions. By their nature, these estimates are subject to measurement uncertainty and the effect on the financial statements of changes in such estimates in future years could be significant. 3. CONTRIBUTING OF SHARES OF NOC Effective June 30, 1997, the shareholders of CanArgo Ltd. contributed their collective 55.9% interest in NOC for shares in a common control transaction. The contribution is summarized as follows: NET ASSETS CONTRIBUTED: Current assets, including $492,295 cash..................... $ 1,291,195 Capital assets.............................................. 4,748,422 Current liabilities......................................... (777,834) Long term debt.............................................. (675,000) Non-controlling interest.................................... (1,399,783) ----------- $ 3,187,000 =========== SHARES ISSUED: 8,275,250 common shares..................................... $ 3,187,000 ===========
F-74 151 CANARGO OIL & GAS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED 4. ACQUISITION OF CANARGO LTD. Effective July 1, 1997, the Corporation acquired all of the outstanding shares of CanArgo Ltd., a privately owned company. This transaction has been accounted for as a reverse takeover as described in Note 1. The acquisition is summarized as follows: NET ASSETS OF CANARGO ENERGY INC. (FORMERLY MONEY WORKS INC.) ACQUIRED: Current assets, including $2,726 cash....................... $ 44,108 Current liabilities......................................... (12,133) -------- $ 31,975 -------- CONSIDERATION: 1,708,640 common shares..................................... $ 31,975 ========
5. OIL AND GAS PROPERTIES
DECEMBER 31, 1997 ------------ Oil and gas properties...................................... $7,617,417 Accumulated Depletion....................................... (555,960) ---------- $7,061,457 ==========
General and administrative expenses of $637,993 were capitalized during the six months ended December 31, 1997. 6. LONG TERM DEBT
DECEMBER 31, 1997 ------------ Advance..................................................... $220,500 Loan........................................................ 675,000 -------- $895,500 ========
The advance from non-controlling interest to NOC bears no interest unless it is not repaid by June 30, 2000, at which time it would bear interest at 15% until repayment. The loan from non-controlling interest to NOC bears interest at a rate of 10% and is repayable out of surplus funds of NOC as and when available. 7. SHARE CAPITAL AND SPECIAL WARRANTS AUTHORIZED Unlimited number of voting common shares Unlimited number of first preferred shares F-75 152 CANARGO OIL & GAS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED 7. SHARE CAPITAL AND SPECIAL WARRANTS -- (CONTINUED) Unlimited number of second preferred shares
ISSUED COMMON SHARES NUMBER AMOUNT - -------------------- ---------- ---------- Balance on incorporation, opening balance............. 1,000 $ 100 Issued upon contribution of an interest in NOC [note 3].................................................. 8,275,250 3,187,000 Issued to CanArgo Ltd. [note 4]....................... 1,708,641 31,975 Issued for cash....................................... 453,500 698,390 ---------- ---------- Balance, December 31, 1997............................ 10,438,391 $3,917,465 ---------- ---------- SPECIAL WARRANTS Special warrants issued............................... 1,636,597 $2,520,359 Issue costs........................................... -- (498,082) ---------- ---------- Balance, December 31, 1997............................ 1,636,597 $2,022,277 ---------- ---------- WARRANTS ISSUED AND BALANCE, DECEMBER 31, 1997........ 681,760 $ -- ---------- ---------- TOTAL SHARE CAPITAL AND SPECIAL WARRANT, DECEMBER 31, 1997................................................ $5,939,742 ==========
On June 30, 1997, the shareholders approved a 40 for 1 consolidation of all the outstanding common shares. The record date of the stock consolidation was July 2, 1997. Accordingly, all references to number of shares and per share information prior to July 2, 1997 have been adjusted to reflect the share consolidation retroactively. On November 3, 1997, the Corporation closed a private placement of 1,636,597 special warrants at a price of Canadian $2.20 per special warrant. Each special warrant is convertible into one common share of the Corporation and one half of one warrant. Each full warrant is exercisable into one common share at a price of Canadian $2.60 per share through to November 1, 1999. In conjunction with the special warrant placement, 681,760 warrants were issued. Each warrant is exercisable into one common share with 455,010 being exercisable at a price of Canadian $2.20, 250,000 warrants of which expire on June 30, 1998 and 205,010 warrants of which expire April 30, 1999, and 226,750 being exercisable at a price of Canadian $2.60 and expiring on November 1, 1999. If the Corporation has not obtained a receipt for a final prospectus indicating the qualification of these securities in each relevant jurisdiction by February 28, 1998 then each special warrant will entitle the holder to receive an additional 0.1 common share and 0.05 warrant without payment of additional consideration. INCENTIVE STOCK OPTION PLAN During the period ended December 31, 1997, 1,035,000 common share options were granted; none were exercised. At December 31, 1997, options exercisable between 1998 and 2002 were outstanding to purchase 1,035,000 common shares at a price of $2.20 per share. F-76 153 CANARGO OIL & GAS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED 8. CONTINGENCIES The non-controlling shareholder in NOC has initiated legal proceedings in Cyprus claiming that a share offer in NOC had not been accepted by the majority shareholder in the time limits set out and accordingly the share issuance to the majority shareholder was invalid. If the non-controlling shareholder is successful in its application before the Cyprus courts, the interest of the Corporation in NOC could be reduced to 49%. The Corporation has obtained a legal opinion from Cypriot counsel confirming the appropriate acceptance of the subscriptions to the share offer. Subsequent to December 31, 1997, the non-controlling shareholder withdrew its legal action without prejudice. Accordingly, the Corporation continues to maintain that the legal proceedings are without merit and consolidates its 55.9% share holding. 9. SUBSEQUENT EVENTS On February 2, 1998, the Corporation entered into an agreement with Fountain Oil Incorporated ("Fountain") under which a business combination would be effected through an exchange of shares. Each common share of the Corporation is exchangeable into 1.6 common shares of Fountain. This business combination is subject to regulatory and shareholder approval. 10. GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP) IN THE UNITED STATES The Corporation's consolidated financial statements have been prepared in accordance with accounting principles generally accepted in Canada, which in the case of the Corporation at December 31, 1997, conforms in all material respects with United States GAAP, except as set forth below. (a) Adjustments to consolidated loss per share
1997 ----------- Loss in accordance with Canadian and U.S. GAAP.............. $ (255,827) ----------- Loss per share in accordance with U.S. GAAP................. $ (0.02) ----------- Weighted average number of common shares outstanding during period in accordance with U.S. GAAP....................... 10,757,176 ===========
F-77 154 CANARGO OIL & GAS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED 10. GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP) IN THE UNITED STATES -- (CONTINUED) (b) Adjustments to consolidated statements of cash flows in respect of non-cash investing and financing activities.
1997 ----------- INVESTING ACTIVITIES In accordance with Canadian GAAP............................ $(5,592,949) Add: Contribution of NOC assets, net of cash................... 2,694,705 Acquisition of Money Works, net of cash................... 29,249 ----------- INVESTING ACTIVITIES IN ACCORDANCE WITH U.S. GAAP........... $(2,868,995) =========== FINANCING ACTIVITIES In accordance with Canadian GAAP............................ $ 6,810,242 Less: Issue of share capital on contribution of NOC assets...... (3,187,000) Issue of share capital on contribution of Money Works..... (31,975) Add: Contribution of NOC assets, net of cash................... 492,295 Acquisition of Money Works, net of cash................... 2,726 ----------- FINANCING ACTIVITIES IN ACCORDANCE WITH U.S. GAAP........... $ 4,086,288 ===========
F-78 155 CANARGO OIL & GAS INC. SUPPLEMENTAL DISCLOSURES ABOUT OIL AND GAS PRODUCTION ACTIVITIES (UNAUDITED, STATED U.S. DOLLARS) The following information about the Corporation's oil producing activities is presented in accordance with United States Statement of Financial Accounting Standards No. 69: Disclosures About Oil and Gas Producing Activities. OIL RESERVES Proved oil reserves are the estimated quantities of crude oil which geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic conditions. Proved developed oil reserves are reserves that can be expected to be recovered from existing wells with existing equipment and operating methods. Estimates of oil reserves are subject to uncertainty and will change as additional information regarding the producing fields and technology becomes available and as economic conditions change. Reserves presented in this section represent NOC's working interest share of reserves net of royalties. The Corporation has a 55.9% beneficial interest in the reserves of NOC. Reserves at December 31, 1997 are based on estimates by the independent petroleum-engineering firm, AMH Group Ltd. and are all located in the Republic of Georgia. The Corporation's net proved and net proved developed oil reserves were as follows:
NET PROVED RESERVES NOC - ------------------- ------------- (THOUSANDS OF BARRELS) Crude oil Net proved reserves, June 30, 1997(1)....................... 5,675 Production.................................................. (112) Reserve additions(1)........................................ 5,452 ------ NET PROVED RESERVES, DECEMBER 31, 1997...................... 11,015 ====== NET PROVED DEVELOPED RESERVES June 30, 1997(1)............................................ 994 December 31, 1997........................................... 1,929
- ------------------------- (1) Estimated by management as the first reserve report prepared for the Corporation was as of December 31, 1997. STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS AND CHANGES THEREIN RELATING TO PROVED OIL RESERVES The following standardized measure of discounted future net cash flows from proved oil reserves has been computed using period end prices and costs and period end statutory tax rates. A discount rate of 10% has been applied in determining the standardized measure of discounted future net cash flows. F-79 156 CANARGO OIL & GAS INC. SUPPLEMENTAL DISCLOSURES ABOUT OIL AND GAS -- CONTINUED PRODUCTION ACTIVITIES (UNAUDITED, STATED U.S. DOLLARS) This information does not necessarily reflect the fair market value of its oil properties. Actual future net cash flows will differ from the presented estimated future net cash flows in that: (i) future production from proved reserves will differ from estimated production; (ii) future production will also include production from probable and potential reserves; (iii) future rather than year end prices and costs will apply; and (iv) existing economic, operating and regulatory conditions are subject to change. The standardized measure of discounted future net cash flows is as follows:
NOC -------------- (IN THOUSANDS) DECEMBER 31, 1997 Future cash inflows......................................... $113,567 Future production, development and restoration costs........ 73,664 -------- Future net cash flows....................................... $ 39,903 Ten percent annual discount................................. 14,255 -------- Standardized measure........................................ $ 25,648 ========
The changes in the standardized measure of discounted future net cash flows for the period is as follows:
NOC -------------- (IN THOUSANDS) JULY 1, 1997(1)............................................. $12,951 Oil sales net of production costs........................... (534) Oil discoveries(1).......................................... 16,100 Development costs incurred.................................. 2,869 ------- DECEMBER 31, 1997........................................... $25,648 =======
- ------------------------- (1) Estimated by management as the first reserve report prepared for the Corporation was as of December 31, 1997. F-80 157 CANARGO OIL & GAS INC. SUPPLEMENTAL DISCLOSURES ABOUT OIL AND GAS -- CONTINUED PRODUCTION ACTIVITIES (UNAUDITED, STATED U.S. DOLLARS) Costs incurred in oil property acquisition, exploration and development activities:
NOC -------------- (IN THOUSANDS) SIX MONTHS ENDED DECEMBER 31, 1997 Property acquisition Proved.................................................... -- Unproved.................................................. -- Development................................................. $2,869 Exploration................................................. -- ------ $2,869 ======
Depletion per unit of net production:
NOC ----------- ($ PER BOE) Six months ended December 31, 1997.......................... $4.98
Results of operations for oil producing activities:
NOC -------------- (IN THOUSANDS) SIX MONTHS ENDED DECEMBER 31, 1997 Sales....................................................... $1,324 Royalty and production expense.............................. (790) Depletion................................................... (556) ------ Loss before tax............................................. $ (22) Income tax.................................................. -- ------ RESULTS OF OPERATIONS FROM PRODUCING ACTIVITIES............. $ (22) ======
NOC's share of revenues under the PSC is determined by the price of Brent crude oil, less transportation charges. At current world oil prices, NOC's share of revenues under the PSC is insufficient to cover royalty, production and depletion expenses. In order to cover royalty, production and depletion expenses under the PSC, at current production volumes of approximately 1,900 barrels per day, the price for Brent crude will need to be approximately US$16.50 per barrel. The closing price for Brent crude on May 25, 1998 was US$14.26 per barrel. F-81 158 AUDITORS' REPORT To the Directors of Ninotsminda Oil Company Limited (formerly "JKX (Ninotsminda) Limited") We have audited the financial statements of Ninotsminda Oil Company Limited and have obtained all the information and explanations we considered necessary. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with International Standards on Auditing. These standards are substantially in accordance with United States generally accepted auditing standards. Those Standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statements presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, proper books of account have been kept by the Company and the financial statements, which are in agreement therewith give a true and fair view of the state of affairs of Ninotsminda Oil Company Limited for the six months ended June 30, 1997 and the year ended December 31, 1996 and of its profit and cash flows for the periods then ended in accordance with International Accounting Standards and comply with the provisions of the Companies Law, Chapter 113. /s/ Ernst & Young Limassol, Cyprus Ernst & Young February 18, 1998 Chartered Accountants
F-82 159 NINOTSMINDA OIL COMPANY LIMITED BALANCE SHEET (STATED IN U.S. DOLLARS)
JUNE 30, DECEMBER 31, 1997 1996 ---------- ------------ ASSETS CURRENT Cash................................................. $ 492,300 $1,565,800 Accounts receivable.................................. 716,300 373,500 Inventory............................................ 82,600 49,600 ---------- ---------- 1,291,200 $1,988,900 Oil and gas properties [note 6]...................... 4,081,700 2,069,900 ---------- ---------- $5,372,900 $4,058,800 ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT Accounts payable..................................... $ 67,500 $ 25,600 Taxes payable........................................ 61,000 61,000 Due to shareholders [note 7]......................... 783,800 188,800 ---------- ---------- 912,300 275,400 Long term debt [note 8].............................. 1,350,000 2,411,600 ---------- ---------- 2,262,300 2,687,000 ---------- ---------- SHAREHOLDERS' EQUITY Retained earnings.................................... 1,291,300 1,367,500 Share premium [note 9]............................... 1,814,300 -- Share capital [note 9]............................... 5,000 4,300 ---------- ---------- 3,110,600 1,371,800 ---------- ---------- $5,372,900 $4,058,800 ========== ==========
See accompanying notes F-83 160 NINOTSMINDA OIL COMPANY LIMITED STATEMENT OF OPERATIONS AND RETAINED EARNINGS (STATED IN U.S. DOLLARS)
PERIOD SIX MONTHS OCTOBER 24, ENDED 1995 TO JUNE 30, DECEMBER 31, 1997 1996 ---------- ------------ REVENUE Oil................................................... $1,500,000 $3,058,900 Other................................................. 17,400 16,000 ---------- ---------- 1,517,400 3,074,900 ---------- ---------- EXPENSES Operating............................................. 638,200 962,500 General and administrative [note 10].................. 216,400 415,900 Interest [note 4]..................................... 76,000 188,900 Depletion............................................. 663,000 79,100 ---------- ---------- 1,593,600 1,646,400 ---------- ---------- (LOSS) INCOME BEFORE TAXES............................ (76,200) 1,428,500 Provision for income taxes............................ -- 61,000 ---------- ---------- (LOSS) NET INCOME FOR THE PERIOD...................... (76,200) 1,367,500 Retained earnings, beginning of period................ 1,367,500 -- ---------- ---------- RETAINED EARNINGS, END OF PERIOD...................... $1,291,300 $1,367,500 ========== ==========
See accompanying notes F-84 161 NINOTSMINDA OIL COMPANY LIMITED STATEMENT OF CASH FLOWS (STATED IN U.S. DOLLARS)
SIX MONTHS PERIOD OCTOBER 24, ENDED 1995 TO JUNE 30, 1997 DECEMBER 31, 1996 ------------- ------------------ OPERATING ACTIVITIES (Loss) income before taxes...................... $ (76,200) $ 1,428,500 Adjustments to reconcile net income to net cash provided by operating activities Depletion..................................... 663,000 79,100 ----------- ----------- Funds from operations........................... 586,800 1,507,600 Changes in non-cash working capital relating to operations.................................... 261,100 (208,700) ----------- ----------- NET CASH PROVIDED BY OPERATING ACTIVITIES....... 847,900 1,298,900 ----------- ----------- INVESTING ACTIVITIES Capital asset additions......................... (2,674,800) (2,149,000) ----------- ----------- NET CASH USED IN INVESTING ACTIVITIES........... $(2,674,800) $(2,149,000) ----------- ----------- FINANCING ACTIVITIES Issuance of shares.............................. 700 4,300 Share premium................................... 1,814,300 -- Increase in due to shareholders................. -- 2,500,000 Repayment of due to shareholders................ (1,061,600) (88,400) ----------- ----------- NET CASH PROVIDED BY FINANCING ACTIVITIES....... 753,400 2,415,900 ----------- ----------- Net (decrease) increase in cash................. (1,073,500) 1,565,800 Cash, beginning of period....................... 1,565,800 -- ----------- ----------- CASH, END OF PERIOD............................. $ 492,300 $ 1,565,800 =========== ===========
See accompanying notes F-85 162 NINOTSMINDA OIL COMPANY LIMITED NOTES TO FINANCIAL STATEMENTS (STATED IN U.S. DOLLARS) 1. INCORPORATION The Company was incorporated in Cyprus on October 24, 1995 with minimal share capital and changed its name to Ninotsminda Oil Company Limited ("NOC") effective January 16, 1998. 2. DESCRIPTION OF BUSINESS The primary purpose of the Company is the exploration for and production of hydrocarbons in the Republic of Georgia. NOC operates under the terms of a Production Sharing Contract ("PSC") signed February 15, 1996 between NOC and the Republic of Georgia represented by the state oil company, Georgian Oil. Under the terms of the PSC, NOC is responsible for the costs associated with the project, which is operated on behalf of NOC by the local operating company, Georgian British Oil Company ("Georgian Oil"). Georgian Oil is responsible for the costs associated with site restoration and abandonment, royalties and all state taxes. The PSC expires in December 2019 and provides for a five year extension. While areas of the license containing field developments are not subject to relinquishment, other areas are subject to relinquishment after 5, 10, 15 and 20 years after the date of issue of the license. Currently the Ninotsminda field is the only producing field in this license. Production from the Ninotsminda field commenced in the early part of 1996, and during 1996 approximately 515,000 barrels of oil were produced. Under the terms of the PSC, Georgian Oil currently takes the first 750 barrels per day ("determined production") of production, after which all production is shared. The level of determined production will change in accordance with the terms of the agreement. After determined production, NOC receives up to 50% of production for cost recovery. Remaining production after cost recovery is then allocated as to 30% to NOC and as to 70% to Georgian Oil. To date, NOC has sold all of its production to one international buyer at prices related to the world market price for Brent crude, with payment in US dollars into NOC's bank account in Cyprus. NOC is in an early stage of operations and is effectively dealing with challenges typical of doing business in the former Soviet Union. NOC is currently not in a position to finance all its working capital and capital investment requirements through its own operations and therefore will require additional external financing. 3. ACCOUNTING POLICIES The Company follows international accounting standards. The significant accounting policies are noted below. ACCOUNTING CONVENTION The financial statements are drawn up under the historical cost convention. F-86 163 NINOTSMINDA OIL COMPANY LIMITED NOTES TO FINANCIAL STATEMENTS, CONTINUED (STATED IN U.S. DOLLARS) 3. ACCOUNTING POLICIES -- (CONTINUED) EXCHANGE RATES The financial statements are presented in United States dollars. The Company's revenues and exploration and production costs are denominated in U.S. dollars. Transactions in other currencies are translated to United States dollars at the rates in effect on the transaction date. Balances are translated to United States dollars at the exchange rate in effect at the balance sheet date. Any resulting exchange gains or losses are recognized as income or expense in the year they are incurred. OIL AND GAS PROPERTIES The Company accounts for oil and gas expenditures under the full cost method of accounting, whereby all costs associated with the exploration for and development of crude oil and natural gas reserves are capitalized as capital assets within one global amortized cost pool. Costs related to evaluated properties, including an estimate for future costs to develop proved reserves, are amortized through depletion charges using the unit of production method based on commercial proved crude oil reserves. INVENTORY Inventory is comprised of crude oil and is carried at the lower of cost and net realizable value. 4. INTEREST PAYABLE The following amounts are included in the due to shareholder:
JUNE 30, DECEMBER 31, 1997 1996 -------- ------------ CanArgo Energy Inc..................................... $134,500 $ 97,800 JKX Nederland BV....................................... 125,400 91,100 -------- -------- $259,900 $188,900 ======== ========
5. PROFITS TAX The Company is subject to Cyprus corporation tax on its taxable profits at the rate of 4.25%. F-87 164 NINOTSMINDA OIL COMPANY LIMITED NOTES TO FINANCIAL STATEMENTS, CONTINUED (STATED IN U.S. DOLLARS) 6. OIL AND GAS PROPERTIES
JUNE 30, DECEMBER 31, 1997 1996 ---------- ------------ Cost Opening balance.................................... $2,149,000 $ -- Additions during the period........................ 2,674,800 2,149,000 ---------- ---------- At December 31..................................... 4,823,800 2,149,000 ---------- ---------- Depletion Opening balance.................................... 79,100 -- Charge for the period.............................. 663,000 79,100 ---------- ---------- At December 31..................................... 742,100 79,100 ---------- ---------- Net book value At December 31..................................... $4,081,700 $2,069,900 ========== ==========
7. DUE TO SHAREHOLDERS Amounts falling due within one year:
JUNE 30, DECEMBER 31, 1997 1996 -------- ------------ CanArgo Energy Inc..................................... $134,500 $ 97,800 JKX Nederland BV....................................... 649,300 91,100 -------- -------- $783,800 $188,900 ======== ========
8. LONG TERM DEBT
JUNE 30, DECEMBER 31, 1997 1996 ---------- ------------ Shareholder loans CanArgo Energy Inc................................. $ 675,000 $1,500,000 JKX Nederland BV................................... 675,000 911,600 ---------- ---------- $1,350,000 $2,411,600 ========== ==========
The shareholder loans bear interest at the rate of 10% per annum and are repayable out of surplus funds as and when available. F-88 165 NINOTSMINDA OIL COMPANY LIMITED NOTES TO FINANCIAL STATEMENTS, CONTINUED (STATED IN U.S. DOLLARS) 9. SHARE CAPITAL AUTHORIZED 10,000 shares at a par value of L1 each ISSUED
NUMBER VALUE ------ ------ Issued during 1996.......................................... 2,000 $4,300 ----- ------ Balance, December 31, 1996.................................. 2,000 $4,300 Issued for cash............................................. 363 700 ----- ------ Balance, June 30, 1997...................................... 2,363 $5,000 ===== ======
During 1997, the Company issued 203 shares to CanArgo and 160 shares to JKX Nederland B.V. at a price of $5,000 per share. The amount paid in excess of the nominal value of the shares is recorded as share premium. 10. RELATED PARTY TRANSACTIONS During 1997, members of the JKX Oil & Gas plc ("JKX") group of companies, including JKX Nederland B.V. (44.1% shareholder in NOC at December 31, 1997) performed services and procured goods and services on behalf of NOC. These goods and services recharged by JKX to NOC, excluding interest expense, totaled $531,300 for the six month period ended June 30, 1997 (December 31, 1996 -- $743,000) of which $381,900 has not yet been agreed to by NOC. 11. SHAREHOLDER DISPUTES There are disputes between shareholders as to their relative ownership interests in NOC. The resolution of these disputes may result in a reallocation of amounts between contributed surplus and due to shareholders. 12. GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP) IN THE UNITED STATES The Company's financial statements have been prepared in accordance with international generally accepted accounting principles, which in the case of the Company conform in all material respects with United States GAAP. F-89 166 PART II INFORMATION NOT REQUIRED IN THE PROSPECTUS ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION The following table sets forth the costs and expenses of the sale and distribution of the securities being registered, other than broker commissions, all of which are being borne by the Company. Securities and Exchange Commission filing fee............... $ 1,663.00 Printing expenses........................................... 50,000.00 Legal fees and expenses..................................... 125,000.00 Accounting fees and expenses................................ 50,000.00 Broker-dealer expense allowance............................. 127,588.00 Escrow Agent Fee............................................ 2,500.00 Miscellaneous............................................... 20,837.00 ----------- Total..................................................... $377,588.00 ===========
All of the amounts shown are estimates based on a maximum offering except for the fees paid to the Securities and Exchange Commission. ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES On January 15, 1999, CanArgo sold 250,000 shares of common stock in exchange for oil and gas interests in the Republic of Georgia, including contractual obligations of Ninotsminda Oil Company. The shares were valued at the market price on the date of issuance in the amount of $109,500. The offer and sale of the shares was exempt from the registration requirements of the Securities Act of 1933, as amended (the "Act"), under Section 4(2) of the Act as a transaction by an issuer not involving a public offering. The purchaser of the shares represented to CanArgo, among other things, that it was acquiring the shares for its own account; that it was acquiring the shares for investment and not with a view toward the distribution thereof; and that it would not sell the shares without registration under the Act or an applicable exemption from such registration requirement. The certificate representing the shares has a restrictive legend endorsed thereon reflecting the restrictions on transferability arising out of the foregoing matters, and CanArgo has issued "stop transfer" instructions to its transfer agent with respect to such shares. ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (a) The following exhibits are filed herewith or incorporated herein by reference: (*) Management Contracts, Compensation Plans and Arrangements are identified by an asterisk. 1(1) Form of Escrow Agreement with Signature Stock Transfer, Inc. 1(2) Form of Selling Agent Agreement -- to be filed by amendment. 2(1) Amended and Restated Combination Agreement between Fountain Oil Incorporated and CanArgo Energy Inc. dated as of February 2, 1998 S-1 167 (Incorporated herein by reference from Form S-3 Registration Statement, File No. 333-48287 filed on June 9, 1998). 2(2) Voting, Support and Exchange Trust Agreement (Incorporated herein by reference as Annex G from Form S-3 Registration Statement, File No. 333-48287 filed on June 9, 1998). 3(1) Registrant's Certificate of Incorporation and amendments thereto (Incorporated herein by reference from July 15, 1998 Form 8-K). 3(2) Registrant's Bylaws (Incorporated herein by reference from March 31, 1999 Form 10-Q). 4(1) Form of 8% Convertible Subordinated Debenture (Incorporated herein by reference from February 29, 1996 Form 10-QSB). 5(1) Opinion of Kelly Lytton Mintz & Vann LLP -- to be filed by amendment. *10(1) Securities Compensation Plan (Incorporated herein by reference from August 31, 1994 Form 10-KSB, filed by Electromagnetic Oil Recovery, Inc., the Company's predecessor). *10(2) Form of Certificate for Common Stock Purchase Warrants issued pursuant to the Securities Compensation Plan (Incorporated herein by reference from Form S-8 Registration Statement, File No. 33-82944 filed on August 17, 1994, filed by Electromagnetic Oil Recovery, Inc., the Company's predecessor). *10(3) Form of Option Agreement for options granted to certain persons, including Directors (Incorporated herein by reference from August 31, 1994 Form 10-KSB, filed by Electromagnetic Oil Recovery, Inc., the Company's predecessor). *10(4) Form of Certificate for Common Stock Purchase Warrants issued to certain investors in August 1994, including Directors (Incorporated herein by reference from August 31, 1994 Form 10-KSB, filed by Electromagnetic Oil Recovery, Inc., the Company's predecessor). *10(5) Restated Employment Agreement between Fountain Oil Incorporated and Nils N. Trulsvik (Incorporated herein by reference from December 31, 1997 Form 10-K/A). *10(6) Employment Agreement between Fountain Oil Incorporated and Ravinder S. Sierra (Incorporated herein by reference from August 31, 1995 Form 10-KSB). *10(7) Amended and Restated 1995 Long-Term Incentive Plan (Incorporated herein by reference from September 30, 1998 Form 10-Q). *10(8) Fee Agreement dated November 15, 1995 between Fountain Oil Incorporated and Robert A. Halpin (Incorporated herein by reference from August 31, 1996 Form 10-KSB). *10(9) Fee Agreement between Fountain Oil Incorporated and Eugene J. Meyers (Incorporated herein by reference from August 31, 1996 Form 10-KSB). S-2 168 *10(10) Amended Fee Agreement dated December 10, 1996 between Fountain Oil Incorporated and Robert A. Halpin (Incorporated herein by reference from December 31, 1996 Form 10-K). *10(11) Employment Agreement between Fountain Oil Incorporated and Alfred Kjemperud (Incorporated herein by reference from March 31, 1997 Form 10-Q). *10(12) Employment Agreement between Fountain Oil Norway AS and Rune Falstad (Incorporated herein by reference from December 31, 1997 Form 10-K/A). *10(13) Amended and Restated CanArgo Energy Inc. Stock Option Plan (Incorporated herein by reference from September 30, 1998 Form 10-Q). *10(14) Workorder between CanArgo Energy Inc. and Nils N. Trulsvik as Consultant (Incorporated herein by reference from September 30, 1998 Form 10-Q). *10(15) Consultancy Agreement between CanArgo Energy Corporation and Fincom AS, Norway (Incorporated herein by reference from September 30, 1998 Form 10-Q). *10(16) Employment Contract between CanArgo Energy Inc. and Anthony J. Potter (Incorporated herein by reference from September 30, 1998 Form 10-Q). *10(17) Workorder between CanArgo Energy Inc. and Alfred Kjemperud as Consultant.(1) 10(18) Convertible Loan Agreement between Ninotsminda Oil Company (NOC) and International Finance Corporation (IFC) dated December 17, 1998.(1) 10(19) Put Option Agreement between CanArgo Energy Corporation, JKX Oil & Gas PLC. and IFC dated December 17, 1998.(1) 10(20) Guarantee Agreement between CanArgo Energy Corporation and IFC dated December 17, 1998.(1) 10(21) Agreement between Georgian Oil Refinery Company and CanArgo Petroleum Products Ltd. dated September 26, 1998.(1) 10(22) Terrenex Acquisition Corporation Option regarding CanArgo (Nazvrevi) Limited.(1) 10(23) Production Sharing Contract between (1) Georgia and (2) Georgian Oil and JKX Navtobi Ltd. dated February 15, 1996. 21 List of Subsidiaries.(1) 23(1) Consent of PricewaterhouseCoopers LLP. 23(2) Consent of Ernst & Young, Chartered Accountants, Calgary, Canada. 23(3) Consent of Ernst & Young, Chartered Accountants, Limassol, Cyprus. 23(4) Consent of AMH Group Ltd.(1) S-3 169 23(5) Consent of Kelly Lytton Mintz & Vann LLP, contained in Exhibit 5(1). 24(1) Power of Attorney.(1) 24(2) Power of Attorney of Robert A. Halpin 27(1) Restated Financial Data Schedule for the fiscal year ended December 31, 1997.(1) 27(2) Restated Financial Data Schedule for the four-month period ended December 31, 1996.(1) 27(3) Restated Financial Data Schedule for the fiscal year ended August 31, 1996.(1) 27(4) Restated Financial Data Schedule for the fiscal year ended August 31, 1995.(1) 27(5) Restated Financial Data Schedule for the quarter ended March 31, 1998.(1) 27(6) Restated Financial Data Schedule for the quarter ended June 30, 1998.(1) 27(7) Restated Financial Data Schedule for the quarter ended March 31, 1997.(1) 27(8) Restated Financial Data Schedule for the quarter ended June 30, 1997.(1) 27(9) Restated Financial Data Schedule for the quarter ended September 30, 1997.(1) (b) No financial statement schedules are required to be filed herewith. - --------------- (1) Previously filed on February 12, 1999. S-4 170 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the registrant has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in Calgary, Alberta, Canada, on May 18, 1999. CANARGO ENERGY CORPORATION By: /s/ DAVID ROBSON -------------------------------- David Robson Chief Executive Officer Pursuant to the requirements of the Securities Act of 1933, this registration statement has been signed by the following persons in the capacities and on the date indicated.
SIGNATURE TITLE DATE - --------- ----- ---- /s/ DAVID ROBSON Chief Executive Officer and May 18, 1999 - --------------------------------------------- Director (Principal Executive David Robson Officer) /s/ MICHAEL BINNION President, Chief Financial May 18, 1999 - --------------------------------------------- Officer and Director Michael Binnion (Principal Financial Officer) /s/ ROBERT A. HALPIN Director May 18, 1999 - --------------------------------------------- Robert A. Halpin* /s/ J.F. RUSSELL HAMMOND Director May 18, 1999 - --------------------------------------------- J.F. Russell Hammond* /s/ PEDER PAUS Director May 18, 1999 - --------------------------------------------- Peder Paus* /s/ NILS N. TRULSVIK Director May 18, 1999 - --------------------------------------------- Nils N. Trulsvik* /s/ ANTHONY J. POTTER Controller (Principal May 18, 1999 - --------------------------------------------- Accounting Officer) Anthony J. Potter
*By /s/ MICHAEL BINNION ------------------------------ Michael Binnion Attorney-in-fact S-5 171 CANARGO ENERGY CORPORATION AMENDMENT NO. 1 TO REGISTRATION STATEMENT ON FORM S-1 EXHIBIT INDEX Filed herewith - -------------- Management Contracts, Compensation Plans and Arrangements are (*) identified by an asterisk X 1(1) Form of Escrow Agreement with Signature Stock Transfer, Inc. 1(2) Form of Selected Dealers Agreement - to be filed by amendment. 2(1) Amended and Restated Combination Agreement between Fountain Oil Incorporated and CanArgo Energy Inc. dated as of February 2, 1998 (Incorporated herein by reference from Form S-3 Registration Statement, File No. 333-48287 filed on June 9, 1998). 2(2) Voting, Support and Exchange Trust Agreement (Incorporated herein by reference as Annex G from Form S-3 Registration Statement, File No. 333-48287 filed on June 9, 1998). 3(1) Registrant's Certificate of Incorporation and amendments thereto (Incorporated herein by reference from July 15, 1998 Form 8-K). 3(2) Registrant's Bylaws (Incorporated herein by reference from March 31, 1999 Form 10-Q). 4(1) Form of 8% Convertible Subordinated Debenture (Incorporated herein by reference from February 29, 1996 Form 10-QSB). 5(1) Opinion of Kelly Lytton Mintz & Vann LLP. -- to be filed by amendment. *10(1) Securities Compensation Plan (Incorporated herein by reference from August 31, 1994 Form 10-KSB, filed by Electromagnetic Oil Recovery, Inc., the Company=s predecessor). *10(2) Form of Certificate for Common Stock Purchase Warrants issued pursuant to the Securities Compensation Plan (Incorporated herein by reference from Form S-8 Registration Statement, File No. 33-82944 filed on August 17, 1994, filed by Electromagnetic Oil Recovery, Inc., the Company=s predecessor). *10(3) Form of Option Agreement for options granted to certain persons, including Directors (Incorporated herein by reference from August 31, 1994 Form 10-KSB, filed by Electromagnetic Oil Recovery, Inc., the Company=s predecessor). *10(4) Form of Certificate for Common Stock Purchase Warrants issued to certain investors in August 1994, including Directors (Incorporated herein by reference from August 31, 1994 Form 10-KSB, filed by Electromagnetic Oil Recovery, Inc., the Company=s predecessor). *10(5) Restated Employment Agreement between Fountain Oil Incorporated and Nils N. Trulsvik (Incorporated herein by reference from December 31, 1997 Form 10-K/A).
