-----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, Q24ZjNjGpzVAbuTPLSXS/ihwg3mvC+j/yaWHL9PgPE4ilApD8iFKU672Hcr7LpY3 b+F/JPnier5kY/szsyh3rQ== 0000899243-02-000846.txt : 20020415 0000899243-02-000846.hdr.sgml : 20020415 ACCESSION NUMBER: 0000899243-02-000846 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 10 CONFORMED PERIOD OF REPORT: 20011231 FILED AS OF DATE: 20020329 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HARKEN ENERGY CORP CENTRAL INDEX KEY: 0000313478 STANDARD INDUSTRIAL CLASSIFICATION: CRUDE PETROLEUM & NATURAL GAS [1311] IRS NUMBER: 952841597 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: 1934 Act SEC FILE NUMBER: 001-10262 FILM NUMBER: 02592924 BUSINESS ADDRESS: STREET 1: 16285 PARK TEN PLACE SUITE 600 CITY: HOUSTON STATE: TX ZIP: 77084 BUSINESS PHONE: 2817171300 MAIL ADDRESS: STREET 1: 16285 PARK TEN PLACE STREET 2: STE 600 CITY: HOUSTON STATE: TX ZIP: 77084 FORMER COMPANY: FORMER CONFORMED NAME: HARKEN OIL & GAS INC DATE OF NAME CHANGE: 19890109 10-K405 1 d10k405.txt FORM 10-K FOR PERIOD ENDING DECEMBER 31, 2001 ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2001 [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to __________ Commission file number 0-9207 HARKEN ENERGY CORPORATION (Exact name of registrant as specified in its charter) Delaware 95-2841597 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 580 WestLake Park Blvd., Suite 600 Houston, Texas 77079 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (281) 504-4000 Securities registered pursuant to Section 12(b) of the Act: Name of each exchange Title of each class: on which registered: Common Stock, Par Value $0.01 Per Share American Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [_] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of the voting Common Stock, par value $0.01 per share, held by non affiliates of the Registrant as of March 1, 2002 was approximately $16,647,000. For purposes of the determination of the above stated amount only, all directors, executive officers and 5% or more shareholders of the Registrant are presumed to be affiliates. The number of shares of Common Stock, par value $0.01 per share, outstanding as of March 1, 2002 was 18,782,559. DOCUMENTS INCORPORATED BY REFERENCE: NONE. - -------------------------------------------------------------------------------- TABLE OF CONTENTS
Page PART I. ITEM 1. Business.................................................................. 3 ITEM 2. Properties................................................................ 25 ITEM 3. Legal Proceedings......................................................... 25 ITEM 4. Submission of Matters to a Vote of Security Holders....................... 26 PART II. ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters..... 27 ITEM 6. Selected Financial Data................................................... 27 ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations..................................................... 29 ITEM 7A.Quantitative and Qualitative Disclosures about Market Risk................ 41 ITEM 8. Financial Statements and Supplementary Data............................... 42 ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure...................................................... 86 PART III. ITEM 10. Directors and Executive Officers of the Registrant........................ 87 ITEM 11. Executive Compensation.................................................... 90 ITEM 12. Security Ownership of Certain Beneficial Owners and Management............ 93 ITEM 13. Certain Relationships and Related Transactions............................ 94 PART IV. ITEM 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K........... 95
2 PART I ITEM 1. BUSINESS Overview Harken Energy Corporation (together with its wholly-owned or controlled subsidiaries, "Harken") is engaged in oil and gas exploration, development and production operations both domestically and internationally through its various subsidiaries. Harken's domestic operations include oil and gas exploration, development and production operations in the onshore and offshore Gulf Coast regions of South Texas and Louisiana, and in portions of West Texas and the Texas Panhandle region. Harken's international operations during the year ended December 31, 2001 included four exclusive Association Contracts with the state-owned oil company in the Republic of Colombia, Technical Evaluation Agreements signed during the year covering acreage in Peru and Panama and Harken's Exploration and Production Contract in the Republic of Costa Rica. Harken was incorporated in 1973 in the state of California and reincorporated in 1979 in the state of Delaware. Harken's principal offices are located at 580 WestLake Park Blvd., Suite 600, Houston, Texas 77079, and its telephone number is (281) 504-4000. Harken divides its operations into two operating segments which are managed and evaluated by Harken as separate operations. Harken's North American operating segment currently consists of Harken's exploration, development, production and acquisition efforts in the United States. Harken's Middle American operating segment currently consists of Harken's exploration, development, production and acquisition efforts in Colombia, Costa Rica, Peru and Panama as well as potential future operations elsewhere in Central America and South America. See "Note 13- Other Information" in the Notes to Consolidated Financial Statements contained in Part II, Item 8 of this Annual Report on Form 10-K for certain financial information about Harken's two operating segments and certain financial information about the geographical areas of Harken's operations. During 2001, Harken's Board of Directors approved a plan to restructure Harken's operations for the purpose of focusing Harken's resources more directly on its U.S. acquisition, exploration and development operations, particularly in the Gulf Coast region of Texas and Louisiana. Pursuant to this restructuring plan, the Board determined it to be in the shareholders' interest to implement such a plan to move Harken's interests in its Middle American operations, assets and obligations under a separate subsidiary which would have the ability and capability to seek financing and other capital plans on its own. RP&C International Inc. and Canaccord Capital (Europe) Limited are acting as financial advisors in connection with the restructuring plan. During 2001, Harken transferred all of its international operations, assets and obligations into a new subsidiary, Global Energy Development Ltd. ("Global"), a Delaware corporation. Global's executive offices are located at 580 WestLake Park Blvd., Suite 750, Houston, Texas 77079. In the past, Harken's international efforts focused principally on Colombian exploration projects. Global's new business strategy is to identify, develop and promote energy projects from throughout Latin America to industry and financial partners and to aggregate assets in Latin America through strategic acquisitions and alliances. In March 2002, Global transferred all of its interests in its international assets and operations to, and obligations relating to such assets and operations were assumed by, a new subsidiary, Global Energy Development PLC ("Global PLC", a United Kingdom company), in exchange for 92.6% of Global PLC's common stock. Upon the completion of this exchange transaction, Global PLC then completed the listing of its common stock for trading on the AIM Exchange in London, and placed 7.4% of such stock in a placement to investors, including certain affiliates of Harken and Global. Global PLC is seeking additional financing and 3 acquisition activities using its shares of its newly listed common stock. At March 27, 2002, Harken, through Global, owned 92.6% of Global PLC common stock. Domestic Exploration and Production Operations During 2000 and 2001, Harken has drilled or participated in the drilling of 38 oil and gas wells domestically, completing 28 of the wells drilled. Harken's domestic drilling activity increased following the August 1999 acquisition of XPLOR Energy, Inc. ("XPLOR", a wholly-owned subsidiary) and the December 1999 acquisition of prospects from Benz Energy, whereby Harken acquired a variety of domestic prospect acreage within its Texas and Louisiana Gulf Coast area of emphasis. Drilling activity was also spurred by increased oil and gas prices, which resulted in significant domestic operating cash flows from Harken's producing property base. Harken capitalized on the higher product prices by selling certain non-strategic producing properties, most of which were outside of Harken's Gulf Coast operating focus. Such producing property sales during 2000 and 2001 generated cash proceeds of approximately $18.3 million, which was used in part to support Harken's exploration and development activities. During the second half of 2001, oil and gas prices decreased, and prices have remained lower during the first quarter of 2002 compared to the prior year period. Accordingly, Harken's domestic operations have shifted from primarily an exploration and development focus to an acquisition growth strategy, with a reduced emphasis on exploration. In January 2002, a wholly-owned subsidiary of Harken acquired certain property interests (the "Republic Properties") from Republic Resources, Inc., subject to approval by Republic's shareholders and debenture holders. The Republic Properties consist of 15 producing property interests located in southern Louisiana and the Texas Gulf Coast region. Harken is seeking additional acquisition opportunities to expand its domestic operations. Although capital expenditure plans for 2002 are decreased compared to the prior two year period, Harken is continuing to seek joint venture and farmout opportunities to explore and develop its domestic prospect portfolio. As of December 31, 2001, Harken operates or owns a non-operating working interest in 254 oil wells and 88 gas wells in the United States. Harken's domestic operations are located in the onshore and offshore Gulf Coast regions of South Texas and Louisiana, portions of West Texas and the Texas Panhandle region. There were no domestic customers during 1999, 2000 or 2001 which individually represented 10% or more of Harken's consolidated revenues. Gulf Coast Operations -- On August 19, 1999, Harken acquired XPLOR whereby XPLOR became a wholly-owned subsidiary of Harken. At December 31, 2001, through XPLOR and other wholly-owned subsidiaries, Harken owns operated and non-operated interests in one oil well and 30 gas wells located in various counties in South Texas, concentrated in the Raymondville area of Willacy County, the Hostetter field in McMullen and Live Oak Counties, and the Esperanza field in Wharton County. Subsequent to December 31, 2001, Harken sold its interest in the Hostetter field. In Louisiana, through XPLOR, Harken owns operated and non-operated interests in 35 oil wells and 18 gas wells concentrated primarily in the Main Pass area offshore Plaquemines Parish, the Lake Raccourci area of LaFourche Parish and the Abbeville and Leleux fields in Vermillion Parish. At December 31, 2001, approximately 59% of Harken's domestic proved reserves are located in the Gulf Coast region of Louisiana and Texas. During 2000 and 2001, Harken drilled or participated in the drilling of several Gulf Coast area exploratory and development wells. Significant successful wells drilled in 2000 include the Thomas Cenac #1 well in Terrebonne Parish, Louisiana, which tested during the first quarter of 2001 at a rate in excess of ten million gross cubic feet of gas and 400 gross barrels of condensate per day, and the State Lease 1480 #2 well in the Lake Raccourci area in LaFourche Parish, Louisiana, which initially produced 350 gross barrels of oil and 4 approximately 800,000 gross cubic feet of gas per day. Harken owns approximately a 27.7% and 40.3% working interest, respectively, in the above wells. Wells drilled in 2001 include the State Lease 14589 #3 and the State Lease 1480 #3, both in the Lake Raccourci area. The State Lease 14589 #3, which was completed in September 2001, had initial gross production of 2.4 million cubic feet equivalent per day and is currently producing 3.0 million gross cubic feet equivalent per day. The State Lease 1480 #3 well was completed in October 2001 and recorded initial production in excess of 3.6 million cubic feet equivalent per day and is currently producing 4.5 million gross cubic feet equivalent per day. Harken holds a 39.59% and 44% working interest, respectively, in these two wells. West Texas Operations - - Harken operates or owns non-operated interests in 157 oil wells and 40 gas wells in Hutchinson and Gray Counties and 61 oil wells in Hockley County, all located in the Panhandle area of Texas. At December 31, 2001, approximately 41% of Harken's domestic proved reserves are located in west Texas. Prospect Acreage -- In addition to the producing property interests discussed above, Harken, through certain wholly-owned subsidiaries, owns interests in a variety of domestic prospect acreage. Through XPLOR, Harken owns acreage interests in the Lake Raccourci and Lapeyrouse fields of LaFourche and Terrebonne Parishes, respectively, in Louisiana. As part of the December 1999 prospect purchase from Benz Energy, Inc., Harken Gulf Exploration owns prospect acreage interests in the Old Ocean field in Matagorda and Brazoria Counties of Texas, the Rayburn field in Liberty County, Texas and certain salt dome prospects in various counties in Mississippi. Harken successfully drilled exploratory wells in the Lake Raccourci, Lapeyrouse and Old Ocean fields during 2000 and 2001. Middle American Exploration and Development Operations - Colombia At December 31, 2001, Harken, through Harken de Colombia, Ltd., a wholly-owned subsidiary of Global, held four exclusive Association Contracts with Empresa Colombiana de Petroleos ("Ecopetrol"), the state-owned Colombian oil company. Global has proved reserves attributable to two of its four Association Contracts, the Alcaravan and Bolivar Contracts. In the Alcaravan Contract, Global has proved reserves in the Palo Blanco field, and in the Bolivar Contract, Global has proved reserves in the Buturama field. Ecopetrol, which purchases all of Global's crude oil production, individually accounted for 24% and 26% of Harken's consolidated revenues in 2000 and 2001, respectively. Harken and Global have responded to recent increased security concerns in Colombia by implementing a number of operating changes including replacing its field operating employees with outsource personnel. Global's operating plans in Colombia are continuing, subject to the ongoing monitoring of security developments. For further discussion of Global's security concerns in Colombia, see "Cautionary Statements" section of this Part I, Item 1. Alcaravan Contract -- The Alcaravan Association Contract (the "Alcaravan Contract") gives Global the exclusive right to explore for, develop and produce oil and gas throughout approximately 24,000 acres in the Alcaravan area of Colombia, which is located in Colombia's Llanos Basin approximately 140 miles east of Santafe de Bogota. Global has completed the six year seismic and