172 *10(6) Employment Agreement between Fountain Oil Incorporated and Ravinder S. Sierra (Incorporated herein by reference from August 31, 1995 Form 10-KSB). *10(7) Amended and Restated 1995 Long-Term Incentive Plan (Incorporated herein by reference from September 30, 1998 Form 10-Q). *10(8) Fee Agreement dated November 15, 1995 between Fountain Oil Incorporated and Robert A. Halpin (Incorporated herein by reference from August 31, 1996 Form 10-KSB). *10(9) Fee Agreement between Fountain Oil Incorporated and Eugene J. Meyers (Incorporated herein by reference from August 31, 1996 Form 10-KSB). *10(10) Amended Fee Agreement dated December 10, 1996 between Fountain Oil Incorporated and Robert A. Halpin (Incorporated herein by reference from December 31, 1996 Form 10-K). *10(11) Employment Agreement between Fountain Oil Incorporated and Alfred Kjemperud (Incorporated herein by reference from March 31, 1997 Form 10-Q). *10(12) Employment Agreement between Fountain Oil Norway AS and Rune Falstad (Incorporated herein by reference from December 31, 1997 Form 10-K/A). *10(13) Amended and Restated CanArgo Energy Inc. Stock Option Plan (Incorporated herein by reference from September 30, 1998 Form 10-Q). *10(14) Workorder between CanArgo Energy Inc. and Nils N. Trulsvik as Consultant (Incorporated herein by reference from September 30, 1998 Form 10-Q). *10(15) Consultancy Agreement between CanArgo Energy Corporation and Fincom AS, Norway (Incorporated herein by reference from September 30, 1998 Form 10-Q). *10(16) Employment Contract between CanArgo Energy Inc. and Anthony J. Potter (Incorporated herein by reference from September 30, 1998 Form 10-Q). *10(17) Workorder between CanArgo Energy Inc. and Alfred Kjemperud as Consultant. (1) 10(18) Convertible Loan Agreement between Ninotsminda Oil Company (NOC) and International Finance Corporation (IFC) dated December 17, 1998. (1) 10(19) Put Option Agreement between CanArgo Energy Corporation, JKX Oil & Gas PLC. and IFC dated December 17, 1998. (1) 10(20) Guarantee Agreement between CanArgo Energy Corporation and IFC dated December 17, 1998. (1) 10(21) Agreement between Georgian Oil Refinery Company and CanArgo Petroleum Products Ltd. dated September 26, 1998. (1) 10(22) Terrenex Acquisition Corporation Option regarding CanArgo (Nazvrevi) Limited. (1)
173 Production Sharing Contract between (1) Georgia and (2) Georgian Oil and JKX X 10(23) Navtobi Ltd. dated February 15, 1996. 21 List of Subsidiaries. (1) X 23(1) Consent of PricewaterhouseCoopers LLP. X 23(2) Consent of Ernst & Young, Chartered Accountants, Calgary, Canada. X 23(3) Consent of Ernst & Young, Chartered Accountants, Limassol, Cyprus. 23(4) Consent of AMH Group Ltd. (1) 23(5) Consent of Kelly Lytton Mintz & Vann LLP, contained in Exhibit 5(1). 24(1) Power of Attorney. (1) X 24(2) Power of Attorney of Robert A. Halpin 27(1) Restated Financial Data Schedule for the fiscal year ended December 31, 1997. (1) 27(2) Restated Financial Data Schedule for the four-month period ended December 31, 1996. (1) 27(3) Restated Financial Data Schedule for the fiscal year ended August 31, 1996. (1) 27(4) Restated Financial Data Schedule for the fiscal year ended August 31, 1995. (1) 27(5) Restated Financial Data Schedule for the quarter ended March 31, 1998. (1) 27(6) Restated Financial Data Schedule for the quarter ended June 30, 1998. (1) 27(7) Restated Financial Data Schedule for the quarter ended March 31, 1997. (1) 27(8) Restated Financial Data Schedule for the quarter ended June 30, 1997. (1) 27(9) Restated Financial Data Schedule for the quarter ended September 30, 1997. (1)
EX-1.(1) 2 ESCROW AGREEMENT 1 EXHIBIT 1(1) ESCROW AGREEMENT AGREEMENT made as of this ____ day of _____, 1999 by and among CanArgo Energy Corporation (the "Issuer" or "Company") and Signature Stock Transfer, Inc. (the "Escrow Agent"), whose addresses appear on the Information Sheet attached to this Agreement. WITNESSETH: WHEREAS, the Issuer has filed Registration Statement No. 333-72295 (the "Registration Statement") with the Securities and Exchange Commission (the "SEC") on Form S-1 to register under the Securities Act of 1933 21,264,643 shares (the "Securities") of the Common Stock, par value $.10 per share ("Common Stock"), of the Issuer; WHEREAS, following the declaration by the SEC of the effectiveness of the Registration Statement the Issuer proposes to offer the Securities for sale on an "all or none" basis with respect to [ten million (10,000,000)] shares of Common Stock (the "Minimum Securities Amount") which are to be sold for a gross sales price of [Three Million Dollars ($3,000,000)] (the "Minimum Dollar Amount"), at the price of [Thirty Cents ($.30)] per share of Common Stock, all as set forth on the Information Sheet (the "Information Sheet") attached hereto as Exhibit A and incorporated herein by this reference; WHEREAS, the Issuer proposes to establish an escrow account (the "Escrow Account"), to which subscription monies which are received by the Escrow Agent directly or indirectly from subscribers in connection with such offering are to be credited, and the Escrow Agent is willing to establish the Escrow Account on the terms and subject to the conditions hereinafter set forth; WHEREAS, the Escrow Agent has established a special bank account into which the subscription monies, which are received by the Escrow Agent directly or indirectly from subscribers and credited to the Escrow Account, are to be deposited; and WHEREAS, the Escrow Agent also serves as the transfer agent and registrar for the Common Stock. NOW, THEREFORE, in consideration of the premises and mutual covenants herein contained, the parties hereto hereby agree as follows: 1. Information Sheet. Each capitalized term not otherwise defined in this Agreement shall have the meaning set forth for such term on the Information Sheet. - 1 - 2 2. Establishment of the Bank Account. 2.1 The Escrow Agent shall establish a non-interest-bearing bank account bearing the designation set forth on the Information Sheet (the "Bank Account") at the ________________ branch of __________________ (the "Bank"). The purpose of the Bank Account is for (a) the deposit of all subscription monies (checks or wire transfers) which are received from prospective purchasers of the Securities and are delivered to the Escrow Agent, (b) the holding of amounts of subscription monies which are collected through the banking system, and (c) the disbursement of collected funds, all as described herein. 2.2 The effective date of the commencement of the offering pursuant to the Registration Statement is [_____ __, 1999] (the "Effective Date"), and the Escrow Agent shall not accept any amounts for credit to the Escrow Account or for deposit in the Bank Account prior to such date. 2.3 The initial Offering Period, which shall commence on the Effective Date, shall consist of the period set forth on the Information Sheet. The Offering Period shall be extended for an Extension Period only if the Escrow Agent shall have received written notice thereof at least two (2) business days prior to the scheduled expiration of the Offering Period. The Extension Period, which shall be deemed to commence simultaneously with the expiration of then initial Offering Period, shall consist of the number of calendar days or business days set forth in such notice not to exceed the period set forth on the Information Sheet. The last day of the initial Offering Period, or the last day of the Extension Period (if the Escrow Agent has received written notice thereof as hereinabove provided), is referred to herein as the "Termination Date". After the Termination Date subscribers shall not deposit, and the Escrow Agent shall not accept, any additional amounts representing payments by prospective purchasers. 3. Deposits to the Bank Account. 3.1 Each prospective purchaser of the Securities shall deliver to the Escrow Agent all monies representing the purchase price of the Securities, which monies shall be in the form of checks or wire transfers. Upon the Escrow Agent's receipt of such monies, they shall be credited to the Escrow Account. All checks delivered to the Escrow Agent shall be made payable to "Signature Stock Transfer, Inc., as Agent for CanArgo Energy Corporation". Any check payable other than to the Escrow Agent as required hereby shall be returned to the prospective purchaser, or if the Escrow Agent has insufficient information to do so, then to the Company (together with any Subscription Information, as defined below or other documents delivered therewith) by noon of the next business day following receipt of such check by the - 2 - 3 Escrow Agent, and such check shall be deemed not to have been delivered to the Escrow Agent pursuant to the terms of the this Agreement. 3.2 Promptly after receiving subscription monies as described in Section 3.1, the Escrow Agent shall deposit the same into the Bank Account. Amounts of monies so deposited are hereinafter referred to as "Escrow Amounts". The Escrow Agent shall cause the Bank to process all Escrow Amounts for collection through the banking system. Simultaneously with each deposit to the Escrow Account, the prospective purchaser shall inform the Escrow Agent in writing of its name, address, taxpayer identification number (if any), the amount of Securities subscribed for by such prospective purchaser, and the aggregate dollar amount of such subscription (collectively, the "Subscription Information"). 3.3 The Escrow Agent shall not be required to accept for credit to the Escrow Account or for deposit into the Bank Account checks which are not accompanied by the appropriate Subscription Information. Wire transfers representing payments by prospective purchasers shall not be deemed deposited in the Escrow Account until the Escrow Agent has received in writing the Subscription Information required with respect to such payments. 3.4 The Escrow Agent shall not be required to accept in the Escrow Account any amounts representing payments by prospective purchasers, whether by check or wire, except during the Escrow Agent's regular business hours. 3.5 Only those Escrow Amounts, which have been deposited in the Bank Account and which have cleared the banking system and have been collected by the Escrow Agent, are herein referred to as the "Fund". 3.6 If the proposed offering is terminated before the Termination Date, the Escrow Agent shall refund any portion of the Fund remaining upon termination after disbursement of the Fund in accordance with instructions delivered by the Issuer to the Escrow Agent in accordance with Article 4 hereof. 4. Disbursement from the Bank Account. 4.1 If by the close of regular banking hours on the Termination Date the Escrow Agent determines that the amount in the Fund is less than the Minimum Dollar Amount or is insufficient to purchase the Minimum Securities Amount, as indicated by the Subscription Information submitted to the Escrow Agent, then in either such case the Escrow Agent shall promptly refund to each prospective purchaser the amount of payment received from such prospective purchaser which is then held in the Fund or which thereafter clears the banking system, without interest thereon or deduction therefrom, by drawing checks on the Bank Account for the amounts of such - 3 - 4 payments and transmitting them to the purchasers. In such event, the Escrow Agent shall promptly notify the Issuer of its distribution of the Fund. 4.2 If at any time up to the close of regular banking hours on the Termination Date, the Escrow Agent determines that the amount in the Fund is at least equal to the Minimum Dollar Amount and represents consideration for the sale of not less than the Minimum Securities Amount, the Escrow Agent shall promptly notify the Issuer of such fact in writing. The Escrow Agent shall promptly disburse the Fund, by drawing checks on or making wire transfers from the Bank Account in accordance with instructions in writing signed by the Issuer as to the disbursement of the Fund, promptly after the Escrow Agent receives such instructions and confirms the concurrent issuance to the purchasers of the Securities being purchased with the funds being disbursed. 4.3 In the event the Issuer determines to reject in whole or in part the subscription of any prospective purchaser for whose account Escrow Amounts have been deposited in the Escrow Account, the Issuer shall promptly notify the Escrow Agent of such determination. Upon receipt of such notification, the Escrow Agent shall promptly refund to such prospective purchaser the amount of payment received from such purchaser attributable to the rejected subscription which is then held in the Fund or which thereafter clears the banking system, without interest thereon or deduction therefrom, by drawing checks on the Bank Account for the amounts of such payments and transmitting them to such purchaser. 4.4 Upon disbursement of the Fund pursuant to the terms of this Article 4, the Escrow Agent shall be relieved of all further obligations and released from all liability under this Agreement. It is expressly agreed and understood that in no event shall the aggregate amount of payments made by the Escrow Agent exceed the amount of the Fund. 5. Rights, Duties and Responsibilities of Escrow Agent. It is understood and agreed that the duties of the Escrow Agent are purely ministerial in nature, and that: 5.1 The Escrow Agent shall notify the Issuer, on a daily basis, of the Escrow Amounts which have been deposited in the Bank Account and of the amounts, constituting the Fund, which have cleared the banking system and have been collected by the Escrow Agent. 5.2 The Escrow Agent shall not be responsible for the performance by the Issuer of its obligations under this Agreement. 5.3 The Escrow Agent shall not be required to accept from the Issuer any Subscription Information pertaining to prospective purchasers unless such - 4 - 5 Subscription Information is accompanied by checks or wire transfers meeting the requirements of Section 3.1, nor shall the Escrow Agent be required to keep records of any information with respect to payments deposited by the Issuer except as to the amount of such payments; however, the Escrow Agent shall notify the Issuer within a reasonable time of any discrepancy between the amount set forth in any Subscription Information and the amount delivered to the Escrow Agent therewith. Such amount need not be accepted for deposit in the Escrow Account until such discrepancy has been resolved. 5.4 The Escrow Agent shall be under no duty or responsibility to enforce collection of any check delivered to it hereunder. The Escrow Agent, within a reasonable time, shall return to the Issuer any check received which is dishonored, together with the Subscription Information, if any, which accompanied such check. 5.5 The Escrow Agent shall be entitled to rely upon the accuracy, act in reliance upon the contents, and assume the genuineness of any notice, instruction, certificate, signature, instrument or other document which is given to the Escrow Agent pursuant to this Agreement without the necessity of the Escrow Agent verifying the truth or accuracy thereof. The Escrow Agent shall not be obligated to make any inquiry as to the authority, capacity, existence or identity of any person purporting to give any such notice or instructions or to execute any such certificate, instrument or other document. 5.6 If the Escrow Agent is uncertain as to its duties or rights hereunder or shall receive instructions with respect to the Bank Account, the Escrow Amounts or the Fund which, in its sole determination, are in conflict either with other instructions received by it or with any provision of this Agreement, it shall be entitled to hold the Escrow Amounts, the Fund, or a portion thereof, in the Bank Account pending the resolution of such uncertainty to the Escrow Agent's sole satisfaction, by final judgment of a court or courts of competent jurisdiction or otherwise; or the Escrow Agent, at its sole option, may deposit the Fund (and any other Escrow Amounts that thereafter become part of the Fund) with the Clerk of a court of competent jurisdiction in a proceeding to which all parties in interest are joined. Upon the deposit by the Escrow Agent of the Fund with the Clerk of any court, the Escrow Agent shall be relieved of all further obligations and released from all liability hereunder. 5.7 The Escrow Agent shall not be liable for any action taken or omitted hereunder, or for the misconduct of any employee, agent or attorney appointed by it, except in the case of willful misconduct or gross negligence. The Escrow Agent shall be entitled to consult with counsel of its own choosing and shall not be liable for any action taken, suffered or omitted by it in accordance with the advice of such counsel. - 5 - 6 5.8 The Escrow Agent shall have no responsibility at any time to ascertain whether or not any security interest exists in the Escrow Amounts, the Fund or any part thereof or to file any financing statement under the Uniform Commercial Code with respect to the Fund or any part thereof. 6. Amendment; Resignation. This Agreement may be altered or amended only with the written consent of the Issuer and the Escrow Agent. The Escrow Agent may resign for any reason upon three (3) business days' written notice to the Issuer. Should the Escrow Agent resign as herein provided, it shall not be required to accept any deposit, make any disbursement or otherwise dispose of the Escrow Amounts or the Fund, but its only duty shall be to hold the Escrow Amounts until they clear the banking system and the Fund for a period of not more than five (5) business days following the effective date of such resignation, at which time (a) if a successor escrow agent shall have been appointed and written notice thereof (including the name and address of such successor escrow agent) shall have been given to the resigning Escrow Agent by the Issuer and such successor escrow agent, then the resigning Escrow Agent shall pay over to the successor escrow agent the Fund, less any portion thereof previously paid out in accordance with this Agreement; or (b) if the resigning Escrow Agent shall not have received written notice signed by the Issuer and a successor escrow agent, then the resigning Escrow Agent shall promptly refund the amount in the Fund to each prospective purchaser, without interest thereon or deduction therefrom, and the resigning Escrow Agent shall promptly notify the Issuer in writing of its liquidation and distribution of the Fund; whereupon, in either case, the Escrow Agent shall be relieved of all further obligations and released from all liability under this Agreement. Without limiting the provisions of Section 8 hereof, the resigning Escrow Agent shall be entitled to be reimbursed by the Issuer for any expenses incurred in connection with its resignation, transfer of the Fund to a successor escrow agent or distribution of the Fund pursuant to this Section 6. 7. Representations and Warranties. The Issuer hereby represents and warrants to Escrow Agent that: 7.1 No party other than the parties hereto and the prospective purchasers have, or shall have, any lien, claim or security interest in the Escrow Amounts or the Fund or any part thereof. 7.2 No financing statement under the Uniform Commercial Code is on file in any jurisdiction claiming a security interest in or describing (whether specifically or generally) the Escrow Amounts or the Fund or any part thereof. 7.3 The Subscription Information submitted with each deposit shall, at the time of submission and at the time of the disbursement of the Fund, be deemed a representation and warranty that such deposit represents a bona fide payment by the - 6 - 7 purchaser described therein for the amount of Securities set forth in such Subscription Information. 7.4 All of the information contained in the Information Sheet is, as of the date hereof, and will be, at the time of any disbursement of the Fund, true and correct. 8. Fees and Expenses. The Escrow Agent shall be entitled to the Escrow Agent Fees set forth on the Information Sheet, payable as and when stated therein. In addition, the Issuer agrees to reimburse the Escrow Agent for any reasonable expenses incurred in connection with this Agreement, including, but not limited to, reasonable counsel fees. 9. Indemnification and Contribution. 9.1 The Issuer ( the "Indemnitor") agrees to indemnify the Escrow Agent and its officers, directors, employees, agents and shareholders (collectively referred to as the "Indemnitees") against, and hold them harmless of and from, any and all loss, liability, cost, damage and expense, including without limitation, reasonable counsel fees, which the Indemnitees may suffer or incur by reason of any action, claim or proceeding brought against the Indemnitees arising out of or relating in any way to this Agreement or any transaction to which this Agreement relates, unless such action, claim or proceeding is the result of the willful misconduct or gross negligence of the Indemnitees. 9.2 If the indemnification provided for in Section 9.1 is applicable, but for any reason is held to be unavailable, the Indemnitor shall contribute such amounts as are just and equitable to pay, or to reimburse the Indemnitees for, the aggregate of any and all losses, liabilities, costs, damages and expenses, including counsel fees, actually incurred by the Indemnitees as a result of or in connection with, and any amount paid in settlement of, any action, claim or proceeding arising out of or relating in any way to any actions or omissions of the Indemnitor. 9.3 The provisions of this Article 9 shall survive any termination of this Agreement, whether by disbursement of the Fund, resignation of the Escrow Agent or otherwise. 10. Governing Law and Assignment. This Agreement shall be construed in accordance with and governed by the laws of the State of Texas and shall be binding upon the parties hereto and their respective successors and assigns; provided, however, that any assignment or transfer by any party of its rights under this Agreement or with respect to the Escrow Amounts or the Fund shall be void as against the Escrow Agent unless (a) written notice thereof shall be given to the Escrow Agent; - 7 - 8 and (b) the Escrow Agent shall have consented in writing to such assignment or transfer. 11. Notices. All notices required to be given in connection with this Agreement shall be sent by registered or certified mail, return receipt requested, or by hand delivery with receipt acknowledged, or by the Express Mail service offered by the United States Post Office, and addressed, if to the Issuer at its address set forth on the Information Sheet, and if to the Escrow Agent, at its address set forth on the Information Sheet. 12. Severability. If any provision of this Agreement or the application thereof to any person or circumstance shall be determined to be invalid or unenforceable, the remaining provisions of this Agreement or the application of such provision to persons or circumstances other than those to which it is held invalid or unenforceable shall not be affected thereby and shall be valid and enforceable to the fullest extent permitted by law. 13. Execution in Several Counterparts. This Agreement may be executed in several counterparts or by separate instruments, and all of such counterparts and instruments shall constitute one agreement, binding on all of the parties hereto. 14. Entire Agreement. This Agreement constitutes the entire agreement between the parties hereto with respect to the subject matter hereof and supersedes all prior agreements and understandings (written or oral) of the parties in connection therewith. IN WITNESS WHEREOF, the undersigned have executed this Agreement as of the day and year first above written. CanArgo Energy Corporation By:_________________________ Title:______________________ Signature Stock Transfer, Inc. By:_________________________ Title:______________________ - 8 - 9 ESCROW AGREEMENT INFORMATION SHEET 1. The Issuer Name CanArgo Energy Corporation Address 1400 Broadfield Boulevard, Suite 100, Houston, Texas 77084 State of incorporation or organization Delaware 2. The Escrow Agent Name Signature Stock Transfer, Inc. Address 14675 Midway Road, Suite 221, Dallas, Texas 75224-9651 3. The Securities Description of the Securities to be offered: Shares of Common Stock, par value $.10 per share, of CanArgo Energy Corporation Offering price per share: $_____________ 4. Minimum Amounts Required for Disbursement of the Escrow Account Aggregate dollar amount which must be collected before the Escrow Account may be disbursed to the Issuer ("Minimum Dollar Amount") [$3,000,000] Total amount of securities which must be subscribed for before the Escrow Account may be disbursed to the Issuer ("Minimum Securities Amount") shares 5. Offering Period Initial Offering Period: Effective Date through June 30, 1999 Extension Period, if any: Through August 6, 1999 6. Title of Escrow Account: Signature Stock Transfer, Inc. as Agent for CanArgo Energy Corporation 7. Wire Instructions Bank Name: Bank Address: Account Name: Signature Stock Transfer, Inc., as Agent for CanArgo Energy Corporation Account Number: ABA Routing No.: 8. Escrow Agent Fees Amount due on execution of the Escrow Agreement: $1,000 Fee for initial closing of at least Minimum Securities Amount: $1,000 Fee for each additional closing: $500
- 9 - EX-10.(23) 3 PRODUCTION SHARING CONTRACT 1 Exhibit 10(23) PRODUCTION SHARING CONTRACT BETWEEN (1)GEORGIA AND (2)GEORGIAN OIL AND JKX NAVTOBI LIMITED COVERING: NINOTSMINDA, RUSTAVI AND MENAVI DATED 15 February 1996 2 TABLE OF CONTENTS PREAMBLE ................................................................................... 49 ARTICLE 1 DEFINITIONS........................................................................ 50 ARTICLE 2 SCOPE OF CONTRACT AND GENERAL PROVISIONS........................................... 57 ARTICLE 3 CONTRACT AREA...................................................................... 58 ARTICLE 4 CONTRACT TERM...................................................................... 59 ARTICLE 5 RELINQUISHMENTS.................................................................... 59 ARTICLE 6 COORDINATION COMMITTEE............................................................. 60 ARTICLE 7 OPERATOR RESPONSIBILITY............................................................ 63 ARTICLE 8 AMENDMENT TO CHARTER OF GMJV....................................................... 64 ARTICLE 9 PROCEDURE FOR DETERMINATION OF COMERCIALITY AND APPROVAL OF DEVELOPMENT PLANS ................................................................. 65 ARTICLE 10 ANNUAL WORK PROGRAMS AND BUDGETS................................................... 68 ARTICLE 11 ALLOCATION OF PRODUCTION, RECOVERY OF COSTS AND EXPENSES, PRODUCTION SHARING, AND RIGHT OF EXPORT ...................................................... 69 ARTICLE 12 CRUDE OIL VALUATION................................................................ 72 ARTICLE 13 ANCILLARY RIGHTS OF THE CONTRACTOR AND OPERATOR.................................... 73 ARTICLE 14 ASSISTANCE PROVIDED BY THE STATE................................................... 75 ARTICLE 15 MEASUREMENT, QUALITY AND VALUATION OF PETROLEUM.................................... 31 ARTICLE 16 NATURAL GAS........................................................................ 32 ARTICLE 17 TAX/FISCAL REGIME.................................................................. 35 ARTICLE 18 ACCOUNTING, FINANCIAL REPORTING AND AUDIT.......................................... 43 ARTICLE 19 CURRENCY, PAYMENTS AND EXCHANGE CONTROL............................................ 44 ARTICLE 20 IMPORT AND EXPORT.................................................................. 45 ARTICLE 21 EXPORT OF HYDROCARDONS, TRANSFER OF OWNERSHIP, AND REGULATIONS FOR DISPOSAL ...................................................................... 46 ARTICLE 22 OWNERSHIP OF ASSETS................................................................ 47 ARTICLE 23 INSURANCE.......................................................................... 48 ARTICLE 24 PERSONNEL.......................................................................... 49 ARTICLE 25 FORCE MAJEURE...................................................................... 49 ARTICLE 26 ASSIGNMENTS AND GUARANTEES......................................................... 50
2 3 ARTICLE 27 CONTRACT ENFORCEMENT AND STABILISATION, AND REPRESENTATIONS AND WARRANTIES ........................................................................ 56 ARTICLE 28 NOTICES AND CONFIDENTIALITY........................................................ 60 ARTICLE 29 TERMINATION AND BREACH............................................................. 61 ARTICLE 30 DISPUTE RESOLUTION................................................................. 62 ARTICLE 31 TEXT............................................................................... 63 ARTICLE 32 APPROVAL AND EFFECTIVE DATE........................................................ 63 ANNEX A CONTRACT AREA...................................................................... 107 ANNEX B PREVIOUS PRODUCTION................................................................ 110 ANNEX C ACCOUNTING PROCEDURE............................................................... 70 ANNEX D THE GBOC LICENCE................................................................... 129 ANNEX E STATE AUTHORISATION FOR SAKNAVTOBI (GEORGIAN OIL).................................. 129
3 4 PRODUCTION SHARING CONTRACT AND LICENSES This Contract is made and entered into as of the 15 February 1996 by and between (1) The State Department Saknavtobi (Georgian Oil) in its capacity as the duly authorised representative of the State (as that term is defined in Article 1.68) pursuant to the authority set out in Annex E, as the party of the first part; (2) the State Department Saknavtobi (Georgian Oil) in its capacity as the state owned oil department organised and existing as a legal entity under the laws of Georgia particularly as it is defined by the Charter of Saknavtobi adopted by the Council of Ministers of the Republic of Georgia, December 31, 1994 #908 (hereinafter referred to as "Georgian Oil"), as the party of the second part; and, (3) as party of the third part, JKX (Ninotsminda) Limited ("JKX"), a company organised and existing under the laws of Cyprus, (JKX, and its successors and assignees, if any, will individually be referred to as "Contractor Party" and collectively referred to as "Contractor"). The State, Georgian Oil, and the Contractor may sometimes be referred to as "Party" and collectively as the "Parties". WITNESSETH: WHEREAS, all Petroleum resources within the territory and under the internal waters, territorial sea, and continental shelf of Georgia are owned by the State; WHEREAS, the State enters into this Contract wishing to promote the development of the Contract Area and Georgian Oil and Contractor desire to join and assist in the exploration, development and production of the potential resources within the Contract Area; WHEREAS, Contractor has the requisite technical, managerial and financial capabilities and experience to carry out Petroleum Operations stipulated in this Contract and desires to cooperate with the State and Georgian Oil for the exploration and exploitation of Petroleum reserves within the Contract Area; WHEREAS, in December 1994 there was granted to the GBOC, (a Georgian British joint venture the founders of which are JP Kenny Exploration & Production Limited and Georgian Oil) a complex licence in respect of the Contract Area, a copy of that licence being annexed hereto as Annex D; and WHEREAS the Parties and GBOC have agreed that in order to promote the development of hydrocarbon resources in Georgia and to promote international investment in Georgia, Petroleum Operations should be carried out pursuant to the terms of this Contract and the terms of the GBOC Licence should be ratified by the State and deemed to be amended to the extent that they are in any way inconsistent with the provisions of this Contract. 4 5 NOW, THEREFORE, in consideration of the promises and the mutual covenants and conditions herein contained, it is hereby agreed as follows: ARTICLE 1 DEFINITIONS The following words and terms used in this Contract shall unless otherwise expressly specified in this Contract have the following respective meanings: 1.1 "Accounting Procedure" means the accounting procedure set out in Annex "C" hereto. 1.2 An "Affiliated Company" or "Affiliate" means: a) with respect to a Contractor Party a company, corporation, partnership or other legal entity: i) in which a Contractor Party owns directly or indirectly more than fifty percent (50%) of the shares, voting rights or otherwise has the right to establish management policy; or ii) which is the owner directly or indirectly has the right to more than fifty percent (50%) of the shares, voting rights or otherwise has the right to establish management policy of a Contractor Party; or iii) in which at least fifty percent (50%) of the shares or voting rights are owned directly or indirectly by a company or other legal entity, which owns directly or indirectly more than fifty percent (50%) of the shares, voting rights or otherwise has the right to establish management policy of a Contractor Party; b) with respect to the State and Georgian Oil, any legal entity directly or indirectly controlled by the State or Georgian Oil, respectively, or operating under their collective management. For the purposes of this part of the definition, the term to "control" (including the related terms "controlled" or "operates under collective management") shall mean with respect to any entity, having the right to carry out direct or indirect supervision of such entity or to define a general scope of its activity based on holding the shares entitled to vote, other form of ownership, or on any other grounds. 1.3 "Annex" or "Annexes" means each or all of the Annexes "A" through "E" attached to this Contract and made a part hereof. In the event of a conflict between the provisions of an Annex and a term in the main body of this Contract, the provisions of the latter shall prevail. 1.4 "Appraisal" means all works carried out by Contractor to evaluate and delineate the commercial character of a Discovery of Petroleum in the Contract Area. 5 6 1.5 "Appraisal Program" means a work program submitted by Contractor under which Contractor will evaluate and delineate a Discovery of Petroleum in the Contract Area. 1.6 "Associated Natural Gas" means all gaseous hydrocarbons produced in association with Crude Oil, which Crude Oil itself can be commercially produced and separated therefrom. 1.7 "Available Crude Oil" means Crude Oil produced and saved from the Contract Area and not used in Petroleum Operations in accordance with Article 11.3. 1.8 "Available Natural Gas" means Natural Gas produced and saved from the Contract Area and not used in Petroleum Operations in accordance with Article 11.3. 1.9 "Barrel" means a quantity consisting of forty-two (42) United States gallons liquid measure, corrected to a temperature of sixty degrees (60 (degrees)) Fahrenheit with pressure at sea level. 1.10 "Budget" means the estimate of the expenditures, listed category by category, relating to Petroleum Operations and contained in any Work Program proposed by Contractor. 1.11 "Calendar Quarter" or "Quarter" is a period of three consecutive months beginning on January 1st, April 1st, July 1st and October 1st of each Calendar Year. 1.12 "Calendar Year" means a period of twelve (12) consecutive months beginning on January 1st and ending on December 31st in the same year, according to the Gregorian Calendar. 1.13 "Commercial Discovery" means a discovery of Petroleum that the Contractor in its sole discretion in accordance with the provisions of Article 9 commits itself to develop and produce under the terms of the Contract. 1.14 "Commercial Production" means regular and continuous production of Petroleum from a Development Area in such quantities (taking into account any other relevant factors) as are worthy of commercial development. 1.15 "Contract" or "PSC" means this Production Sharing Contract together with all attached Annexes and any variation, extension or modification hereto which may be agreed in writing by all the Parties. 1.16 "Contract Area" means the area specified in Article 3 hereof and delineated in Annex A, as reduced or enlarged from time to time in accordance with the provisions of this Contract. 1.17 "Contract Year" means a period of twelve (12) consecutive months within the term of the Contract. 6 7 1.18 "Contractor" means the Contractor Parties, their assignees and successors, as provided herein. 1.19 "Coordination Committee" means the committee composed of representatives of all Parties constituted in accordance with Article 6. 1.20 "Cost Recovery Petroleum" means Cost Recovery Crude Oil and Cost Recovery Natural Gas. 1.21 "Cost Recovery Crude Oil" is defined as set forth in Article 11.5. 1.22 "Cost Recovery Natural Gas" is defined as set forth in Article 11.5 1.23 "Costs and Expenses" comprise the Exploration Expenditures, Development Expenditures, Operation Expenses and Drilling Costs together with Finance Costs whether directly or indirectly incurred by Contractor. 1.24 "Crude Oil" means crude mineral oil, asphalt, ozokerite and all kinds of hydrocarbons whether in a solid, liquid or mixed state at the wellhead or separator or which is obtained from Natural Gas through condensation or extraction. 1.25 "Customs Duties" means all import (or export) tariffs and duties and other mandatory payments as stipulated by applicable laws, regulations or other legal measures of Georgia with respect to the import or export of materials, equipment, goods and any other similar items. 1.26 "Development Area" means all or any part of the Contract Area specified in an approved Development Plan containing a Commercial Discovery. 1.27 "Development Expenditures" shall mean all costs and expenses for Development Operations with the exception of Operation Expenses and Drilling Costs whether directly or indirectly incurred, including but not limited to training, administration, service, Finance Costs and related expenses. 1.28 "Development Plan" is the plan to be produced by Contractor in accordance with Article 9.6. following a declaration that Commercial Production may be established. 1.29 "Development" or "Development Operations" or "Development Work" means and includes any activities or operations associated with work to develop for production and subsequently to produce and render marketable for commercial sale and shall include, but not be limited to: a) all the operations and activities under the Contract with respect to the drilling of wells, other than Exploration wells, the deepening, reworking, plugging back, completing and equipping of such wells, together with the design, construction and installation of such equipment, pipeline or gathering lines, installations, production units and all other systems relating to such wells and related operations in 7 8 connection with production and operation of such wells as may be necessary in conformity with sound oil field practices in the international Petroleum industry. b) all operations and activities relating to the servicing and maintenance of pipelines, gathering lines, installations, production units and all related activities for the production and management of wells including the undertaking of re-pressurising, recycling and other operations aimed at intensified recovery, enhanced production and oil recovery rate. 1.30 "Discovery" means a well that the Contractor determines has encountered Petroleum which would justify Commercial Production. 1.31 "Dollar" or "U.S.$" means the currency of the United States of America. 1.32 "Double Tax Treaty" means any international treaty or convention for the avoidance of double taxation of income and/or capital which is applicable in Georgia whether generally or particularly by virtue of Article 17.3. 1.33 "Drilling Costs" shall mean all expenditures whether directly or indirectly incurred during Exploration and Development for well drilling, completing and reworking operations including, but not limited to, labour, geological design, engineering and other Subcontractors (including all fees, tariffs and charges payable to any such Subcontractors), material and equipment consumed or lost, perforation, formation testing, cementing, well-logging and transportation. 1.34 "Effective Date" means the date on which this Contract has been signed by all Parties and a decree confirming its terms has been issued in terms satisfactory to the Contractor by the Head of State of Georgia. 1.35 "Excess Associated Natural Gas" is defined as set forth in Article 16.1.b. 1.36 "Excess Crude" is defined as set forth in Article 11.15. 1.37 "Exploration" or "Exploration Operations" means operations conducted under this Contract in connection with the exploration for previously undiscovered Petroleum, or the evaluation of discovered reserves which shall include geological, geophysical, aerial and (other survey) activities and any interpretation of data relating thereto as may be contained in Exploration Work Programs and Budgets, and the drilling of such shot holes, core holes, stratigraphic tests, Exploratory Wells for the discovery of Petroleum, Appraisal wells and other related operations. 1.38 "Exploration Expenditures" shall mean all costs and expenses for Exploration Operations other than Drilling Costs whether directly or indirectly incurred including but not limited to training, administration, service, Finance Costs and related expenses and overhead and study costs. 8 9 1.39 "Exploratory Well" means any well drilled with the objective of confirming a structure or geologic trap in which Petroleum capable of Commercial Production in significant quantities has not been previously discovered. 1.40 "Field" means a Petroleum reservoir or group of reservoirs within a common geological structure or feature. "Field" may be an "Oil Field" or a "Natural Gas Field" as designated by Contractor. 1.41 "Finance Costs" or "Interest Costs" shall include all amounts of interest, fees and charges paid in respect of any debt incurred in carrying out the Petroleum Operations and any refinancing of such debts, providing that in the case of Affiliate debt, it shall include interest only to the extent that it does not exceed a rate which would have been agreed upon between independent parties in similar circumstances and such interest is not limited by which assets or services are purchased by the loan principal. 1.42 "Force Majeure" is defined as set forth in Article 25.2. 1.43 "Foreign Employee" is defined as set forth in Article 17.21 1.44 "Foreign Subcontractors" means Subcontractors which are organised outside of Georgia. 1.45 "Gas Sales Contract" is any contract to be entered into for the sale of Non-associated Natural Gas in accordance with the provisions of Article 16.2. 1.46 "GMJV" means Georgia-Makoil Joint Venture. 1.47 "GMJV Licence" is the licence annexed hereto as Annex D, being the "Complex Licence" issued by the Chairman of the specialized office for Licensing and Informatics of "Saknavtobi" Department of the Republic of Georgia to GMJV dated December 1994 together with all enclosures and associated authorisations of Government. 1.48 "Joint Operating Agreement" or "JOA" means the agreement to be concluded between the Contractor Parties, Georgian Oil and GBOC which shall be supplementary to and consistent with the provisions of this Contract and which shall regulate the terms under which Petroleum Operations will be conducted. 