exploratory drilling program of the Alcaravan Contract (the "Exploration Period"). In October 2001, Global received notification from Ecopetrol that Global could proceed with the sole risk development of the Palo Blanco field of the Alcaravan Association Contract. As such, the term of the Alcaravan Contract related to the productive areas has been extended for a period of 22 years from the date of such election by Ecopetrol, (the "Exploitation Period"), subject to the entire term of the Alcaravan Contract 5 being limited to no more than 28 years. Due to Ecopetrol's election not to participate, Global elected to proceed with the development of the Palo Blanco field on a sole risk basis, whereby Global is entitled to receive Ecopetrol's 50% share of production after deduction for Ecopetrol's 20% royalty interest, until Global has recovered 200% of its successful well costs expended, after which time Ecopetrol could elect to begin to receive its share of production. Accordingly, Global reflects its 80% interest in gross production and cash flows in its financial statements and reserve information. The Alcaravan Contract provides that two years following the end of the Exploration Period, the Alcaravan Contract area will be further reduced to 25% of the original area. Global has retained the acreage covering those structure areas associated with the Palo Blanco and Anteojos discoveries. Two years thereafter, the Alcaravan Contract area will be reduced to the area of the field that is in production or development, plus a reserve zone of five kilometers in width around the productive boundary of such field. The producing field plus the zone surrounding such field will become the area of exploitation. Global has and will continue to designate any acreage to be released subject to acceptance by Ecopetrol. Alcaravan Contract Operations - Global has drilled five wells on the Alcaravan acreage, two of which are currently producing. In February 1997, Global drilled the Estero #1 well located on the Palo Blanco prospect. The Estero #1 well was drilled to a depth of 8,608 feet to test the Carbonera, Mirador, Guadalupe, Gacheta and Ubaque formations and was found to be productive. In January 2001, Global drilled the Estero #2 well on the Palo Blanco field to test the Ubaque formation. The Estero #2 well was subsequently completed and initial production sales began in April 2001. Daily production from the Estero #1 and Estero #2 wells from the Palo Blanco field have averaged a total of approximately 1,900 gross barrels per day during the first quarter of 2002. At December 31, 2001, Global reflects proved reserves of approximately 2.9 million net barrels related to its interest in the Palo Blanco field. During 2001, Global produced a total of approximately 590,000 gross barrels of oil from its Palo Blanco field, and since inception and through December 31, 2001, Global has produced a cumulative total of approximately 1,047,000 gross barrels of oil from its Palo Blanco field. In April 1999, Global commenced pipeline transportation of production from the Alcaravan Contract Area through its constructed flowline connecting the Palo Blanco field to an existing crude oil pipeline system adjacent to the field. During early portions of the Estero #1 production tests, Global produced at rates in excess of 3,000 gross barrels of oil per day from the Estero #1 well, although sustained production during 2000 and the first quarter of 2001 was limited to approximately 1,000 gross barrels of oil per day due to pipeline constraints and pumping capacity. Beginning in April 2001, such pipeline constraints were partially alleviated. In addition, during the second quarter of 2001, Global purchased the 45 kilometer Guarimena to Santiago crude oil pipeline and negotiated a new transportation agreement with the owner/operator of the pipeline that transports crude oil from Santiago north to market points. As a result of the above steps, though Global's Palo Blanco production levels are currently less than transport capacity, Global is now allowed to transport up to 3,000 gross barrels of oil per day combined from both Estero #1 and Estero #2 wells. Bocachico Contract -- Under the Bocachico Association Contract (the "Bocachico Contract"), Global acquired the exclusive rights to conduct exploration and production activities and drilling on this area, which covers approximately 54,700 acres in the Middle Magdalena Valley of Central Colombia. Global has fulfilled all of the work requirements for the first four years of the Bocachico Contract. Global is currently negotiating with Ecopetrol to amend the Bocachico Contract whereby the remaining work requirements for the fifth and sixth year will be transferred to Global's newly signed Cajaro Association Contract, which is discussed below. With the execution of the amendment, Global will complete the Exploration Period related to the Bocachico Contract. The production sharing, term and acreage relinquishment arrangements under the Bocachico Contract are substantially similar to those under the Alcaravan Contract. 6 Bocachico Contract Operations - From 1996 to 1998, Global drilled and completed three wells on the Bocachico Contract area, all in the Rio Negro prospect. Global initiated sales of production from both the Torcaz #2 and Torcaz #3 wells to a local purchaser at the wellsites and for most of 1998 these wells produced in excess of 100 gross barrels of oil per day. Global has not sustained production consistently from the Torcaz wells subsequent to 1998 and is currently studying the wells in order to determine the optimum production method with which to economically produce the heavy crude encountered in such wells. Global currently reflects no proved reserves associated with this Rio Negro field in the Bocachico Contract. In December 1999, Global submitted an application to Ecopetrol for their participation in the Rio Negro field. Global is to submit an updated application to Ecopetrol in May 2002. Global's net revenue interest in production from the Bocachico Contract will depend upon whether or not Ecopetrol elects to participate. If Ecopetrol does not elect to participate, Global would then have the choice to proceed with the development of the prospect area on a sole-risk basis. If Global does proceed on a sole-risk basis, it will be entitled to receive Ecopetrol's 50% share of production, after deduction for Ecopetrol's 20% royalty interest, until Global has recovered 200% of its successful well costs expended, after which time Ecopetrol could elect to receive its share of production. Should Ecopetrol elect to participate in the development of the Bocachico Contract, Global would receive 40% of the gross revenues from production from the Bocachico Contract area and to the extent that a field produces in excess of 60 million barrels, Global's net revenue interest would decrease. Should Ecopetrol elect to participate or Global elect to proceed on a sole risk basis, the term of the Bocachico Contract related to the productive areas will be extended for a period of 22 years from the date of such election, subject to the entire term of the Bocachico contract being limited to no more than 28 years. Bolivar Contract -- Under the Bolivar Association Contract, (the "Bolivar Contract"), Global acquired the exclusive rights to conduct exploration and production activities in the Bolivar Contract area, which covers approximately 250,000 acres in the Northern Middle Magdalena Valley of Central Colombia. In February 2001, Global received notification from Ecopetrol that it had elected not to participate in the development of the Buturama field of the Bolivar Association Contract. Due to Ecopetrol's election not to participate, Global has elected to proceed with the development of the field on a sole risk basis, whereby Global is entitled to receive Ecopetrol's 50% share of production, after deduction of Ecopetrol's 20% royalty interest, until Global has recovered 200% of its successful well costs expended, after which time Ecopetrol could elect to begin to receive its share of production. Accordingly, Global reflects its 80% interest in gross production and cash flows in its financial statements and reserve information. In addition, the term of the Bolivar Contract related to the productive areas has been extended for a period of 22 years from the date of such election by Ecopetrol (the "Exploitation Period"), subject to the entire term of the Bolivar Contract being limited to no more than 28 years. Global has completed all of the work obligations for the first five years of the Bolivar Contract. Global is currently negotiating with Ecopetrol whereby Global would relinquish 50% of the Bolivar Contract area acreage in exchange for a release from the sixth year Bolivar Contract work obligations. The release of such acreage would not affect Global's proved reserves on the Bolivar Contract area. The production sharing, term and acreage relinquishment arrangements under the Bolivar Contract are substantially similar to the Alcaravan and Bocachico Contracts. Bolivar Contract Operations - Global has drilled four wells on the Bolivar Contract area, two of which are currently productive. In November 1997, Global spudded its first well on the Bolivar Contract acreage, the Catalina #1, which was drilled as a horizontal well to test the Rosa Blanca formation of the Buturama field and was found to be productive. In March 1998, Global spudded the Olivo #1, which was drilled from the same surface location as the Catalina #1 using underbalanced horizontal drilling and was also 7 found to be productive. Two additional wells, the Laurel #1, drilled in 1999, and the Olivo #2, drilled in early 2001, were unproductive. At December 31, 2001, Global reflects proved reserves (primarily proved undeveloped) of approximately 2.1 million net barrels related to its interest in the Buturama field. During 2001, the Catalina # 1 and Olivo #1 produced a total of 69,000 gross barrels of oil and, since inception, Global has produced cumulative production of approximately 1,014,000 gross barrels of oil from these wells. During the last part of 2001 and first quarter of 2002, the Catalina #1 and Olivo #1 wells have experienced mechanical problems, with workovers planned in early 2002. For further discussion of Harken's security concerns in Colombia, see "Cautionary Statements" section below. Given the lower level of production expected from the producing wells within the Buturama field, Global has retired and seeks to sell certain of its Buturama field facilities. Global expects to continue to transport 100% of current and projected Bolivar area production through its current trucking operations. Cajaro Contract -- In December 2001, Global signed an Association Contract ( the "Cajaro Contact") with Ecopetrol, covering the Cajaro Contract area. Under the Cajaro Contract, which became effective in February 2002, Global acquired the exclusive rights to conduct exploration and production activities in the Cajaro Contract area, which covers approximately 83,000 acres in Colombia's Llanos Basin adjacent to Global's Alcaravan Contract area. The signing of the Cajaro Contract was pursuant to Global's exercise of contract option rights contained as part of the El Retorno Technical Evaluation Agreement, which Global had previously signed in May 2001, following the completion of certain seismic reprocessing procedures. Under the terms of the Cajaro Contract, if during the three year minimum Exploration Period, Global discovers one or more fields capable of producing oil or gas in quantities that are economically exploitable and Ecopetrol elects to participate in the development of the field or Harken chooses to proceed with the development on a sole risk basis, the term of the Cajaro Contract will be extended for a period of 22 years from the date of such discovery. Global's net revenue interest in any production that may be discovered on the Cajaro Contract will depend on whether or not Ecopetrol elects to participate. Upon the election by Ecopetrol to participate in a field and upon commencement of production from the field, Global will begin to be reimbursed by Ecopetrol out of Ecopetrol's share of production, net of royalties, for 50% of all seismic costs and direct exploratory well costs (including costs related to dry holes) incurred prior to the point of Ecopetrol's participation. Reimbursement by Ecopetrol to Global may either be in cash, or through allowing its share of production to apply to Global's cost recovery. Production from a field in which Ecopetrol elects to participate will be allocated as follows: Ecopetrol, on behalf of the Colombian government, will receive a royalty interest ranging from 5% to 25% (based on levels of average monthly production) of all production, and all production (after royalty payments) will be allocated 50% to Ecopetrol and 50% to Global. Ecopetrol and Global will be responsible for all future development costs and operating expenses in direct proportion to their interest in production. Similar to Global's other Association Contracts with Ecopetrol, for any Cajaro Contract field in which Ecopetrol elects not to participate, Global could elect to proceed with the development of the field on a sole risk basis, whereby Global would be entitled to receive Ecopetrol's 50% share of production, after deduction of Ecopetrol's royalty interest, until Global has recovered 200% of its successful well costs expended, after which time Ecopetrol could elect to begin to receive its share of production. The acreage relinquishment arrangements under the Cajaro Contract are substantially similar to those under Global's other Association Contracts with Ecopetrol. 