1.49 "LIBOR" means the three (3) months U.S. Dollars London Interbank fixing offer rate quoted daily in the London Financial Times. 1.50 "Marketing Team" is defined as set forth in Article 16.2.a.ii. 1.51 "Measurement Point" means the location specified in an approved Development Plan where the Petroleum is metered and delivered to the Parties. 1.52 "Month" or "Calendar Month" means a calendar month. 9 10 1.53 "Natural Gas" means Non-associated Natural Gas and Associated Natural Gas in their natural state. 1.54 "Natural Gas Field" means a field from which more than fifty (50) percent of the estimated reserves on an energy equivalency basis are Natural Gas at surface conditions. 1.55 "Non-associated Natural Gas" means all gaseous hydrocarbons produced from gas wells, and includes wet gas, dry gas and residue gas remaining after the extraction of liquid hydrocarbons from wet gas. 1.56 "Oil Field" means a field from which more than fifty (50) percent of the estimated reserves comprise Crude Oil. 1.57 "Operation Expenses" shall mean those costs incurred in day-to-day Petroleum Operations in or in relation to the Contract Area, whether directly or indirectly incurred including but not limited to all costs, expenses and expenditures associated with the Production, processing, transportation, export and sale of Petroleum, training, administration, service, Finance Costs, payments for abandonment and site restoration in accordance with Article 9.8, insurance costs in accordance with Article 23 and related expenses, all made after the commencement of Commercial Production. 1.58 "Operator" shall (unless the Parties otherwise agree) be GBOC (or with the consent of the Parties a subsidiary of GBOC) which shall perform the obligations of an operator in accordance with the provisions of this Contract and the JOA. 1.59 "Party" or "Parties" means the parties whose authorised representatives have affixed their signatures hereto. 1.60 "Petroleum" means Crude Oil and Natural Gas. 1.61 "Petroleum Operations" means the Exploration Operations, the Development Operations, Production Operations, and transportation, export and other activities related thereto carried out pursuant to this Contract and the JOA. 1.62 "Petroleum Operations Account" shall have the meaning given to it in paragraph 4.1 of section I of the Accounting Procedure. 1.63 "Previous Production" means agreed production figures for the Contract Area set out in Annex B. 1.64 "Production" or "Production Operations" means operations and all related activities carried out for Petroleum production after the approval of any Development Plan, including without limitation extraction, injection, stimulation, treatment, transportation, storage, lifting, and associated operations, but does not include any storage or transportation beyond the Measurement Point. 10 11 1.65 "Profit Natural Gas" is defined as set forth in Article 11.10. 1.66 "Profit Oil" is defined as set forth in Article 11.10. 1.67 "Profit Tax" is defined as set forth in Article 17. 1.68 "State" or "Government" means the Government of Georgia and all political or other agencies or instrumentalities or subdivisions thereof including but not limited to any local government or other representative, agency or authority, which has the authority to govern, legislate, regulate, levy and collect taxes or duties, grant licences, permits, approve or otherwise impact (whether financially or otherwise) directly or indirectly upon any of the Parties' rights, obligations or activities under the Contract; the word "Governmental" shall be construed accordingly. 1.69 "Study Area" is the part of the Contract Area which will be defined in a Study Program. 1.70 "Study Program" shall mean the program to be produced and carried out by the Contractor in accordance with Article 9 following the conclusion that Commercial Production is feasible. 1.71 "Subcontractor" means any natural person or juridical entity contracted directly or indirectly by or on behalf of Contractor to supply goods, works or services related to this Contract. 1.72 "Tax Inspectorate" is defined as set forth in Article 17.18. 1.73 "Third Party" or "Third Parties" means one or more of a natural person or juridical entity other than a Party hereto and any Affiliate of a Party. 1.74 "Taxes" means all levies, duties, payments, fees, taxes or contributions payable to or imposed by Governmental agencies, Governmental subdivisions or republican, municipal or local authorities within the Government of Georgia. 1.75 "VAT" means Georgian value added tax. 1.76 "Withhold Tax" is defined as set forth in Article 17.23. 1.77 "Work Program" and "Work Program and Budget" shall mean any work program and work program and Budget to be submitted to the Coordination Committee by the Contractor in accordance with the provisions of Article 10 and which shall set out the proposed Petroleum Operations to be carried out in the Contract Area together with the associated Budget as the case may be. 11 12 ARTICLE 2 SCOPE OF CONTRACT AND GENERAL PROVISIONS 2.1 By its approval of this Contract the State hereby ratifies the GBOC Licence as amended by the terms of this Contract. The terms of the GBOC Licence shall with effect from the Effective Date be merged with this Contract and be deemed to be amended so that any provision which is inconsistent with the provisions of this Contract or which otherwise detracts or lessens the rights of the Contractor hereunder shall be deemed to have been replaced with the applicable provision of this Contract. Where there is any inconsistency between the terms of the GBOC Licence or this Contract, then the provisions of this Contract shall apply. The benefits, rights and obligations under the GBOC Licence as amended by this Contract shall extend to Georgian Oil and each Contractor Party. Without prejudice to the rights of Georgian Oil and the Contractor to carry out Petroleum Operations in accordance with this Contract GBOC's rights and interests under the GBOC Licence shall be held by it for the benefit of Georgian Oil and the Contractor. 2.2 Subject to the terms and conditions of the Contract and with the consent and concurrence of GBOC, the State hereby grants to Georgian Oil and the Contractor Parties the exclusive rights to conduct Petroleum Operations in the Contract Area during the term of this Contract. 2.3 Georgian Oil and Contractor shall be responsible to the State for the execution of such Petroleum Operations with GBOC acting as operator all in accordance with the provisions of the Contract. 2.4 In performing Petroleum Operations, Contractor shall provide all financial and technical requirements, unless otherwise provided in this Contract, or agreed with Georgian Oil, and conduct all operations in accordance with the standards generally accepted in the international Petroleum industry. Contractor may borrow capital from Third Parties and/or from Affiliated Companies for the financing required for the investments necessary for Petroleum Operations. Interest Costs charged for such loans, premiums, expenses (of whatever nature) and exchange control gains and losses shall be chargeable as provided in the Accounting Procedure, and recoupable as Cost Recovery Petroleum as provided in Article 11. 2.5 Contractor shall be compensated for its services, not by way of reimbursement in cash of its expenditures under the Contract, but by receipt of its share of Petroleum from the Contract Area to which it may become entitled by way of recovery of Costs and Expenses from Cost Recovery Petroleum under Article 11. If Petroleum produced from Development Areas within the Contract Area developed by Contractor is insufficient to reimburse Contractor for Costs and Expenses incurred by Contractor, Contractor shall bear its own losses in respect of any shortfall. 12 13 2.6 This Contract together with the JOA to be executed pursuant hereto defines the Parties' rights and obligations, governs their mutual relations and establishes the rules and methods for the Exploration, Development, Production, and sharing of Petroleum between them. The entire interests, rights and obligations of each of the Parties under this Contract shall be solely governed by the provisions of this Contract and the JOA to be executed pursuant hereto. The Contractor and Georgian Oil may as between themselves, agree in writing to amend any provision of this Contract where to do so would, in the opinion of both the Contractor and Georgian Oil improve the day to day operations contemplated hereunder, but not so as to vary any fundamental provision of this Contract. 2.7 During the period in which this Contract is in force, all Available Crude Oil and Available Natural Gas resulting from Petroleum Operations, will be shared between Georgian Oil and the Contractor in accordance with the provisions of Article 11 of this Contract. 2.8 Georgian Oil and Contractor agree that the Operator shall be GBOC. That appointment shall be effective from the Effective Date. The Operator shall act as the designated non-profit agent of Georgian Oil and Contractor for the conduct of Petroleum Operations in accordance with this Contract and the JOA. As described in Article 17 of this Contract the Operator shall be entitled to full and complete exemption from all Taxes imposed prior to or after the Effective Date. 2.9 The State hereby appoints Georgian Oil, a state owned body, as its designated representative to perform the obligations which it is required to perform and to enjoy the benefits (including the right to receive its share of Petroleum) which has been granted hereunder. The Contractor shall be entitled to rely on the fact that Georgian Oil is the representative of the State for the purposes of this Contract and that the benefits given to Georgian Oil can be considered benefits given to the State. ARTICLE 3 CONTRACT AREA 3.1 The Contract Area is as set out by the geographic location and coordinates described in Annex "A" attached hereto and delineated in the map which forms part thereof. The total area of the Contract Area may hereafter be reduced only in accordance with the provisions of this Contract. 13 14 3.2 Except as for all rights and authorisations necessary for the implementation of the provisions of this Contract, no right is granted in favour of the Contractor or Georgian Oil to the use or disposal of any other natural or man-made resources or aquatic resources. ARTICLE 4 CONTRACT TERM 4.1 The term of the Contract shall be deemed to have begun on the date of the GBOC Licence and shall continue for a total of twenty-five (25) consecutive Contract Years, unless the Contract is sooner terminated in accordance with Article 29 of this Contract, or is extended in accordance with Article 5, 16 or 25 of this Contract. 4.2 If in respect of any Development Area, Commercial Production remains possible beyond the initial period of 25 consecutive Contract Years specified in Article 4.1 or any extension provided under this Article 4.2, the Contractor, after giving notice to the State at least one (1) year prior to the end of any such term shall automatically be entitled to have an extension of the term of this Contract with respect to such Development Area for an additional term of five (5) Contract Years, or the producing life of the Development Area, whichever is lesser. ARTICLE 5 RELINQUISHMENTS 5.1 Subject to Article 5.2, Contractor shall select and relinquish portions of the Contract Area as follows: a) at least fifty percent (50%) of the original Contract Area, not later than five (5) Contract Years after the date of the GBOC Licence; and b) at least fifty percent (50%) of the Contract Area remaining after the relinquishment of Clause 5.1(a) occurs not later than ten (10) Contract Years after the date of the GBOC Licence; and c) at least fifty percent (50%) of the Contract Area remaining after the relinquishment of Clause 5.1(b) occurs not later than fifteen (15) Contract Years after the date of the GBOC Licence; and 14 15 d) at least fifty percent (50%) of the Contract Area remaining after the relinquishment of Clause 5.1(c) occurs not later than twenty (20) Contract Years after the date of the GBOC Licence. 5.2 The Contractor shall not be required pursuant to Article 5.1 to relinquish any portion of the original Contract Area containing a Development Area. 5.3 Unless the Contract is earlier surrendered or terminated, the Contractor shall furnish the State and Georgian Oil with a description of the boundaries of the part of the Contract Area to be relinquished not less than ninety (90) days in advance of the deadline for the relinquishment prescribed in Article 5.1. 5.4 The area designated under Article 5.3 for relinquishment shall consist as far as practicable of rectangular blocks bounded by lines running due north and south and due east and west and shall not be less than five (5) square kilometres. The area designated for relinquishment need not consist of one contiguous area. 5.5 Contractor may at any time relinquish voluntarily all or any part of the Contract Area. Article 5.4 shall apply to all voluntary relinquishments. Any such voluntary relinquishment of less than all of the Contract Area shall be credited toward any subsequent relinquishment obligations hereunder. ARTICLE 6 COORDINATION COMMITTEE 6.1 For the purpose of providing the overall supervision and direction of and ensuring the performance of the Petroleum Operations, Georgian Oil and Contractor shall establish a Coordination Committee within forty-five (45) days of the Effective Date. 6.2 The Coordination Committee shall comprise a total of eight (8) members. Georgian Oil (for itself and the State) shall appoint a total of four (4) representatives and Contractor shall appoint four (4) representatives to form the Coordination Committee. Georgian Oil and Contractor shall each designate one of its representatives as its chief representative. All the aforesaid representatives shall have the right to attend and present their views at meetings of the Coordination Committee. Each representative shall have the right to appoint an alternate who shall be entitled to attend all meetings of the Coordination Committee but who shall have no vote except in the absence of the representative for whom he is the alternate. When a decision is to be made on any proposal, the chief representative from each Party shall be the spokesman on behalf of such Party. 15 16 6.3 The first chairman of the Coordination Committee shall be the chief representative designated by the Contractor (or his alternate), and the first vice chairman shall be the chief representative designed by Georgian Oil (or his alternate). The chairman and vice chairman shall be appointed for a term of two (2) years. Following the end of each such two (2) year term of appointment, the identity of the chairman and the vice chairman shall rotate so that for the next two (2) year period the previous chairman shall become vice chairman for the next two (2) years and the vice chairman shall become chairman for the next two (2) years. The chairman of the Coordination Committee shall preside over meetings of the Coordination Committee and in the absence of the chairman (or his alternate), the vice chairman shall preside. Such Parties may designate a reasonable number of advisors, who may attend, but shall not be entitled to vote at, Coordination Committee meetings. 6.4 A regular meeting of the Coordination Committee shall be held at least once a Calendar Quarter. The secretary to be designated pursuant to Article 6.9 shall be responsible for calling such regular meetings of the Coordination Committee and shall do so at the request of the chairman by sending a notice to the Parties. Other meetings, if necessary, may be held at any time at the request of Georgian Oil or Contractor. In each case the secretary shall give the Parties at least 30 days notice (or such shorter period as the Parties may agree) of the proposed meeting date, the time and location of the meeting. 6.5 The Parties hereby empower the Coordination Committee to: a) review and examine any Work Program and Budget proposed by the Contractor and any amendment thereof; b) determine the Commerciality of each proposed Development Operation; c) review and adopt proposed Development Operations and Budgets; d) approve or confirm the following items of procurement and expenditures: i) approve procurement of any item within the Budget with a unit price exceeding Two Hundred and Fifty Thousand U.S. $ (U.S.$ 250,000) or any single purchase order of total monetary value exceeding One Million U.S. $ (U.S.$1,000,000); ii) approve a lease of equipment, or an engineering subcontract or a service contract within the Budget worth more than One Million U.S. $ (US$1,000,000) in total; and iii) confirm excess expenditures pursuant to Article 10.5 hereof and the expenditures pursuant to Article 10.6 hereof; 16 17 e) demarcate boundaries of a Development Area; f) review and approve the insurance program proposed by the Contractor and emergency procedures on safety and environmental protection; g) review and approve personnel policies, selection and training programs for Operator. Without prejudice to the foregoing, it is accepted that part of the personnel policy of Operator shall be to give priority to former employees of Georgian Oil, provided that the conduct of Petroleum Operations shall not be affected; h) discuss, review, decide and approve other matters that have been proposed by either Georgian Oil, Contractor or the Operator; i) review and examine matters required to be submitted to relevant authorities of the State; j) review and discuss the development work and technological regimes proposed by Contractor and Georgian Oil; and k) appoint sub-committees to meet from time to time to review any aspect of Petroleum Operations, which the Coordination Committee thinks fit. 6.6 Decisions of the Coordination Committee shall be made by unanimous decision of the representatives present and entitled to vote. Each representative will have one vote. All decisions made unanimously shall be deemed as formal decisions and shall be conclusive and equally binding upon the Parties. 6.7 Georgian Oil and Contractor shall endeavour to reach agreement on all matters presented to the Coordination Committee, however, if these Parties fail to reach agreement on any matter during a meeting of the Coordination Committee then following discussion and after the Contractor has provided full reasons for its proposal the Contractor's proposal shall prevail. In the event that on any matter the Parties are unable to reach agreement and the Contractor is insisting that its proposal shall prevail, if Georgian Oil is reasonably of the view that the proposed action would result in serious depletion of a field or reservoir resulting in either permanent damage to that field or reservoir or materially reduced recovery of Petroleum over the life of the field or reservoir then the matter will be referred to an independent expert appointed by the Contractor and Georgian Oil whose decision on the matter shall be final and binding. The costs of the expert shall be met by the Parties equally and shall be recoverable as Costs and Expenses. 6.8 A matter which requires urgent handling may be decided by the Coordination Committee without convening a meeting, with the Coordination Committee making decisions through telexes or the circulation of documents. 17 18 6.9 The Coordination Committee shall nominate a secretary, to record minutes of the meetings of the Coordination Committee, and may establish technical and other advisory sub-committees. The secretary shall take a record of each proposal voted on and the results of such vote at each meeting of the Coordination Committee. Each representative of the Parties shall sign and be provided with a copy of such record at the end of such meeting. The secretary shall provide each Party with a copy of the minutes of each meeting of the Coordination Committee within fifteen (15) days after the end of such meeting. Each Party shall thereafter have a period of fifteen (15) days to give notice of any objections to the minutes to the secretary. Failure to give notice within the said fifteen (15) day period shall be deemed approval of those minutes. In any event the record of proposals voted on to be provided at the end of each meeting shall be conclusive and take precedence over the minutes 6.10 All costs and expenses incurred with respect to the activities of the Coordination Committee shall be paid or reimbursed by the Contractor and charged to Operation Expenses in accordance with the Accounting Procedure. ARTICLE 7 OPERATOR RESPONSIBILITY 7.1 The Parties agree that GBOC shall act as the Operator for Petroleum Operations within the Contract Area in accordance with approved Work Programs and Budgets unless otherwise stipulated in this Article 7. 7.2 The Operator shall have the following obligations: a) To perform the Petroleum Operations reasonably, economically and efficiently in accordance with directions received from the Coordination Committee. It is recognised that the Coordination Committee through the Operator will have operating control of all Petroleum Operations, including the right to authorise the appointment of the Operations Director; b) To assist the Contractor as requested in implementation of the Work Programs and Budgets approved by the Coordination Committee; c) To be responsible for domestic procurement of installations, equipment and supplies and entering into subcontracts and service contracts on behalf of Contractor with domestic service providers and vendors related to the Petroleum Operations, in accordance with approved Work Programs and Budgets and instructions from Contractor; 18 19 d) To prepare and submit for approval a personnel training program and its annual budget and carry out the same as approved by the Coordination Committee; e) To establish and maintain complete and accurate accounting records regarding its costs and expenditures for the Petroleum Operations in accordance with the Accounting Procedure and this Contract; f) To make necessary preparation for regular meetings of the Coordination Committee, and to submit to the Coordination Committee information related to the matters reviewed and approved by the Coordination Committee; g) To assist Contractor and Georgian Oil as requested in the provision of reports to the Coordination Committee on Petroleum Operations conducted under this Contract. 8.1 Operator, Georgian Oil GMJV and Contractor, and their direct and indirect shareholders, shall not be directly or indirectly liable to persons or entities not Parties for any loss or damage arising out of, occasioned by or associated with the performance of the Petroleum Operations under this Contract. Responsibility for all activities (including Petroleum activities) affecting the Contract Area prior to the date of the GBOC Licence and the direct and indirect consequences of such activities shall remain with the State and the Contractor shall have no responsibility therefor. The State shall indemnify the Contractor in respect of such prior activity to the extent that the Contractor suffers any loss as a direct or indirect result thereof. 8.1 The Operator shall provide all Parties with copies of all relevant data and reports pertaining to Petroleum Operations required by such Parties. 8.1 The Parties agree to use their best endeavours to agree and execute a Joint Operating Agreement which should be in place no later than 31 January 1996. The Joint Operating Agreement shall be based on good international Petroleum industry practices and shall be wholly consistent with and shall not detract from the provisions of this Contract. ARTICLE 8 AMENDMENT TO CHARTER OF GMJV 8.1 By their execution hereof Georgian Oil and JP Kenny Exploration & Production Limited (as the founders of GBOC) hereby confirm that upon this Contract being given full force of law in Georgia in accordance with the provisions of Article 32, the Charter of GBOC shall forthwith be amended to reflect the rights and obligations of the Parties set out in this Contract. Furthermore the Parties recognise GBOC's role as Operator in the Contract Area in accordance with this Contract. 19 20 ARTICLE 9 PROCEDURE FOR DETERMINATION OF COMMERCIALITY AND APPROVAL OF DEVELOPMENT PLANS 9.1 If, at any time Contractor concludes that Commercial Production (or significant additional Commercial Production if Commercial Production has previously been established) from the Contract Area is feasible, it shall notify Georgian Oil within five (5) days of reaching such a conclusion. 9.2 Within forty-five (45) days of receipt of such notice, Contractor shall in the first instance present to the Coordination Committee for approval a proposed Study Program which shall be deemed approved if no written objections are raised by any member of the Coordination Committee within thirty (30) days following receipt thereof. The proposed Study Program shall specify in reasonable detail the appraisal work including seismic, drilling of wells and studies to be carried out and the estimated time frame within which the Contractor shall commence and complete the program. 9.3 Thereafter the Contractor shall carry out the Study Program approved by the Coordination Committee. Within ninety (90) days after completion of such Study Program, the Contractor shall submit to the Coordination Committee a comprehensive evaluation report on the Study Program. Such evaluation report shall include, but not be limited to: geological conditions, such as structural configuration; physical properties and extent of reservoir rocks; pressure, volume and temperature analysis of the reservoir fluid; fluid characteristics, including gravity of liquid hydrocarbons, sulphur percentage, sediment and water percentage, and product yield pattern; Natural Gas composition; production forecasts (per well and per Field); and estimates of recoverable reserves. 9.4 Together with the submission of the evaluation report, or at any other time, the Contractor shall submit to the Coordination Committee a written declaration including one of the following statements: a) that the Commercial Production previously notified to Georgian Oil pursuant to Article 9.1 is feasible; b) that such Commercial Production is not feasible (contrary to the notice containing Contractor's initial expectations); or c) that Commercial Production will be conditional on the outcome of further specified work that the Contractor commits to carry out under a 20 21 further Exploration or Study Program in specified areas within or outside the relevant Study Area. 9.5 In the event the Contractor makes a declaration under Article 9.4(c) above, Contractor shall be entitled to retain the relevant Study Area pending the completion of the further work committed under that Article, at which time the Contractor shall advise the Coordination Committee of its conclusion as to whether or not there is in fact a new Commercial Discovery and the provisions of Article 9.4(a) or (b) shall be applied accordingly. 9.6 If the Contractor declares pursuant to Article 9.4(a) that Commercial Production is feasible, the Contractor shall submit to the Coordination Committee (a) a proposed Development Plan in respect of the relevant Commercial Discovery (containing the matters specified in Article 9.7 and 9.8) and (b) a proposed designation of the Development Area, both of which shall be subject to the Coordination Committee's approval. Such approval will not be unreasonably withheld or delayed, provided that each shall be deemed approved as submitted if no written objections are presented thereto by any member of the Coordination Committee within forty-five (45) days of receipt. Upon approval being granted or deemed as provided under this Article 9.6, the Contractor, with any requested assistance from the Operator, shall proceed promptly and diligently to implement the Development Plan in accordance with good international Petroleum industry practices, to install all necessary facilities and to commence Commercial Production. 9.7 The Contractor's proposed Development Plan to be submitted pursuant to Article 9.6 shall detail the Contractor's proposals for Development and operation of the Development Area. It will detail any facilities and infrastructure which may be required up to the Measurement Point, either inside or outside of the Development Area. Any Development Plan shall set forth production parameters, number and spacing of wells, the facilities and infrastructure (including proposed locations) to be installed for production, storage, transportation and loading of Petroleum, an estimate of the overall cost of the Development, and estimates of the time required to complete each phase of the Development Plan, a production forecast and any other factor that would affect the economic or technical feasibility of the proposed Development. 9.8 Any Development Plan shall also include an abandonment and site restoration program together with a funding procedure for such program. Each abandonment plan shall describe removal and abandonment measures deemed necessary following completion of Production from the relevant Development Area together with an estimate of the costs thereof. The abandonment plan shall provide for the removal of facilities and equipment used in Petroleum Operations or their in place abandonment, if appropriate, in the Development Area and the return of used areas to a condition that reasonably permits the use of such areas for purposes similar to those uses existing prior to the commencement of Petroleum Operations hereunder. All expenditures incurred 21 22 in abandonment and site restoration shall be treated as Costs and Expenses and recoverable from Cost Recovery Petroleum in accordance with Article 11 and the Accounting Procedure. All funds collected pursuant to the funding procedure shall be dedicated to site restoration and abandonment and will be placed in a special interest bearing account by Contractor, which shall be held in the joint names of the State and the Contractor or their nominees. Contractor's responsibilities for environmental degradation, site restoration and well abandonment obligations, and any other actual, contingent and potential activity associated with the environmental status of the Development Area shall be limited to the obligation to place the funds agreed to be paid in accordance with the said funding procedure in the approved account in accordance with generally accepted international Petroleum industry practice. Any agreed deposits in approved accounts shall be made on a quarterly basis in arrears commencing with the Calendar Quarter after recovery of the relevant Development Expenditures and Drilling Costs. All such payments deposited by Contractor shall be treated as Costs and Expenses and recoverable as Operation Expenses from Cost Recovery Petroleum in accordance with Article 11 of this Contract. No Taxes shall be imposed on any amounts paid into, received or earned by or held in the special interest bearing account. The State shall be solely responsible for the implementation of the abandonment plan. 9.9 Any significant changes to an approved Development Plan or proposals related to extension of a Field or for enhanced recovery projects shall be submitted to the Coordination Committee. 9.10 Subject to the terms of this Contract the Contractor shall carry out, at its own expense and financial risk, all the necessary Petroleum Operations to implement an approved Development Plan. However, if, the Contractor is able to demonstrate to the reasonable satisfaction of the Coordination Committee that exploitation turns out not to be commercially profitable, the Contractor shall not be obligated to continue Development or Production. 9.11 Should access to suitable infrastructure necessary for Development of any Discovery or for export of Contractor's share of Petroleum from any Discovery be unavailable or restricted as a result of the acts or omissions of the State or Georgian Oil, Contractor may, at its option, declare its obligations under this Contract to be suspended under the terms of Article 25 (Force Majeure) until such time as the condition has been remedied. Where there is a perceived need recognised by the State, Georgian Oil and the Contractor to improve the economic effectiveness of the Petroleum Operations by constructing and operating certain common facilities with other organisations (including for example roads, pipelines, compression and pumping stations and communication lines) the Parties shall use their best efforts to reach agreement between themselves and other appropriate enterprises as to the construction and operation of such facilities with all costs, tariffs and investments made by the Contractor to be recoverable as Operation Expenses in accordance with Article 11 of the Contract and Accounting Procedure. 22 23 ARTICLE 10 ANNUAL WORK PROGRAMS AND BUDGETS 10.1 Contractor shall be responsible for the procurement of installations, equipment and supplies and entering into contracts for the purchase of goods and services with Foreign Subcontractors and others arising out of Petroleum Operations, all in accordance with approved Work Programs and Budgets. Operator shall assist the Contractor when requested in respect of the matters set out in the previous sentence, and shall implement domestic procurement operations as provided in Clause 7.2(c) in accordance with approved Work Programs and Budgets. 10.2 Within ninety (90) days after the Effective Date, Contractor shall submit to the Coordination Committee for its approval a Work Program and the corresponding Budget for the next succeeding Calendar Year. 10.3 Before the 15th October of each Calendar Year, the Contractor shall prepare and submit to the Coordination Committee for its review a proposed annual Work Program and Budget for the next Calendar Year. If the Coordination Committee requests any modifications in an annual Work Program and/or Budget, the Contractor shall promptly make such modifications to the Work Program and/or Budget and resubmit the modified Work Program and Budget to the Coordination Committee. The Coordination Committee shall approve each Work Program and Budget within forty five (45) days after receipt of same. If the Coordination Committee fails to notify the Contractor of its approval of the Work Program and Budget within said forty five (45) days after its receipt, the annual Work Program and Budget proposed by the Contractor together with any modifications timely requested by the Coordination Committee, shall be deemed to have been approved by the Coordination Committee. 10.4 In connection with the review and approval of the annual Work Program and Budget, the Contractor and Operator shall submit to the Coordination Committee such supporting data as may be requested by the Coordination Committee. 10.5 The Contractor may, in accordance with the following provisions, incur expenditures in excess of the approved Budget or expenditures outside the approved Budget in carrying out the approved Work Program, provided that the objectives in the approved Work Program are not substantially changed: a) In carrying out an approved Budget, the Contractor may, if necessary, incur excess expenditures of no more than ten percent (10%) of the approved Budget in any specified budgetary category. The Contractor 23 24 shall report quarterly the aggregate amount of all such excess expenditures to the Coordination Committee for confirmation. b) For the efficient performance of Petroleum Operations, the Contractor may, without approval, undertake certain individual projects which are not included in the Work Program and Budget, for a maximum expenditure of Two Hundred Fifty Thousand U.S.$ (U.S.$250,000), but shall, within ten (10) days after such expenditures are incurred, report to the Coordination Committee for confirmation. c) Excess expenditures under this Article 10.5 shall not exceed five percent (5%) of the approved or modified total annual Budget for the Calendar Year. If the aforesaid excess is expected to be in excess of said five percent (5%) of the total annual Budget, the Contractor shall present its reasons therefor to the Coordination Committee and obtain its approval prior to incurring such expenditures. 10.6 In case of emergency, the Contractor may incur emergency expenditures for the amount actually needed but shall report such expenditures to the Coordination Committee as soon as they are made. The said emergency expenditures shall not be subject to Article 10.5 above. 10.7 The Parties agree that the approval of a proposed Work Program and Budget will not be unreasonably withheld and shall be approved if the proposed Work Program is consistent with generally accepted international Petroleum practices. 10.8 Petroleum Operations will only be performed in accordance with the approved or modified annual Work Program and Budget. ARTICLE 11 ALLOCATION OF PRODUCTION, RECOVERY OF COSTS AND EXPENSES, PRODUCTION SHARING, AND RIGHT OF EXPORT 11.1 Contractor shall provide or procure the provision of all funds required to conduct Petroleum Operations under this Contract, except as otherwise provided in this Contract, and Contractor shall be entitled to recover its Costs and Expenses from Petroleum produced from the Contract Area as provided below. 11.2 Costs and Expenses directly or indirectly incurred by JKX and its Affiliated Companies prior to the Effective Date pursuant to the provisions of the GMJV Licence shall be deemed to be Costs and Expenses for the purposes of this Contract and shall be deemed to be incurred on the Effective Date and shall be 24 25 recoverable from Cost Recovery Petroleum in accordance with the provisions of this Contract. 11.3 Contractor and Operator shall have the right to use free of charge Petroleum produced from the Contract Area to the extent required for Petroleum Operations under the Contract. The amount of Petroleum which Contractor and Operator shall be entitled to use for Petroleum Operations shall not exceed the amount which would be expected to be used in accordance with international Petroleum industry practice. For the avoidance of doubt, the use of such Petroleum shall only be for the benefit of Petroleum Operations and not the personal gain of any Party. 11.4 Available Crude Oil and Available Natural Gas in excess of Previous Production, shall be measured at the applicable Measurement Point and allocated as set forth hereinafter. Available Crude Oil and Available Natural Gas not in excess of Previous Production shall be for the account of Georgian Oil and Georgian Oil shall be entitled to lift such Available Crude Oil and Available Natural Gas at the Measurement Point in priority to the lifting of Profit Petroleum and Cost Recovery Petroleum by the Parties. 11.5 Contractor and Georgian Oil shall be entitled to recover all Costs and Expenses incurred in respect of Petroleum Operations from a maximum of fifty percent (50%) per Calendar Year of all Available Crude Oil and Available Natural Gas from the Contract Area (hereinafter referred to as "Cost Recovery Crude Oil" and "Cost Recovery Natural Gas", as the case may warrant). Recovery of Costs and Expenses shall be in a manner consistent with the Accounting Procedure and Article 11.6. 11.6 Costs and Expenses shall be recoverable from Cost Recovery Petroleum on a first in, first out basis (i.e. Costs and Expenses incurred will be recovered according to the date they were incurred, earliest first). Recovery of Costs and Expenses will commence as soon as Cost Recovery Petroleum is available. 11.7 To the extent that in a Calendar Year outstanding recoverable Costs and Expenses related to the Contract Area exceed the value of all Cost Recovery Crude Oil or Cost Recovery Natural Gas from the Contract Area for such Calendar Year, the excess shall be carried forward for recovery in the next succeeding Calendar Years until fully recovered, but in no case after termination of the Contract. 11.8 Recovery of Costs and Expenses shall be achieved by transferring to a Party at the Measurement Point title to quantities of Cost Recovery Petroleum of equivalent value (determined in accordance with Article 12) to the Costs and Expenses to be recovered in accordance with this Article 11. 11.9 To the extent that the value of Cost Recovery Petroleum received by a Party from the Contract Area during a Calendar Quarter is greater or lesser than the 25 26 Party was entitled to receive for that Calendar Quarter, an appropriate adjustment shall be made in accordance with the Accounting Procedure. 11.10 Following recovery of Costs and Expenses from Cost Recovery Petroleum in accordance with the provisions of this Article 11, the remaining Petroleum including any portion of Cost Recovery Petroleum not required for recovery of Costs and Expenses (hereinafter referred to as "Profit Oil" or "Profit Natural Gas") shall be allocated between Georgian Oil and the Contractor in the following proportions, over each Calendar Year: a) Profit Oil Georgian Oil's Share Contractor Share 70% 30% b) Profit Natural Gas - shall be shared on the same basis as stated in (a) above after converting the Natural Gas to barrels of Crude Oil on an energy equivalency basis. 11.11 Contractor shall prepare and provide Georgian Oil not less than ninety (90) days prior to the beginning of each Calendar Quarter a written forecast setting out the total quantity of Petroleum that Contractor estimates can be produced and saved hereunder during each of the next four (4) Calendar Quarters in accordance with good Petroleum industry practices and the Work Program established in accordance with Article 10. 11.12 Crude Oil shall be measured at the Measurement Point for purposes of the Contract and delivered to Georgian Oil and each Contractor Party who as owners shall take in kind, assume risk of loss and separately dispose of their respective entitlements of Cost Recovery Oil and Profit Oil. All Cost Recovery Natural Gas and Profit Natural Gas shall be sold on a jointly committed basis in accordance with Article 16 of this Contract. 11.13 For the avoidance of any doubt, title to their relevant shares of Petroleum shall pass from the State to Georgian Oil and each Contractor Party as appropriate at the Measurement Point. GBOC and GMJV have no title to any Petroleum. 11.14 Georgian Oil and Contractor shall agree on procedures for taking volumes of Crude Oil corresponding to their respective entitlements on a regular basis and in a manner that is appropriate having regard to the respective destinations and uses of the Crude Oil, all in accordance with the provisions of this Contract. If necessary Georgian Oil and Contractor will enter into a lifting agreement setting out the agreed procedures for taking volumes of Crude Oil, and such agreement shall comply with the principles of good international Petroleum industry practice. 11.15 In the event that in any Calendar Year Contractor's Cost Recovery Oil plus its Profit Oil exceeds fifty percent (50%) of the total Cost Recovery Oil plus Profit Oil, a volume of Crude Oil equivalent to that excess ("Excess Crude") shall be offered for sale to the State from Contractor's next available share of Crude Oil. 26 27 The State shall thereafter have the right for the next ten (10) days to elect to purchase all or a portion of the Excess Crude and take delivery, within twenty (20) days of the date of Contractor's offer at a price for the Crude Oil equal to the world market price for similar Crude Oil minus a discount of ten percent (10%). Purchases shall be made in U.S.$ and the world market price shall be calculated as set forth in Article 12. Payment shall be made on delivery at the Measurement Point. 11.16 Details of all Costs and Expenses approved by the Contractor and Georgian Oil will be provided to the State on a quarterly basis. ARTICLE 12 CRUDE OIL VALUATION 12.1 It is the intent of the Parties that the value of the Cost Recovery Petroleum shall reflect the prevailing international market price for Crude Oil from time to time in effect. For the purpose of determining the value of the Cost Recovery Petroleum taken and disposed of by the Parties and/or their assignees under this Contract during each Calendar Quarter, Georgian Oil and Contractor shall, prior to the date of Commercial Production, agree upon the basket of Crude Oils freely traded in international markets and referred to in subparagraph a) below and the value of the Cost Recovery Petroleum shall be adjusted to reflect the weighted average daily f.o.b. prices for term contract sales from Petroleum producing countries in international markets for the same Calendar Quarter of such basket of crude oils, it being understood that the following principles will apply: a) The weighted average of the basket shall be such that the average gravity of the basket and the average gravity of the Crude Oil produced under this Contract are equal; and b) The prices for individual referenced Crude Oil markers used within the basket shall be based upon the numerical average of a daily report of the actual price for each referenced Crude Oil marker as published in agreed internationally recognised publications; and c) Adjustment provisions will be incorporated into the basket formula to take account of transportation costs involved in Crude Oil produced under this Contract arriving at a designated sales point (where the sales point is not the Measurement Point) and to take account of gravity variation beyond a pre-agreed range; and 27 28 d) Unless agreed otherwise, the last calculated weighted average basket price shall serve as the provisional price for a Calendar Quarter until a new price is determined. 12.2 In the event that Georgian Oil and Contractor are unable to agree upon the basket of crude's envisaged in Article 12.1 above, or the principles relating thereto, then either Georgian Oil or Contractor may refer the question for a final, non-revisable determination by an independent expert designated by the UK Institute of Petroleum. Pending such determination, the price shall be as determined in Article 12.1d) above. 12.3 Natural Gas shall be valued at the actual revenues received less transportation, storage, treatment, processing, marketing, distribution, liquefaction and all other associated costs incurred by Contractor beyond the Measurement Point in supplying Natural Gas to customers beyond the Measurement Point. ARTICLE 13 ANCILLARY RIGHTS OF THE CONTRACTOR AND OPERATOR 13.1 In addition to the rights to carry out Petroleum Operations within the Contract Area the State and Georgian Oil shall provide or otherwise procure access to Contractor to all existing facilities and infrastructure in the Contract Area owned by or otherwise under the control of the State or Georgian Oil for the purpose of carrying out its Petroleum Operations during the term of the Contract. Such access shall be on terms as regards access and tariffs no less favourable than those offered to other persons or entities. 13.2 Provided that Georgian Oil nad the State are provided with copies of the following data the Contractor shall have the right to use, reproduce, reprocess and export all existing geoscience, engineering, environmental and geodetic data (including magnetic tapes and films) maps, surveys, reports, and studies it deems necessary to carry out Petroleum Operations hereunder including, but not limited to: magnetic surveys, seismic surveys, well logs and analysis, core analysis, well files, geologic and geophysical maps and reports, reservoir studies, reserve calculations, accurate geodetic coordinates for the location of all wells and seismic lines and all other pertinent data relative to the Contract Area. In the event that any data was to be sold to a Third Party by either Georgian Oil or the contractor the proceeds would be shared according to the share of the Profit Oil in accordance with Article 11. 13.3 The Contractor shall have the right within the Contract Area to conduct all geoscience, engineering, environmental and geodetic studies it deems necessary to carry out Petroleum Operations hereunder. 28 29 Said studies may include, but are not limited to: seismic surveys, magnetic surveys, global positioning surveys, aerial photography, and the collection of soil/water/oil/rock samples for scientific and environmental studies. Contractor shall be granted access to and/or permission to fly subject to obtaining appropriate consents (which will not be unreasonably withheld or delayed) over the Contract Area to conduct said studies. Contractor shall have the right to import equipment and supplies necessary to conduct said studies as well as the right to export data, film and samples to laboratories outside the State to conduct such studies. 13.4 Subject to (i) prior approval by the Coordination Committee; and (ii) prior consultation with any necessary local administration or State body and relevant landowners, the Contractor and/or Operator shall have the right to clear the land, to dig, pierce, drill, construct, erect, locate, supply, operate, manage and maintain pits, tanks, wells, trenches, excavations, dams, canals, water pipes, factories, reservoirs, basins, maritime storage facilities and such, primary distillation units, separating units for first oil extraction, sulphur factories and other Petroleum producing installations, as well as pipelines, pumping stations, generator units, power plants, high voltage lines, telephone, telegraph, radio and other means of communication (including satellite communication systems), plants, warehouses, offices, shelters, personnel housing, hospitals, schools, premises, ports, docks, harbours, dikes, jetties, dredges, breakwaters, underwater piers and other installations, ships, vehicles, railroads, road, bridges, ferry-boats, airlines, airports and other means of transportation, garages, hangers, workshops, foundries, maintenance and repair shops and all the auxiliary services which are necessary or useful to Petroleum Operations or related to them and, more generally, everything that is or could become necessary or accessory to carrying out the Petroleum Operations. 13.5 The agents, employees and personnel of both Contractor and Operator, their nominees or Subcontractors, may enter or leave the Contract Area and have free access, within the scope of their functions, to all installations put in place by the Contractor or Operator or otherwise utilised in Petroleum Operations. 13.6 Subject to prior consultation with any appropriate local State bodies the Contractor shall have the right to utilise the upper soil, mature timber, clay, sand, lime, gypsum and stones other than precious stones, and any other similar substances, necessary for the performance of Petroleum Operations. The Contractor may utilise the water necessary for Petroleum Operations, on condition that reasonable efforts are taken to minimise potentially adverse effects on irrigation and navigation, and that land, houses and the watering places are not adversely affected. All such operations shall be carried out in accordance with international Petroleum practices. 13.7 The Contractor shall have the right to use existing pipeline and terminal facilities belonging to or under the control of the State or Georgian Oil. The State and Georgian Oil shall assist in making these facilities available to the Contractor on terms with regard to access and tariffs that are no less 29 30 favourable than those available to others and shall in no event exceed five percent (5%) of the sales price of Crude Oil hereunder. 13.8 It is recognised by the Parties that in order to maximise the benefit of Petroleum Operations to the State, Georgian Oil and the Contractor, it is in the interests of the State to promote cooperation among Georgian and foreign enterprises carrying on Petroleum Operations in Georgia to share infrastructure in such a manner as to ensure efficient operation among themselves. The State and Georgian Oil hereby agree to secure access for the Contractor to any new or modernised pipelines or other infrastructure passing through Georgia which may be constructed or upgraded during the term of the Contract on terms with regard to access and tariffs as are no less favourable than those available to others including Georgia Oil and any other State body. These provisions shall apply to any new or upgraded pipeline through Georgia which may be constructed or modernised by or on behalf of the consortium responsible for the development of the Azerbaijan Sector of the Caspian Sea ("AIOC") whether or not in conjunction with the State and/or Georgian Oil, and in any agreement with AIOC or any entity connected therewith the State and/or Georgian Oil shall secure these benefits for the Contractor and Georgian Oil. The State and Georgian Oil will take all necessary steps to ensure that the Contractor is supplied with all necessary information (including copies of contracts ,invoices and accounts) to determine that the Contractor is being granted terms which are no less favourable than those available to others, including Georgian Oil. ARTICLE 14 ASSISTANCE PROVIDED BY THE STATE 14.1 To enable the Contractor to properly carry out the Petroleum Operations, the State shall have the obligation to assist the Contractor and Georgian Oil upon request to: a) provide the approvals or permits needed to conduct Petroleum Operations and to carry on associated business activities and to open bank accounts (for both local and foreign currency) in Georgia; b) arrange for Foreign Exchange to be converted in accordance with the principles set out in Article 19.7 of this Contract; c) use office space, office supplies, transportation and communication facilities and make arrangements for accommodations as required; d) assist with any custom formalities; 30 31 e) provide entry and exit visas and work permits for employees and their family members of Operator, Contractor, Contractor Parties, their Affiliates and Foreign Subcontractors, who are not citizens of Georgia, who come to Georgia for the implementation of the Contract and to provide assistance for their transportation, travel and medical facilities whilst in Georgia; f) provide necessary permissions to send abroad documents, data and samples for analysis or processing during the Petroleum Operations; g) contact and instruct appropriate departments and ministries of the State and any other bodies controlled by the State to do all things necessary to expedite Petroleum Operations; h) provide permits, approvals, and land rights requested by Contractor and/or Operator for the construction of bases, facilities and installations for use in conducting Petroleum Operations; and i) provide to the Contractor data and samples concerning the Contract Area other than those produced as a result of Petroleum Operations hereunder. ARTICLE 15 MEASUREMENT, QUALITY AND VALUATION OF PETROLEUM 15.1 All Petroleum produced, saved and not used in the Petroleum Operations in accordance with Article 11.3 shall be measured at the Measurement Point approved in the Development Plan. 15.2 The Measurement Point shall be at the end of the facilities for which the cost is included as a Cost and Expense which is recoverable from Cost Recovery Petroleum under the Contract. The Measurement Point shall be determined in accordance with the provisions set out in Article 9. 15.3 All Petroleum shall be measured in accordance with standards generally acceptable in the international Petroleum industry. All measurement equipment shall be installed, maintained and operated by Operator. Contractor and Georgian Oil shall be entitled periodically to inspect the measuring equipment installed and all charts and other measurement or test data at all reasonable times. The accuracy of measuring equipment shall be verified by tests at regular intervals and upon request by either Georgian Oil or the Contractor, using means and methods generally accepted in the international Petroleum industry. 31 32 15.4 Should a meter malfunction occur, Operator shall immediately have the meter repaired, adjusted and corrected and following such repairs, adjustment or correction shall have it tested or calibrated to establish its accuracy. Upon the discovery of metering error, Operator shall have the meter tested immediately and shall take the necessary steps to correct any error that may be discovered. 15.5 In the event a measuring error is discovered, Contractor shall use all reasonable efforts to determine the correct production figures for the period during which there was a measuring error and correct previously used readings. Contractor shall submit to the Coordination Committee a report on the corrections carried out. In determining the correction, Contractor shall use, where required, the information from other measurements made inside or outside the Development Area. If it proves impossible to determine when the measuring error first occurred, the commencement of the error shall be deemed to be the point in time halfway between the date of the last previous test and the date on which the existence of the measuring error was first discovered. 15.6 All measurements for all purposes in this Contract shall be adjusted to standard conditions of pressure at sea level and temperature at sixty degrees Fahrenheit (60 (degrees)F). ARTICLE 16 NATURAL GAS 16.1 Associated Natural Gas a) Associated Natural Gas produced within the Contract Area shall be used primarily for purposes related to the Production Operations and production enhancement including, without limitation, oil treating, gas injection, gas lifting and power generation. b) Based on the principle of full utilisation of the Associated Natural Gas and with no impediment to normal production of the Crude Oil, any Development Plan shall include a plan of utilisation of Associated Natural Gas. If there is any excess Associated Natural Gas remaining in any Oil Field after utilisation pursuant to Article 16.1.a) above (hereafter referred to as "Excess Associated Natural Gas"), the Contractor shall carry out a feasibility study regarding the commercial utilisation of such Excess Associated Natural Gas. i) If Georgian Oil and Contractor agree that Excess Associated Natural Gas has no commercial value, then such Natural Gas 32 33 shall be disposed of by the Operator through reinjection, venting, flaring or otherwise, provided that there is no impediment to normal production of the Crude Oil. ii) If Georgian Oil and Contractor agree that Excess Associated Natural Gas has commercial value, they will endeavour to enter into gas sales agreement(s) and/or other commercial and/or technical arrangements with Third Parties required to develop such Natural Gas. Investments in the facilities necessary for production, transportation and delivery of Excess Associated Natural Gas shall be made by the Contractor. The construction of facilities for such Production and utilisation of the Excess Associated Natural Gas shall be carried out at the same time as the Development Operations, or at any time as may be agreed to by the Parties. iii) If either Georgian Oil or Contractor considers that Excess Associated Natural Gas has commercial value while the other considers that Excess Associated Natural Gas has no commercial value, the one who considers Excess Associated Natural Gas to have commercial value may utilise such Excess Associated Natural Gas, at its own cost and expense and without impeding the Production of Crude Oil and without affecting the shares of Crude Oil and Natural Gas otherwise to be allocated under the other provisions of this Contract, but if such Excess Associated Natural Gas is not so utilised at any time or from time to time, then such Excess Associated Natural Gas shall be disposed of by the Operator, provided that there is no impediment to normal Production of the Crude Oil. c) The price of Associated Natural Gas produced from the Contract Area shall be determined by Georgian Oil and Contractor based on general pricing principles taking into consideration such factors as sales prices of internationally transported gas delivered in Western Europe, quality and quantity of the Associated Natural Gas (including the equivalent substitute energy value) and the economics of Development. Unless otherwise agreed, Georgian Oil and Contractor shall participate in all gas sales agreements entered into for the sale of Associated Natural Gas produced from the Contract Area in proportion to their Article 11 allocation rights. Gas sales prices shall be denominated in U.S.$. d) Investments made in conjunction with the utilisation of both Associated Natural Gas and Excess Associated Natural Gas, together with investments incurred after approval of a Development Plan in carrying out feasibility studies on the utilisation of Excess Associated Natural Gas, shall be charged to Operation Expenses. 33 34 16.2 Non-associated Natural Gas a) When any Non-associated Natural Gas is discovered within the Contract Area, Georgian Oil and Contractor shall implement a program regarding the Appraisal and possible development and marketing of the Non-associated Natural Gas in the domestic and international markets. This program shall include the following principles: i) After Non-associated Natural Gas has been discovered within the Contract Area, the Contractor shall present to the Coordination Committee, a report, including, without limitation, an initial estimate of the boundaries of the Non-associated Natural Gas reservoir and a range of recoverable reserves. ii) The decision period for commitment by Contractor to an Appraisal Program shall be as soon as is practical in all the circumstances but shall not be longer than thirty-six (36) months from the submission of the discovery report. During this decision period, the Coordination Committee will form a Marketing Team whose goal will be to conduct preliminary market studies and analyse the potential markets for the Non-associated Natural Gas. During this decision period, Contractor will report to the Coordination Committee at regular intervals on the progress and results of the technical evaluation of moving forward with an Appraisal Program. Within the said decision period, Contractor will make its election whether or not to commit to an Appraisal Program for the Non-associated Natural Gas. iii) If the Contractor commits to an Appraisal Program for the Non-associated Natural Gas reservoir, delineation and review of the potential of the Non-associated Natural Gas reservoir will continue for a period not longer than six (6) years from the submission of the discovery report. During the review and Appraisal periods, Contractor shall maintain all rights and interests in the relevant portion of the Contract Area. iv) The expenses incurred by the Contractor in carrying out the said review, evaluation and Appraisal Program and the expenses incurred by the Marketing Team representatives in conducting the preliminary market studies and analysing the markets for the Non-associated Natural Gas shall be charged to Operation Expenses and are recoverable from Cost Recovery Petroleum. 34 35 b) Following the completion of the Appraisal Program and review of the potential of the discovery, Contractor shall submit an appraisal report to the Coordination Committee. If the Coordination Committee decides that the Discovery is commercial, the Parties shall agree on a Development Plan. The Parties shall also endeavour to finalise Gas Sales Contract(s) and other agreements necessary for the commercialisation of such Non-associated Natural Gas. c) The price of the Non-associated Natural Gas produced from the Contract Area shall be determined based on general pricing principles, taking into consideration such factors as representative sales prices of internationally transported volumes delivered to distributors and end users in Western Europe, quality and quantity of the Natural Gas (including the equivalent substitute energy) and the economics of the Development of such Natural Gas. Unless otherwise agreed, Georgian Oil and Contractor shall participate in all Gas Sales Contracts entered into for the sale of Non-associated Natural Gas produced from the Contract Area in proportion to their Article 11 allocation rights. Sales contract prices shall be denominated in U.S.$. d) The production period of any Gas Field within the Contract Area shall be a period equal to the greater of the term of the Gas Sales Contract(s) or other commercial Natural Gas agreement for such Gas Field and twenty-five (25) consecutive years beginning on the date of commencement of Commercial Production in such Gas Field. If such period exceeds the maximum term of the Contract, the term of the Contract so far as it relates to such Gas Field shall extend until the end of such production period. Georgian Oil and Contractor shall endeavour to conclude Gas Sales Contract(s) and implement a Development Plan for each Gas Field to deplete such Field within its production period, subject always to the application of good international Petroleum industry development and operating practices. 16.3 Contractor may participate in the installation and operation of the pipeline(s) required to transport Natural Gas produced from the Contract Area to the market for such Natural Gas and share in any revenues generated from the use of said pipeline(s) by others. If Contractor participates in the installation and operation of such pipeline(s), the installation and operation of such pipeline(s) shall be included in a Development Plan and Petroleum Operations under this Contract. Any such investment shall be recoverable from Cost Recovery Petroleum. 16.4 If the State, any state-owned company or other entity, or Georgian Oil provides Natural Gas transportation services to Contractor, then the tariffs charged to Contractor for such services shall be non-discriminatory, reasonably based on the investment necessary to provide the transportation services and in no event will exceed charges made to other entities including Georgian Oil and other State bodies. The State and Georgian Oil will ensure that such 35 36 transportation services will be provided in a time frame that will not delay field development. ARTICLE 17 TAX/FISCAL REGIME 17.1 This Article shall apply to each Contractor Party individually. 17.2 Each Contractor Party, Foreign Subcontractor, GMJV, Foreign Employee and Operator shall be entitled to full and complete exemption from all Taxes prior to or after the Effective Date of this Contract except as otherwise provided for in this Contract. 17.3 It is acknowledged that Georgia may enter into Double Tax treaties which may have effect to give relief from Taxes to, but not limited to, Contractor, Contractor Parties, Foreign Subcontractors and Foreign Employees. 17.4 Each Contractor Party shall be subject to the Law of Georgia on Taxation of Enterprises, dated 21 December 1993 as enacted and in effect on the date of execution of this Contract, and as amended by the provisions of this Contract (the "Profit Tax"). Each Contractor Party having its head office or management in Georgia will be subject to the Profit Tax. Each Contractor Party not having its head office or management in Georgia but carrying out Petroleum Operations in the Contract Area will be subject to the Profit Tax. 17.5 Each Contractor Party shall be subject to the Profit Tax at a rate fixed for the duration of the Contract of ten percent (10%), for a Calendar Year on the taxable base defined in Article 17.8. 17.6 Georgian Oil (or its successors or assignees) shall assume, pay and discharge, in the name and on behalf of each Contractor Party, that Contractor Party's Profit Tax liability for a Calendar Year calculated in accordance with this Article 17 out of Georgian Oil's seventy percent (70%) share of Profit Oil and Profit Natural Gas for that Calendar Year. The Georgian Oil Profit Oil and Profit Natural Gas share as determined by Article 11 of this Contract will include an amount equal in value to all of the Contractor Parties' Profit Tax liabilities. 17.7 The obligation to assume, pay and discharge each Contractor Party's payment of Profit Tax (and only this tax) set out above by Georgian Oil in accordance with the provisions of Article 17.6 shall fulfil the entire tax liability of each Contractor Party. Except for the Profit Tax obligation described in this Article 17 the Contractor and the requirement to charge VAT on local sales (each Contractor Party) GMJV and Operator shall not be subject to any other Taxes, fees, bonuses, duties, levies, funds or similar types of payments of any nature imposed prior to the Effective Date, currently or in the future by the State or 36 37 any other Governmental entity or subdivision of the State including but not limited to Mineral Usage Tax, Enterprise Property Tax, VAT, Stamp Duty, Profit Repatriation Tax, Export Duty, Customs Duty, Freight Tax, Dividend Tax, Land Tax, natural resource levies, levies on special usage of subsurface resources, extraction based levies, land rental fees, charges and levies reimbursing the State or any other Governmental entity or subdivision of the State for the cost of geological prospecting work incurred by the State, fees for licences to conduct cartographic, geological or geophysical surveys, any tariff or similar fee on the transportation and export of Petroleum, any fee or payment related to the assignment of all or a portion of Contractor's or a Contractor Party's interest under this Contract. 17.8 The calculation of the taxable base (balance profit/(loss)) for each Contractor Party for a Calendar Year shall be as follows: a) The taxable base (balance profit/(loss))for each Contractor Party shall be determined as the total of each such Contractor Party's sales revenues from Cost Recovery Petroleum, Profit Oil and Profit Natural Gas acquired by that Contractor Party pursuant to Article 11 of this Contract reduced by, (i) the Contractor Party's sales revenues from Cost Recovery Petroleum and (ii) the Contractor Party's share of costs and the Contractor Party's own costs incurred during a Calendar Year in respect of Petroleum Operations which are not included in Costs and Expenses determining Cost Recovery Petroleum in Article 11 of this Contract and (iii) any loss calculated in accordance with Article 17.9 of this Contract. b) Sales revenues from Cost Recovery Petroleum shall be defined as the value of the volumes of Cost Recovery Petroleum, taken and disposed of by the Contractor Party and/or their assignees under this Contract during a Calendar Year and determined by applying the principles of valuation set out in Article 12 of this Contract. Sales revenues from Profit Oil and Profit Natural Gas shall be defined as the value of the volumes of Profit Oil and Profit Natural Gas taken and disposed of by the Contractor Party and/or their assignees under this Contract during a Calendar Year. Profit Oil volumes, other than Excess Crude sold to the State, and Profit Natural Gas volumes sold to Third Parties will be valued at the actual price received at the Measurement Point where actually sold at the Measurement Point. Where Profit Oil volumes are not sold at the Measurement Point, they shall be valued at the actual price received at the sales point less transportation and other associated costs incurred by the Contractor Party in transporting such Profit Oil from the Measurement Point to the actual sales point. The value of sales of Profit Oil and Profit Natural Gas to any Affiliate or sales involving barter will be determined by applying the principles of valuation as set out in Article 12 of this Contract. 37 38 Sales of Excess Crude by a Contractor Party to the State in accordance with Article 11.15 of this Contract will be valued at the world market price for similar Crude Oil minus a discount of ten percent (10%). c) For the purposes of this Article 17 and specifically for the purposes of calculating the taxable base of a Contractor Party in accordance with this Article 17.8 and Article 17.9, costs and expenses incurred directly or indirectly by a Contractor Party and its Affiliated Companies prior to the Effective Date of this Contract shall be deemed to have been incurred on the Effective Date of this Contract. d) For the purposes of calculating the taxable base of a Contractor Party in accordance with this Article 17.8 and Article 17.9, sales revenues related to Petroleum Operations and costs incurred in respect of Petroleum Operations shall be determined in U.S.$. Sales revenues in currency other than the U.S.$ and costs incurred in currency other than the U.S.$ shall be translated into U.S.$ in accordance with the principles set out in Article 19.11 of this Contract. 17.9 If in calculating the taxable base of a Contractor Party the total sum of deductions, represented by sales revenues from Cost Recovery Petroleum and costs incurred in respect of Petroleum Operations which are not included in Costs and Expenses in determining Cost Recovery Petroleum in Article 11 of this Contract, exceed sales revenues from Cost Recovery Petroleum, Profit Oil and Profit Natural Gas in any Calendar Year, the resulting loss (balance loss) may be carried forward by a Contractor Party to the following Calendar Year and to subsequent Calendar Years, one at a time in chronological order, and shall be deductible in full and without restriction in computing such Contractor Party's taxable base in such Calendar Year(s) until such time as the loss is wholly offset against such Contractor Party's taxable base. 17.10 Each Contractor Party shall maintain its tax books and records exclusively in U.S$ although a local currency equivalent (with conversion in accordance with the provisions of Article 19) shall also be prepared for information purposes only. The calculation of the taxable base for each Contractor Party in accordance with Article 17.8 of this Contract will be exclusively in U.S.$ and the calculation and the payment of the Profit Tax enumerated in this Article 17 shall be in U.S.$. 17.11 If a Contractor Party is a party to more than one production sharing contract (consortium) situated within Georgia and/or the Georgian continental shelf, for the purposes of calculating the Contractor Party's taxable base in accordance with Article 17.8 of this Contract the production sharing contracts in which the Contractor Party has a share may at the election of the Contractor Party be treated as if the production sharing contracts were one production sharing contract resulting in the Contractor Party's share of sales revenues and 38 39 deductions attributable to the production sharing contracts being consolidated for Profit Tax purposes. The Profit Tax return for each Contractor Party shall be prepared and submitted as follows: a. Each Contractor Party shall prepare a Profit Tax return in U.S.$ for each Calendar Year and submit it to Georgian Oil by 15 February following the Calendar Year, so that Georgian Oil can submit a Contractor Party's Profit Tax return to the Tax Inspectorate by 15 March following the Calendar Year. b. No other records or documentation shall be required to be submitted to the Tax Inspectorate at the time the Profit Tax return is submitted to the Tax Inspectorate or thereafter. Such records and documentation are to be made available to the Tax Inspectorate only during an audit by the Tax Inspectorate in accordance with Article 17.19 of this Contract c. The Profit Tax return for each Contractor Party for each Calendar Year shall set out in U.S.$ the calculation of the taxable base as described in Article 17.8 and the amount of the Profit Tax calculated on that taxable base. d. The Profit Tax return shall be prepared based on Contractor books and accounts of Petroleum Operations as described in Article 18 of this Contract which Contractor is required to maintain in U.S.$ in accordance with the Accounting Procedure attached hereto as Annex C. No books and records in addition to those specified by this Contract shall be required to be maintained by Contractor for any reason including but not limited to the calculation of Profit Tax and taxable base required by this Article 17. e. Only one (1) Profit Tax return shall be required to be prepared and submitted to the Tax Inspectorate for each Contractor Party for a Calendar Year. Only one (1) Profit Tax payment shall be required in respect of each Contractor Party's Profit Tax liability for a Calendar Year. No Profit Tax return or similar declaration and no Profit Tax payment whether estimated or actual shall be required in respect of a Calendar Quarter. 17.13 Proper official assessments of a Contractor Party's Profit Tax liability for each Calendar Year, and proper official receipts shall be issued by the proper tax authorities and shall state the date and amount and other particulars customary in Georgia for such receipts and the currency in which the Profit Tax was paid. 17.14 Georgian Oil shall furnish to each Contractor Party the proper official assessments and proper official receipts that evidence official payment by 39 40 Georgian Oil of that Contractor Party's Profit Tax liability for a Calendar Year by 15 April following the Calendar Year. 17.15 Georgian Oil shall not credit, directly or indirectly, Contractor Parties' Profit Tax payments against Georgian Oil's tax or any other payments to the Government or the treasury of Georgia required from Georgian Oil. However, Georgian Oil may deduct the payments of Contractor Parties Profit Tax for a Calendar Year in calculating Georgian Oil's tax liability for that Calendar Year. 17.16 Georgian Oil shall assume, pay and discharge any penalties, interest, fines or similar levies for late payment of a Contractor Party's Profit Tax liability in respect of any Calendar Year. 17.17 The filing of the Profit Tax return and the payment of Profit Tax for a Calendar Year will be considered the final settlement of all Profit Tax liabilities for a Contractor Party for that Calendar Year upon the date thirty-six (36) months from the date the Profit Tax return for such Calendar Year was filed. 17.18 The State will notify each Contractor Party within one (1) month of the Effective Date of this Contract of the tax inspectorate office ("the Tax Inspectorate") which is to be located in Tbilisi and be responsible for and administer the implementation of the provisions of this Contract including but not limited to the filing of a Contractor Party's Profit Tax return for each Calendar Year, the issuing of official assessments and receipts evidencing the payment of each Contractor Party's Profit Tax liability, any audit in respect of any Calendar Year of a Contractor Party's Profit Tax return and any other payment, liability or procedures in respect of any other Taxes. 17.19 The Tax Inspectorate shall have the following rights of audit in respect of a Contractor Party's Profit Tax return: a) The Tax Inspectorate shall have the authority to conduct an audit of each Contractor Party's Profit Tax return for each Calendar Year. b) In conducting such an audit the Tax Inspectorate shall only be entitled to examine the Contractor books and accounts of Petroleum Operations which the Contractor is required to maintain as described in Article 18 of this Contract in U.S.$ in accordance with the Accounting Procedure attached hereto as Annex C except in circumstances where the Tax Inspectorate has reasonable grounds to suspect fraud or non disclosure of required information. c) The Tax Inspectorate shall be bound by the documentation requirements specified in the Accounting Procedure and shall not be entitled to request from any Party or the Operator any documentation in addition to that documentation 40 41 to support the calculation of the taxable base which is required for each Contractor Party for each Calendar Year under this Article 17 except in circumstances where the Tax Inspectorate has reasonable grounds to suspect fraud or non disclosure of required information. d) Costs and Expenses for the purposes of determining Cost Recovery Petroleum are defined in Article 11 of this Contract. The Tax Inspectorate shall be bound by the provisions of Article 11 of this Contract and shall have no right to challenge the Costs and Expenses which a Contractor Party is entitled to recover from Petroleum. e) Upon completing such an audit, the Tax Inspectorate shall discuss any proposed adjustments with the Contractor Party and, where appropriate, issue a notice of additional Profit Tax due or a notice of refund. If the Contractor Party and the Tax Inspectorate are unable to agree upon the amount of Profit Tax underpaid or overpaid, the issue shall be resolved in accordance with the dispute resolution procedures contained in Article 30 of this Contract. 17.20 If as a result of an audit by the Tax Inspectorate a final determination is made either that an underpayment or overpayment of Profit Tax has occurred in respect of a Calendar Year, such underpayment or overpayment will be subject to interest at a rate of LIBOR plus four (4) percent calculated from 15 March in the Calendar Year the Profit Tax return was filed until the date of payment or refund of the Profit Tax. 17.21 Employees of the Contractor, Contractor Parties, their Affiliates and Subcontractors, and those employees assigned by Contractor to Operator who are not citizens of Georgia ("Foreign Employees") shall be liable to Georgian personal income tax imposed by the State only on their income earned as a direct result of their employment in Georgia and only if the Foreign Employee is present in Georgia for a period or periods exceeding in the aggregate one hundred and eighty-three (183) days in any Calendar Year. A Foreign Employee will continue to be subject to the provisions of any applicable Double Tax Treaty. 17.22 Foreign Employees who perform work in Georgia and their employers that would otherwise be covered by and subject to social insurance, pension fund contributions and similar payments under the social security system of Georgia will be exempt from those payments. 17.23 The only Taxes, duties, fees or other charges to be levied by the State or by any other Governmental entity on a Foreign Subcontractor in connection with Petroleum Operations pursuant to this Contract shall be a tax to be withheld by any person or other legal entity making payments to a Foreign Subcontractor in the currency in which the payment is made (the "Withhold Tax"). The Withhold Tax shall be calculated and will apply as follows: a) The Withhold Tax will be calculated at a fixed rate of twenty (20) percent, on the taxable profit of a Foreign Subcontractor defined in this 41 42 Article 17.23. The taxable profit of a Foreign Subcontractor will be deemed to be equal to twenty (20) percent of any payments received by a Foreign Subcontractor in respect of work and/or services undertaken in Georgia in connection with Petroleum Operations pursuant to this Contract resulting in a total tax of four (4) percent to be withheld from such payments. b) Any person or other legal entity making payments to a Foreign Subcontractor must pay the Withhold Tax to the Tax Inspectorate within thirty (30) days from the date of payment of the Foreign Subcontractor. The Tax Inspectorate shall issue the person or other legal entity making the payment with proper official receipts in the name of the Foreign Subcontractor within fifteen (15) days of the payment of the Withhold Tax that evidence the payment of the Withhold Tax stating the date, the amount, the currency in which it was paid and other particulars customary for such receipts. c) In the event that such Withhold Tax is paid late the person responsible for paying the Withhold Tax to the Tax Inspectorate shall be subject to interest at a rate of LIBOR plus four (4) percent calculated from the latest date that the Withhold Tax should have been paid to the Tax Inspectorate. No fines, penalties or similar levies will be payable in respect of any late payment. d) A Foreign Subcontractor will have no requirement to file a tax return or any other similar declaration, the payment of the Withhold Tax will satisfy all such requirements and obligations. e) A Foreign Subcontractor will continue to be subject to the provisions of any applicable Double Tax Treaty. 17.24 VAT shall be imposed as follows: a) Goods, works and services supplied directly or indirectly to or by a Contractor Party or its Affiliates, Operator or a Foreign Subcontractor for the purpose of Petroleum Operations shall be exempt from VAT with credit (zero per cent rate)., save that the customer shall charge VAT ( at the then current rate but not exceeding twenty, (20) per cent ) on Petroleum sold locally within Georgia which is not intended for export in circumstances in which the purchaser is a Georgian national or Georgian entity ( "Local Sales" ). Contractor shall be entitled to a refund of VAT within five business days of the submission of its monthly VAT declarations to the Tax Inspectorate equal to the US$ equivalent of VAT charged on Local Sales. For the purposes of these declarations the refund due to the Contractor will be calculated using the VAT charged and/or paid on a monthly basis. If a full VAT refund is not paid within five days as specified above, Contractor shall be entitled to 42 43 recover the relevant amount as Costs and Expenses in accordance with the provisions of Article 11. b) All imports including but not limited to goods, equipment, works, services, loans and other forms of financing acquired by a Contractor Party or its Affiliates, Operator, their Subcontractors or their agents for the purpose of Petroleum Operations shall be exempt from VAT with credit (zero per cent rate). c) Import and re-export of goods for personal use by Foreign Employees and family members will be subject to VAT at a rate of zero per cent (0%). d) Exports of Petroleum by each Contractor Party or its agents shall be exempt from VAT with credit (zero per cent rate). e) Excess Crude sold by a Contractor Party to the State in accordance with the provisions of Article 11.15 of this Contract shall be exempt from VAT with credit (zero percent rate). f) All re-exports by a Contractor Party or its Affiliates, Operator, Subcontractors or their agents of goods, works and services supplied for the purposes of Petroleum Operations including but not limited to re-export of goods temporarily imported into Georgia for the purposes of Petroleum Operations shall be exempt from VAT with credit (zero per cent rate). g) Any goods, works and services supplied to or by and any imports of goods, works and services acquired directly or indirectly by a Contractor Party and its Affiliated Companies, Operator, Foreign Subcontractors or their agents for the purpose of Petroleum Operations prior to the Effective Date of this Contract shall be deemed for the purposes of this Article to be supplied or acquired on the Effective Date of this Contract. h) The Tax Inspectorate shall provide each Contractor Party and its Affiliates, Operator, Foreign Subcontractors and their agents with certificates confirming the exemptions and/or VAT zero percent (0%) rate provided in this Contract within twenty (20) days of the Contractor Party requesting such a certificate. 17.25 Each Contractor Party and its Affiliates and Operator shall have no liability or responsibility for any Taxes which its Subcontractors or their agents do not pay or for any other failure of such Subcontractors or their agents to comply with the laws of Georgia. 43 44 ARTICLE 18 ACCOUNTING, FINANCIAL REPORTING AND AUDIT 18.1 Contractor shall maintain books and accounts of Petroleum Operations in accordance with the Accounting Procedure attached hereto as Annex C. These shall be maintained in U.S.