8 Middle American Exploration and Development Operations - Costa Rica Under the terms of an Exploration and Production Concession contract with the Republic of Costa Rica (the "Costa Rica Contract"), Global, through an investment in its subsidiary Harken Costa Rica Holdings ("HCRH", a Nevada limited liability company) owns an interest in approximately 1.4 million acres in the North and South Limon Back Arc Basin onshore and offshore Costa Rica. Global's participation in Costa Rica is structured whereby a wholly-owned subsidiary owns a percentage share of the stock of HCRH, with an affiliate of MKJ Xploration, Inc. ("MKJ") owning the remaining stock of HCRH. Through June 30, 2001, Global owned 80% of the stock of HCRH. In July 2001, Global elected not to pay the $4 million of additional funds to be transferred to HCRH, which, in accordance with the contract between Global and MKJ, resulted in Global's ownership in HCRH being reduced to 40% (with MKJ's ownership being increased to 60%) and MKJ consequently assumed the operations of HCRH and the Costa Rica Contract. Costa Rica Operations -- In November 1999, HCRH commenced its offshore seismic acquisition program in Costa Rica to collect approximately 100 square kilometers of 3-D seismic information. The seismic data confirmed the viability of the Moin prospect in both the Tertiary and Cretaceous target horizons. In July 2000, HCRH filed its environmental impact study requesting an environmental permit related to the planned drilling operation with the Costa Rican environmental agency SETENA. In March 2002, SETENA denied its approval of the requested environmental permit. HCRH has filed an appeal related to this ruling by SETENA. In January 2002, the Costa Rica Constitutional Court rendered a published opinion in a suit that had been filed against another oil and gas operator and the Costa Rican ministry of Environment and Energy ("MINAE") by certain environmental groups. In its opinion, in this case, the Constitutional Court of Costa Rica found, among other issues, that SETENA did not have the current authority to grant environmental permits. In addition, proposed legislation pending in the Costa Rica legislature seeks to abolish the Costa Rica government's rights to grant hydrocarbon exploration contracts. Due to the Costa Rica Constitutional Court decision discussed above, even though it did not directly involve HCRH or the Moin #2 well, as well as the pending legislation described above, Harken and Global believe that HCRH's appeal to SETENA for reconsideration of its denial of the requested permit, or any similar recourse, will be unsuccessful. Further, recent political developments in Costa Rica, in the opinion of Harken and Global, severely limit the opportunity for future oil and gas exploration in Costa Rica. These significant adverse developments have resulted in Harken and Global fully impairing its investment in the Costa Rica project in its Consolidated Balance Sheet as of December 31, 2001. See "Cautionary Statements" below. Middle American Operations - Peru In April 2001, Global, through a wholly-owned subsidiary, signed a Technical Evaluation Agreement ("Peru TEA") with PeruPetro, the national oil company of Peru. The Peru TEA covers an area of approximately 6.8 million gross acres in northeastern Peru. Under the terms of the Peru TEA, Global has the option to convert the Peru TEA to a seven year exploration contract, with a twenty-two year production period. Terms of the Peru TEA allow Global to conduct a study of the area that will include the reprocessing of seismic data and evaluation of previous well data. 9 Middle American Operations - Panama In September 2001, Global, through a wholly-owned subsidiary, signed a Technical Evaluation Agreement ("Panama TEA") with the Ministry of Commerce and Industry for the Republic of Panama. The Panama TEA covers an area of approximately 2.7 million gross acres divided into three blocks in and offshore Panama. Under the terms of the Panama TEA, which extends for a period of 24 months, Global is to perform certain work program procedures and studies to be submitted to the Panamanian government with an option to negotiate and enter into one or more Contracts for the Exploration and Exploitation of Hydrocarbons with the Ministry of Commerce and Industry. Other Middle American Operations Global is committed to broadening its exploration efforts internationally, in addition to its existing operations in Colombia, Costa Rica, Peru and Panama. With most of the major discoveries of oil and gas expected to be in remote, politically difficult or underexplored areas around the world, Global's operational experience in those areas may enable Global to expand its exploration efforts elsewhere in Latin America. Global's business strategy is to identify, develop and promote energy projects from throughout Latin America to industry and financial partners and to aggregate assets in Latin America through strategic acquisitions and alliances. Cautionary Statements Certain statements contained in this Annual Report, including statements of Harken management's current expectations, intentions, plans and beliefs, are "forward-looking statements", as defined in Section 21D of the Securities Exchange Act of 1934 and the Private Securities Litigation Reform Act of 1995: . statements before, after or including the words "may", "will", "could", "should", "believe", "expect", "future", "potential", "anticipate", "intend", "plan", "estimate", or "continue" or the negative or other variations of these words; and . other statements about matters that are not historical facts. Such forward-looking statements involve known and unknown risk, uncertainties and other factors which may cause the actual results, performance, timing or achievements of Harken to be materially different from any results, performance, timing or achievements expressed or implied by such forward-looking statements. Additional cautionary statements include, among others, the following: Risks associated with our operations: Price fluctuations, markets and reserve values The results of our operations are highly dependent upon the prices received for our oil and natural gas production. Substantially all our sales of oil and natural gas are made in the spot market, or pursuant to contracts based on spot market prices, and not pursuant to long-term, fixed-price contracts. Accordingly, the prices received for our oil and natural gas production are dependent upon numerous factors beyond our control. These factors include, but are not limited to, the level of consumer product demand, governmental regulations and taxes, the price and availability of alternative fuels, the level of foreign imports of oil and natural gas, and the overall economic environment. Significant declines in prices for oil and natural gas could have a material 10 adverse effect on our financial condition, results of operations and quantities of reserves recoverable on an economic basis. Should the industry experience significant price declines from current levels or other adverse market conditions, we may not be able to generate sufficient cash flow from operations to meet our obligations and make planned capital expenditures. Any significant decline in prices of oil or gas could have a material adverse effect on our financial condition and results of operations. In addition, prices in effect for oil and natural gas at December 31, 2001 were significantly lower than the average in effect a year earlier at December 31, 2000. The Securities and Exchange Commission ("SEC") requires that we report our oil and natural gas reserves using the price as of the last day of the year, and accordingly, the value of our oil and natural gas reserves as reported in our Annual Report on Form 10-K for the fiscal year ended December 31, 2001 is significantly lower than the prior year value of our oil and natural gas reserves. In addition, using lower values in forecasting reserves will result in a shorter life being given to producing oil and natural gas properties because such properties as their production levels are estimated to decline will reach an uneconomic limit, with lower prices, at an earlier date. Our operations require significant expenditures of capital that may not be recovered We require significant expenditures of capital in order to locate and acquire producing properties and to drill exploratory wells. In conducting exploration and development activities from a particular well, the presence of unanticipated pressure or irregularities in formations, miscalculations or accidents may cause our exploration, development and production activities to be unsuccessful, potentially resulting in abandoning the well. This could result in a total loss of our investment. In addition, the cost and timing of drilling, completing and operating wells is difficult to predict. The oil and gas we produce may not be readily marketable at the time of production Crude oil, natural gas, condensate, and other oil and gas products are generally sold to other oil and gas companies, government agencies and other industries. The availability of ready markets for oil and gas that we might discover and the prices obtained for such oil and gas depend on many factors beyond our control, including: . the extent of local production and imports of oil and gas, . the proximity and capacity of pipelines and other transportation facilities, . fluctuating demand for oil and gas, . the marketing of competitive fuels, and . the effects of governmental regulation of oil and gas production and sales. Natural gas associated with oil production is often not marketable due to demand or transportation limitations and is often flared at the producing well site. Pipeline facilities do not exist in certain areas of exploration and, therefore, any actual sales of discovered oil and gas might be delayed for extended periods until such facilities are constructed. We may encounter operating hazards in our operations that may result in substantial loss We are also subject to operating hazards normally associated with the exploration and production of oil and gas, including, without limitation, blowouts, cratering, pollution, earthquakes, labor disruptions and fires. 11 The occurrence of any such operating hazard could result in substantial losses to our company due to injury or loss of life and damage to or destruction of oil and gas wells, formations, production facilities or other properties. In accordance with customary industry practices, we maintain insurance coverage limiting financial loss resulting from certain of these operating hazards. Losses and liabilities arising from uninsured or underinsured events could reduce our revenues or increase our costs. There can be no assurance that any insurance will be adequate to cover losses or liabilities associated with operational hazards. We cannot predict the continued availability of insurance, or its availability at premium levels that justify its purchase. Drilling oil and gas wells particularly in the Louisiana wetlands, the onshore regions of Texas and in Colombia, Costa Rica, Peru and Panama could be hindered by hurricanes, earthquakes and other weather-related operating risks Our operations in the Louisiana wetlands, the onshore regions of Texas and in Colombia, Costa Rica, Peru and Panama are subject to risks from hurricanes and other natural disasters. Damage caused by hurricanes, earthquakes or other operating hazards could result in substantial losses to our company. The occurrence of such an event that is not fully covered by insurance could have a material adverse effect on our financial position and results of operations. We face strong competition from larger oil and gas companies The exploration and production business is highly competitive. Many of our competitors have substantially larger financial resources, staffs and facilities. Our competitors in the United States include numerous major oil and gas exploration and production companies and in Colombia, Peru and Panama include such major oil and gas companies as BP Amoco, Exxon/Mobil, Texaco, Conoco, Shell and Arco. These major oil and gas companies are often better positioned to obtain the rights to exploratory acreage that we compete for. Our operations are subject to various litigation Presently, various Harken subsidiaries are defendants in various litigation matters. The nature of Harken and its subsidiaries operation also expose it to further possible litigation claims in the future. Although Harken and its subsidiaries each make every effort to avoid litigation, these matters are not totally within its control. There is risk that any matter in litigation could be adversely decided against Harken or its subsidiaries, irregardless of their belief, opinion and position, which could have a material adverse effect on Harken's financial condition and results of operations. Litigation is highly costly and the costs associated with defending litigation could also have a material adverse effect on Harken's financial condition. Our operations are subject to stringent environmental laws and regulations that may change Our operations are subject to stringent foreign, federal, state and local laws and regulations governing the discharge of materials into the environment or otherwise relating to environmental protection. These laws and regulations may require the acquisition of a permit before drilling commences, restrict the types, quantities and concentrations of various substances that can be released into the environment, limit or prohibit construction or drilling activities on certain sensitive lands, and impose substantial liabilities for pollution resulting from former or current operations. Failure to comply with these laws and regulations may result in the imposition of administrative, civil and criminal penalties. Changes in environmental laws and regulations occur frequently, and any changes that result in more stringent and costly waste management or cleanup requirements could result in substantial costs or loss of revenue for our company. 12 We may be subject to liability for failing to comply with environmental laws and regulations or for clean-up obligations related to our current or former properties While we believe that we are in substantial compliance with current environmental laws and regulations, we may incur substantial liability for failing to comply with such laws and regulations in the future. The Comprehensive Environmental Response, Compensation and Liability Act, referred to as CERCLA but also known as "Superfund," and comparable state laws impose liability without regard to fault or the legality of the original conduct on certain classes of persons who are considered to be responsible for the release of a "hazardous substance" into the environment. These persons include the owner or operator of the disposal site where the release occurred and companies who arrange for the disposal or transport of the hazardous substances found at the site. Under CERCLA, such persons may be subject to joint and several liability for the costs of cleaning up the released hazardous substances, for damages to natural resources, and for the costs of certain health studies. The Resource Conservation and Recovery Act, referred to as RCRA, generally does not regulate most wastes generated by the exploration and production of oil and gas. However, these wastes may be regulated as solid waste. Also, ordinary industrial wastes, such as paint wastes, waste solvents, and laboratory wastes, may be regulated as hazardous waste. We own or lease, and have in the past owned or leased, properties that have been used for the exploration and production of oil and gas. In addition, many of these properties have been operated by third parties whose treatment and release of hydrocarbons or other wastes were not under our control. These properties and the wastes disposed on these properties may be subject to CERCLA, RCRA, and analogous state laws. Under such laws, we could be required to remove or remediate previously released wastes or property contamination. The Oil Pollution Act of 1990, referred to as OPA, pertains to the prevention of and response to spills or discharges of hazardous substances or oil into navigable water of the United States. Under OPA, a person owning or operating a facility or equipment from which there is a discharge or threat of a discharge of oil into or upon navigable waters or adjoining shorelines is liable, regardless of fault, as a "responsible party" for removal costs and damages. Federal law imposes strict, joint and several liability on facility owners for containment and clean-up costs and certain other damages, including natural resource damages arising from a spill. The OPA