$ in accordance with generally accepted international Petroleum industry accounting principles. All books and accounts which are made available to Georgian Oil in accordance with the provisions of the Accounting Procedure shall be prepared both in the Georgian and English languages. 18.2 The Accounting Procedure specifies the procedure to be used to verify and establish promptly and finally Contractor's Costs and Expenses under Article 11 of this Contract. 18.3 Sales revenues, expenditures, financial results, tax liabilities, and loss carry-forwards of each Contractor Party shall be determined in accordance with the rules, rights, and obligations set forth in this Contract in so far as such sales revenues, expenditures, financial results, tax liabilities, and loss carry-forwards are related to Petroleum Operations under this Contract. 18.4 To the extent that Georgian Oil incurs Costs and Expenses which are recoverable from Cost Recovery Petroleum in accordance with Article 11, Georgian Oil shall maintain separate books and accounts. These books and accounts shall be maintained in U.S.$, in the Georgian language and the English language and shall be in accordance with generally accepted international Petroleum industry accounting principles. Prior to Georgian Oil commencing to incur Costs and Expenses an accounting procedure which establishes the method for accounting for Georgian Oil's participation in the funding of Petroleum Operations shall be agreed and approved by Contractor. The Contractor shall have the right to audit the books and accounts maintained by Georgian Oil. ARTICLE 19 CURRENCY, PAYMENTS AND EXCHANGE CONTROL 19.1 Contractor and each Contractor Party, and their Affiliates, Subcontractors and Operator shall have the right to open, maintain, and operate Foreign Exchange 44 45 bank accounts both in and outside of Georgia and local currency bank accounts inside Georgia. 19.2 Contractor and each Contractor Party, and their Affiliates and Foreign Subcontractors shall have the right to transfer all funds received in or converted to Foreign Exchange in Georgia to bank accounts outside Georgia without payment of any Taxes, Governmental fee, duty or other such impost for the right to effect such transfer of funds. 19.3 Contractor and each Contractor Party, and their Affiliates and Foreign Subcontractors shall have the right to hold, receive and retain outside Georgia and freely use all funds received and derived directly or indirectly from Petroleum Operations by them outside Georgia without any obligation to repatriate or return the funds to Georgia, including but not limited to all payments received from export sales of Contractor Parties' share of Petroleum and any sales proceeds from an assignment of their interest in this Contract. 19.4 Contractor and each Contractor Party, and their Affiliates, Foreign Subcontractors and Operator shall be exempt from all legally required or mandatory conversions of Foreign Exchange into local or other currency. Notwithstanding the provisions of this Article 19.4 the Contractor and each Contractor Party and Operator will pay citizens of Georgia and Georgian Subcontractors engaged by them in Petroleum Operations in local currency for so long as this is a requirement of the law of Georgia. 19.5 Contractor and each Contractor Party, and their Affiliates, Foreign Subcontractors and Operator have the right to import into Georgia funds required for Petroleum Operations under this Contract in Foreign Exchange. 19.6 Contractor and each Contractor Party, and their Affiliates and Foreign Subcontractors shall have the right to pay outside of Georgia for goods, works and services of whatever nature in connection with the conduct of Petroleum Operations under this Contract without having first to transfer to Georgia the funds for such payments. 19.7 Whenever such a need arises Contractor and each Contractor Party and their Affiliates, Foreign Subcontractors and Operator shall be entitled to purchase local currency with Foreign Exchange and covert local currency into Foreign Exchange at the most favourable exchange rate legally available and in any event at an exchange rate which shall be no less beneficial than that granted to other foreign investors by the National Bank of Georgia, without deductions or fees other than usual and customary banking charges. 19.8 Contractor and each Contractor Party, and their Affiliates and Foreign Subcontractors shall have the right to pay outside Georgia principal and interest on loans used for funding Petroleum Operations without having to first transfer to Georgia the funds for such payment. 45 46 19.9 Contractor and each Contractor Party and their Affiliates, Foreign Subcontractors and Operator shall have the right to pay, wages, salaries, allowances and benefits of their foreign personnel working in Georgia in Foreign Exchange partly or wholly outside Georgia. 19.10 Contractor and each Contractor Party, and their Affiliates shall have the right to pay their Foreign Subcontractors working on Petroleum Operations in Georgia in Foreign Exchange partly or wholly outside Georgia. 19.11 Conversions of currency shall be recorded at the rate actually experienced in that conversion. Expenditures and sales revenues in currency other than the U.S.$ shall be translated to U.S.$ at the official rates as posted by the National Bank of Georgia at the close of business on the first business day of the current month until such times as the relevant exchange rates being the arithmetic average of the buying and selling rates at the close of business on the first business day of then current month are published by "The Wall Street Journal", or if not published by "The Wall Street Journal", then by the "Financial Times" of London. ARTICLE 20 IMPORT AND EXPORT 20.1 Contractor, each Contractor Party and Affiliates and their agents and Subcontractors and Operator shall have the right to import and re-export from Georgia free of any Taxes and restrictions including but not limited to VAT and Customs Duties in their own name materials, equipment, machinery and tools, vehicles, spare parts, foodstuffs, goods and supplies necessary in the Contractor's opinion for the proper conduct and achievement of Petroleum Operations including but not limited to Exploration, exploitation, Appraisal, Development, Production, transportation, storage and marketing. 20.2 Contractor, each Contractor Party and Affiliates, their agents and Subcontractors shall have the right to sell any materials or equipment or goods which were used in Petroleum Operations without paying Customs Duties provided that such items are no longer needed for Petroleum Operations and the costs of such items have not been and are not intended to be included as Costs and Expenses recoverable from Cost Recovery Petroleum. 20.3 Contractor, each Contractor Party, their customers and their carriers shall have the right to freely export, free of all Taxes including but not limited to Customs Duties and at any time, the share of Petroleum to which the Contractor and each Contractor Party is entitled in accordance with the provisions of this Contract. 46 47 20.4 Petroleum to which the Contractor Parties are entitled to in accordance with the provisions of this Contract shall not be subject to any requirements imposed currently or in the future by the State or any other Governmental entity or subdivision of the State as to export quotas or export licences or any other similar requirements. The provisions of this Article 20.4 shall not apply to Excess Crude which the State elects to purchase in accordance with Article 11.15 of this Contract. 20.5 All copies of original records and data and representative portions of all samples or information prepared or obtained by the Contractor Parties and Affiliates and their Subcontractors with regard to activities under this Contract which is exported for use thereof by the Contractor Parties including but not limited to processing, analysing or studying shall be exempt from any requirements imposed currently or in the future by the State or any other Governmental entity or subdivision of the State as to export licences, any restrictions on export and Customs Duties, Taxes or other export charges with respect to such data and information. 20.6 The Contractor Parties shall be exempt from any obligatory registration existing currently or in the future in Georgia as exporters of Petroleum. 20.7 Foreign Employees and family members of Contractor and its Affiliates, its agents and Foreign Subcontractors, shall have the right to import into and re-export from Georgia, free of Taxes, Customs Duties and restrictions at any time, all foodstuff, furniture, clothing, household appliances, vehicles, spare parts and all personal effects for personal use by the Foreign Employees and family members assigned to work in, or travel to, Georgia. ARTICLE 21 EXPORT OF HYDROCARBONS, TRANSFER OF OWNERSHIP, AND REGULATIONS FOR DISPOSAL 21.1 The Contractor, Contractor Parties, any purchaser from such parties and their respective carriers shall, for the duration of this Contract, have the unrestricted right to export from any export point selected by the Contractor for such purpose, the share of Petroleum to which the Contractor is entitled under this Contract provided that access to such export point is not restricted generally on the grounds of safety or national security. Access to export points shall be given to the above parties on a non discriminatory basis and at rates no less favourable than those granted to others by the State or Georgian Oil. 21.2 The transfer of title to each Contractor Party and Georgian Oil of its share of Petroleum shall be effective upon the lifting of that share by such Party at the Measurement Point or, at the Parties' option, at some other point. 47 48 21.3 The Contractor and Georgian Oil shall each be entitled to designate (at their own cost) an employee, independent company or consultant who shall check the liftings of Petroleum from the Measurement Point or at such other point as may be designated in accordance with Article 21.2. 21.4 If one of the Parties is unable to lift its share of Petroleum in due time, with the result that Petroleum Operations may be interfered with or in any way disrupted, then after giving such notice as is practical in the circumstances any other Party may dispose of it, and subsequently give back to such Party an equivalent amount of Petroleum (taking into account any costs incurred). ARTICLE 22 OWNERSHIP OF ASSETS 22.1 Ownership of any asset, whether fixed or moveable, acquired by or on behalf of Contractor in connection with Petroleum Operations hereunder shall vest in Georgian Oil without consideration when both the costs of such asset have been recovered by Contractor under this Contract and either the Contract has come to an end or, if earlier, when the asset is no longer required for Petroleum Operations by the Contractor. The Contractor shall enjoy continued free, exclusive and unrestricted use of all assets at no cost or loss of benefit to the Contractor until the termination of this Contract or if earlier until they are no longer required for Petroleum Operations. The Contractor shall bear the custody and maintenance of such assets and all risks of accidental loss or damage thereto, until ownership transfers to Georgian Oil, provided however that all costs necessary to operate, maintain and repair such assets and to replace or repair any damage or loss shall be recoverable as Operation Expenses from Cost Recovery Petroleum in accordance with the provisions of Article 11. 22.2 Whenever Contractor relinquishes any part of the Contract Area, all moveable property located within the portion of the Contract Area so relinquished may be removed to any part of the Contract Area that has been retained for use in Petroleum Operations. 22.3 The provisions of Article 22.1 and 22.2 shall not apply to materials or other property that are rented or leased to Contractor, its Affiliates or Operator or which belong to employees of Contractor, its Affiliates or Operator. 48 49 ARTICLE 23 INSURANCE 23.1 Contractor shall obtain and maintain such types and amounts of insurance for the Petroleum Operations as are reasonable and such that they comply with accepted international Petroleum industry practice and standards. 23.2 The insurance which may be obtained may cover : a) destruction and damage to any property held for use during Petroleum Operations and classified as fixed capital and/or leased or rented property and/or interests in pipelines operated by the Contractor; b) destruction of Crude Oil in storage; c) liability to Third Parties; d) liability for pollution and expenses for cleaning up in the course of Drilling and Production Operations; e) expenses for wild well control; f) liability incurred by the Contractor in hiring land drilling rigs, vessels and aircraft serving the Petroleum Operations; and g) losses and expenses incurred during the transportation and storage in transit of goods shipped from areas outside the Contract Area. 23.3 In any insurance contracts, the amount for which the Contractor itself is liable (the "deductible amount") shall be reasonably determined between the Contractor and the insurer and such deductible amount shall in the event of any insurance claim be considered as Costs and Expenses of Petroleum Operations recoverable from Cost Recovery Petroleum. 23.4 It is understood that, in order to meet their insurance obligations, insurance providers used by Contractor may conclude reinsurance and co-insurance agreements with any other insurance enterprises and organisations. 49 50 ARTICLE 24 PERSONNEL 24.1 Contractor shall be entitled to bring foreign personnel into Georgia in connection with the performance of Petroleum Operations. The entry into Georgia of such personnel is hereby authorised, and the State shall issue at the Contractor's request the required documents, such as entry and exit visas, work permits and residence cards. At Contractor's request, the State shall facilitate all immigration formalities at the points of exit and entry into Georgia for the employees and family members of the Contractor, its Affiliates, Subcontractors, Operator, agents and brokers. The Contractor (or Operator on its behalf) shall contact the appropriate offices of the State to secure the necessary documents, and to satisfy the required formalities. 24.2 The employees working within the scope of Petroleum Operations shall be placed under the authority of the Contractor, its Affiliates, its Subcontractors, agents or brokers or the Operator each of which shall act individually in their capacity as employers. The works, hours, wages, and all other conditions relating to their employment shall be determined by the relevant employer of such employees. In relation to employees who are citizens of Georgia their employment shall be in accordance with Georgian law. To the extent that any expatriate personnel are engaged under a contract subject to Georgian law, that contract shall comply with the provisions of Georgian law. The Contractor, its Affiliates, its Subcontractors, agents or brokers however, shall enjoy full freedom in the selection and assignment of their employees. ARTICLE 25 FORCE MAJEURE 25.1 If as a result of Force Majeure, Contractor is rendered unable, wholly or in part, to carry out its obligations under this Contract, other than the obligation to pay any amounts due, then the obligations of Contractor, so far as and to the extent that the obligations are affected by such Force Majeure, shall be suspended during the continuance of any inability so caused, but for no longer period. Contractor shall notify the Parties of the Force Majeure situation within seven (7) days of becoming aware of the circumstances relied upon and shall keep Georgian Oil informed of all significant developments. Such notice shall give reasonably full particulars of the said Force Majeure, and also estimate the period of time which Contractor will probably require to remedy the Force Majeure. Contractor shall use all reasonable diligence to remove or 50 51 overcome the Force Majeure situation as quickly as possible in an economic manner. The period of any such non performance or delay, together with such period as may be necessary for the restoration of any damage done during such delay, shall be added to the time given in this Contract for the performance of any obligation dependent thereon (and the continuation of any right granted) and to the term of this Contract. 25.2 For the purposes of this Contract, "Force Majeure" shall mean a circumstance which is irresistible or beyond the reasonable control of Contractor, any act of the State, or Georgian Oil or any other hindrance of Contractor's performance not due to its fault or negligence. ARTICLE 26 ASSIGNMENTS AND GUARANTEES 26.1 No assignment, mortgage or charge or other encumbrance shall be made by a Party of its rights obligations and interests arising under this Contract other than in accordance with the provisions of this Article 26. Any purported assignment made in breach of the provisions of this Article 26 shall be null and void. In relation to Georgian Oil (or any successor of Georgian Oil as the designated representative of the State) any transfer (whether directly or indirectly ) of any equity or control with the result or effect that Georgian Oil or any successor to the rights and interests of Georgian Oil ceases to be wholly owned or controlled by the State shall be deemed to be an assignment under this Contract which must comply with the provisions hereof. 26.2 Save in the case of any assignment made pursuant to the provisions of Articles 26.3, 26.5 and 26.6 the following shall apply. Any Party wishing to assign all or part of its rights and interests hereunder or in any circumstances where there is deemed to be an assignment, the Party wishing to make the assignment shall first give written notice to the other Parties specifying the proposed terms and conditions of the assignment. Following receipt of those terms and conditions, for a period of thirty (30) days each Party shall have the preferential right to match the terms and conditions of the proposed assignment or deemed assignment. This right may be exercised by any Party giving written notice of its intention to match the relevant terms and conditions (the "Acceptance") and thereafter the relevant Parties shall negotiate all necessary documentation in good faith. If within a further period of ninety (90) days from receipt of the Acceptance the relevant parties have not reached final agreement the Party seeking to assign may within a further period of thirty (30) days complete an assignment to a Third Party on the same terms and conditions. For the avoidance of doubt any assignment to a Third Party shall be subject to the assigning Party and the Third Party complying with the provisions of this Article 26. 51 52 26.3 A Contractor Party may assign all or part of its rights, obligations and interests arising from this Contract to another Contractor Party or to an Affiliate without the prior consent of the State or Georgian Oil provided that any such Affiliate: a) has the technical and financial ability to perform the obligations to be assumed by it under the Contract; and b) as to the interest assigned to it, accepts and assumes all of the terms and conditions of the Contract. Any such assignment shall be subject to the prior written consent of the State (which may be represented by Georgian Oil for so long as the state has nay interest in Georgian Oil) which consent shall not be unreasonably withheld or delayed. If within thirty (30) days following notification of an intended assignment accompanied by a copy of the deed of assignment and related documentation the State has not given its decision such assignment shall be deemed to have been approved by the State. It is agreed that JKX may transfer part of its rights and obligations under this Contract to Makoil Inc. (or any Affiliate of that company) without the need to receive the prior consent of the State or the need to comply with the provisions of Article 26.2. The Contractor will notify Georgian Oil prior to any such transfer taking place. 26.4 A Contractor Party may assign all or part of its rights, obligations and interests arising from this Contract to an Affiliate without the prior consent of the State of Georgian Oil provided that any such Affiliate: a) has the technical and financial ability to perform the obligations to be assumed by it under the Contract; and b) as to the interest assigned to it, accepts and assumes all of the terms and conditions of the Contract. JKX shall give notice to Georgian Oil prior to any assignment under this Article 26.4. 26.5 Each reference in this Contract to the Contractor shall be treated as including each assignee to which an assignment has been made by the Contractor pursuant to this Article 26. Each reference in this Contract to Georgian Oil shall be treated as including each assignee to which an assignment has been made by Georgian Oil pursuant to this Article 26 provided the Contractor has the prior consent of Georgian Oil (not to be unreasonably withheld) the Contractor and its assignees shall not be restricted in any way and shall not be required to obtain consent for any pledge or assignment of their respective interests in this Contract or any Petroleum Operations undertaken pursuant hereto to any bank, lender or other person providing financing in connection with this Contract or such Petroleum Operations and if such bank, lender or other person shall foreclose upon such interest pledged or assigned, 52 53 such bank, lender or person shall become entitled to the rights of an assignee hereunder. 26.6 Georgian Oil may assign all or part of its rights, obligations and interests arising from this Contract (including all or part of its right to lift a share of Profit Oil) to a wholly owned Affiliate with the prior consent of the Contractor provided that any such Affiliate: a) has the technical and financial ability to perform the obligations to be assumed by it under the Contract; and b) as to the interest assigned to it, accepts and assumes all of the terms and conditions of the Contract. 26.7 Georgian Oil may assign all or part of its rights, obligations and interests arising from this Contract (including all or part of its right to lift its share of Profit Oil) to a Third Party provided that any such Third Party: a) has the technical and financial ability to perform the obligations to be assumed by it under the Contract; and b) as to the interest assigned to it, accepts and assumes all of the terms and conditions of the Contract; c) agrees in writing to the funding and financing obligations set out in this Article 26. Any such assignment shall be subject to the prior written consent of the Contractor which consent shall not be unreasonably withheld or delayed. Any consent may be given subject to the conditions and further documentation appearing below. If within thirty (30) days following notification of an intended assignment accompanied by a copy of the deed of assignment and related documentation the Contractor has not given its decision such assignment shall be deemed to have been approved by the Contractor. In the event that the proposed assignee is not a company or entity wholly owned by the State (as determined by the Contractor acting properly and reasonably) then any assignment shall be subject to that assignee assuming its proportionate future share of financing Petroleum Operations as if it was a Contractor Party and paying to the existing Contractor Parties its proportionate share of Costs and Expenses which have not been recovered from Cost Recovery Petroleum as at the date of the proposed assignment in each case as if it was a Contractor Party. The consent of the Contractor shall be subject to the proposed assignee executing a deed of adherence in terms satisfactory to the Contractor agreeing to be bound by the terms of the Contract as amended 53 54 by the terms of this Article 26 including an agreement to meet its funding obligations hereunder. For the avoidance of doubt the proportionate future share of financing Petroleum Operations and the proportionate share of unrecovered Costs and Expenses to be met by any assignee shall include both an amount equal to the proposed participating interest of the assignee in this Contract and a proportionate share of any part of the State's (or Georgian Oil's) carried interest being met by the Contractor. 26.8 In the event that a Third Party which is not an entity wholly owned by the State (as determined by the Contractor acting properly and reasonably) acquires a direct or indirect equity interest in Georgian Oil (or any holding or subsidiary company of Georgian Oil or any other entity holding all or any of the State's interest hereunder) giving that Third Party a direct or indirect interest in the rights hereunder then Georgian Oil (or any such holding or subsidiary company of Georgian Oil or other entity holding all or any of the State's interest hereunder) will assume its proportionate future share of funding obligations as if it was a Contractor Party and shall pay to the existing Contractor Parties its proportionate share of Costs and Expenses which have not been recovered from Cost Recovery Petroleum as at the date on which the Third Party acquires the direct or indirect interest in the rights hereunder. Before the State and/or Georgian Oil allows any Third Party to acquire a direct or indirect interest in Georgian Oil (or any holding company or subsidiary company of Georgian Oil or any entity holding all or any of the State's interest hereunder) the prior written consent of the Contractor will be required, such consent not to be unreasonably withheld or delayed. The consent of the Contractor may be given subject to Georgian Oil (or any holding or subsidiary company of Georgian Oil or any other entity holding all or part of the interests of the State hereunder) or such Third Party acquiring the interest executing a deed of adherence in terms satisfactory to the Contractor agreeing to be bound by the terms of the Contract as amended by the terms of this Article 26 including an agreement to meet its funding obligations hereunder. For the avoidance of doubt the proportionate future share of financing Petroleum Operations and unrecovered Costs and Expenses to be met by Georgian Oil (or any holding or subsidiary company of Georgian Oil or any other entity holding all or any of the interests of the State) or such Third Party shall include both an amount representing the direct or indirect interest of the Third Party as if the direct or indirect interest acquired by the Third Party was treated as the participating interest of a Contractor Party and a proportionate share of any part of the State's (or Georgian Oil's) carried interest being met by the Contractor. 26.9 The provisions of Article 26.8 will not apply to the transfer of a direct or indirect equity interest in Georgian Oil of up to 25% of the total equity to the employees or former employees of Georgian Oil should any such transfer be made as part of a privatisation programme. 26.10 In the event of there being any proposed assignment in accordance with the terms of this Article 26 then to the extent of the interest assigned the assignor 54 55 shall be released from all further obligations and liabilities arising under the Contract after the effective date of the assignment. The assignee shall thereafter be liable for the obligations arising from such interest in the Contract except to the extent provided in the Contract. 26.11 No Taxes, fees or other charges shall be payable to the State or to Georgian Oil as a consequence of or prior to any assignment. 26.12 To the extent that either Georgian Oil or any Third Party is obliged to pay its proportionate share of funding future Petroleum Operations and unrecovered Costs and Expenses the proportionate share of the Contractor (and any other party then responsible for funding Petroleum Operations) shall be reduced proportionally so that should the State at any time cease to have any interest in Georgian Oil (or any successor to Georgian Oil as the State's representative) or any participating interest in this Contract, the Contractor shall only be obliged to fund thirty percent (30%) of Petroleum Operations (or such other figure as represents its then participating interest hereunder). ARTICLE 27 CONTRACT ENFORCEMENT AND STABILISATION, AND REPRESENTATIONS AND WARRANTIES 27.1 In the course of performing the Petroleum Operations, the Operator and the Parties shall be subject to all applicable laws, decrees, rules and regulations of the State to the extent that such laws and regulations are not inconsistent with or detract from, lessen or otherwise interfere with the provisions of this Contract. 27.2 The State agrees and commits to Contractor, for the duration of this Contract, to maintain the stability of the legal, tax, financial, mining, customs and economic conditions of this Contract. 27.3 The Parties agree to cooperate in every possible way in order to achieve the objectives of this Contract. The State and its subdivisions shall facilitate the exercise of Contractor's activities by granting it all decrees, permits, resolutions, licenses and access rights and making available to it all appropriate existing facilities and services under the direct or indirect control of the State or Georgian Oil so that the Parties may derive the greatest benefit from Petroleum Operations for their own benefit and for the benefit of Georgia. 27.4 If at any time after this Contract has been signed there is a change in the applicable laws, regulations or other provisions effective within Georgia which 55 56 to a material degree adversely affect the economic position of the Contractor or any Contractor Party hereunder, the terms and conditions of this Contract shall be altered so as to restore the Contractor to the same overall economic position as that which the Contractor would have been in had this Contract been given full force and effect without amendment as is stipulated in accordance with Article 27.5 27.5 To the extent that the Contractor's overall economic position is not restored through mutually agreed changes to the terms and conditions of this Contract the State shall fully indemnify the Contractor against such economic effects through payment of financial compensation or other means acceptable to the Contractor. 27.6 If the Contractor believes that its economic position has been adversely affected as provided in Articles 27.4 and 27.5 it may give notice to the State and to Georgian Oil describing how its position has been so affected and the Parties shall thereafter promptly meet with a view to reaching agreement on the remedial action to be taken. If matters have not been resolved within 90 days the matter may be referred to arbitration by any Party in accordance with the provisions of Article 30. 27.7 The State hereby represents and warrants to the Contractor as follows: a) The State has taken the appropriate steps necessary to authorise Georgian Oil to execute this Contract on behalf of the State and has the power to do so; b) The signatory to this Contract on behalf of Georgian Oil (in each of its capacities hereunder) is duly authorised to bind Georgian Oil; c) Georgian Oil has been legally vested by the State with the necessary power to authorise Petroleum Operations in the Contract Area and to compensate the Contractor by allocating to it a share of the Petroleum produced. d) The conduct of Petroleum Operations by Georgian Oil and each Contractor Party as a consortium is recognised in accordance with the laws of Georgia. e) Upon completion of the matters and procedures set out in Article 32 there is no other entity or authority whose approval or authorisation is required to permit the Contractor to enjoy and enforce its rights hereunder. 56 57 ARTICLE 28 NOTICES AND CONFIDENTIALITY 28.1 Except as otherwise specifically provided, all notices authorised or required between the Parties by any of the provisions of this Contract, shall be in writing in Georgian and English and delivered in person or by registered mail or by courier service or by any electronic means of transmitting written communications which provides confirmation of complete transmission, and addressed to such Parties as designated below. The originating notice given under any provision of this Contract shall be deemed delivered only when received by the Party to whom such notice is directed, and the time for such Party to deliver any notice in response to such originating notice shall run from the date the originating notice is received. The second or any responsive notice shall be deemed delivered when received. "Received" for purposes of this Article with respect to written notice delivered pursuant to this Contract shall be actual delivery of the notice to the address of the Party to be notified specified in accordance with this Article. Each Party shall have the right to change its address at any time and/or designate that copies of all such notices be directed to another person at another address, by giving written notice thereof to all other Parties. The addresses for service of notices on each of the parties is as follows:- JKX Attention: Company Secretary Fax :44-1483-242406 The State and Georgian Oil Attention: General director Fax:873-682-340-878 28.2 Subject to the provisions of the Contract, the Parties agree that all information and data acquired or obtained by any Party in respect of Petroleum Operations shall be considered confidential and shall be kept confidential and not be disclosed during the term of the Contract to any person or entity not a Party to this Contract, except: a) To an Affiliate, provided such Affiliate maintains confidentiality as provided herein; b) To a governmental agency or other entity when required by the Contract; 57 58 c) To the extent such data and information is required to be furnished in compliance with any applicable laws or regulations, or pursuant to any legal proceedings or because of any order of any court binding upon a Party; d) To prospective or actual contractors, consultants and attorneys employed by any Party where disclosure of such data or information is essential to such contractor's, consultant's or attorney's work; e) To a bona fide prospective transferee of a Party's participating interest (including an entity with whom a Party or its Affiliates are conducting bona fide negotiations directed toward a merger, consolidation or the sale of a majority of its or an Affiliate's shares); f) To a bank or other financial institution to the extent appropriate to a Party arranging for funding; g) To the extent such data and information must be disclosed pursuant to any rules or requirements of any government or stock exchange having jurisdiction over such Party, or its Affiliates; h) To its respective employees for the purposes of Petroleum Operations, subject to each Party taking customary precautions to ensure such data and information is kept confidential; i) To the extent that any data or information which, through no fault of a Party, becomes a part of the public domain. 28.3 Disclosure as pursuant to Article 28.2 (d), (e), and (f) shall not be made unless prior to such disclosure the disclosing Party has obtained a written undertaking from the recipient party to keep the data and information strictly confidential for at least three (3) years and not to use or disclose the data and information except for the express purpose for which disclosure is to be made. ARTICLE 29 TERMINATION AND BREACH 29.1 At any time, if in the opinion of Contractor acting reasonably and properly, circumstances do not warrant continuation of the Petroleum Operations, Contractor may, by giving written notice to that effect to Georgian Oil, relinquish its rights and be relieved of its obligations pursuant to this Contract, except such rights and obligations as related to the period prior to such relinquishment. Neither this Contract nor any of the rights granted hereunder nor the GMJV Licence may be terminated as a result of any act or omission of GMJV save in the case where GMJV or GBOC has carried out an act or 58 59 omitted to do something at the specific request of the Contractor and GBOC has previously advised the Contractor prior to carrying out the act or omitting to do something that to carry out that act or to omit to do the relevant thing may result in this Contract being terminated. 29.2 Without prejudice to the provisions stipulated in Article 29.1 above, this Contract may only be terminated by the State in its entirety by giving ninety (90) days advance written notice thereof to all Parties, when and only if a material breach of Contract is alleged to have been committed by Contractor and, provided that conclusive evidence thereof has been found by prior arbitration as stipulated in Article 30. For the purposes of this Article, a material breach means a fundamental breach which, if not cured, is tantamount to the frustration of the entire Contract either as a result of the unequivocal refusal to perform contractual obligations or as a result of conduct which has destroyed the commercial purpose of this Contract. ARTICLE 30 DISPUTE RESOLUTION 30.1 The Parties hereby consent to submit to the International Centre for Settlement of Investment Disputes any dispute in relation to or arising out of this Contract for settlement by arbitration pursuant to the Convention on the Settlement of Investment Disputes between States and Nationals of Other States. 30.2 The Parties agree that, for the purposes of Article 25(1) of the Convention, any dispute in relation to or arising out of this Contract is a legal dispute arising directly out of any investment. 30.3 For the purposes of Article 25(2)(b) of the Convention, it is agreed that, although JKX is a national of Cyprus, it is controlled by a national of the United Kingdom and shall be treated as a national of that state for the purposes of the Convention. 30.4 A Party need not exhaust administrative or judicial remedies prior to commencement of arbitrage proceedings. 30.5 Any arbitrage tribunal constituted pursuant to this Contract shall apply the provisions of this Contract as supplemented and interpreted by general principles of the laws of Georgia and England as are in force on the Effective Date. 59 60 ARTICLE 31 TEXT 31.1 This Contract shall be executed in three (3) originals in the Georgian language and three (3) originals in the English language each of which shall have equal legal force and effect; provided however that in the case of dispute, conflict or arbitration the English version shall (after the Georgian version has been reviewed and its provisions discussed in good faith) be used as the authentic version to determine the rights and obligations of the Parties which shall be determined by reference solely to the English version of this Contract. ARTICLE 32 APPROVAL AND EFFECTIVE DATE 32.1 This Contract shall enter into force and effect in its entirety on the Effective Date. The provisions of this Article 32 shall be effective as at the date of execution of this Contract by all the Parties hereto and shall bind the Parties with effect from that date. 32.2 Following the execution of this Contract, Georgian Oil and the State shall use their respective best endeavours to procure as soon as possible that such further steps are taken as are necessary to cause this Contract and all rights thereunder to be and remain legally valid and fully effective under the laws of Georgia including without limitation the enactment of such general or specific laws by the legislative branches of the State including the Parliament of Georgia as are necessary to make this contract legally valid and fully effective with the full force of law in Georgia for the duration of this Contract in full compliance with the Constitution of Georgia and all requisite legal formalities and procedures. 32.3 The State shall notify the Contractor within 5 days of the steps necessary to give this Contract full force of law in accordance with this Article 32 being satisfied. The Contractor shall thereafter have a period of thirty (30) days within which to notify the State whether or not it considers the conditions set out herein to have been satisfied.. If the Contractor has not notified the State that it considers the conditions satisfied by 31 December 1996 then the Contractor may by written notice to the State terminate this Contract. 60 61 32.4 The State hereby guarantees to each Contractor Party and their assignees for the duration of this Contract: a) all rights granted or to be granted under this Contract by or on behalf of the State; b) all benefits granted or to be granted under this Contract by or on behalf of the State; c) to maintain the economic position of each Contractor Party and in the event that all or any part of this Contract is not given the full force of law to maintain that position as if the Contract had been given full force of law. That position shall be maintained by indemnity in cash or otherwise in a way satisfactory to the Contractor; d) that all provisions of the Georgian language version of the Contract accurately convey the same meaning as all the provisions of the English language version of the Contract; e) the stability of the legal, fiscal and economic terms of the Contract so far as they directly or indirectly affect the Contractor; f) that the privatisation, insolvency, liquidation, reorganisation or any other change in the structure or legal existence of Georgian Oil shall not affect the obligations or guarantees of the State hereunder. This Contract is executed this ______________ day of ________________ 1995 _____ in three (3) versions in the Georgian language and three (3) in the English language. FOR THE STATE FOR BY GEORGIAN OIL IN JKX NAVTOBI LIMITED ITS CAPACITY AS THE STATE REPRESENTATIVE By: ___________________________ FOR GEORGIAN OIL By: ____________________________ 61 62 Annex A Contract Area 62 63 ENCLOSURE N2 The Title: Plans, geological profiles and structure of the oil deposits on Ninotsminda, West Rustavi and Manavi license territories. Number of pages: 1 Page 1 1. Schematic map pf the location of joint venture " Georgia MAKOIL" license area on the territory of the Republic of Georgia. Sc. 1:200 000 Page 2 2. Geological map and well location scheme of Ninotsminda and Manavi area. Sc. 1:25 000 Page 3 3. Structural map of Nintsminda and Manavi area Middle Eocene Top. Sc. 1:50 000 Page 4 4. Scheme of the well location on Rustavi area. Sc. 1:25 000 64 Page 5 5. Structural map of Rustavi area Middle Eocene Top. Sc. 1:25 000 Page 6 6. Geological profiles of Ninotsminda and Manavi areas. Sc. 1.25 000 Page 7 7. Geological profiles of Rustavi area. Sc. 1:25 000 ENCLOSURE N 1 The Title: The space borders and point co-ordinates of the East Georgia, Ninotsminda, Manavi and West Rustavi license territories. The license area is located in Sararejo and Gardabani Regions Ninotsminda is located on the territory of the villages Ninotsminda and Giorgitsmiinda. Manavi is located on the territory of villages Manavi and Tokhliauri. The West Rustavi is located on the territory of the farmng area of village Krtsanis. Below are given the geographic co-ordinates of the area. Ninotsminda - Manavi Point 1 latitude 41 44'08"N.L. co-ordinates longitude 45 14'00"E.L. Point 2 latitude 41 45'27"N.L. co-ordinates longitude 45 23'24"E.L. Point 3 latitude 41 44'45"N.L. co-ordinates longitude 45 29'53"E.L. Point 4 latitude 41 33'43"N.L. co-ordinates longitude 44 58'36"E.L. Point 5 latitude 41 36'04"N.L. co-ordinates longitude 44 56'35"E.L. Point 6 latitude 41 46'25"N.L. co-ordinates longitude 45 20'17"E.L. Point 7 latitude 41 46'00"N.L. co-ordinates longitude 45 13'50"E.L.