establishes a liability limit for onshore facilities of $350 million; however, a party cannot take advantage of this liability limit if the spill is caused by gross negligence or willful misconduct, if the spill resulted from a violation of a federal safety, construction, or operating regulation, or if a party fails to report a spill or cooperate in the cleanup. The Federal Water Pollution Control Act, also referred to as the Clean Water Act and analogous state laws impose strict controls regarding the discharge of pollutants, including produced waters and other oil and gas wastes, into state waters or waters of the United States. The discharge of pollutants into regulated waters is prohibited, except in accord with the terms of a permit issued by EPA or the state. Federal regulations under the OPA and the Clean Water Act also require certain owners and operators of facilities that store or otherwise handle oil, such as us, to prepare and implement spill prevention, control and countermeasure plans and spill response plans relating to possible discharge of oil into surface waters. Our foreign operations are subject to environmental laws and regulations and we have experienced some difficulty in getting appropriate permits and authorizations from foreign governments Our operations are subject to similar laws and regulations in Costa Rica, Colombia, Peru and Panama. While we believe that our operations are in substantial compliance with existing requirements of governmental bodies in these foreign countries, our ability to conduct continued operations is subject to satisfying applicable regulatory and permitting controls in these foreign countries. Our current permits and authorizations and ability to get future permits and authorizations in these foreign countries may be susceptible, on a going 13 forward basis, to increased scrutiny, greater complexity resulting in increased costs, or delays in receiving appropriate authorizations. Our exploration and production operations in Colombia, including well drilling and seismic activities, require specific federal and local environmental licenses and permits, the acquisition of which in the past has been subject to extensive delays. We may continue to experience similar delays in the future. Failure to obtain these licenses and permits in a timely manner may prevent us from obtaining financing for our projects. Our Costa Rica operations have experienced significant adverse actions relating to obtaining necessary environmental permits in Costa Rica Harken, through Global, holds a 40% working interest in certain onshore and offshore properties on the Gulf Coast side of Costa Rica. Before a drilling permit may be granted in Costa Rica by MINAE for the previously announced and planned Moin well, the Costa Rican environmental agency, SETENA, must issue an environmental permit. All work, surveys and assessments necessary to request the issuance of the environmental permit were completed by Global and its partner in this project, and filed with SETENA. In March 2002, SETENA denied its approval of the requested environmental permit. HCRH has filed an appeal related to this ruling by SETENA. In January 2002, the Costa Rica Constitutional Court rendered a published opinion in a suit that had been filed against another oil and gas operator and MINAE by certain environmental groups. In its opinion, in this case, the Constitutional Court of Costa Rica found, among other issues, that SETENA did not have the current authority to grant environmental permits. In addition, proposed legislation pending in the Costa Rica legislature seeks to abolish the Costa Rica government's rights to grant hydrocarbon exploration contracts. Due to the Costa Rica Constitutional Court decision discussed above, even though it did not directly involve HCRH or the Moin #2 well, as well as the pending legislation described above, Harken and Global believe that HCRH's appeal to SETENA for reconsideration of its denial of the requested permit, or any similar recourse, will be unsuccessful. Further, recent political developments in Costa Rica, in the opinion of Harken and Global, severely limit the opportunity for future oil and gas exploration in Costa Rica. These significant adverse developments have resulted in Harken and Global fully impairing its investment in the Costa Rica project in its Consolidated Balance Sheet as of December 31, 2001. Our foreign operations involve substantial costs and are subject to certain risks because the oil and gas industries in such countries are less developed The oil and gas industries in Colombia, Costa Rica, Peru and Panama are not as developed as the oil and gas industry in the U.S. As a result, our drilling and development operations in many instances take longer to complete and often cost more than similar operations in the U.S. The availability of technical expertise, specific equipment and supplies is more limited in Colombia, Costa Rica, Peru and Panama than in the U.S. We expect that such factors will continue to subject us to economic and operating risks not experienced in our domestic operations. We follow the full cost method of accounting for exploration and development of oil and gas reserves in which all of our acquisition, exploration and development costs are capitalized. Costs related to the acquisition, holding and initial exploration of oil and gas associated with our contracts in countries with no proved reserves are initially capitalized, including internal costs directly identified with acquisition, exploration and development activities. If we abandon all exploration efforts in a country where no proved reserves are assigned, all acquisition and exploration costs associated with the country are expensed. From time to time, we make assessments as to whether our investment within a country is impaired and whether exploration activities within a country will be abandoned based on our analysis of drilling results, seismic data and other information 14 we believe to be relevant. Due to the unpredictable nature of exploration drilling activities, the amount and timing of impairment expenses are difficult to predict. If we fail to comply with the terms of certain contracts related to our foreign operations, we could lose our rights under each of those contracts Terms of each of the Colombia Association Contracts, the Costa Rica Contract, the Peruvian Technical Evaluation Agreement and the Panamanian Technical Evaluation Agreement require that we perform certain activities in accordance with a prescribed timetable. Our failure to timely perform those activities as required could result in the loss of our rights under a particular contract, which would likely result in a significant loss to our company. As of March 27, 2002, we were in compliance with the requirements of each of the Colombia Association Contracts, the Costa Rica Contract, the Peruvian Technical Evaluation Agreement and the Panamanian Technical Evaluation Agreement. We may require significant additional financing for our foreign operations that may not be available We anticipate that full development of our existing and future oil and gas discoveries and prospects in Colombia, Costa Rica, Peru and Panama may take several years and may require extensive production and transportation facilities requiring significant additional capital expenditures. If we are unable to timely obtain adequate funds to finance these investments, our ability to develop oil and gas reserves in these countries may be severely limited or substantially delayed. Such limitations or delay would likely result in substantial losses for our company. We anticipate that amounts required to fund our foreign activities will be funded from our existing cash balances, asset sales, stock issuances, production payments, operating cash flows and from joint venture partners. We cannot assure you that we will have adequate funds available to finance our foreign operations. Our foreign operations are subject to political, economic and other uncertainties We currently conduct significant operations in Colombia and Costa Rica, and may also conduct operations in Peru, Panama and other foreign countries in the future. At December 31, 2001, approximately 35% of our proved reserves and 26% of our consolidated revenues were related to Global's Colombian operations. Exploration and production operations in foreign countries are subject to political, economic and other uncertainties, including: . the risk of war, revolution, border disputes, expropriation, renegotiation or modification of existing contracts, import, export and transportation regulations and tariffs resulting in loss of revenue, property and equipment; . taxation policies, including royalty and tax increases and retroactive tax claims; . exchange controls, currency fluctuations and other uncertainties arising out of foreign government sovereignty over international operations; . laws and policies of the United States affecting foreign trade, taxation and investment; and . the possibility of being subjected to the jurisdiction of foreign courts in connection with legal disputes and the possible inability to subject foreign persons to the jurisdiction of courts in the United States. 15 Central and South America and certain other regions of the world have a history of political and economic instability. This instability could result in new governments or the adoption of new policies, laws or regulations that might assume a substantially more hostile attitude toward foreign investment. In an extreme case, such a change could result in termination of contract rights and expropriation of foreign-owned assets. Any such activity could result in a significant loss to our company. Guerrilla activity in Colombia could disrupt or delay our operations, and we are concerned about safeguarding our operations and personnel in Colombia. Colombia's 37-year armed conflict between the government and leftist guerrilla groups has escalated in recent years. The current government's quest for peace was unsuccessful. The breakdown of peace negotiations has resulted in increased military action by the Colombian government directed against the rebel groups operating in Colombia. Unless the parties determine to return to peace negotiations, the military confrontation with the rebel groups is expected to continue. Also, the increased activity of right-wing paramilitary groups, formed in opposition to the left-wing FARC and ELN groups, has contributed to the escalation in violence. The increase in violence has affected business interests in Colombia. Targeting such enterprises as symbols of foreign exploitation, particularly in the North of the country, the rebel groups have attempted to hamper production of hydrocarbons. The cumulative effect of escalation in the armed conflict and the resulting unstable political and security situation has led to increased risks and costs and the downgrading of Colombia's country risk rating. Our oil and gas operations are in areas outside guerrilla control and with the exception of its increased security requirements, our operations continue mostly unaffected, although from time to time, guerilla activity in Colombia has delayed our projects there. This guerilla activity has increased over the last few years, causing delays in the development of our fields in Colombia. Guerilla activity, such as road blockades, has also from time to time slowed our deployment of workers in the field and affected our operations. In addition, guerillas could attempt to disrupt the flow of our production through pipelines. In addition to these security issues, we have also become the subject of media focus in Colombia that may further compromise our security position in the country. Our company and the Colombian government have taken steps to maintain security and favorable relations with the local population. These steps have included the hiring of security to patrol our facilities, and programs to provide local communities with health and educational assistance. We anticipate continuing these steps throughout the term of our operations in Colombia. Our operating plans in Colombia are continuing, subject to the ongoing monitoring of these security developments. Global has responded to recent increased security concerns in Colombia by implementing a number of operating changes, including replacing its field operating personnel with outsource personnel. We are also continuing to analyze and upgrade our security procedures. We cannot assure you that these attempts to reduce or prevent guerilla activity will be successful or that guerilla activity will not disrupt operations in the future. We also cannot assure you that we can maintain the safety of our operations and personnel in Colombia or that this violence will not affect our operations in the future. Continued or heightened security concerns in Colombia could also result in a significant loss to our company. The United States government may impose economic or trade sanctions on Colombia that could result in a significant loss to our company. Colombia is among several nations whose progress in stemming the production and transit of illegal drugs is subject to annual certification by the President of the United States. Although Colombia was so certified in 2001, there can be no assurance that, in the future, Colombia will receive certification or a national interest waiver. The failure to receive certification or a national interest waiver may result in any of the following: 16 . all bilateral aid, except anti-narcotics and humanitarian aid, would be suspended; . the Export-Import Bank of the United States and the Overseas Private Investment Corporation would not approve financing for new projects in Colombia; . U.S. representatives at multilateral lending institutions would be required to vote against all loan requests from Colombia, although such votes would not constitute vetoes; and . the President of the United States and Congress would retain the right to apply future trade sanctions. Each of these consequences could result in adverse economic consequences in Colombia and could further heighten the political and economic risks associated with our operations there. Any changes in the holders of significant government offices could have adverse consequences on our relationship with the Colombian national oil company and the Colombian government's ability to control guerrilla activities and could exacerbate the factors relating to our foreign operations discussed above. Any sanctions imposed on Colombia by the U.S. government could threaten our ability to obtain necessary financing to develop the Colombian properties or cause Colombia to retaliate against us, including by nationalizing our Colombian assets. Accordingly, the imposition of the foregoing economic and trade sanctions on Colombia would likely result in a substantial loss to our company and a decrease in the price of our common stock. We cannot assure you that the United States will not impose sanctions on Colombia in the future or predict the effect in Colombia that these sanctions might cause. We may suffer losses from exchange rate fluctuations We account for our Colombian, Costa Rican, Peruvian and Panamanian operations using the U.S. dollar as the functional currency. The costs associated with our exploration efforts in Colombia, Costa Rica, Peru and Panama have typically been denominated in U.S. dollars. We expect that a substantial portion of our future Colombian revenues may be denominated in Colombian pesos. To the extent that the amount of our revenues denominated in Colombian pesos is greater than the amount of costs denominated in Colombian pesos, we could suffer a loss if the value of the Colombian peso were to drop relative to the value of the U.S. dollar. Any substantial currency fluctuations could have a material adverse effect on our results of operations. Government agencies in Colombia, Costa Rica, Peru and Panama may take action resulting in an increase in our costs, delays in our operations or the termination or suspension of our operations We are required to obtain an environmental permit or approval from the governments in Colombia, Costa Rica, Peru and Panama prior to conducting seismic operations, drilling a well or constructing a pipeline in such foreign locations. Our operations in foreign countries have been delayed in the past and could be delayed in the future through the process of obtaining an environmental permit. Compliance with these laws and regulations may increase our costs of operations, as well as further restrict our foreign operations. Costa Rica has implemented policies and laws with a high level of attention to the protection of its ecological areas and environment. As a result, HCRH's operations in Costa Rica are subject to much greater control, scrutiny and restrictions than are usually encountered in international exploration operations. Due to such additional regulations and requirements in Costa Rica, as well as recent rulings by Costa Rica government agencies, HCRH will likely not be able to continue operations in Costa Rica for the foreseeable future. 17 Risks associated with market conditions: Our stock price is volatile Our stock price has been and is highly volatile. Our stock price is highly influenced by current expectations of future revenue and earnings growth rates. As an exploration and production company, these expectations may be greatly influenced by the success or failure of each well that we drill. Based in part on the results of such drilling activity in Colombia, the market price of our common stock declined significantly in 2000 and 2001. We may issue additional shares of common stock that may dilute the value of our common stock to current stockholders and may adversely affect the market price of our common stock We may be required to issue up to approximately 9.5 million shares of common stock as a result of outstanding warrants, stock options, convertible notes and preferred stock which could become exercised or converted, particularly in the event of an increase in the market price of our common stock. If we issue additional shares, your ownership position in our company may be significantly diluted. In addition, we may elect to issue a significant number of additional shares of common stock for financing or other purposes, which could result in a decrease in the market price of our common stock. There are currently several registration statements with respect to our common stock issued or issuable that are or will become effective, pursuant to which certain of our stockholders may sell up to an aggregate of 11.5 million shares of common stock. If the selling stockholders named in such registration statements sell all of the shares of common stock registered pursuant to such registration statements, such sales could result in a decrease in the market price of our common stock. We have issued shares of preferred stock with greater rights than our common stock and may issue additional shares of preferred stock in the future We are permitted under our charter to issue up to ten million shares of preferred stock. We can issue shares of our preferred stock in one or more series and can set the terms of the preferred stock without seeking any further approval from our common stockholders. Any preferred stock that we issue may rank ahead of our common stock in terms of dividend priority or liquidation premiums and may have greater voting rights than our common stock. As of the date hereof, we have issued 494,465 shares of Series G1 Preferred Stock and 95,800 shares of Series G2 Preferred Stock in private placement transactions exempt from registration under the Securities Act of 1933. For a further discussion of the terms of the Series G1 Preferred and Series G2 Preferred stock, see Part II, Item 8, Notes to Consolidated Financial Statements, "Note 8 - -- Stockholders' Equity." These shares of preferred stock have rights senior to our common stock with respect to dividends and liquidation. In addition, such preferred stock may be converted into shares of common stock, which could dilute the value of common stock to current stockholders and could adversely affect the market price of our common stock. Our strategic plan includes the acquisition of additional reserves through business combinations Our strategic plan includes the acquisition of additional reserves, including through business combinations. We may not be able to consummate future business combinations on favorable terms. Additionally, future business combinations may not achieve favorable financial results. 18 Future business combinations may also involve the issuance of shares of our common stock, which could have a dilutive effect on your interests as a stockholder. Furthermore, acquisitions may require substantial financial expenditures that will need to be financed through cash flow from operations or future debt and equity offerings by us. We may not be able to acquire companies or oil and gas properties using our equity as currency. In the case of cash acquisitions, we may not be able to generate sufficient cash flow from operations or obtain debt or equity financing sufficient to fund future acquisitions of reserves. Risks associated with our financial condition: If estimates of our oil and gas reserve information are adjusted, our financial condition may suffer Our proved oil and gas reserve information is based upon criteria mandated by the SEC and represents only estimates. Our future production, revenues and expenditures with respect to such oil and gas reserves will likely be different from estimates and the differences may be material. If estimates of oil and gas reserves are greater than future production amounts, or if future production costs and expenditures are greater than estimates, our business, financial condition, and results of operations may be negatively affected. Our reserve estimates of future production volumes are based on underlying estimates of the accumulation of oil and gas and the economic recoverability of those volumes. Petroleum engineering is a subjective process of estimating underground accumulations of oil and gas that cannot be measured in an exact manner. Estimates of economically recoverable oil and gas reserves and of future net cash flows necessarily depend upon a number of variable factors and assumptions. Because all reserve estimates are to some degree subjective, each of the following items may prove to differ materially from those assumed in estimating reserves: . the quantities of oil and gas that are ultimately recovered, . the production and operating costs incurred, . the amount and timing of future development expenditures, and . future oil and gas sales prices. Furthermore, different reserve engineers may make different estimates of reserves and cash flows based on the same available data. The estimated discounted future net cash flows described in this Annual Report on Form 10-K for the year ended December 31, 2001, should not be considered as the current market value of the estimated oil and gas reserves attributable to our properties from proved reserves. Such estimates are based on prices and costs as of the date of the estimate, in accordance with SEC requirements, while future prices and costs may be materially higher or lower and do not reflect the impact of sales of producing properties consummated during 2002. We have required waivers and amendments to our bank credit facility covenant requirements Our bank credit facility with Bank One, N.A. ("Bank One") requires Harken, as well as certain of its subsidiaries (the "Borrowers") to maintain certain financial covenant ratios and requirements, as calculated on a quarterly basis. For the quarter ended December 31, 2001, Harken and the Borrowers were each not in compliance with its respective debt service coverage ratio requirement. In March 2002, Harken and the 19 Borrowers received a letter from Bank One waiving the Borrowers debt service coverage ratio requirement for the fourth quarter of 2001 and the first quarter of 2002, and waiving Harken's debt service coverage ratio requirement for the fourth quarter of 2001, deleting the requirement beginning in the first quarter of 2002 and adding a current ratio requirement beginning in the first quarter of 2002. Accordingly, we have reflected all of the unpaid facility balance classified as a long-term obligation in our Consolidated Financial Statements. If Harken or the Borrowers are not in compliance with their bank financial covenant ratios or requirements in the future and are unable to obtain a waiver or amendment to the facility requirements, the credit facility would be in default and callable by Bank One. In addition, due to cross-default provisions in Harken's 5% European Note agreement, a majority of our debt obligations would become due in full if any debt is in default. The classification of our long-term debt obligations at December 31, 2001 reflects our expectations that future operating results will result in Harken and the Borrowers being in compliance with the bank financial covenant ratios and requirements in future quarters. However, expectations of future operating results and continued compliance with financial covenants cannot be assured and our lenders' actions are not controllable by us. If our projections of future operating results are not achieved and our debt is placed in default, we could experience a material adverse impact on our financial position and results of operations. We have a history of losses and may suffer losses in the future We have reported losses in each of the last five years including a net loss of $40,823,000 for the year ended December 31, 2001 that was primarily caused by the writedown of Harken's oil and gas properties and the impairment of Harken's investment in Costa Rica. We have reported cumulative net losses of approximately $263 million over the last five years. Our ability to generate net income is strongly affected by, among other factors, the market price of crude oil and natural gas. If the market price of crude oil and natural gas declines, we may report additional losses in the future. If estimated discounted future net cash flows decrease, we may be required to take additional writedowns We periodically review the carrying value of our oil and gas properties under applicable full-cost accounting rules. These rules require a writedown of the carrying value of oil and gas properties if the carrying value exceeds the applicable estimated discounted future net cash flows from proved oil and gas reserves. Given the volatility of oil and gas prices, it is reasonably possible that the estimated discounted future net cash flows could change in the near term. If oil and gas prices decline in the future, even if only for a short period of time, it is possible that additional writedowns of oil and gas properties could occur. Whether we will be required to take such a charge will depend on the prices for oil and gas at the end of any quarter and the effect of reserve additions or revisions, property sales and capital expenditures during such quarter. Because of oil and gas prices as of December 31, 2001, the net evaluated capitalized costs related to our domestic oil and gas properties exceeded the domestic cost ceiling which resulted in a non-cash writedown of our domestic oil and gas properties of approximately $14.4 million. Similarly, as of December 31, 2001, the net evaluated capital costs related to our Colombia oil properties also exceeded the Colombia cost ceiling, resulting in a non-cash writedown of our oil properties of approximately $4.3 million. 20 Properties and Locations Production and Revenues -- The following table shows, for the periods indicated, operating information attributable to Harken's oil and gas interests: Domestic
Year Ended December 31, ------------------------------------------------------------------------------ 1997 1998 1999 2000 2001 ----------- ---------- ----------- ----------- ----------- Production: Natural Gas (Mcf) 1,922,000 2,063,000 2,847,000 4,012,000 3,844,000 Oil (Bbls) 416,000 433,000 510,000 529,000 273,000 Revenues: Natural Gas $ 5,331,000 $4,373,000 $ 6,879,000 $16,178,000 $16,643,000 Oil $ 8,029,000 $5,508,000 $ 9,188,000 $15,422,000 $ 6,708,000 ----------- ---------- ----------- ----------- ----------- Total $13,360,000 $9,881,000 $16,067,000 $31,600,000 $23,351,000 =========== ========== =========== =========== =========== Unit Prices: Natural Gas (per Mcf) $ 2.77 $ 2.12 $ 2.42 $ 4.03 $ 4.33 Oil (per Bbl) $ 19.30 $ 12.72 $ 18.02 $ 29.15 $ 24.57 Production costs per equivalent barrel $ 7.58 $ 7.36 $ 7.84 $ 10.10 $ 10.14 Amortization per equivalent barrel $ 6.60 $ 6.03 $ 5.41 $ 6.43 $ 9.10
21 Colombia
Year Ended December 31, ----------------------------------------------------------------------------- 1997 1998 1999 2000 2001 -------- ----------- ----------- ------------ ----------- Production: Oil (Bbls) -- 61,000 248,000 460,000 500,000 Natural Gas (Mcf) -- -- -- -- -- Revenues: Oil $ -- $ 538,000 $ 3,026,000 $ 10,649,000 $ 8,291,000 Natural Gas $ -- $ -- $ -- $ -- $ -- -------- ----------- ----------- ------------ ----------- Total $ -- $ 538,000 $ 3,026,000 $ 10,649,000 $ 8,291,000 ======== =========== =========== ============ =========== Unit Prices: Oil (per Bbl) $ -- $ 8.82 $ 12.20 $ 23.15 $ 16.58 Natural Gas (per Mcf) $ -- $ -- $ -- $ -- $ -- Production and transportation costs per equivalent barrel $ -- $ 4.39 $ 4.90 $ 4.96 $ 5.87 Amortization per equivalent barrel $ -- $ 1.04 $ 3.52 $ 9.45 $ 8.66
Acreage and Wells -- At December 31, 2001, Harken owned interests in the following oil and gas wells and acreage. Domestic
Gross Wells Net Wells Developed Acreage Undeveloped Acreage ------------- ------------------ ------------------ ------------------- State Oil Gas Oil Gas Gross Net Gross Net ----- ---- ------ ----- ------ ------ ------ ------ Mississippi -- -- -- -- -- -- 17,156 16,493 Texas 219 70 212.17 43.54 39,081 23,848 20,090 4,986 Louisiana 35 18 27.88 4.30 6,958 2,939 16,301 10,303 Wyoming -- -- -- -- -- -- 21,650 13,281 ----- ---- ------ ----- ------ ------ ------ ------ Total 254 88 240.05 47.84 46,039 26,787 75,197 45,063 ===== ==== ====== ===== ====== ====== ====== ======
22 Colombia