65 Then in the direction of point 1. The Ninotsminda-Manavi space makes 72.7sq.km. West Rustavi Point 1 latitude 41 36'12"N.L. co-ordinates longitude 41 49'34"E.L. Point 2 latitude 41 35'08"N.L. co-ordinates longitude 44 49'15"E.L. Point 3 latitude 41 33'41"N.L. co-ordinates longitude 44 58'30"E.L. Point 4 latitude 41 33'43"N.L. co-ordinates longitude 44 58'36"E.L. Point 5 latitude 41 36'04"N.L. co-ordinates longitude 44 56'35"E.L.
Then in the direction of point 1. The space of West Rustavi deposites is 35.sq.km. ANNEX B PREVIOUS PRODUCTION 66 Total Determined Production is 137.35 tons per day. This shall decline at 10% per year. The total amount of Determined Production will be transferred to Georgian Oil after all wells to be transferred have commenced production provided that this takes place within 6 months of the transfer. The Determined Production will be phased on a well by well basis for a period of 6 months. Georgian Oil and Contractor shall appoint experts to estimate Determined Production for each well upon transfer. Oil in excess of actually Determined Production will be shared in accordance with article 11. 67 ANNEX C ACCOUNTING PROCEDURE 68 SECTION I GENERAL PROVISIONS 1. PURPOSE The accounting procedures included in this Accounting Procedure establish a framework of accounting principles as generally accepted within the international Petroleum industry. The purpose of this Accounting Procedure is to establish a fair and equitable method for accounting for Petroleum Operations under the Contract. The purpose of this Accounting Procedure is not to define Costs and Expenses for the purposes of determining Cost Recovery Petroleum or to define what costs will be deductible in the calculation of Profit Tax. Costs and Expenses are defined in Article 11 of the Contract. Calculation procedure for the taxable base and Profit Tax is set forth in Article 17 of the Contract. 2. DEFINITIONS For the purpose of this Accounting Procedure the following terms shall have the following meanings: "Accounting Procedure" shall mean the accounting principles, practices and procedures set forth in this Annex C. "Accepted Accounting Practices" shall mean accounting principles, practices and procedures generally accepted and recognised in the international Petroleum industry. "Cash Accounting Basis" shall mean the basis of accounting which records the effect of transactions and events on financial conditions and income when they are settled in cash. "Material and Equipment" means property, including without limitation all exploration, appraisal and development facilities together with supplies and equipment, acquired and held for use in Petroleum Operations. "Controllable Material" means all materials, equipment physical assets, consumables and other stocks and inventory acquired and held for use in Petroleum Operations. A list of types of such Controllable Material shall be furnished to Georgian Oil upon request. The words and phrases defined in the Contract but not defined above shall have the same meaning in this Accounting Procedure as is given to them in the Contract. 69 3. AUDITS Georgian Oil shall have the right to inspect and audit Contractor's books, accounts and records relating to Petroleum Operations under the Contract for the purpose of verifying that the Costs and Expenses charged to the Petroleum Operations Account comply with the terms and conditions of the Contract and this Accounting Procedure. Such books, accounts and records shall be available in Georgia at all reasonable times for inspection subject to thirty (30) days notice by duly authorised representatives of Georgian Oil, including outside independent auditors. Audits shall be conducted in such a manner as not to interfere unduly with ongoing operations. All costs associated with the audit will be the sole responsibility of Georgian Oil. Georgian Oil shall have a period of twelve (12) months after the end of each Calendar Year in which to audit and verify costs and expenses, volumes and value of Petroleum and arithmetic calculations. Any exception by Georgian Oil shall be communicated to the Contractor with each disputed charge specified, with supporting rationale, within thirty (30) days after the completion of the particular audit. If the Contractor and Georgian Oil are unable to agree on any item or adjustment, the issue will be resolved in accordance with the dispute resolution procedures contained in Article 30 of the Contract. All accounts of Petroleum Operations for any Calendar Year shall conclusively be presumed to be true and correct twelve (12) months following the end of any such Calendar Year, unless, within the said twelve (12) month period Georgian Oil expresses any exception thereto in writing to the Contractor. 4. CONTRACTOR'S BOOKS 4.1 The Contractor shall maintain in English in U.S.$ and on a Cash Accounting Basis books and accounts for Petroleum Operations. Such books and accounts shall be kept in accordance with Accepted Accounting Practices and the provisions of the Contract and this Accounting Procedure ("Petroleum Operations Account"). The documentation required to support such books and accounts shall be the documentation as specified in this Accounting Procedure. If no documentation is specified then the documentation required shall be the documentation reasonably acceptable and recognised in the international Petroleum industry. 4.2 All U.S.$ expenditures shall be charged in the amount expended. Expenditures incurred in currencies other than U.S.$ shall be translated into U.S.$ as per Article 19.11 of the Contract. A record shall be kept of the exchange rates used in translating expenditures incurred in currencies other than U.S.$. Any gain or loss resulting from the exchange of currencies required for Petroleum Operations and any fees or other banking charges levied in connection with such exchange of currencies or any gain or loss resulting from translation of expenditures and sales revenues in accordance with the provisions of Article 19.11 shall be included in Costs and Expenses and recoverable from Cost Recovery Petroleum and credited or charged to the Petroleum Operations Account. 4.3 Contractor shall maintain books and accounts relating to Petroleum Operations for four (4) years following the end of the Calendar Year to which they relate. 70 5. PRECEDENCE OF DOCUMENTS In the event of any inconsistency or conflict between the provisions of this Accounting Procedure and the provisions of the Contract treating the same subject differently, the provisions of the Contract shall prevail. 6. REVISION OF ACCOUNTING PROCEDURE This Accounting Procedure may be revised from time to time by mutual written agreement Georgian Oil and Contractor. 7. ARBITRATION PROCEDURES Any dispute in relation to or arising out of this Accounting Procedure shall, unless settled by agreement among the Parties be submitted to arbitration in accordance with Article 30 of the Contract. 8. OPERATOR To the extent that Operator is to incur Costs and Expenses on behalf of Contractor, Contractor will advance Operator funds necessary to settle such liabilities. Operator shall provide Contractor a projection of cash expenditures no later than the tenth (10th) day of the month for funding requirements for the following month. Contractor may then advance funds to Operator no later than the last business day of the month preceding the month the funds are being advanced for. Such cash advances will be deducted from actual expenditures for the month with any over or short position carried forward to the next month. 71 SECTION II COSTS, EXPENSES AND EXPENDITURES DIRECT CHARGES The Contractor shall charge the Petroleum Operations Account for all costs and expenses whether directly or indirectly incurred necessary to conduct Petroleum Operations under this Contract. For the purposes of this Accounting Procedure costs and expenses incurred directly or indirectly by a Contractor Party and its Affiliated Companies prior to the Effective Date of this Contract shall be deemed to be incurred on the Effective Date of this Contract. Chargeable costs and expenses shall include, but not be limited to: 2.1 LICENSES, PERMITS All costs, if any, attributable to the acquisition, maintenance, renewal or relinquishment of licenses, permits, contractual and/or surface rights acquired for Petroleum Operations and any bonuses paid in accordance with the Contract when paid by Contractor. Documentation requirements: Copy of contract or payment request documentation indicating purpose of payment, amount of payment and recipient of payments. 2.2 SALARIES, WAGES AND RELATED COSTS 2.2.1 Gross salaries and wages in respect of employees of Contractor and its Affiliates who are in Georgia directly engaged in Petroleum Operations whether temporarily or permanently assigned. Documentation requirements: Copy of timesheet indicating project or area worked during time period. 2.2.2 Gross salaries and wages in respect of employees of Contractor and its Affiliates outside of Georgia directly engaged in Petroleum Operations whether temporarily or permanently assigned, and not otherwise covered in Section 2.7.2. Documentation Requirements: Copy of timesheet indicating project or area worked during time period. 2.2.3 Salaries and wages, including everything constituting the employees' total compensation. To the extent not included in salaries and wages, the Petroleum Operations Account shall also be charged with the cost to Contractor and its Affiliates of payroll taxes, holiday, vacation, sickness, disability benefits, living and housing allowances, travel time, bonuses, and other similar allowances in accordance with Contractor and its Affiliates usual practice, as well as costs to Contractor and its Affiliates for employee benefits, including but not limited to employee group life insurance, group medical insurance, 72 hospitalisation, retirement, and other benefit plans of a like nature applicable to labour costs of Contractor and its Affiliates. Documentation Requirements: Copy of records indicating Contractor or its Affiliates payment to or on behalf of employee. These records will be made available only during the conduct of an audit in accordance with the provisions of paragraph 3 of Section I of this Accounting Procedure. 2.2.4 Expenditures or contributions made pursuant to assessments imposed by the State or any Governmental authority which are applicable to the Contractor and its Affiliates costs of salaries and wages under paragraph 2.2 of this section II of this Accounting Procedure including but not limited to payroll taxes and social insurance contributions. Documentation Requirements: Copy of records indicating Contractor or its Affiliates payment to the State or Governmental authority on behalf of employee. 2.2.5 Expenses ((including related travel costs) which are considered reasonable in accordance with Contractor's and its Affiliates usual practice)of those employees whose salaries and wages are chargeable to the Petroleum Operations Account under paragraphs 2.2.1 and 2.2.2 of this Section II and for which expenses the employees are reimbursed under the usual practice of Contractor and its Affiliates. Documentation Requirements: Copy of expense reimbursement request documents. 2.2.6 Gross salaries and wages, pensions, benefits and other related costs (together with attributable office costs) of those employees of the Contractor and its Affiliates not solely engaged in the conduct of Petroleum Operations shall be apportioned to the Petroleum Operations and the Contractor's other activities based on the percentage time worked on the Petroleum Operations or other activities multiplied by the total cost of the employee for the time period. Documentation Requirements: Copy of timesheet indicating project or area worked during period. 2.3 EMPLOYEE RELOCATION COSTS 2.3.1 Except as provided in Section 2.3.3, Contractor or its Affiliates cost of employees' relocation to or from the Contract Area vicinity or location where the employees will reside or work, whether permanently or temporarily assigned to the Petroleum Operations. If such employee works on other activities of the Contractor in addition to Petroleum Operations, such relocation costs shall be charged to the other activities based on the percentage time expected to be worked on other activities multiplied by the employee relocation costs. Documentation Requirements: Copy of expense payment requests to or on behalf of employee. 73 2.3.2 Such relocation costs shall include transportation of employees and their family, personal and household effects of the employee and their family, transit expenses, and all other related costs in accordance with Contractor and its Affiliates usual practice. Documentation Requirements: Copy of payment requests to or on behalf of employee. 2.3.3 Relocation costs from the vicinity of the Contract Area to another location classified as a foreign location by Contractor shall not be chargeable to the Petroleum Operations Account unless such foreign location is the point of origin of the employee. Documentation Requirements: Copy of payment requests to or on behalf of employee. 2.4 OFFICES, CAMPS AND MISCELLANEOUS FACILITIES All costs of maintaining any offices, sub-offices, camps warehouses, housing, and other facilities of the Contractor and/or Affiliates directly serving the Petroleum Operations either within Georgia or elsewhere. If such facilities serve operations in addition to the Petroleum Operations the costs shall be allocated to the properties served on an equitable basis approved by the Parties. Documentation Requirements: Copy of invoice, payment request document or contract indicating purpose of payment, amount of payment, recipient of payment and date goods and/or services were received. 2.5 MATERIAL AND EQUIPMENT Cost, net of any discounts taken by contract, of Material and Equipment purchased or furnished by Contractor whether directly or indirectly. Such costs shall include, but are not limited to, export brokers' fees, taxes, transportation charges, loading, unloading fees, export and import duties and licence fees associated with the procurement of Material and Equipment and in-transit losses, if any, not covered by insurance. So far as it is reasonably practical and consistent with efficient and economical operation, such Material and Equipment shall be purchased for, and the cost thereof charged to the Petroleum Operations Account. Documentation Requirements: Copy of invoice, payment request document or contract indicating purpose of payment, amount of payment, recipient of payment and date goods and/or services were received. 74 2.6 EXCLUSIVELY OWNED EQUIPMENT AND FACILITIES OF CONTRACTOR AND AFFILIATES Charges for exclusively owned equipment, facilities and utilities of Contractor and its Affiliates at costs or rates not to exceed the average cost or rates of non-affiliated Third Parties then prevailing for Contractor for like equipment, facilities, and utilities for use. Exclusively owned equipment leased to the Petroleum Operations lost or damaged beyond repair may be charged at replacement cost plus transportation costs to deliver like equipment to the location where the like equipment will be used. Documentation Requirements: Copy of invoice, payment request document or contract indicating purpose of payment, amount of payment, recipient of payment and date goods and/or services were received. Additionally, documentation as to how the average commercial cost or rates were determined are required. 2.7 SERVICES 2.7.1 The cost of services provided by Third Parties, Contractor and Affiliates of Contractor other than those services covered by Section 2.7.2. Such charges for services by Contractor and Contractor's Affiliates shall not exceed those currently prevailing if performed by Third Parties, considering quality and availability of services. Documentation Requirements: Copy of invoice, payment request document or contract indicating purpose of payment, amount of payments, recipient of payment and date services were performed. 2.7.2 The cost of services performed by Contractor and Contractor's Affiliates technical and professional staffs not located within Georgia. Documentation Requirements: Copy of timesheet indicating project or area worked during period. The charges for such services shall not exceed those currently prevailing if performed by Third Parties, considering the quality and availability of such services. 75 Examples of such services include, but are not limited to, the following: Geologic studies and interpretation Seismic data processing Well log analysis, correlation and interpretation Laboratory services Well site geology Project engineering Source rock analysis Petrophysical analysis Geochemical analysis Drilling supervision Development evaluation Accounting and professional services Other data processing Costs shall include salaries and wages of such technical and professional personnel, lost time, governmental assessments, employee benefits, and expenses which are considered reasonable in accordance with Contractor and its Affiliates usual practice. Costs shall also include all support costs necessary for such technical and professional personnel to perform such services, such as, but not limited to, rent, utilities, administration, support staff, drafting, telephone and other communications expenses, computer support, supplies, and depreciation. 2.8 INSURANCE Premiums paid for insurance required by law or the Contract to be carried for the benefit of the Petroleum Operations. If the insurance is for the benefit of operations in addition to the Petroleum Operations the premiums paid shall be allocated to the operations covered on an equitable basis. Documentation Requirements: Copy of invoice, payment request document or contract indicating purpose of payment, amount of payment, recipient of payment and period of coverage. 2.9 DAMAGES AND LOSSES TO PROPERTY 2.9.1 All costs or expenditures necessary to replace or repair any damages, losses incurred by fire, flood, storm, theft, accident, or any other cause. Operator shall maintain written documentation of damages or losses. Documentation Requirements: Copy of invoice, payment request document or contract indicating purpose of payment, amount of payment, recipient of payment. 2.9.2 Expenditures incurred in the settlement of all losses, claims, damages, judgements, and other expenses for the account of Petroleum Operations. 76 Documentation Requirements: Copy of invoice, payment request document or contract indicating purpose of payment, amount of payment, recipient of payment. 2.10 LITIGATION AND LEGAL EXPENSES The costs and expenses of litigation and legal services necessary for the protection of the Petroleum Operations under this Contract as follows: 2.10.1 Legal Services necessary or expedient for the protection of the Petroleum Operations, and all costs and expenses of litigation, arbitration or other alternative dispute resolution procedure, including but not limited to lawyers' fees and expenses, court costs, cost of investigation of procuring evidence, together with all judgements obtained against the Parties or any of them arising from the Petroleum Operations. Documentation Requirements: Copy of invoice, payment request document or contract indicating purpose of payment, amount of payments, recipient of payment and date services were performed. 2.10.2 If the Parties hereunder shall so agree, actions or claims affecting the Petroleum Operations hereunder may be handled by the legal staff of a Contractor Party or its Affiliates; and a charge commensurate with the similar costs of providing and furnishing such services rendered may be made, but no such charges shall be made until the service and the charge has been approved by the Parties. Documentation Requirements: Copy of timesheet indicating project or area worked during period. 2.11 TAXES AND DUTIES All State or Governmental Taxes, duties, assessments and charges, of every kind and nature (except for the Profit Tax determined in accordance with the provisions of Article 17 of the Contract), assessed or levied upon or in connection with the Petroleum Operations. If Contractor or an Affiliate is subject to income or withholding tax as a result of services performed for Petroleum Operations under the Contract, its charges for such services may be increased by the amount of such taxes incurred. Documentation Requirements: Copy of records indicating Contractor's payment to governmental authority, purpose of payment, amount of payment and recipient of payment. 77 2.12 FINANCE COSTS All Finance Costs. Documentation Requirements: Copy of loan document, amount of principal and interest paid, any arrangement or other fees and lending institution. 2.13 SALE AND SALVAGE OF MATERIALS PREVIOUSLY CHARGED TO PETROLEUM OPERATIONS Proceeds from the sale or salvage of Material and Equipment previously charged to Petroleum Operations will be credited to the Petroleum Operations less any expenses associated with the disposition of the Material and Equipment. Material and Equipment transferred to Contractor or an Affiliate will be credited to the Petroleum Operations at fair market value. Documentation Requirements: Copy of sales agreement indicating amount recovered, parties to agreement, date of sale of Material and Equipment and a description. 2.14 ABANDONMENT AND SITE RESTORATION Any costs and expenditures in relation to abandonment and site restoration and any payments in accordance with the funding procedure described in Article 9.8 of the Contract and Section VII of this Accounting Procedure shall be charged to the Petroleum Operations Account. Documentation Requirements: Copy of invoice, payment request document indicating purpose of payment, amount of payment, recipient of payment, if applicable copy of any schedule indicating funding requirements for abandonment and site restoration. 2.15 ENERGY EXPENSES All costs of fuel, electricity, heat, water or other energy used for Petroleum Operations. Documentation Requirements: Copy of invoice, payment request document or contract indicating purpose of payment, amount of payments, recipient of payment. 78 2.16 COMMUNICATION CHARGES The costs of acquiring, leasing, installing, operating, repairing and maintaining communications systems. Documentation Requirements: Copy of invoice, payment request document or contract indicating purpose of payment, amount of payments, recipient of payment. 2.17 COORDINATION COMMITTEE All costs and expenditures incurred with respect to the activities of the Coordination Committee pursuant to Article 6 of the Contract. Documentation Requirements: Copy of invoice, payment request document indicating purpose of payment, amount of payments, recipient of payments. 2.18 CREDITS The Contractor will credit to the Petroleum Operations Account the net proceeds of the following transactions: 2.18.1 The net proceeds of any successful insurance claim in connection with Petroleum Operations where the claim is with respect to operations or assets which were insured and where the insurance premiums with respect thereto have been charged to the Petroleum Operations Account. 2.18.2 The net proceeds of any successful claim in connection with Petroleum Operations where the costs and expenditures relating to the subject of the claim have been charged to the Petroleum Operations Account. 2.19 OTHER EXPENDITURES Any other costs and expenditures incurred by Contractor and its Affiliates for the necessary and proper conduct of the Petroleum Operations in accordance with approved Work Program and Budget and not covered in this Section II or in Section III, of this Accounting Procedure. Documentation Requirements: Documentation reasonably acceptable and recognised in the international Petroleum industry to support those costs or expenditures. 79 SECTION III INDIRECT CHARGES 3.1 PURPOSE Contractor shall charge an administration overhead to the Petroleum Operations Account for the cost of indirect services and related office costs of Contractor and its Affiliates not otherwise provided in this Accounting Procedure. For the purposes of this Accounting Procedure costs and expenses incurred directly or indirectly by a Contractor Party and its Affiliated Companies prior to the Effective Date of this Contract shall be deemed to be incurred on the Effective Date of this Contract. Indirect costs chargeable under this Section III represent the cost of general administration and support services provided by the Contractor and its Affiliates outside of Georgia for the indirect benefit of Petroleum Operations. Such support will include the services and related office costs of personnel performing administrative, legal, treasury, tax and employee relations, provision of expertise and other non-technical functions which can not be specifically identified or attributed to particular projects. No cost or expenditure included under Section II of this Accounting Procedure shall be included or duplicated under this Section III. 80 3.2 AMOUNT The charge under Section 3.1 will be charged at rates on total annual expenditures attributable to Petroleum Operations as follows: ANNUAL EXPENDITURES U.S$ 0 to U.S.$10,000,000 of expenditures per Calendar Year = 5% Excess above U.S.$10,000,000 of expenditures per Calendar Year =3% 3.3 CHANGES The indirect charges provided for in this Section III may be amended periodically by mutual agreement between Georgian Oil and Contractor if, in practice, these charges are found to be insufficient or excessive. SECTION IV INVENTORIES 4.1 PERIODIC INVENTORIES, NOTICE AND REPRESENTATION At reasonable intervals as agreed with Georgian Oil, inventories shall be taken by Contractor of all Controllable Material, which shall include materials and physical assets. Written notice of intention to take inventory shall be given by Contractor to Georgian Oil; at least thirty (30) days before any inventory is to begin so that Georgian Oil may be represented when any inventory is taken. Failure of Georgian Oil to be represented at an inventory shall bind Georgian Oil to accept the inventory taken by Contractor who shall in that event furnish Georgian Oil with a copy thereof. 4.2 RECONCILIATION AND ADJUSTMENT OF INVENTORIES Reconciliation of inventory shall be made by Contractor and Georgian Oil and a list of overages and shortages shall be jointly determined by Contractor and Georgian Oil, and the inventory accordingly adjusted by Contractor. 81 SECTION V FINANCIAL REPORTS 5.1 ACCOUNTS OF PETROLEUM OPERATIONS Contractor shall submit to Georgian Oil by March 15 following each Calendar Year accounts for that Calendar Year of the Petroleum Operations prepared in accordance with this Accounting Procedure. 5.2 STATEMENT FOR RECOVERY OF COSTS AND OF COST RECOVERY PETROLEUM The Contractor shall, render to Georgian Oil as promptly as practical but not later than forty five (45) days after the end of the last Calendar Quarter in which the date of commencement of Commercial Production first occurs, and not later than forty five (45) days after the end of each succeeding Calendar Quarter a Calendar Quarter Cost Recovery report and Calendar Quarter Profit Petroleum division report showing: (i) Recoverable Costs and Expenses carried forward from the previous Calendar Quarter, if any; (ii) Recoverable Costs and Expenses incurred during the Calendar Quarter; (iii) Total recoverable Costs and Expenses for the Calendar Quarter (sum of (i) plus (ii)); (iv) Volume and value of Cost Recovery Petroleum taken and separately disposed of by Contractor for the Calendar Quarter; (v) Amount of Costs and Expenses actually recovered for the Calendar Quarter; (vi) Amount of recoverable Costs and Expenses to be carried forward into the succeeding Calendar Quarters if any; (vii) Excess, if any, of the value of Cost Recovery Petroleum taken and separately disposed of by Contractor over recoverable Costs and Expenses for the Calendar Quarter; (viii) The value and volume of Petroleum produced, used in Petroleum Operations, available for lifting and actually lifted by Parties during the Calendar Quarter; and (ix) Profit Petroleum allocated to each Contractor Party and Georgian Oil during the Calendar Quarter. 82 5.3 PAYMENTS If such statement shows an amount due to Georgian Oil, payment of that amount shall be made in U.S.$ by Contractor to Georgian Oil with the rendition of such statement. SECTION VI CONTROL AND MAJOR ACCOUNTS 6.1 COST RECOVERY CONTROL ACCOUNT Contractor will establish a cost recovery control account and an offsetting Contract account to control therein the amount of cost remaining to be recovered, if any, and the amount of cost recovered. 6.2 MAJOR ACCOUNTS For the purpose of classifying costs, expenses and expenditures for cost recovery, costs, expenses and expenditures shall be recorded in major accounts including but not limited to the following: (a) Exploration Expenditures (b) Development Expenditures, other than Operation Expenses (c) Operation Expenses Any other necessary sub-accounts shall be used. All Costs and Expenses, regardless of classification, shall be recovered as per Article 11 of the Contract. 83 SECTION VII ABANDONMENT AND SITE RESTORATION The Development Plan shall also include an abandonment and site restoration program together with a funding procedure for such program. All funds collected pursuant to the funding procedure shall be indicated to site restoration and abandonment and will be placed in a special interest bearing account by Contractor which shall be held in the joint names of the State and the Contractor or their respective nominees, or its designee. Contractor's responsibilities for environmental degradation, site restoration and well abandonment obligations, and any other actual contingent and potential activity associated with the environmental status of the Development Area shall be limited to the obligation to place the necessary funds in the approved account. All expenditures incurred in abandonment and site restoration including but not limited to all payments deposited by Contractor in the special interest bearing account shall be treated as Costs and Expenses in accordance with Article 11 and Article 9.8 of the Contract and chargeable to the Petroleum Operations Account. 84 ANNEX D THE GBOC LICENCE 85 Approved by The Chairman of Department "Georgian Oil" R Tevzadze 1994 COMPLEX LICENSE 1. Series 34 47 2. Number 5 3. License type N 4. Issued: to the joint venture "Georgia-MAKOIL" of the Department "Georgian Oil", Republic of Georgia and private corporation "MAKOIL Inc.", USA. 5. Address: The Republic of Georgia, Tbilisi, Kostava Str.N 65. 6. Bank Requisites: 000070546, MPO 436. 7. Basic activity: exploration and research of oil and gas deposits, production, transportation and oil marketing on the international market. 8. Aim of activity: The license is issued to "Georgia MAKOIL" for increasing oil production on the territories of Ninotsminda, Manavi and West Rustavi, by means of introducing new drilling and producing technologies. 9. The license area is located on the territory of Sagarejo and Gardabani Regions. 10. The borders and coordinates of the license area are given in Enclosure N1. 11. Plans, geological profiles and structural maps are given in Enclosure N2. 12. The territory to be used is determined by Department "Georgian Oil" after outlining oil and gas deposits on the initiative of "Georgia MAKOIL". 13. The two stage duration of the license of the joint venture "Georgia MAKOIL" is determined by a 25 (twenty five) year term. The purpose of the first three year (3 year) stage is to carry out research on the production capacity of the license territory and the agreement sides to make necessary changes and corrections to the Charter. The second stage is considered for the following 22 (twenty two) years. If any of the first three (3) wells drilled by the joint venture proves to be oil producing, then the joint venture has the right to drill such a number of wells within the license area, that it considers necessary. 14. If in none of the first three drilled wells is found oil, the joint venture ceases its activity and it is liquidated according to the established norm. 15. The license entitles the joint venture "Georgia MAKOIL" to carry out geological and geophysical researches, exploration, appraisal and exploitation drilling, oil and gas production, transportation, primary processing and export. 16. The Enclosures are consisting part of this license: N1 Space borders and coordinates of Ninotsminda, West Rustavi deposits and Manavi Territory. N2 Plans, geological profiles and structural maps of the license area. N3 The right to use the territory connected with mineral usage. N4 The condition of the explored reserves by 01.01.94. N5 Feasibility Study of the exploration research and development works on the license area. N6 The payment of the license duty. N7 Terms of mineral usage tax. N8 The amount and agreed share distribution in time period of the expected produced oil on the license territory. N9 The Agreement on confidentiality of the new geological and other information, received during the mineral usage. 