Gross Wells Net Wells Developed Acreage Undeveloped Acreage --------------- ------------------ --------------------- --------------------- Contract Area Oil Gas Oil Gas Gross Net Gross Net ----- ----- ---- ---- ------ ----- ------- ------- Alcaravan 2 -- 1.60 -- 2,253 2,253 98,747 49,374 Bocachico 2 -- 1.60 -- 7,835 3,918 46,865 23,432 Bolivar 2 -- 1.60 -- 1,953 1,953 248,047 124,024 Cajaro - -- -- -- -- -- 82,752 41,376 ----- ----- ---- ---- ------ ----- ------- ------- Total 6 -- 4.80 -- 12,041 8,124 476,411 238,206 ===== ===== ==== ==== ====== ===== ======= =======
The Cajaro Contract was signed in December 2001, and effective beginning February 2002. Costa Rica
Gross Wells Net Wells Developed Acreage Undeveloped Acreage --------------- ------------------ --------------------- --------------------- Contract Area Oil Gas Oil Gas Gross Net Gross Net ----- ----- ---- ---- ------ ----- ------- ------- Costa Rica -- -- -- -- -- -- 1,400,000 560,000
Drilling Activity -- A well is considered "drilled" when it is completed. A productive well is completed when permanent equipment is installed for the production of oil or gas. A dry hole is completed when it has been plugged as required and its abandonment is reported to the appropriate government agency. International activity relates to Harken's Colombian operations. Colombian net wells drilled information is reflected net of certain development finance and operating agreements, and does not consider any potential future participation by Ecopetrol. The following tables summarize certain information concerning Harken's drilling activity: Domestic
Number of Gross Wells Drilled -------------------------------------------------------------------------------------- Exploratory Developmental Total ------------------------- ----------------------- -------------------------- Productive Drilled Productive Drilled Productive Drilled ---------- ------- ---------- ------- ---------- ------- 1999 4 4 3 3 7 7 2000 3 6 13 13 16 19 2001 6 13 6 6 12 19 ----- ----- ---- ---- ------ ----- Total 13 23 22 22 35 45 ===== ===== ==== ==== ====== =====
23
Number of Net Wells Drilled ---------------------------------------------------------------------------------------- Exploratory Developmental Total ----------------------- ------------------------- ------------------------ Productive Drilled Productive Drilled Productive Drilled ---------- ------- ---------- ------- ---------- ------- 1999 0.94 0.94 0.41 0.41 1.35 1.35 2000 0.68 1.59 2.49 2.49 3.17 4.08 2001 1.38 2.49 3.25 3.25 4.63 5.74 ---- ---- ---- ---- ---- ----- Total 3.00 5.02 6.15 6.15 9.15 11.17 ==== ==== ==== ==== ==== =====
Colombia
Number of Gross Wells Drilled -------------------------------------------------------------------------------------------- Exploratory Developmental Total ----------------------- ------------------------- ------------------------ Productive Drilled Productive Drilled Productive Drilled ---------- ------- ---------- ------- ---------- ------- 1999 -- 1 -- -- -- 1 2000 -- -- -- -- -- -- 2001 1 3 -- -- 1 3 ---- ---- ---- ---- ---- ----- Total 1 4 -- -- 1 4 ==== ==== ==== ==== ==== =====
Number of Net Wells Drilled ---------------------------------------------------------------------------------------- Exploratory Developmental Total ----------------------- ------------------------- ------------------------ Productive Drilled Productive Drilled Productive Drilled ---------- ------- ---------- ------- ---------- ------- 1999 -- 1.00 -- -- -- 1.00 2000 -- -- -- -- -- -- 2001 1.00 3.00 -- -- 1.00 3.00 ---- ---- ---- ---- ---- ----- Total 1.00 4.00 -- -- 1.00 4.00 ==== ==== ==== ==== ==== =====
Employees As of December 31, 2001, Harken had 65 employees, including 21 employees of Global and its subsidiaries. Harken has experienced no work stoppages or strikes as a result of labor disputes and considers relations with its employees to be satisfactory. Harken maintains group life, medical, dental, surgical and hospital insurance plans for its employees. 24 ITEM 2. PROPERTIES See "Item 1. Business" for discussion of oil and gas properties and locations. Harken and Global have offices in Houston, Texas, Southlake, Texas and Bogota, Colombia. Harken leases approximately 26,800 square feet of office space in Houston, Texas, which lease runs through October 2006, approximately 2,200 square feet in Southlake, Texas, which runs through May 2004, and approximately 9,700 square feet of office space in Bogota, Colombia, which lease runs through April 2002. ITEM 3. LEGAL PROCEEDINGS In September 1997, Harken Exploration Company, a wholly-owned subsidiary of Harken, was served with a lawsuit filed in U.S. District Court for the Northern District of Texas, Amarillo Division, styled D. E. Rice and Karen Rice, -------------------------- as Trustees for the Rice Family Living Trust ("Rice") vs. Harken Exploration - ---------------------------------------------------------------------------- Company. In the lawsuit, Rice alleges damages resulting from Harken Exploration - ------- Company's alleged spills on Rice's property and claimed that the Oil Pollution Act ("OPA") should be applied in this circumstance. In October 1999, the trial court granted Harken's Motion for Summary Judgment that the OPA did not apply and dismissed the Rice claim under it. Rice appealed the trial court's summary judgment to the U.S. Fifth Circuit Court of Appeals. In April 2001, the Fifth Circuit Court of Appeals issued its opinion affirming the trial court's summary judgment in Harken's favor. In Harken management's opinion, the results of any further appeal will not have a material adverse effect on Harken's financial position. The plaintiff in this matter may continue to pursue a damage claim in Texas state court. In Harken management opinion, the results of such an additional claim will not have a material adverse effect on Harken's financial position. Search Acquisition Corp. ("Search Acquisition"), also know as Harken Texas Acquisition Corp., a wholly-owned subsidiary of Harken, is a defendant in a lawsuit filed by Petrochemical Corporation of America and Lorken Investments Corporation (together, "Petrochemical") on June 28, 1994 in 101st Distict Court, Dallas, Texas. This lawsuit arises out of Petrochemical's attempt to enforce a judgment of joint and several liability entered in 1993 against a group of twenty limited partnerships known as the "Odyssey limited partnerships." Petrochemical claims that Search Exploration, Inc. is liable for payment of the judgment as the successor-in-interest to eight Odyssey limited partnerships. Search Acquisition was the surviving corporation in the 1995 acquisition of Search Exploration, Inc. On February 28, 1996, the court granted Search Acquisition's motion for summary judgment. On July 3, 1998, the Fifth District Court of Appeals for the State of Texas reversed the trial court's summary judgment and remanded the case to the trial court. In late 2001, a jury trial was held in this matter. The jury returned a verdict finding for Petrochemical in the amount of $1.5 million of actual damages and $3 million in punitive damages. As of March 27, 2002 the court had not yet decided on Search Acquisition's various motions to overturn the verdict. Search Acquisition anticipates that it will appeal if this verdict is not overturned in full. Should the verdict be overturned in full, Search Acquisition anticipates that Petrochemical will appeal. In Harken management's opinion at this time, the ultimate outcome of this matter against Search Acquisition, a wholly-owned subsidiary that has minimal oil and gas reserves, will not have a material adverse effect upon Harken's financial condition or operations taken as a whole. 420 Energy Investment, Inc. and ERI Investments, Inc. (collectively "420 Energy") filed a lawsuit against XPLOR, a wholly-owned subsidiary of Harken, on December 21, 1999 in the New Castle County Court of Chancery of the State of Delaware. 420 Energy alleges that they are entitled to appraisal and payment of the fair value of their common stock in XPLOR as of the date XPLOR merged with Harken. Harken has relied on an indemnity provision in the XPLOR merger agreement to tender the costs of defense in this matter to certain third parties. Although the outcome of this litigation is uncertain, Harken believes that any liability to 25 Harken as a result of this litigation will not have a material adverse effect on Harken's financial condition. In February 2002, 420 Energy filed a new lawsuit against XPLOR, Harken and other defendants in state court in Dallas, Texas. Harken intends to pursue and enforce, through whatever steps are necessary, the indemnification from the third parties discussed above with regard to the extension of this suit also. In Harken management's opinion, the ultimate outcome of this litigation will not have a material adverse effect on Harken's financial condition. Harken and its subsidiaries currently are involved in various other lawsuits and other contingencies, which in management's opinion, will not have a material adverse effect on Harken's financial position. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 26 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Price Range of Common Stock Since March 18, 1991, Harken common stock has been listed on the American Stock Exchange and traded under the symbol HEC. At December 31, 2001, there were approximately 18,928 holders of record of Harken common stock. The following table sets forth, for the periods indicated, the reported high and low closing sales prices of Harken common stock on the American Stock Exchange Composite Tape, as restated for the effect of the one-for-ten reverse stock split effected on November 7, 2000. Prices --------------------- High Low ------- ----- 2000 -- First Quarter $15.00 $6.25 Second Quarter 10.00 5.63 Third Quarter 9.38 6.25 Fourth Quarter 6.88 2.38 2001 -- First Quarter 6.97 3.05 Second Quarter 3.59 2.27 Third Quarter 2.39 1.50 Fourth Quarter 1.75 0.86 Dividends Harken has not paid any cash dividends on common stock since its organization and it is not contemplated that any cash dividends will be paid on shares of common stock in the foreseeable future. Dividends shall not be paid to holders of common stock prior to all dividend obligations related to Harken Series G1 Preferred and Series G2 Preferred being satisfied. For further discussion of the terms of the Harken Series G1 Preferred and Series G2 Preferred issued during the year, see Item 8, Notes to Consolidated Financial Statements, "Note 8 - Stockholders' Equity." Such issuances pursuant to an exemption from registration under Section 4.2 of the Securities Act of 1933, as amended. 27 ITEM 6. SELECTED FINANCIAL DATA The following table sets forth historical financial data derived from our audited Consolidated Financial Statements and should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations and our Consolidated Financial Statements and accompanying Notes to Consolidated Financial Statements.
1997 1998 1999 2000 2001 ------------- ------------- ------------- ------------- ------------- Operating Data: Revenues $ 18,768,000 $ 19,770,000 $ 23,456,000 $ 44,395,000 $ 32,423,000 Loss before extraordinary items $ (284,000) $ (55,787,000) $ (12,295,000) $(160,671,000) $ (43,998,000) Net loss $ (284,000) $ (55,787,000) $ (12,845,000) $(152,933,000) $ (41,023,000) Basic and diluted loss per common share (1): Loss before extraordinary items $ (0.03) $ (4.42) $ (1.44) $ (9.55) $ (2.61) ------------- ------------- ------------- ------------- ------------- Net loss $ (0.03) $ (4.42) $ (1.48) $ (9.09) $ (2.45) ============= ============= ============= ============= ============= Balance Sheet Data: Current assets $ 126,392,000 $ 144,163,000 $ 32,178,000 $ 29,144,000 $ 14,245,000 Current liabilities $ 15,752,000 $ 20,426,000 $ 11,202,000 $ 13,877,000 $ 10,867,000 ------------- ------------- ------------- ------------- ------------- Working capital $ 110,640,000 $ 123,737,000 $ 20,976,000 $ 15,267,000 $ 3,378,000 ============= ============= ============= ============= ============= Total assets $ 238,780,000 $ 320,116,000 $ 298,785,000 $ 145,347,000 $ 95,806,000 Long-term obligations: Convertible notes $ 39,880,000 $ 85,000,000 $ 95,869,000 $ 69,940,000 $ 51,388,000 Development finance obligation $ 25,740,000 $ 38,552,000 $ 1,302,000 $ -- $ -- Bank credit facilities $ -- $ -- $ 10,500,000 $ 9,937,000 $ 7,937,000 Other long-term obligations $ -- $ -- $ 5,078,000 $ 4,917,000 $ 9,400,000 ------------- ------------- ------------- ------------- ------------- Total $ 65,620,000 $ 123,552,000 $ 112,749,000 $ 84,794,000 $ 68,725,000 ============= ============= ============= ============= ============= Stockholders' equity $ 157,408,000 $ 176,138,000 $ 174,834,000 $ 46,676,000 $ 16,214,000 Series F preferred stock outstanding (3) -- 15,000 -- -- -- Series G1 preferred stock outstanding (4) -- -- -- 158,155 446,417 Series G2 preferred stock outstanding (4) -- -- -- -- 95,300 Weighted average common shares outstanding (1) 10,908,770 13,025,273 14,413,517 16,863,610 18,063,584 Proved reserves at end of year (2): Bbls of oil 13,088,000 31,522,000 29,678,000 6,794,000 7,626,000 Mcf of gas 33,293,000 108,451,000 52,818,000 54,836,000 39,393,000 Future net cash inflows $ 144,543,000 $ 226,974,000 $ 451,118,000 $ 421,634,000 $ 104,166,000 Present value (discounted at 10% per year) $ 90,580,000 $ 144,851,000 $ 280,427,000 $ 264,697,000 $ 63,297,000
(1) Loss per share amounts and weighted average common shares outstanding calculations reflect the impact of a one-for-ten reverse stock split which was effective November 7, 2000. (2) These estimated reserve quantities, future net revenues and present value figures are related to proved reserves located in the United States and Colombia. No consideration has been given to probable or possible reserves. Oil and gas year end prices were held constant except where future price increases were fixed and determinable under existing contracts and government regulations. Due primarily to the significant decline in Harken's estimated present value of future net cash flows as a result of low oil and gas prices during 1998, Harken recorded a non-cash valuation allowance on its domestic oil and gas properties of approximately $50.5 million during the year ended December 31, 1998. Due primarily to a significant reduction in Harken's proved undeveloped oil reserves on its Bolivar Association Contract in Colombia, Harken recorded a non-cash valuation allowance of approximately $156.4 million during the year ended December 31, 2000. Due to reduced oil and gas prices as of December 31, 2001, Harken recorded a consolidated non-cash valuation allowance of approximately $18.7 million during the year ended December 31, 2001. (3) See "Notes to Consolidated Financial Statements, Note 8 - Stockholders' Equity" contained in Part II, Item 8, for a discussion of Harken Series F Preferred Stock. (4) See "Notes to Consolidated Financial Statements, Note 8 - Stockholders' Equity" contained in Part II, Item 8, for a discussion of Harken Series G1 and Series G2 Preferred Stock. 28 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. Overview The year ended December 31, 2001 was a year in which Harken's two operating segments initiated new business strategies in response to changing industry conditions. Harken's domestic operating segment has completed a period of significant successful drilling activity over the past two years, and in light of reduced prices for oil and natural gas, has reduced its exploration and development activity at this time in favor of pursuing oil and gas reserve growth through merger and acquisition activity. In January 2002, Harken, along with a wholly-owned subsidiary, entered into such an acquisition transaction, subject to the seller obtaining its stockholder and debenture holder approval, acquiring certain producing property interests (the "Republic Properties") in exchange for Harken common stock. Harken's international operating strategy was significantly revised with the announced restructuring plan whereby Harken's Latin American assets and operations were transferred to, and the obligations relating to such assets and operations were assumed by, a subsidiary, Global Energy Development Ltd. ("Global"), which subsequently transferred such assets, obligations and operations into a newly formed subsidiary whose stock has now been listed on a United Kingdom exchange, facilitating the ability for Global to seek financing, growth and other capital plans on its own. Global's new business strategy is to identify, develop and promote energy projects from throughout Latin America to industry and financial partners and to aggregate assets in Latin America through strategic acquisitions and alliances. The changing focus for each of Harken's two operating segments reflect a response to exposing Harken stockholders to the growth opportunities of the oil and gas industry overall, as it seeks to meet energy demand domestically, particularly in the wake of future supply uncertainties following the September 11, 2001 tragedy. Harken's consolidated revenues and cash flows were strong during the first half of 2001 due largely to the high product prices being received. Sales of certain domestic producing properties during late 2000 and early 2001 took advantage of higher prices, maximizing the sales proceeds which were used in part to fund Harken's domestic and Colombian drilling activities. Although a large portion of the production from sold properties has been offset by production from newly completed wells, cash flows during the last part of 2001 have decreased due to reduced domestic production and overall product pricing. As a part of Harken's change in business strategy mentioned above, Harken has taken steps to maximize its cash flow by decreasing its administrative costs through reductions in personnel, reductions in salaries, increasing efficiencies in its production operations, and by reducing its long-term debt obligations. Harken's continued steps in these areas should continue to increase operating efficiency and cash flow during 2002. Harken reflected non-cash writedowns of its domestic and Colombian oil and gas properties in accordance with the full cost accounting method due to reduced oil and gas prices as of December 31, 2001. Additionally, recent political and regulatory developments in Costa Rica have made the further exploration of Harken's Costa Rica prospect unlikely, resulting in the impairment of its equity investment in its minority owned Costa Rica operating subsidiary. These non-cash charges during the year contributed to Harken's consolidated net loss of approximately $41.0 million during 2001. Harken also continued to modify its capital structure by retiring an additional $18.8 million of European Notes outstanding during 2001, resulting in an aggregate reduction of over $44 million since December 31, 1999. Additional European Note exchanges are being pursued and are expected by Harken to occur later in 2002, with a view toward reducing the outstanding 5% European Note balances prior to their maturity in 2003. Harken anticipates converting the remaining 5% European Notes to Harken common stock 29 upon their maturity in 2003. Terms of the 5% European Notes also permit Harken to convert up to 50% of the remaining Notes outstanding to Harken common stock in November 2002. Debt retirements with cash will also be pursued through available cash. Critical Accounting Policies Full cost accounting method -- Harken accounts for the costs incurred in the acquisition, exploration, development and production of oil and gas reserves using the full cost accounting method. Under full cost accounting rules, the net capitalized costs of evaluated oil and gas properties shall not exceed an amount (the "cost ceiling") equal to the present value of future net cash flows from estimated production of proved oil and gas reserves, based on current economic and operating conditions, including the use of oil and gas prices as of the end of each quarter. Harken reflected a full cost valuation allowance totaling $18.7 million as of December 31, 2001, based on NYMEX prices of $19.84/barrel and $2.57/mmbtu. Subsequent increases in oil and gas prices as of March 27, 2002 were not considered in the calculation of the full cost valuation allowance. Commodity derivative instruments in place as of December 31, 2001 had no impact on the full cost valuation allowance calculation. For a complete discussion of Harken's proved oil and gas reserves, see Note 14 - Oil and Gas Disclosures in the Notes to Consolidated Financial Statements contained in Part II, Item 8. Given the volatility of oil and gas prices, it is reasonably possible that the estimate of discounted future net cash flows from proved oil and gas reserves could change in the near term. If oil and gas prices decline further in the future, even if only for a short period of time, it is possible that additional impairments of oil and gas properties could occur. In addition, it is reasonably possible that additional impairments could occur if costs are incurred in excess of any increases in the cost ceiling, revisions to proved oil and gas reserves occur, or if properties are sold for proceeds less than the discounted present value of the related proved oil and gas reserves. Colombia operations -- During the year ended December 31, 2001, approximately 26% of Harken's consolidated revenues were generated from sales to Ecopetrol, the state-owned Colombian oil company. The country of Colombia is currently experiencing heightened security issues which could affect Harken's Colombian operations as well as the strength and operations of Ecopetrol. If Ecopetrol experiences significant adverse conditions in its operations, it may not be able to meet its ongoing financial obligations to Harken for delivered production or be able to purchase future production under the terms of existing contract provisions. Harken's Colombian operations could also be directly affected by guerilla activity or other instances or threats of violence, preventing or interrupting Harken from producing, transporting or delivering future production volumes. Valuation of accounts receivable -- Harken sells its domestic oil and gas production to a broad and diverse group of industry partners, many of which are major oil and gas companies, and as a whole, do not represent a significant credit risk. In addition, Harken charges certain industry partners, who participate in Harken-operated wells, with their share of drilling costs and operating expenses. In determining a reserve for potential losses in collection of its accounts receivable, Harken considers, among other factors, the current financial condition of its industry partners in light of current industry conditions. In the event of a significant decline in oil and gas prices, many of our industry partners may not be able to meet their ongoing financial obligations to Harken or be able to meet the terms of existing contract provisions. 30 Classification of long-term debt -- Harken's bank credit facility with Bank One, N.A. ("Bank One") requires Harken, as well as certain of its subsidiaries (the "Borrowers") to maintain certain financial covenant ratios and requirements, as calculated on a quarterly basis. For the quarter ended December 31,2001, Harken and the Borrowers were each not in compliance with its respective debt service coverage ratio requirement and have received a waiver to these facility requirements from Bank One. Accordingly, Harken has reflected all of the unpaid facility balance classified as a long-term obligation in its Consolidated Financial Statements. If Harken or the Borrowers are not in compliance with their bank financial covenant ratios or requirements in the future and are unable to obtain a waiver or amendment to the facility requirements, the credit facility would be in default and callable by Bank One. In addition, due to cross-default provisions in Harken's 5% European Note agreement, a majority of Harken's debt obligations would become due in full if any debt is in default. The classification of Harken's long-term debt obligations at December 31, 2001 reflects Harken's expectations that future operating results will result in Harken and the Borrowers being in compliance with the bank financial covenant ratios and requirements in future quarters. However, expectations of future operating results and continued compliance with financial covenants cannot be assured and our lenders' actions are not controllable by Harken. If Harken's projections of future operating results are not achieved and its debt is placed in default, Harken could experience a material adverse impact on its financial position and results of operations. Accounting for derivatives -- Harken holds commodity derivative financial instruments designed to mitigate commodity price risk associated with a portion of its future monthly natural gas production and related cash flows. These commodity derivatives qualify for hedge accounting as discussed in Note 12 - Hedging Activities in the Notes to Consolidated Financial Statements contained in Part II, Item 8. Harken does not participate in speculative derivatives trading. Hedge accounting requires that commodity derivative instruments be designated as hedges and that fluctuations in their market value are effective in mitigating the hedged commodity price risk, and that such effectiveness be documented and monitored. While Harken intends to continue to meet the conditions to qualify for hedge accounting, if hedges are not highly effective, or if the forecasted hedged production does not occur, the changes in the fair value of the commodity derivative instruments would be reflected in earnings. 31 RESULTS OF OPERATIONS The following table presents certain data for Harken's continuing operations for the years ended December 31, 1999, 2000 and 2001. A discussion follows of certain significant factors which have affected Harken's operating results during such periods. This discussion should be read in conjunction with Harken's Consolidated Financial Statements and related footnotes contained in Part II, Item 8. Year Ended December 31, ---------------------------------------- Domestic Exploration and - ------------------------ Production Operations 1999 2000 2001 - --------------------- ---------- ----------- ----------- Gas sales revenues $6,879,000 $16,178,000 $16,643,000 Gas volumes in Mcf 2,847,000 4,012,000 3,844,000 Gas price per Mcf $ 2.42 $ 4.03 4.33 Oil sales revenues $9,188,000 $15,422,000 $ 6,708,000 Oil volumes in barrels 510,000 529,000 273,000 Oil price per barrel $ 18.02 $ 29.15 $ 24.57 Gas plant revenues $ 652,000 $ 928,000 $ -- Middle American Exploration and - ------------------------------- Production Operations - --------------------- Oil sales revenues $3,026,000 $10,649,000 $ 8,291,000 Oil volumes in barrels 248,000 460,000 500,000 Oil price per barrel $ 12.20 $ 23.15 $ 16.58 Other Revenues - -------------- Interest Income $3,693,000 $ 1,188,000 $ 673,000 Other Income $ 18,000 $ 30,000 $ 108,000 For the year ended December 31, 2001 compared with the prior year - ----------------------------------------------------------------- North American Operations Domestic gross oil and gas revenues during 2001 relate primarily to Harken's continuing operations in the onshore and offshore areas of the Texas and Louisiana Gulf Coast and the Western and Panhandle regions of Texas. Domestic gas revenues increased 3% to $16.6 million during 2001 compared to $16.2 million for the prior year period due primarily to the increase in average gas prices received during the current year, as Harken 32 received an overall average price of $4.33 per mcf of gas during 2001 compared to $4.03 per mcf received during 2000. Gas prices were particularly strong during the first half of 2001, but weakened during the fourth quarter of 2001. Gas production volumes during 2001 decreased slightly compared to the prior year period, despite the sales of certain producing properties, due to new production from Harken's drilling activity during the past twelve months, particularly from the Old Ocean field in the Texas Gulf Coast region and the Lake Raccourci and Lapeyrouse fields in southern Louisiana. Domestic oil revenues decreased 57% to $6.7 million during 2001 compared to $15.4 million during 2000 primarily due to the December 2000 sale of Harken Southwest Corporation, which owned and operated Harken's Four Corners area production and due to the second quarter 2001 sale of Harken's New Mexico operations. In addition, Harken's Gulf Coast oil production was reduced by temporary operational curtailments during the first quarter of 2001 at Harken's Main Pass area offshore Louisiana. Overall, domestic oil production volumes decreased 48% during the year compared to the prior year. Gas plant revenues during 2000 were derived through Harken Southwest Corporation, which was sold in December 2000. Domestic oil and gas operating expenses consist of lease operating expenses and production and reserve based taxes. Domestic oil and gas operating expenses decreased 23% to $9.3 million during 2001 compared to $12.1 million during the prior year primarily due to the above mentioned sales of producing properties. Oil and gas operating expenses decreased slightly per unit of production due to the replacement of sold producing fields with newly completed gas production. Harken continues to seek to sell a specific domestic field operation with high operating costs per barrel. Such efforts are intended to further reduce Harken's overall operating expenses per unit of production beginning early 2002. Harken expects that oil and gas production volumes generated as a result of the recent drilling activity together with the acquisition of the Republic Properties discussed above, will continue to help to mitigate the production decreases as a result of sales of non-strategic producing properties. Through March 26, 2002, however, average first quarter 2002 gas prices have remained lower than prices received in the prior year period. Harken's oil and gas revenues are highly dependent upon product prices, which Harken is unable to predict. Middle American Operations Harken's Middle American operations are conducted through Global. Harken's Colombian oil revenues have decreased 22% from $10.6 million during 2000 to $8.3 million during 2001 due to a decrease in the average price received per barrel, which decreased from $23.15 during 2000 to $16.58 during 2001. During 2000 and 2001, Harken's Colombian production operations related primarily to Global's Bolivar