86 N10 The obligatory terms on mineral and environmental protection conclusion from the Ministry of Environmental Protection. N11 Work Safety conclusion from the Department of Technical Supervision in the Republican Economy. N12 The report of the Department "Georgian Oil" scientific technical committee session. N13 Terms of continuation and termination of the license validity. N14 The obligation of the joint venture "Georgia-MAKOIL". N15 Control of the license terms on mineral usage. N16 Report of the License Commission session. N17 Normative technical documentation of oil. N18 Expert conclusion Nl9 Terms of the joint venture accounting to the Budget of the Republic of Georgia. N20 The list of additional documents, presented by the joint venture "Georgia MAKOIL". N21 On Concessions in Mineral Usage Issues. N22 On leased equipment N23 On additional normative acts of legislation. The Authorised Representative of the The Authorized Representative of Specialized Office for Licensing and the Joint Venture "Georgia Informatics of Department "Georgian Oil" MAKOIL I. Tavdumadze Eugene Kozlowski - ----------------------- ---------------- 87 ENCLOSURE N1 The title: The space borders and point coordinates of the East Georgia Ninotsminda, Manavi and West Rustavi license territories. The license area is located in Sagarejo and Gardabani Regions. Ninotsminda is located on the territory of the villages Ninotsminda and Giorgitsminda. Manavi is located on the territory of villages Manavi and Tokhliauri. The West Rustavi is located on the territory of the farming area of village Krtsanisi. Below are given the geographic coordinates of the area: Ninotsminda - Manavi Point 1 latitude 41 44'08" N.L. Co-ordinates longitude 45 14'00" E.L. Point 2 latitude 41 45'27"N.L. Co-ordinates longitude 45 23'24" E.L. Point 3 latitude 41 44'45"N.L. Co-ordinates longitude 45 29'53" E.L. Point 4 latitude 41 33'43"N.L. Co-ordinates longitude 44 58'36" E.L. Point 5 latitude 41 36'04" N.L. Co-ordinates longitude 44 56'35" E.L. Point 6 latitude 41 46'26" N.L. Co-ordinates longitude 45 20'17" E.L. Point 7 latitude 41 46'00" N.L. Co-ordinates longitude 45 13'50"E.L. Then in the direction of point 1. The Ninotsminda - Manavi space makes 72.7 sq.km. West Rustavi Point 1 latitude 41 36'12" N.L. coordinates longitude 44 49'34" E.L. Point 2 latitude 41 35'08" N.L. coordinates longitude 44 49'15" E.L. Point 3 latitude 41 33'41 " N.L. coordinates longitude 44 58'30" E.L. Point 4 latitude 41 33'43"N.L. coordinates longitude 44 58'36"E.L. Point 5 latitude 41 36'04" N.L. coordinates longitude 44 56'35" E.L. Then in the direction of point 1. The space of West Rustavi deposit is 35.7 sq.km. 88 ENCLOSURE N2 The title: Plans, geological profiles and structure maps of the oil deposits on Ninotsminda, West Rustavi and Manavi license territories. Page 1 1. Schematic map of the location of joint venture "Georgia MAKOIL" license area on the territory of the Republic of Georgia. Sc. 1:200 000 Page 2 2. Geological map and well location scheme of Ninotsminda and Manavi area. Sc. 1:25 000 Page 3 3. Structural map of Ninotsminda and Manavi area Middle Eocene Top.Sc. 1:50 000. Page 4 4. Scheme of the well location on Rustavi area. Sc. 1 :2S 000 Page 5 5. Structural map of Rustavi area Middle Eocene Top. Sc. 1:25 000. Page 6 6. Geological profiles of Ninotsminda and Manavi areas. Sc. 1:25 000 Page 7 6. Geological profiles of Rustavi area. Sc. 1:25 000 ENCLOSURE N3 The title: The question of the license area land territory. On Ninotsminda and Rustavi oil deposits the mining territory will be outlined after space lining the oil deposits. This is why, before passing the Law on Land Issues, the activity on oil deposits and exploration territory must be determined in accordance with the current Land Legislation, by creating corresponding agreement in each separate case. 89 ENCLOSURE N4 The title: The condition of the oil reserves, explored on the East Georgia Ninotsminda and West Rustavi territories by 01.01 94. Ninotsminda C category reserves 23.283 thousand tons. Recoverable 6,333 thousand tons. a) Oil area space thousand sq.m 1 200 b) Oil bearing capacity average m 319 c) Open porosity 0 012 d) Oil content 0.8 e) Oil recovery factor 0 2772 f) Re-counting factor 0.071 Oil characteristics a) Density gr./sq.cm - 0.823 b) Viscosity in formation condition m pasc - 0.415 c) c) Sulphur content % - 0.24 d) Paraffin content % - 4.89 e) Resin and asphaltene content % - 8.69 f) Temperature in formation condition C (degree) - 95 West Rustavi C category reserves 7.480.9 thousand tons Recoverable 2,221.9 a) Oil area space thousand sq.m 8 880 b) Oil bearing capacity total effective m 159/159 c) open porosity - 0:01 d) Oil content - 0.8 e) Oil recovery factor % - 0.3 f) Re-counting factor - 0.05 Oil characteristics a) Density gr./sq.sm - 0 845 b) Viscosity in formation condition m pasc - 0.49 c) Sulphur content % - 0.14 d) Paraffin content % - 3.0 e) Resin and asphaltene content % - 11.08 f) Temperature in formation condition C - 93 90 ENCLOSURE N5 The title: Joint venture "Georgia MAKOIL": Feasibility Study of exploration research and development operations on the East Georgia ` Ninotsminda, West Rustavi and Manavi license territories. Geological - Technological Study 1. GEOLOGICAL APPRAISAL OF THE EAST GEORGIA NINOTSMINDA, WEST RUSTAVI DEPOSITS AND MANAVI RESEARCH TERRITORY. For the purpose of increasing oil production on Ninotsminda and Rustavi deposits and for the purpose of increasing the oil flowing of the formations, in the Department "Georgian Oil" was solved to use the method of horizontal drilling. The mentioned reservoirs are located within the oil region near Tbilisi. Ninotsminda and Manavi are the separate domes of the eastern part of Samgori anticline zone. Rustavi is an indefinite structure, located South from Samgori structure. Because of the difficult geological conditions for drilling and development, it was resolved, that this problem will be solved by participation of foreign f~nns. This observation is a short geological evaluation of the mentioned region, and it is based on published and unpublished data and on the discussions, held in November of 1990 during the visit of the representatives of the Ministry. 2. GEOLOGICAL LOCATION The deposit to be discussed is located in the Eastern part of Georgia, 20 - 30 km to the East from the capital of Georgia, Tbilisi. Georgia is located in the Caucasian Mountains, that was formed at the same time as the Alps. The Caucasian region consists of two parallel north - west and south - east directed mountain ridges that are separated by Mtkvari - Kolkheti depression. Georgia inhabits the above depression and slopes of the surrounding folding zones. Stratigraphically, the Tbilisi region mainly consists of formations, that belong to the Alpine Orogenese (it is located in the IX block of the Georgian regional division and includes the formations from the Upper Cretaceous to the Quarterly period). - - Quarterly - 100m, conglomerates - - Miocene - 2 500 - 3 500m, conglomerate, sandstone, clay. - - Oligocene - 1 000 - 1 500m, clay, sandstone. - - Upper Eocene - 1 500m, terrigenic flysch - - Middle Eocene - 800m igneous formations - - Low Eocene - 1 800b - 2 200m flysch, sandstone, clay - - Palaeocene - 100 - 500m limestone, calcareous clay, marl - - Upper Cretaceous - 1 000m limestone, calcareous clay, igneous formations 91 Tbilisi surrounding region oil deposits are located within the Georgian between mountain depression, that is the part of the South Caspian oil - gas region. The between mountain depression is bordered by Dzirula massive. It is faced by under-thrusting, that separates it from Greater Caucuses in the North and from the folding zones of the Lesser Caucuses in the South. Achara-Trialeti folding zone is located in the north-west part of the Lesser Caucasus. A number of folding are singled out here, the axis of which is sinking from the West to the East. Separate anticline domes are developed on the folding zone depression within the between mountain depression. In the Paleogene formations they contain oil and gas industrial accumulations. In this section the folding are usually asymmetric, mostly on the sliding south wing. 3. CHARACTERISTICS OF THE RESERVOIR The main reservoirs of the deposits in the region of our interest are made of igneous formations. These layers were set on the underwater field of an igneous island. Such formations are observed on Japanese and Indonesian islands. The formations of this type do not have well developed porosity and oil existence in such reservoirs is determined by technological disorders in the fractures. The formations of the mentioned reservoir are partially similar to the volcanic formations of Nevada Trap Spring Field reservoir. 4. DESCRIPTION OF THE DEPOSIT Data on some deposits of the folding system is given in table N1. Samgori, Patardzenli, Ninotsminda and Manavi are separate anticlines of the same folding zone. Ninotsminda was considered a part of Samgori Patardzeuli deposit, but some seismic and industrial materials show, that this is a separate fold. Manavi is an anticline of the maintained folding zone, which is located in the barest East and it has not been developed. Rustavi is located in the South of Samgori Patardzeuli anticline zone and similar to the Samgori Patardzeuli, Middle Eocene igneous formations are productive here. Though Samgori-Patardzeuli deposit is not included in the proposed licensed territory, the geological and industrial characteristics are known better, but it is assumed, that this deposit is analogous with the proposed one. 5. SURFACE CONDITIONS The relief is mountainous. It is higher in the north-east. It is covered by deep ravines and is used for irrigation. Three structural levels of the region are characterized as oil and gas bearing. Close to the surface is observed small oil accumulation in the Upper Eocene, the following is the main oil deposit in the middle Eocene, deeper is the gas accumulation in the Low Eocene. 92 6. CHARACTERISATION OF THE RESERVOIR The main reservoir is the Middle Eocene igneous formations, that are characterized by fracture reservoirs. Reservoir characteristics include definite variety, in the depth and in the width. According to the industrial geophysical information their separation is quite complicated. The industrial materials of the deposit show, that effective porosity and permeability is basically connected with fractures. Surface observations show, that the fracturing is controlled in the partition of the anticlines. 7. Industrial data 7. INDUSTRIAL DATA Besides the Middle Eocene reservoir, on Ninotsminda territory north wing in the Upper Eocene sandstone is opened an oil deposit in well N59. Oil showing is observed in wells N1, 35 36 on Samgori-Ninotsminda structure. 7.1 The primarily discovered wells were completed in 1974. The production made 2 200 bbl oil. From the discovery was produced 96 mln Bbl. The wells of as high as of low rate are met on the deposit. The deposit regime is water resisting. The water rate is low, but along with the decrease of oil rate it increases obviously. It is assumed, that there is strong of water-resistance, but the technique, used before did not include pressure maintaining operations. As the oil deposit regime is water resisting, Ninotsminda unproductive wells started producing oil later. 7.2 Reserves with the primary appraisal - 580 mln bbl, 50% to be produced 290 mln bbl, note: 35% to be produced 203 mln bbl. This evaluation, made in Grozno Oil Scientific Research Institute was not accepted by "Georgian Oil". In "Georgian Oil" they consider 30-45 mln bbl is left in the deposit. 93 7.3 NINOTSMINDA Surface conditions: steep forestry hills in the east, less steep in the west. Production: The deposit is not completely developed. From the well N4 is produced 470 thousand bbl oil without water from 9250-9380 feet, for two years. Despite the fact that Ninotsminda borders Samgori deposit, it is a separated industrial unit. Existence of a fault with insignificant migration is assumed between Samgori-Patardzeuli-Ninotsminda. Reserves: Confirmation of Ninotsminda reserves evaluation has not been made. According to the "Saknavtobi" figures, oil reserves for producing by 1992, C category reach 6 333 thousand tons. The figure given for Samgori cannot be spread on Ninotsminda deposit. Ninotsminda area is being under the early stage of development. Deposit sizes, especially eastern part of the anticline have not been researched at all. The Upper Eocene oil deposit of the North wing is not researched either. 7.4 MANAVI In the East of Ninotsminda area several wells are drilled, they are several miles away from the wells, functioning on this territory. The wells are not drilled to the project depth, but oil bearing of the Middle Eocene formations is assumed. On Ninotsminda territory productive Paleogene formations are located under the testing. it is not excluded, that Mascara temto~y has analogous structure. The seismic study of this region is very poor and structural composition needs to be cleared out. The wells are intended to be drilled on Manavi Crest, or the latter might be a farest depression of Ninotsminda folding. At the very least, the perspective of Manavi territory is doubtful. This was to be solved by well N10, that was being drilled, but this problem was not solved, as it is temporarily conserved because of the electricity shortage. 7.5 RUSTAVI This deposit is located in the South from the folding zone of Teleti deposit and is separated from it by a underthrusting type faulting. Despite this, reservoir and production features are more similar to the Teleti deposit (table 1). Rustavi is being under observation. The structure can be determined on the basis of seismic materials of the Trust "Saknavtobgeopizika". The quality of the materials is good. Potential of development: The development possibilities of Ninotsminda deposit are good. Separate parts of this region can be qualified as researched and undeveloped. We do not have information on the undeveloped reserves, but the reserves of Manavi region and Ninotsminda undeveloped part are about 30% more than of Samgori complex central and west parts. In case of equivalence of other geological parameters, Ninotsminda Manavi must have at least 75 mln bbl oil reserves, as the borders of the production region are not defined yet and this figure might increase. Rustavi deposit is studied more completely than Ninotsminda Manavi, But the potentiality of this deposit is not known yet. Enter of a strong water flow might not be correct either. The energy of the layer can be transferred to reservoir fluid, because of the rock flexibility, that is similar to the condition of Nevada Trap Spring Field volcanic reservoir. Weaker water flows mean that sudden increase of the water 94 profile rather belongs to the erosive deepening along the fracture, than to water cones. In case of dividing the reservoir into permeable and unpermeable sections, horizontal drilling will be required, for the purpose to obtain the undeveloped parts of the deposit. As the structure is covered by fracture system of priority orientation, by this method can be increased not only the production from the wells but the oil outflow on the whole deposit. For determining the potential of the deposit, it is necessary to carry out detailed analysis of the reservoir and of the drilling technique. 7.6 RESEARCH CAPACITIES As the research region is outlined, the research possibilities are limited. But still there exist definite possibilities on Ninotsminda and Manavi areas. Seismic conditions in Samgori region basically are good, but on Ninotsminda territory, where the structure is complicated because of a fault of under-thrusting character, data are getting worse. It is possible, that the sizes of Ninotsminda and Manavi folding are not determined completely, or there exist bordering unidentified secondary folding. 7.7 HORIZONTAL DRILLING Development of Ninotsminda-Manavi region by the method of horizontal drilling is too early, if this is not caused by complex relief. On well-developed Rustavi area there might be sections where this method of exploitation can be used. The existing data shows that in the Middle Eocene profile some facies can be presented by comparably better permeable layers. It might become possible to drill with vertical drilling derrick through oil-bearing layers and to determine the purpose of horizontal drilling from there. The direction of horizontal drilling must be defined by the analysis of the region fracture orientation. 7.8 TRANSFER OF THE PRODUCTION The wells on Ninotsminda and West Rustavi deposits will be connected to the existing oil-storing points. Oil from Ninotsminda oil-storing point will be transferred through the oil pipeline to Samgori oil-storing station. On the basis of a further agreement, the parties can sell oil to oil factory, at oil international price. As for West Rustavi deposit, at the beginning the oil will be transferred from here to Samgori oil-storing station by container trucks. 8. DESIGNING OF THE DEPOSIT EXPLORATION AND DEVELOPMENT PROJECT Execution of deposit exploration and development operations is considered on two stages. The purpose of the first three year stage is to research the producing capacity of deposits on the license territory and to drill two(2) horizontal and one(l) vertical wells. If oil is not found in any of the first three(3) wells, the joint venture ceases its activity and will be liquidated according to the established rule. The second 22(twenty two) year stage of exploration and development operations is considered in that case, if any of the first three(3) wells, drilled 95 by the joint venture proves to be oil producing. Then the joint venture has the right to drill such a number of wells within the license area, that it considers necessary. In case of getting positive results while drilling, there is planned a work program on the license area, that will enable "Georgia MAKOIL" to start oil production in advance. This will, in its turn, provide the inflow of income, after they will begin widening of the activity region on Manavi field, where the location of collectors is deeper and less studied and finally, widescale research operations will commence. The plan on the works execution and accounting is given in table 2, that is designed annually for the first five years. The key issues of the table are the following. Each line of the table represents a definite stage of the plan, and each type of the operation depends on the positive results of the previous stage. The expenses, given in the table, along with the drilling expenses, include geological-geophysical research and other unconsidered expenses. Both deposits have the capacity to increase annual production effectively. So the operations will be carried out simultaneously. According to the 1995 year plan, it is intended to open a deposit on Manavi area and later in 1996-1998 to carry out exploration, evaluation and development operations of the new deposit. THE ECONOMY OF THE PROJECT 8.2 NINOTSMINDA AND WEST RUSTAVI OIL DEPOSITS The primary processing of the industrial materials, repairing and deepening of the wells and drilling of new wells are determined in details, considering the drilling rig supplier on the world market. Seismic research works, which might be quite expensive in case of complex relief, especially on Manavi territory, are considered as well. Despite this, the seismic research will give the possibility to find prospective drilling area quickly, where the operations will begin. The parameters for the positive execution of the project are: - The amount of oil on each deposit is not less, than 2.2 mln.t. - The maximum productivity of each well is not less, than 50 t per day. - The total amount of the investment for the first five years must not exceed $15 mln USA. - The maximal number of exploitation wells, together on the both deposits - 16, the number of exploration wells - 7. 96 9. TECHNIQUE AND TECHNOLOGY OF DRILLING OPERATIONS EXECUTION 9.1 CONSTRUCTION AND TECHNOLOGY OF THE WELLS The purpose of the joint venture "Georgia MAKOIL" is to increase oil production in the Republic of Georgia in the possible short period of time. It is planned to renovate several wells on Ninotsminda and West Rustavi deposits, that are temporarily under conservation for different reasons. These wells will have constructions, corresponding with western technologies. Study of exploitation areas of some wells is expected, if this is allowed technically and geologically. At the same time, new exploitation wells will be drilled, in which, along with the horizontal drilling method other western advanced technology will be used, in order to provide optimal oil production. 9.2 CIRCULATION SYSTEM The circulation system will serve the following: - Cleaning of the well bore during the drilling process; - Maintaining the pressure of the layer; - Maintaining integrity of the well bore; - Lubricating of the drilling bit; - Keeping the oil and gas layer structure from destruction. 9.3 DRILLING OPERATIONS AND LAYOUT OF THE CASING For underground repairing of the wells "Georgia MAKOIL" will use the mobile equipment of "Georgian Oil", besides, it will bring from abroad such equipment, which will ensure running of the heaviest casing and arrange wellhead according to the accepted standards and norms, with the double safety factor. This casing will stand against the strength, that is caused by mining and layer pressures in the maximally long periods of time. Vertical, directional and horizontal wells will be drilled. 9.4 TECHNOLOGY OF THE WELL COMPLETION "Greorgia MAKOIL" plans to drill the wells, in which exploitation of one or several formations simultaneously will be possible. In case if along with the Middle Eocene formations the oil will be discovered in the Upper Eocene formations, in the process of the well completion will be used special liquids, wire-line perforators on the tubing, on each well will be fixed a protection reflex valve, that will work continuously. 9.5 SAFETY OF THE DRILLING OPERATIONS While carrying out the operations on the wells, the basic purpose is to Insure safety of the well personnel and regional people, in case of an emergency situation. This safety will be provided by planning the double Safety factor, while designing the well project. The periodical control of the equipment and regulations of the technical control are considered. 97 9.6 THE WORKING PERSONNEL The working personnel of the joint venture will be formed basically by the citizens of the Republic of Georgia The joint venture will guarantee to improve the qualification of the Georgian personnel up to the western technologies level, which will enable them to carry out any kind of operation without the assistance of western experts. The questions of employing and releasing, payment, concessions and insurance, work safety, etc., are resolved in accordance with the Legislation of the Republic of Georgia and are determined in the work agreement. 9.7 PROTECTION OF HEALTH OF THE PERSONNEL AND WORK SAFETY The main principle of the activity of joint venture "Georgia MAKOIL" is the safety of all kinds of operations, the basis of which are the international requirements on the safety conditions. It intends the creation of the higher norms for personnel training with the help of special programs. Healthy condition of each employee is a significant objective of the joint venture activity. For the purpose of maintaining good health of the personnel will be held general medical examination. Later the examination will be made regularly once a year. 10. PERSONNEL SAFETY ENSURANCE AND ENVIRONMENTAL PROTECTION 10.1 Joint venture "Georgia MAKOIL" has developed two main guidelines, which will govern their conduct of business. First: Safety and welfare of the personnel has the primary importance. Environmental protection is the second significant principle of the "Georgia MAKOIL" activity and it is considered as important, as safety of the people. 10.2 IDENTIFICATION OF HAZARDS AND RISKS All oil field operations have the inherent potential for the occurrence of unplanned (accidental) events. The severity of accidents range from minor inconvenience, with no injury nor capital/financial losses, to a catastrophic event with potential loss of life, irreversible damage to the environment, and millions of dollars in capital/financial losses. The primary tool for "Georgia MAKOIL" safety management program is the identification of potential hazards that an operation is exposed to, joint venture determines the amount of risk each hazard possess. As the element of risk, associated with each individual hazard increases, the safety management system creates more comprehensive safety procedures to minimize the potential for unplanned events. 10.3 SAFETY MEASURES Safety management is achieved by a systematic approach that addresses Prevention, Information and Training. 98 10.4 COMPLIANCE OF SAFETY MEASURES An important element for executing the safety program is the accorded work of the personnel. They should be taught the discipline mechanism, rules of safety measures. Meetings on the safety issues must be held regularly, on which the methods of the further operation execution and all the aspects of health and environmental protection will be discussed. Detailed control of the executed operations will be held after each conducted work. Each employee will get acquainted with his own safety responsibilities. Besides, engineering of safety technique will be considered, and it will ensure training of the personnel and fulfillment of the safety measures. 10.5 CONTINUOUS MONITORING SYSTEM "Georgia MAKOIL" will institute Continuous monitoring System that allows an ongoing check of the effectiveness of its safety management system. Each work group, or crew will have one person, that will be responsible for the crew's safe working and will be the first person in the monitor process. He will be trained to enable him to perform safety related duties effectively. For the safety of the crew will be also responsible an inspector, that represents the next level of the monitoring system. Part of the daily work report for all operations will be dedicated to the safety aspects of the work program. This is a prime element of safety management and it provides for daily monitoring of safety operations. The Safety Officer will have overall responsibility for safety in operations. He will review operations on a daily basis to asses the safety of all work. This complex of measures is successfully used in different regions of the world. It enables to carry out oil production and other related operations with high level of productivity, economically and safely. The keystone of any safety system is prevention. By eliminating hazards or minimizing the degree of risk an operation may possess the potential for accident is greatly reduced. A vital element of accident prevention is the supply of information to the individuals that are performing operations. When personnel are informed about the procedures, equipment, and expected results of an operation, they have a greatly improved understanding of which aspects of their work program nay present hazards. Training of personnel in safe working procedures, workplace awareness are a proven element of accident prevention. Employees are trained to use all safety equipment needed for their positions as well as fire fighting, lifesaving and medical first aid treatment techniques. 99 10.6 PERIODIC MONITORING SYSTEM Joint venture "Georgia MAKOIL" intends to utilize various methods that are available for monitoring the safety management system on a regular basis. A weekly safety audit will be conducted on all aspects of company operations. All sub-contractor will be instructed to submit weekly safety reports to "Georgia MAKOIL". The enterprise will review employee records on a regular basis to identify areas of operations and individuals that have higher accident frequency rates. 10.7 EMERGENCY SYSTEMS AND FACILITIES Modem technology has developed several types of safety devices that are able to rapidly stop or isolate various functions of drilling and producing operations, thereby increasing safety. The most important is the emergency drilling rig shut off, which can completely stop all engines of a drilling rig in a matter of seconds. The exploitation well protective valve is important as well. Such valve will automatically shut the well and keep the surface equipment from damages. For ensuring safety "Georgia MAKOIL" intends to bring and install other equipment that will strengthen the quality of safety. The joint venture will have first aid station, fire equipment station, emergency breathing apparatus, etc. 11. ENVIRONMENTAL PROTECTION 11.1. BASELINE SURVEY A baseline survey will be conducted on all fields that "Georgia MAKOIL" will operate on before operations commence. The purpose of these surveys is to determine and record the current status of pollution, contamination and environmental awareness. A photographic library is a component of the survey. 11.2 IDENTIFICATION OF ENVIRONMENTAL HAZARDS AND RISKS An important part of any of "Georgia MAKOIL" operational planning is an Environmental Impact Assessment (EIA). EIA includes the analysis of possible activity and determination of sensitive areas of the environment. The amount of risk is then quantified for each hazard that has been identified. 100 11.3 ENVIRONMENTAL PROTECTION MEASURES "Georgia MAKOIL" plans an integral program of environmental protection activities, including: - Materials management to prevent adverse inter-reaction with the environment; - Waste avoidance or recycling where possible; - International standards training for the company personnel; - Emergency response facilities to limit environmental damage. - Authorization permits for any activities that may cause pollution. 101 CONTINUOUS MANAGING SYSTEM A schedule of repeat environmental auditing will be generated in the planning stage of operations. In "Georgia MAKOIL" authority staff will be a deputy who will be responsible for observation of the effects of the operations on the environment and for conducting the auditing measures. The joint venture intends to have a laboratory supplied with monitoring systems, equipment and inspection staff. Besides, they will install the equipment that will minimise the risk of environmental pollution. A project with detailed description of all measures, that provide maximal environmental protection will be prepared just before commence of drilling, development and exploitation operations. These projects will go through the corresponding expertise in the Ministry for Environmental Protection of the Republic of Georgia. 102 ENCLOSURE N6 The payment of the license duty for the joint venture "Georgia MAKOIL" 6.1 The amount of the license duty is determined by 2 000 (two thousand) USA dollars. ENCLOSURE N7 Terms of payment on mineral usage for joint venture "Georgia MAKOIL" Note: Resolution N 752 of the Cabinet of Ministers of the Republic of Georgia, out of 20.10.93. 7.1 The following payment norms are applied for mineral usage: a) For conducting oil and gas deposit research-exploration works in the amount of 2% (two percent) of the annual accounting. b) For detailed exploration of oil and gas deposits in the amount of 4% (four percent) of the annual accounting. c) For producing crude oil and gas in the amount of 10% (ten percent) of the produced production on Ninotsminda and Manavi areas, and 5% (five percent) on Rustavi area The payment of the mineral usage tax is commenced from the date of issuing the license on mineral usage and is effective throughout the duration of the license. Land usage tax is determined as a part of oil production price. 7.2 Rule of calculation and payment of the tax a) "Georgia MAKOIL" presents to the State Payment Inspection a document in an established form about the estimated (divided by quarters) payment, not later than within 5 days from getting license on the operations determined in paragraphs /a/ and /b/. The payment is transferred to the budget on a monthly basis, not later than the 1 5th day of the month that follows the month of estimation in the amount of 1/3 of the quarterly payment. b) Estimation of the payment on produced oil, determined in paragraph /c/ is made on a monthly basis, not later than the 1 5th day of the month that follows the month of estimation. The payment can be paid by the part of the produced oil. The payment sum presented by the calculation is subject to transfer to the budget within 5 days. 103 Transfer of the payment to the budget is made in accordance with the Law "On Budget System and Rights" of the Republic of Georgia and with other Legislation acts. Besides the Tax on Mineral usage, the company pays the taxes established by the Legislation of the Republic of Georgia. ENCLOSURE N8 The title: The assumed amount and agreed share distribution in time period of the oil produced by joint venture "Georgia MAKOIL" on Ninotsminda, West Rustavi and Manavi license territories 8.1 The assumed amount of produced oil is given in table N3. Table N3 Assumed annual oil production in bbl.
SPACE 1ST YEAR 2ND YEAR 3RD YEAR 4TH YEAR 5TH YEAR - ----- -------- -------- -------- -------- -------- Rustavi 9 000 474 500 839 500 1 095 000 1 277 500 Ninotsmind 63 000 1 058 500 1 606 000 1 971 000 2 518 500 Manavi - 182 500 182 500 365 000 547 500 Total 72 000 1 715 500 2 628 000 3 431 000 4 343 500
During the first 5 years the total production will be 12 190 000 bbl. 8.2 SHARE DISTRIBUTION OF THE PRODUCED OIL IN TIME PERIOD, TO DEPARTMENT "GEORGIAN OIL": In Tables 4, 4a and 5 is shown the average daily amount of oil from each deposit, that might be produced on the research territory from the wells in their current condition. This oil will be considered as "determined production" of oil. "Determined oil" belongs to "Georgian Oil" and will be sold in accordance with the agreement between "Georgian Oil" and the joint venture along with the regular business operations. NINOTSMINDA (The Upper Eocene) Table N3
YEARS DAILY OIL PRODUCTION IN TONS ANNUAL OIL PRODUCTION IN TONS ----- ---------------------------- ----------------------------- 1990 5.71 1 749 5 1991 7.13 2 601.2 1992 2.1 384.6
Average daily production 5.6 104
NINOTSMINDA (The Middle Eocene) Table N4a YEARS DAILY OIL PRODUCTION IN TONS ANNUAL OIL PRODUCTION IN TONS ----- ---------------------------- ----------------------------- 1990 113.3 41 746.6 1991 153.1 56 159.4 1992 124 43 218.7
Average daily production 130 tons. Decline of the production is 50% per year. WEST RUSTAVI Table N 5
YEARS DAILY OIL PRODUCTION IN TONS ANNUAL OIL PRODUCTIONS IN TONS ----- ---------------------------- ------------------------------ 1990 2.05 652.8 1991 2.1 792.5 1992 1.07 341
Average daily production 1.74 tons. 8.3 Total amount of Determined Production is 137.35 tons per day. Note: Initial Determined Production to be agreed by well testing (at least 1 week of constant flow) - The Initial Determined Production will be subject to an annual decline commensurate with any decline observed on the field in future) 8.4 MAKOIL and/or its assignees and Georgian Oil shall be entitled to recover ("Cost Recovery") all petroleum operation expenditures, including all capital and operating expenses, overhead costs, abandonment costs and similar within the license area. Up to the half of the gross annual production within the license areas, whatever remains after providing Georgian Oil with daily "Determined Production", will be used to recover these expenses (hereinafter referred to as Cost Recovery Oil"). Since Makoil and/or its assignees will provide one hundred percent (100%) of the funding with Georgian Oil providing services wherever possible, Makoil and/or its assignees will have priority in lifting Cost Recovery Oil. 8.5 Georgian Oil and Makoil and/or its assignees both have the right to audit each other's records related to recoverable costs. 8.6 Such oil is hereinafter referred to as "Cost Recovery Oil". Such costs and expenses will be recovered from Cost Recovery Oil in the following manner: a) Exploration expenditures b) Development expenditures c) Drilling costs d) To the extent that in any calendar year costs, expenses and expenditures recoverable per paragraphs a) b) and c) preceding exceed the value of Cost Recovery Oil for such calendar year, the excess be carried forward for recovery in the next succeeding calendar year or years, but in no case after the termination o the license term. e) For the purpose of determining costs, expenses and expenditures for their recovery the following terms shall apply: 105 i) "Exploration Expenditures" shall mean all costs and expenses for exploration operations other than Drilling Costs, but including training and related expenses, and overhead and study costs, also all taxes that are included in cost recovery under Georgian Law. ii) "Development Expenditures" shall mean costs and expenses for development of all deposits, with the exception of Operating Expenses and Drilling Costs, also all taxes that are included in cost recovery under Georgian Law. iii) "Operating Expenses" shall mean all costs, expenses expenditures associated with the production and primary processing of oil, including training and related expenses, also all taxes that are included in cost recovery under Georgian Law. iv.) Drilling Costs" shall mean expenditures incurred during Exploration and Development for well drilling and completing operations including, but not limited to labour, geophysical works, engineering-technical and other contractors, expenses on various materials, perforation, formation development, cementing, well-logging and transportation, also all taxes that are included in cost recovery under Georgian Law. 8.7 SHARING OF OIL PRODUCED Georgian Oil and Makoil and/or its assignees will share and be entitled to use separately the oil remaining after deducting Cost Recovery Oil and Georgian Oil's share of the Determined Production from gross annual production (hereinafter referred to as "Profit Oil") Profit Oil will be shared between Department Georgian Oil and Makoil and/or its assignees in the following manner: Georgian Oil share Makoil and/or its assignees share 70% (seventy percent) 30% (thirty percent) All taxes applied to Makoil share in accordance with the Georgian legislation will be paid from this share. 106 8.8 GAS PRODUCTION If commercial production of gas commences on the license area, the founders will jointly discuss all economic options for its usage and will resolve together the best one for Georgian Oil and Makoil and/or its assignees. All costs and expenses related to gas production will be recovered in accordance with the cost recovery rule provided in this Enclosure #8. 8.9 Oil selling prices are determined in accordance with the international world price for similar crude oil. Oil blend is determined as "Brent blend" or Libyan crude oil. 8.10 The amount of oil Makoil and/or its assignees export abroad should not exceed 50% (fifty percent) of the produced oil. If Makoil and/or its assignees share from Cost Recovery Oil and Profit Oil exceeds 50% (fifty percent) of produced oil then the Republic of Georgia has right to purchase the exceed oil on the world market price minus a discount of 10%. 8.11 Georgian Oil is entitled to purchase 50% (fifty percent) Cost Recovery Oil from the Joint Venture and all oil that Makoil and/or its assignees will sell in Georgia The pricing for oil purchased by Georgian Oil is determined by the world market price minus a discount of 10%; needs to be conditional on Georgian Oil being able to give the price, if not Makoil has right to export oil 8.12 Georgian Oil transfers to the Joint Venture the right of using the wells located on the license area. 8.13 Oil storing facilities and oil pipe-lines remain in Georgian Oil's discretion and they can be transferred to the Joint Venture under rental terms on the basis of an additional agreement. Georgian Oil agrees to contribute cost of wells and other facilities,equipment and buildings to the Charter Capital of the Joint Venture as a share of Georgian Oil. DISTRIBUTION OF THE JOINT VENTURE INCOME Note: The Charter of the Georgian-American joint venture "Georgia MAKOIL". The income got by the joint venture from selling the produced oil and from any other sources is divided in the following manner: 13.1 Firstly, such income is used to pay to the buyers of the third party, that provides the joint venture with goods and services, in order to pay salaries to the joint venture staff, work force and managers, to purchase insurance guarantees for the joint venture, to pay other trade obligations for the third persons and to pay other operation expenses of the joint venture. As far as possible, the joint venture will pay all such costs and obligations in currency of the Republic of Georgia or in foreign currency, if it does not gain economic privilege by paying in hard currency. 107 13.2 For the purpose of increasing the interest of the participating sides and stabilizing the income, they are entitled to take out of the country hard currency sums equivalent to their contribution to the Charter Fund without any State, customs, tariff, income and other (including Royalty tax) taxes. "MAKOIL" is granted the priority right on the primary transfer of the mentioned sum.Concerning the interests of the joint venture, the terms of transferring might be reconsidered by the Board of Directors, but by no means should it exceed their (each separately) contribution to the Charter Fund. During and after the process of transferring of this sum, taxation of the profit is subject to all the terms determined by the Law.Besides, the profit in the enterprise funds, remained after paying taxes and sums determined for spending by decision of the Board of Directors, is divided between the parties proportionally to their share contribution to the Charter Fund (50%-50%).Transfer of sums by "MAKOIL" must be conducted according to the following scheme: a) Ten percent (10%) of the Gross income of the joint venture by the first year of the effectiveness of the license. b) Fifteen percent (15%) of the Gross income of the joint venture by the second year of the effectiveness of the license. c) Twenty percent (20%) of Me Gross income of the joint venture by the fourth year of the effectiveness of the license. d) Twenty five percent (25%) of the Gross income of the joint venture by the forth year of the effectiveness of the license. e) Thirty percent(30%) of the Gross income of the joint venture by the fifth year of the effectiveness of the license. Such payment is estimated for "MAKOIL" at least once in a calendar year, or more frequently if the majority of the Board of Directors agrees. 13.3 The profit received from business activity of the joint venture, after deduction of depreciation costs, is used for founding joint venture and accounting to the State Budget. ENCLOSURE N9 The title: The Agreement on confidentiality of new geological and other information,received during mineral usage. Note: Article 5 of the Charter of the joint venture "Georgia MAKOIL". At the request of the joint venture, all the parties participating in the Agreement must provide the joint venture with all geological and geophysical information, production and other corresponding information, that might be possessed the participants of and that might be needed for exploration, preparation and exploitation activities on the research territory. At the request of any party, the joint venture provides them with new or additional 108 geological, geophysical, exploitation or other information about the Agreement the research territory, received or acquired by it. But, if any of the parties or the joint venture considers that the received information must be discussed from commercial or competitive point of view as confidential, then the received information must be considered confidential. The party, that gets such information from the other party must not make it known, share with others or publish, until the party, which received the information notifies in writing, that the information is not confidential any more. In connection with newly received or acquired confidential information, that is sent to any party by the joint venture, must be added the following: 1. Such information is considered confidential within 1 (one) year from receiving it and cannot be in any form, totally or partially announced by any party or its representatives without a preliminary notification in writing from the joint venture. None of the parties or their representatives can use the information in any activity other than the joint venture operations. Each party agrees, that the confidential information will be transferred only to its representatives, who need it for the assistance and development of the joint venture, and are informed about the confidentiality of this information, and who agreed in the writing form to preserve its confidentiality. All the participants of the Agreement agree to provide the joint venture in the possible shortest time with the information about the personality of each representative, who can be trusted and shared the confidential information. 2. In case, when any Agreement participant party or the person, with who this party information according to this Agreement, is obliged under the Law to make known any confidential information, this party has to notify the joint venture immediately about this, in order to enable the lager to take protective and other legal measures. In case, when such protective and other measures were not taken, the party, that possesses the confidential information, provides its part required only by the Law and will try its best to get the confidence on the treatment of such information. ENCLOSURE N 10 The title: Conclusion from the Ministry of Environmental Protection ENCLOSURE N 11 The title: Conclusion from the Department of Technical Supervision in the Republican Economy 109 ENCLOSURE N12 The title: The Minutes of the Scientific-Technical Committee Session of Department :Georgian Oil THE MINUTES OF THE SCIENTIFIC-TECHNICAL COMMITTEE SESSION OF DEPARTMENT "GEORGIAN OIL" The session was attended by: The Chairman of the Scientific-Technical Committee - G. Beraia The members of the Scientific-Technical Committee: M. Bakhia, D. Papava, V. Sakvarelidze, M. Oniashvili, O. Jashi, G. Apaidze, G. Lobzhanidze A. Bortsvadze, G. Antadze, V. Chkhobadze, G. Chachanidze, I. Tavdu~nadze S. Gudushauri. Invited guest: Eugene S. Kozlowski, Representative of the joint venture "Georgia MAKOIL". The speakers: Eugene S. Kozlowski, S. Gudushauri. At the session was admitted, that the joint venture "Georgia MAKOIL" was founded on the basis of Department "Georgian Oil" and USA private Corporation "MAKOIL Inc." (it is registered in accordance with the legislation of the Republic of Georgia).. The mentioned joint venture requests permission on mineral usage on the East Georgia oil deposits of Ninotsminda, West Rustavi and Manavi research territories, for geological research and oil production. This license area is located in Sagarejo and Gardabani regions, on the villages Ninotsminda, Giorgitsminda, Manavi, Tokhliauri and Krtsanisi farming territories. The joint venture is financed by the USA side, with the Georgian side providing geological materials and various services. The joint venture presented the program on geological and geophysical research, exploration and exploitation drilling, deposit development and oil production on the license area. It is stated in the program to drill 23 wells during 5 years of the first stage of activity, 8 wells out of these on Ninotsminda, 8 - on Rustavi, and 7 - on Manavi areas; to develop new prospective areas in the old wells, to establish new drilling and producing technologies, to increase the oil production to 12 190 000 bbl for 5 years. The measures determined in the program ensure the complete and scientific study of the land, environmental protection and work safety. The Session listened to: The conclusion on the issues, presented by the joint venture "Georgia MAKOIL', made by the expert S. Gudushauri. 110 The Session concluded: 1. To issue to the joint venture "Georgia MAKOIL" a complex license on mineral usage on the East Georgia Ninotsminda and West Rustavi oil deposits and Manavi research area on a 25 year term. 2. The share distribution of the produced oil to be carried out in accordance with Article 13 of the Charter of the joint venture. 3. The license to be prepared in accordance with the Resolutions N146, out of February 18, 1993 and N752, out of October 20, 1993 of the Cabinet of Ministers of the Republic of Georgia and other Legislation Statements of the Republic of Georgia. The Chairman G. Beraia The Secretary G. Lobzhani-dze 111 ENCLOSURE N13 The title: The terms of continuation and termination of the license validity The program of returning the territory Note:Decree N 146, out of February 18, 1993 of the Cabinet of ministers of the Republic of Georgia, Articles 7.1, 7.4. The license on geological study, drilling and development works, oil and gas deposit exploitation on Ninotsminda and West Rustavi oil deposits and Manavi research territory is issued to the joint venture "Georgia MAKOIL" on a 25 year term. The term of the license duration is determined from the date of its registration. Note: Decree N146, out of February 18, 1993, Article 7.3. In case of the deposit exploitation for more than 20 years, the term of the license duration can be extended on the initiative of "Georgia MAKOIL". In case of expiration of the license duration in terms of exploitation the deposit, explored by the joint venture for less than 20 (twenty) years, the joint venture is granted the right of priority claim on continuation of the license validity. The right on mineral usage is terminated: Note: Decree N 146, out of February 18, 1993, Article 15.1 a) After expiration of the term, determined by the license b) In case of "Georgia MAKOIL"'s refusal on mineral usage. c) In case of occurring such conditions stated in the license, that will later exclude further execution of the rights granted for mineral usage. Note: Decree N146, out of February 18, 1993, Article 15.2 The right on mineral usage can be terminated, suspended or limited prior to the determined term, in the following cases: a) if the lives or the health of the persons working or living within the area of activity,connected with mineral usage are threatened directly; b) if the mineral user violates the essential terms, determined in the license; c) if the mineral user regularly violates the rules on mineral usage and preservation, also on environmental protection, established by the current Legislation, standards, regulations,norms, including the enterprise conservation regulation. d) in case of emergency situation /disaster, military action, etc. e) if the user does not start mineral using in accordance with terms and requirements of the program determined in the license; f) if the joint venture is liquidated. 112 The termination, suspension or limitation of the right on mineral usage before the established term according to the paragraphs above, is conducted by the Specialized Office of Licensing and Information of Department "Georgian Oil", or the Ministry of Environmental Protection of the Republic of Georgia, or by the Department for Technical Supervision in the Republican Economy in each certain case, considering the terms of license. ARTICLE 15.3 If the joint venture disagrees with the decision on termination, suspension or limitation of the mineral usage right, it can apply with a claim to the Court, or to the upper authorities according to the administrative regulation. Note: Decree N146, out of February 18, 1993, Article 15.4 15.4. In case determined by subparagraph 15.2/a/, mineral usage must be terminated immediately after making decision and the mineral user must be sent a written notification. 15.5. In case determined by subparagraphs 15.2./b,c,e/, the decision about termination of the mineral usage right for the mineral user can be made after three months from violation the nobles by him and after notifying in writing about not taking measures to liquidate these violations. 15.6 In case determined by subparagraph 15.2 /dl, mineral usage can be terminated from the moment of occurring conditions, determined in this paragraph. 15.7 right before the established term can be conducted not later than 6 months from informing by it the Department in writing. The refusal on the activities does not set it free of charge of presenting accounting on the executed works, conclusions, generalizations, recommendations. 15.8. In case of terminating mineral usage right before the established term, liquidation or conservation of the enterprise is conducted in accordance with the regulations determined by the current Legislation. The expenses of enterprise liquidation or conservation are for the joint venture to cover, if mineral usage is terminated as a fault of the joint venture for the reasons stated in subparagraphs 15.2/a/and 15.2/b/, or on the initiative of the joint venture. 15.9. The expenses of enterprise liquidation and conservation will be covered by the State, if mineral usage is terminated for the reasons stated in subparagraph 15.2/a/ with the joint venture being innocent, also for the terms stated in subparagraph 15.2./d/. 15.10. If the conditions and terms causing suspension and limitation of mineral usage right are liquidated, this right can be regained completely, besides, the period during which usage was suspended will not be included in the entire duration of the license mineral validity. 15.11. In case of long term conservation of the enterprise, or violation of conservation terms, that might cause the damage of oil deposit, the Specialized Office for Licensing and information of Department "Georgian Oil" is entitled to cancel the issued license and pass it to a new owner in accordance with the established regulation of the statement. 113 15.12. The activities determined in the license should not interfere with other economic activities which are carried out on the license area. THE TERMS OF ANNOUNCING THE LICENSE INEFFECTIVE Note: Decree Nl46, out of February 18, 1993, Article 17 16.0 on the license issuing will be considered ineffective in the following cases: a) If "Georgia MAKOIL" refuses to pay the payment, connected with license issuing; b) Violation of the Antimonopoly Legislation requirements of the Republic of Georgia; c) Establishment of the agreement facts for the purpose of liberalizing the license terms between the authorities participating in issuing mineral usage license and the persons interested in purchasing the license, and for the purpose of reducing taxes. d) Granting "Georgia MAKOIL" illegal concessions. e) Existence of the other basis, determined by the Legislation of the Republic of Georgia The disputes in cases of canceling the agreement will be discussed by the Court or Arbitration. 114 ENCLOSURE N14 The title: The obligations of the joint venture "Georgia MAKOIL" Note: Decree N146, out of February 18, 1993, Article 16.1,16.2. 17.1 The owner of the license is entitled: a) To use the mineral area within established space for the purposes determined by the license for geological study of the land, for carrying out research-exploration works and producing oil, condensate and gas. b) To use the results of his activity according to his consideration, including part of the produced oil, that as determined by the license terms goes into his possession. To include executors in the works connected with mineral usage on rental basis. To address the license issuing Bodies about reconsidering the terms, if the existing reality is completely different from the situation of the license issuing period. 17.2 The owner of the license is obliged: a) To accord the program on the work execution with the Specialized Office for Licensing and Informatics of Department "Georgian Oil". The Office is entitled while forming the work program to demand from the license owner to carry out the additional works, that are connected with execution of the mineral usage works (carry out radioactive, stratigraphic, hydro geological, temperature, geophysical research). b) To observe mineral usage demands of the Republic of Georgia, the standards of working technology, connected with mineral usage, according to the established form. c) To follow the demands of technical projects on work conducting, to ensure safety of the personnel and population while carrying out land usage operations; To preserve established standards /norms, regulations/ on mineral, atmosphere, land, forest, water and other environmental protection. d) To put in good shape land territories and other environmental areas, damaged while carrying out mineral usage works, to ensure their usefulness for exploitation. To participate in execution of the Social and Ecological Program in the region of activity. e) To ensure preservation of the geological and other kind of documentation, got in the process of geological research of the land. f) To pay mineral usage and other obligatory taxes in a timely and correct manner. g) The owner of the license is obliged to accord any evasion from the work execution "Georgian Oil". To present annual report about its activity, which 115 will include information about the results of the conducted research-exploration works, about new geological and geophysical data on the produced oil and on oil and gas reserves remained under the land, also other information established by the license. h) The owner of the license has no right on the surface of the land space stated in the license and on other natural resources, unless it is determined by the work program. The usage of such resources is regulated by the Laws and Normative Acts. i) The owner of the license is obliged to present information about opened natural resources (radioactive pressures, temperature anomalies, thermal waters), storage of injurious materials and about discovery of archaeological areas to the Specialized Of lice for Licensing and Informatics of Department "Georgian Oil". It is not permitted to give this information to juridical and physical persons without the approval of Department "Georgian Oil". The joint venture "Georgian MAKOIL" will consider the possibility to use the scientific -technical potential of "Georgian Oil " and Scientific Center in carrying out production and project works. ENCLOSURE N15 The title: Control of the license terms on mineral usage Note: Resolution N146, out of February l 8, 1993, Article l8 18.1 The control on mineral usage terms determined in the license is carried out by the Specialized Office of Licensing and Informatics of the Department, the Department for Technical Supervision in the Republican Economy and the Ministry of the Environmental Protection, which are acting within their competence, in accordance with the regulations approved by the Cabinet of Ministers of the Republic of Georgia. 18.2 The owner of the License is obliged to present documentation to the controlling Bodies, provide explanation on the issues under the competence of the controlling Bodies, ensure monitoring terms. 18.3 The controlling Bodies notify in writing the land owner and the Specialized Office for Licensing and Informatics of the Department "Georgian Oil" about the results of audit, evaluation of the mineral usage terms by the land owner, which includes evaluations concerning mineral usage obligatory payments and current standards /norms, rules/, and in case of considering it necessary, they suspend enterprise's activity and propose to cancel the license on mineral usage. 18.4 The Specialized Office for Licensing and Informatics of the Department regularly audits separate areas of the joint venture and its entire activity twice a year. "Georgia MAKOIL" is obliged to provide the representative of the Specialized Office for Licensing and Informatics of Department "Georgian Oil" with transportation mean in the period of auditing. 116 ENCLOSURE N16 The title: Issuing of a license on mineral usage to the joint venture Georgia MAKOIL" Report of the License Commission Session 7.06.94 The session was attended by: 1. Beraia Giorgi - Chief Engineer of the Department, Chairman of the Commission 2. Lobzhanidze Ivane - Vice Chairman of the Department in Foreign Economy affairs 3. Papava Dito - Chief Geologist of the Department, member of the Commission 4. Oniashvili Mamia - Vice Chairman of the Department in Capital Construction affairs, member of the Commission. 5. Sakvarelidze Vakhtang - Vice chairman of the Department in Economy affairs, member of the Commission 6. Mkhatvari Amiran - Chief Mine-surveyor of the department, member of the Commission 7. Tavdumadze Irakli - Head of the Specialised Office for Licensing and Informatics of the Department, Secretary of the Commission 117 Agenda: Issuing of a license on carrying out geological research, exploration works and increasing oil production on the East Georgia Ninotsminda and West Rustavi oil deposits and Manavi research territory. The license was discussed Text enclosure Graphic enclosure The license is worked out considering the Statement on "Regulation of Mineral Usage Licensing" and other Legislation Statements. The Commission approves and agrees with the validity and terms of issuing license on mineral usage on East Georgia Ninotsminda and West Rustavi oil deposits and Manavi research territory. Signature: G. Beraia I. Lobzhanidze D. Papava M. Oniashvili V. Sakvarelidze A. Mkhatvari I. Tavdumadze 118 ENCLOSURE N17 The title: Normative-technical documentation of oil The normative-technical documentation of the supplied oil with its physical-chemical characteristics must correspond the figures given in the table:
THE CHARACTERISTICS NORM ------------------- ---- 1. Water contents (%) not more than 1.0 2. Chloride salts contents (ml.gr/Lt) not more 1 800 than 3. Mechanical mixture contents (%) not more than 0.05 4. Steam saturation pressure in the deliver 66 650 point in oil temperature conditions not more than /500/
119 ENCLOSURE N 18 EXPERT CONCLUSION on the materials on the East Georgia Ninotsminda, West Rustavi oil deposits and Manavi research territory license areas, presented by "Georgia MAKOIL" The joint venture "Georgia MAKOIL" presented the data, noting: the location of the enterprise activity, its operating relations with the industrial and financial partners, the information on technical and technological capacities and intellectual level of the enterprise. The license area is located on Gardabani and Sagarejo regions territories. It consists of 108,4 sq. km. Two oil deposits are open here: Ninotsminda and West Rustavi oil deposits are connected with the Middle Eocene formations, and the assumed gas deposits are connected with the Lower Eocene and Paleocene-Crateceous formations. For the last three years the average daily-oil rate of Ninotsminda deposit ranges from 113 to 153 tons per day, average 130 tons daily. On West Rustavi deposit the average daily oil rate ranges from 1.07 to 2.05 tons per day, average 1.74 tons daily. The joint venture is planning to carry out geological and geo-physical studies, drilling and development work complex, and to increase oil production on each deposit. Study of the geological structure of the land, discovery and appraisal of new oil and gas deposits, study of their location and formation conformity will be held with the use of geological and geo-physical methods. For exploration and exploitation drilling, the joint venture intends to introduce western advanced technique and technology, namely horizontal drilling, perforation of the casing with tubing, etc.. The oil production is determined to increase effectively: from 72 000bbl in 1994 to 4 343 500bbl by 1998. For this purpose the existing production equipment will be renewed, the well net will be extended, the working methods, technical capacity and training of the personnel will provide safe working conditions for the population and work force, also protection of atmosphere, land, forest, water and other environment. 120 During the first 5 years it is planned to drill 23 new wells: eight - on Ninotsminda territory, eight - on West Rustavi territory, and seven - on Manavi field. Recultivation of the location will be held after drilling. Share distribution of the produced oil is profitable for the Republic of Georgia. 50% of the produced oil will serve the Republic, and the remained 50% is under the possession of "MAKOIL". So the information presented by the joint venture "Georgia MAKOIL" is enough for issuing a 25 year term license on geological research of the license territory and carrying out production operations from the deposits, that meets the demands of the Statement "On Relation of Licensing Mineral Usage" of the resolution N146 of the Cabinet Ministers of the Republic of Georgia, out of February 18, 1993. The expert Chief Geologist of the Research Drilling Management Office of Department "Georgian Oil" S. Gudushauri 121 ENCLOSURE N 19 Title: The Terms on Accounting to the Budget of the Republic of Georgia by the Joint Venture "Georgia MAKOIL" According to the taxation legislation, in force at the moment of issuing the license, "Georgia MAKOIL" should pay to the Budget of the Republic of Georgia the following taxes: 1) According to the paragraph 6 of Law N368-1 issued by the Republic of Georgia in 21.12.1993, the Profit tax is determined in the amount of twenty per cent (20%). The tax is reduced by 10 % for industrial and constructing enterprises. According to the paragraph 2 of Article 7, all recently founded enterprises are free from Profit tax during one year from the moment of their State registration and during the following 2 years the tax is cut by fifty per cent (50%). According to Article 2, foreign persons pay the Income tax from dividends, interests, from income got by their participation in the enterprises founded by foreign investments, from copy rights, license usage, rent and other kinds of income, the source of which is on the territory of the Republic of Georgia, and the amount of this tax is determined by 10%. 2) According to the Law on VAT issued by the Republic of Georgia in 24.12.1993 the amount of the tax is fourteen per cent (14%). 3) According to the enclosure of Law N 377-1 on excises issued by the Republic of Georgia in 4.12.1993 the amount of excises is changed according to the types of excised goods. 4) The terms on payment by "Georgia MAKOIL" for usage of natural resources, in this case for mineral usage is stipulated in enclosure N 7 of the existing license documents. 5) Customs tax for imported goods is two per cent (2%) and eight percent (8%) for exported goods. 6) The tax on environmental influence is 10 kupons per 1 L. petrol. 7) The Parliament of the Republic of Georgia has not passed the Law on land tax yet. It will refer to the Company as soon as it is passed. 8)According to Article 3 of the law N 379-1 S of the Republic of Georgia out of 24.12.93, the tax on enterprise property is one per cent (1%). 9) According to the law N376-lS of the Republic of Georgia, out of 24.12.93, the tax on physical person's income applies to the income in the form of money and in the natural form, got during the calendar year. 10) In accordance with the temporary Regulation on "The State Excise", approved by the Resolution N286 of the Cabinet of Ministers of the Republic of Georgia, out of 7.03.92, the payers of the state excise tax are juridical and physical persons, in the interests of who the special certified offices transfer documentation and carry out juridical activities. 122 11) In accordance with the Law N381-1S "On the Physical Person's Property Tax", out of December 24, 1993, the payers of the tax on property are physical persons 12) In accordance with Resolution N 454 of the Cabinet of Ministers of the Republic of Georgia out of 10.06.93, all the enterprises functioning on the territory of the Republic of Georgia must sell 20% of their hard currency income to the State Currency Fund, 2% - to the currency funds of the local Bodies, 10% to the National Bank. 123 ENCLOSURE N20 The title: Necessary Additional Information Presented by joint venture :"Georgian MAKOIL" An application on receiving the mineral usage license on the East Georgia Ninotsminda and West Rustavi oil deposits and Manavi research territory. Topic: Necessary additional information 1. Name and address of the applicant Joint venture "Georgia MAKOIL",, Tbilisi, Kostava str. N65 2. Bank requisites Tbilisi, Commercial Bank "Iberiabank" account N 3. Main activity Exploration, research and development of oil and gas deposits 4. Expected annual expenses: Annual expenses: income from financial activity, 1994 - $ 2600 thousand expenses, profit. Possible for 1994, 1995 - $4 4000 thousand 1995, 1996 years 1996 - $2 600 thousand 5. Financial sources: . a) Private capital Charter Fund 10(ten) million dollars . b) Imported capital, or share holders' The sum necessary for the contribution to the joint venture Capital development of the joint venture will be provided by the Company "MAKOIL", in an established terms a) Main capital /source/ "MAKOIL" b) Stockpiled product None c) Current account Charter Fund d) Hard currency account Charter Fund e) Payment with debtors None f) Losses None g) Charter capital 10 (ten) thousand dollars h) Actual capital in fund None i) Depreciation of main capital None j) Credits and other loan sources None Director: Book keeper: 124 20.3 The sphere of activity of the joint venture "Georgia MAKOIL", a joint venture between "Georgian Oil" and Company "MAKOIL"is being established with the aim of carrying out profitable long term entrepreneurial business in the oil and gas industry within Georgia for the benefit of the joint venture and the people of Georgia. The joint venture will maximize the use of the basic production assets and the working capital of the Founders for the fulfillment of its business program. The joint venture's sphere of activity will be principally as follows: 1. To act as an operating enterprise for the projects and business activities jointly involving "Georgian Oil" and the Company "MAKOIL". 2. To increase oil and gas production in the Republic of Georgia by exploration, development, production and operation of oil and gas fields on the territory of Georgia. 3. Initial activity will be held on the space identified by Ninotsminda and West Rustavi deposits, and Manavi research territory. At all times the methods and technology will be designed to protect the environment. 4. The oil and gas related activities of transportation, refining, processing and the sale, export and import of oil and gas products will be developed. 5. To develop, within Georgia, expertise in modern oil and gas exploration and production technology and to develop the work force of the joint venture by special training. 6. The Republic of Georgia is currently importing large quantities of gas from Russia and Turkministan. Georgia MAKOIL will have the option of drilling for gas in their concession areas in order to reduce the dependency on foreign imported natural gas. If gas in commercial quantities is found, it will be purchased from Georgia MAKOIL at current competitive prices. 125 The joint venture "Georgia MAKOIL" 20.0 An application on receiving the mineral usage license on the East Georgia Ninotsminda and West Rustavi oil deposits and Manavi research territory. Organization: The joint venture "Georgia MAKOIL" Board of Directors: "Georgian Oil" Revaz Tevzadze "MAKOIL" Eugene Kozlowsk The list of the joint venture "Georgia MAKOIL" members: 1. Eugene Kozlowski (Attached) 2. Gregg S. Kozlowski (Attached) 3. David B. Lapoint (Attached) 4. Ivan Lobzanidze Ivan Lobzanidze was born in 1948. He graduated from the Georgian Technical University with speciality of drilling engineer. He has great experience in exploration of oil and gas deposits and in oil production. He has been working in the Department since 1970. Currently he is the Deputy Chairman of "Saknavtobi" Department. ENCLOSURE N 21 The title: Concessions in payment on mineral usage 126 The Cabinet of Ministers of the Republic of Georgia DECREE N208 April 12, 1994 Tbilisi About Concessions in the Mineral Usage Tax The Cabinet of Ministers of the Republic of Georgia states, that in accordance with the temporary regulation "About the Mineral Usage Tax" confirmed by Decree N752 of the Cabinet of Ministers of the Republic of Georgia out of October 20, 1993, the limited amount of the oil and gas production tax is determined by 5-10 percent, and of geological study - 2-4 percent. The said tax belongs to oil and gas prime cost, i.e. financing and accordingly volume of private source oil and gas exploration-research works on the Georgian territory will be adequately reduced, as 65% of prime cost of oil and gas produced in Georgia makes pay-roll tax for geological-research works. For the purposes of rapid development of oil and gas industry in the Republic of Georgia, which is one of the main pre-conditions for stabilization of the Economy, it is important to extend widely oil and gas exploration operations, that needs attraction of foreign investments to Georgian oil industry. Considering the importance of the above issue, the Cabinet of ministers of the Republic of Georgia resolves: Release the state specialized enterprises of Department "Georgian Oil", also joint ventures founded by foreign investments on the territory of the Republic of Georgia from the tax on oil and gas production, and related geological-research tax /mineral usage tax/ for five years from the date of license issuing. The Prime Minster of the Republic of Georgia O. Patsatsia 127 ENCLOSURE N 22 The title: On Leased Equipment Capital expenses of the joint venture. It includes: leased foreign equipment; seismic equipment, brought for carrying out seismic measures; drilling equipment; oil production and refining equipment, materials for these equipment, which are brought temporarily, and after operations are carried out, they will be sent out of the Republic free from customs tax. ENCLOSURE N 23 The title: On Additional Normative Acts of Legislation If the Republic of Georgia after the date of effectiveness of the license passes new normative acts of legislation, which creates difficult economic and financial situation for the joint venture, "Georgian Oil and " MAKOIL" will take all possible measures to minimize the economic damage and to protect profitability of the joint venture, in order to ensure the commercial results determined in the license. Except, if the normative acts refer to safety equipment and to environmental protection demands. 128 THE MINUTES of the Meeting of a Joint Venture "Georgia MAKOIL" of Department "Georgian Oil" and a USA Firm "MAKOIL" May 15, 1992, Tbilisi The meeting was attended by: From side of Department "Georgian Oil" - R. Tevzadze, President of the joint venture "Georgia MAKOIL", I. Papava, I. Lobzhanidze, N. Tevzadze, From side of USA firm "MAKOIL" - G. Mchedlishvili, A. Chichinadze- Eugene Kozlowski, Vice President of "Georgia MAKOIL", Gregory Kozlowski Agenda: 1. Election of the General Director; 2. Approval of the staff schedule of administration; 3. The assumed work program (for 3 years). 1. In his speech R. Tevzadze, President of :Georgia MAKOIL" stated, that the joint venture "Georgia MAKOIL" is registered on February 21, 1993, by the Ministry of Finances of the republic of Georgia. In accordance with the current Legislation, the joint venture must be registered in the local Administrative Bodies, this is why it is important to elect the General Director of the Company, who will carry out all the formalities for the secondary registration of the joint venture. R. Tevzadze suggested to elect Mr. I. Lobzhanidze as the General Director of the Company. He characterized Mr. Lobzhanidze as an honest person, who has a 20 year working experience in oil industry. The Meeting resolved: 1. To elect temporarily I. Lobzhanidze as the General Director of the joint venture "Georgia MAKOIL". 2. E. Kozlowski, Vice President of the joint Venture "Georgia MAKOIL" gave a speech, concerning the staff schedule of administration. He said, that after getting the license, it is necessary to form Administration, which will include 8 persons: General Director General Director Book-keeper Administrative Manager Interpreter Secretary Driver Guard The Meeting resolved: 129 I. Lobzhanidze, General Director to find appropriate candidates for the above administrative personnel. 3. E. Kozlivski gave information on the work program (for the first 3 years). R. Tevzadze mentioned, that it is necessary to present this work program to the Cabinet of Ministers of the Republic of Georgia. The meeting approved the presented program. The graphic of the work execution is attached to the Minutes. President R. Tevzadze Vice President E. Kozlowski Board of Director Gr. Kozlowski N. Tevzadze A. Chichinadze 130 ANNEX E STATE AUTHORISATION FOR SAKNAVTOBI (GEORGIAN OIL) 131 PROTOCOL OF MEETING On concession and Production Sharing Principles for the purposes of attracting additional investment to the Georgian oil industry 15 February 1996 between D. Zubitashvili, President of fuel and energy corporation of Georgia, R. Tevzadze, Chief of department "Georgian Oil" and D.Robson, President of lKX Oil & Gas 1.For the rapid development of the Georgian economy it is most important that Georgia can be self sufficient in its energy requirements. Georgia wishes to attract further investment by western oil companies in the Georgian oil industry including additional investment by the JKX Oil & Gas Group. It is recognized that one of the main conditions of such investment is the introduction of production sharing legislation which is widely used throughout the international oil industry. 2 JKX and Georgian Oil have already presented a draft Production Sharing Contract to the relevant governmental Ministries in Georgia. In a Presidential Decree N78, dated 4 February 1996, Georgian Ministry of Justice, fuel and energy corporation of Georgia and department "Georgian Oil" were instructed to prepare production sharing legislation within 3 months. Georgian Oil was also authorized to enter into Production Sharing Contracts with JKX before the proposed production sharing legislation is introduced provided that the production sharing contracts are amended to comply with the Georgian production sharing legislation after it is passed. 3.JKX is prepared immediately to continue its investment programme even though the production sharing legislation may not be in force for some months. In order to protect the economic and fiscal position of JKX before and after the passing of the Georgian production sharing legislation or any other legislation by the Georgian Parliament, it is hereby agreed, that the stability of the fiscal and economical terms of the JKX/Georgian Oil production sharing contract affecting JKX shall be guaranteed and protected so far as they are directly or indirectly affected by Georgian legislation, rules or regulations. President of fuel and energy corporation of Georgia D. Zubitashvili Chief of department "Georgian Oil" R. Tevzadze President of JKX Oil & Gas D. Robson EX-23.(1) 4 INDEPENDENT ACCOUNTANTS' CONSENT 1 EXHIBIT 23(1) [LETTERHEAD OF PRICEWATERHOUSECOOPERS LLP] CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the inclusion in this Registration Statement of CanArgo Energy Corporation on Form S-1, of our report which includes a paragraph regarding the ability of CanArgo Energy Corporation to continue as a going concern, dated March 5, 1999 (except for Note 20, as to which the date is March 29, 1999) on our audit of the consolidated financial statements of CanArgo Energy Corporation as of December 31, 1998 and 1997, and for the years ended December 31, 1998, 1997 and August 31, 1996 and the four-month period ended December 31, 1996. We also consent to the reference to our firm under the caption "Experts." /s/ PricewaterhouseCoopers LLP Houston, Texas May 18, 1999 EX-23.(2) 5 CONSENT OF INDEPENDENT CHARTERED ACCOUNTANT 1 EXHIBIT 23(2) [LETTERHEAD OF ERNST & YOUNG] REPORT OF INDEPENDENT CHARTERED ACCOUNTANTS We consent to the reference to our firm under the caption "Experts" and to the use of our report dated February 18, 1998 with respect to the consolidated financial statements of CanArgo Oil and Gas Inc. (formerly "CanArgo Energy Inc.") included in the Registration Statement (Form S-1) and related prospectus of CanArgo Energy Corporation for the registration of up to 21,264,643 shares of its common stock. /s/ Ernst & Young LLP Chartered Accountants Calgary, Canada May 18, 1999 EX-23.(3) 6 CONSENT OF INDEPENDENT CHARTERED ACCOUNTANTS 1 EXHIBIT 23.3 [ERNST & YOUNG LETTERHEAD] CONSENT OF INDEPENDENT CHARTERED ACCOUNTANTS We consent to the reference to our firm under the caption "Experts" and to the use of our report dated February 18, 1998 with respect to the consolidated financial statements of Ninotsminda Oil Company (formerly "JKX (Ninotsminda) Limited) included in the Registration Statements (Form S-1 and related prospectus of CanArgo Energy Corporation. Ernst & Young /s/ ERNST & YOUNG - ----------------------- Ernst & Young Chartered Accountants Limassol, Cyprus 13th May, 1999 EX-24.(2) 7 POWER OF ATTORNEY 1 Exhibit 24(2) POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that the undersigned, Robert A. Halpin, constitutes and appoints each of MICHAEL BINNION and SUSAN E. PALMER, and either of them, his true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments (including post-effective amendments) to CanArgo Energy Corporation's Registration Statement on Form S-1 filed on February 12, 1999, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorney-in-fact and agent full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as the undersigned might or could do in person, and hereby ratifying and confirming all that said attorney-in-fact, or his or her substitute, may lawfully do or cause to be done by virtue hereof. /s/ Robert A. Halpin Date: May 7, 1999 - ---------------------------- ---------------------- Robert A. Halpin -----END PRIVACY-ENHANCED MESSAGE-----