and Alcaravan Association Contract areas. During 2000 and the first quarter of 2001, sales of production from Global's Estero #1 well on the Alcaravan Contract area were limited to approximately 1,000 gross barrels of oil per day due to pipeline constraints and pumping capacity. During the second quarter of 2001, Global took steps to resolve such limitations and, though it is currently producing approximately 1,900 gross barrels of oil per day, is now allowed to transport up to approximately 3,000 gross barrels of oil per day from both Estero #1 and Estero #2 wells. Estero #2 was completed during the first quarter of 2001, and produced throughout the remainder of the 33 year, mitigating production declines related primarily to Global's Bolivar Contract area production. Global's production volumes during 2002 will continue to be dependent on existing well production, pumping efficiency, and security conditions. Middle American operating expenses have increased 26% from $2.3 million during 2000 to $2.9 million for 2001, primarily due to increases in transportation and security costs. During the third quarter of 2001, Global took steps to reduce operating expenses related to its producing fields in Colombia, which have resulted in operating expense reductions beginning in the fourth quarter of 2001. Interest and Other Income Interest and other income decreased during 2001 compared to the prior year due to Harken's usage of cash for capital expenditures during 2000 and 2001, and due to lower yield rates on invested funds. Harken generated approximately $1.2 million of interest income during 2000, compared to approximately $673,000 of interest income during 2001. Additional decreases in Harken's cash balances could be mitigated or offset by additional capital sources. Other Costs and Expenses General and administrative expenses decreased 18% during 2001 compared to 2000 primarily due to personnel reductions and efforts to improve administrative efficiency. Harken reduced the number of its employees by 34% during the year. Depreciation and amortization expense increased during 2001 compared to the prior year period primarily due to downward revisions during 2000 in Colombia proved reserves. Depreciation and amortization on oil and gas properties is calculated on a unit of production basis in accordance with the full cost method of accounting for oil and gas properties. During the fourth quarter of 2001, due to reduced oil and gas prices at December 31, 2001, Harken recorded non-cash valuation allowances of approximately $14.4 million related to its domestic oil and gas properties and $4.3 million related to its Colombian oil properties. The valuation is based on the present value, discounted at ten percent, of Harken proved oil and gas reserves based on yearend prices. Subsequent increases in oil and gas prices as of March 27, 2002 were not considered in the calculation of the full cost valuation allowance. In March 2002, the Costa Rica environmental agency SETENA denied its approval of the requested environmental permit related to Harken's Costa Rica Contract. HCRH has filed an appeal related to this ruling by SETENA. In January 2002, the Costa Rica Constitutional Court rendered a published opinion in a suit that had been filed against another oil and gas operator and MINAE by certain environmental groups. In its opinion, in this case, the Constitutional Court of Costa Rica found, among other issues, that SETENA did not have the current authority to grant environmental permits. In addition, proposed legislation pending in the Costa Rica legislature seeks to abolish the Costa Rica government's rights to grant hydrocarbon exploration contracts. Due to the Costa Rica Constitutional Court decision discussed above, even though it did not directly involve HCRH or the Moin #2 well, as well as the pending legislation described above, Harken and Global believe that HCRH's appeal to SETENA for reconsideration of its denial of the requested permit, or any 34 similar recourse, will be unsuccessful. Further, recent political developments in Costa Rica, in the opinion of Harken and Global, severely limit the opportunity for future oil and gas exploration in Costa Rica. These significant adverse developments have resulted in Harken and Global fully impairing its approximately $8.7 million investment in the Costa Rica project in its Consolidated Balance Sheet as of December 31, 2001. During the fourth quarter of 2001, Harken also reflected an impairment of approximately $3.2 million related to certain transportation facility costs related to Global's Bolivar Contract area in Colombia, as the carrying value of such facilities was in excess of estimates of future cash flows. Such estimated future cash flows were based on current production levels, future production expectations based on December 31, 2001 reserve estimates, projected locations of future wells to be drilled and the lack of a ready market to purchase such facilities. Harken continues to utilize transportation facilities related to its Alcaravan Contract area. Harken also reflected an impairment of approximately $1.6 million related to certain deferred transaction costs incurred by Global, primarily for certain merger transaction efforts which were a part of the restructuring of Harken's international assets. Such merger transaction efforts were terminated during the fourth quarter of 2001 and the corresponding transaction costs were charged to earnings. In addition, Harken reflected an impairment of $620,000 on certain Colombia oilfield equipment held by Global, as based on reduced drilling plans by Global, and the current low industry demand for such equipment in light of heightened Colombia security concerns, the carrying value of such inventory was in excess of estimated future cash flows from sale or use of such equipment. Interest and other expense decreased during 2001 compared to the prior year period primarily due to the repurchase and exchange of certain 5% European Notes during 2000 and 2001. Such decrease in net interest expense was despite the decrease in the amounts of interest capitalized to Harken's Colombian unevaluated property costs. In addition, during the first quarter of 2001, Harken expensed the remaining unamortized issuance costs related to the IFC project loan finance facility, which was terminated in May 2001. For the year ended December 31, 2000 compared with the prior year - ----------------------------------------------------------------- North American Operations Domestic oil and gas revenues during 2000 and 1999 relate primarily to the operations in the onshore and offshore areas of the Texas and Louisiana Gulf Coast, the Western and Panhandle regions of Texas, the Four Corners area primarily on the Navajo Indian Reservation, the Magnolia region of Arkansas and the Carlsbad region of New Mexico. During the fourth quarter of 2000, Harken sold its Four Corners operations and certain non-operated interests in the Texas Gulf Coast region. Domestic oil revenues increased 68% to $15.4 million during 2000 compared to $9.2 million during 1999 primarily due to the increase in average oil prices, which averaged $11.13 more per barrel during 2000 compared to the prior year. Domestic gas revenues increased 135% to $16.2 million during 2000 compared to $6.9 million for the prior year due primarily to the increase in gas production as a result of the merger with XPLOR in August 1999. Gas production volumes during 2000 increased 41% compared to the prior year. The increased gas revenues were also due to the increase in average gas prices received during the year, as Harken received an 35 overall average price of $4.03 per Mcf of gas production during 2000 compared to $2.42 per Mcf received during 1999. Gas plant revenues increased 42% from $652,000 during 1999 to $928,000 during the current year primarily due to increased liquids prices during the year. Harken's gas plant revenue relates to its Four Corners operation, which was sold in December 2000. Domestic oil and gas operating expenses consist of lease operating expenses and gas plant expenses, along with a number of production and reserve based taxes. Domestic oil and gas operating expenses increased 57% to $12.1 million during 2000 compared to $7.7 million during the prior year primarily due to the increase in operating expenses from the above mentioned merger with XPLOR. Oil and gas operating expenses as a percentage of related oil and gas revenues remained approximately the same between 2000 and 1999. Middle American Operations During 1999 and 2000, Middle American production operations consisted of production testing conducted on Global's Bolivar and Alcaravan Association Contract areas in Colombia. Colombian oil revenues during the year have increased 252% from $3.0 million during 1999 to $10.6 million during 2000 due to increased production volumes and higher oil prices. In addition, beginning November 1999 and May 2000, pursuant to specific negotiations with Ecopetrol, Harken began receiving Ecopetrol's working interest share of monthly Bolivar and Alcaravan Contract area production, respectively. As such, Harken received 80% of gross production, compared to only 40% during most of 1999. During 2000, Estero #1 well sales of production were limited to approximately 1,000 gross barrels of oil per day due to pipeline constraints and pumping capacity. The Catalina #1 and Olivo #1 wells on the Bolivar Contract area produced an average of a combined 800 gross barrels of oil per day during 2000. Due primarily to increased production, Middle American operating expenses have also increased from $1,214,000 during 1999 to $2,283,000 during 2000. 36 Interest and Other Income Interest and other income decreased during 2000 compared to the prior year due to Harken's usage of cash during 1999 and 2000 for capital expenditures, and the October 1999 purchase of certain development finance interests for $20 million. Harken generated approximately $3,693,000 of interest income during 1999, compared to approximately $1,188,000 of interest income during 2000. Harken's cash balances, which include investments in short-term marketable debt securities, increased during the last half of 2000 despite its capital expenditure activity due to the issuance of shares of Harken common and preferred stock, as well as from domestic property sales. Other Costs and Expenses General and administrative expenses increased to $13,223,000 during 2000 compared to $11,043,000 in 1999 primarily due to administrative expenses associated with Harken's new Costa Rica activities and its growing Colombian production operations. In addition, Harken added minimal administrative expenses as a result of the increased operations relating to the August 1999 merger with XPLOR. Depreciation and amortization expense increased significantly to $13,649,000 during 2000 compared to $6,848,000 in the prior year primarily due to downward revisions in Harken's Colombia proved reserves. Depreciation and amortization on oil and gas properties is calculated on a unit of production basis in accordance with the full cost method of accounting for oil and gas properties. During the fourth quarter of 2000, Harken recorded a non-cash valuation allowance on its Colombian oil and gas properties of $156,411,000. The valuation allowance is based upon the present value, discounted at ten percent, of Harken's Colombian reserves, which declined primarily due to a significant reduction in Harken's proved undeveloped reserves on its Bolivar Association Contract following the recently drilled Olivo #2 well in Colombia, which was drilled during late December 2000 and during the early part of the first quarter of 2001. To a lesser extent, Harken's proved producing reserve volumes were also reduced due to production information. Interest expense and other decreased to $5,297,000 during 2000 from $7,296,000 during the prior year primarily due to the conversion and purchase of the Development Finance Agreements during 1999 and early 2000 and due to repurchases of certain European Notes outstanding during 2000. Such decreases in interest expense were partially offset by the interest expense added from XPLOR and the Benz Convertible Notes, as well as the decrease in the amounts of interest capitalized to Harken's Colombian exploration activity, as such activity during 2000 was decreased compared to the prior year period. Related to the February 2000 transaction whereby Harken exchanged European Notes in the face amount of $6,000,000 plus accrued interest for 300,000 shares of Harken common stock, Harken reflected a charge to earnings of $2,068,000 related to the fair value of the shares of Harken common stock issued in excess of the number of shares which would have been issued pursuant to the $65.00 per share conversion price of the European Notes. During 2000, Harken repurchased a total of approximately $19 million face amount of European Convertible Notes for approximately $10.7 million cash plus transaction expenses. In connection with such 37 repurchases, Harken has recorded $7,745,000 of extraordinary item gains during the year, which is net of a charge for related unamortized issuance costs. LIQUIDITY AND CAPITAL RESOURCES Harken's working capital at December 31, 2001 was approximately $3.4 million, compared to approximately $15.3 million at December 31, 2000. The decrease in working capital during the year resulted primarily from approximately $28.7 million of capital expenditures, which were funded partially by sales of domestic oil and gas properties totaling approximately $13.4 million. Assisted by strong oil and natural gas prices during the first half of 2001 Harken's operations generated approximately $7.7 million of cash flow during the year. Harken's cash resources at December 31, 2001 totaled approximately $8.5 million. Considering its existing cash resources and the potential additional capital sources listed below, Harken believes that it will have sufficient cash resources to fund all of its planned capital expenditures during 2002. Harken's ongoing exploration, development and acquisition efforts are expected to be funded through a combination of cash on hand, cash flows from operations, issuances or exchanges of debt or equity securities, or through cash provided by either existing or newly established financing arrangements. During 2001, Harken's Board of Directors approved a plan to restructure Harken's operations for the purpose of focusing Harken's resources more directly on domestic acquisition, exploration and development operations, particularly in the Gulf Coast region of Texas and Louisiana. Pursuant to this restructuring plan, the Board determined it to be in the shareholders' interest to implement such a plan to move Harken's interests in its Middle American operations, assets and obligations under a separate subsidiary with the name Global Energy Development Ltd. ("Global"), which would have the ability and capability to seek financing and other capital plans on its own. In March 2002, Global transferred all of its interests in its international and operations to, and obligations relating to such assets and operations were assumed by, a United Kingdom subsidiary, Global Energy Development PLC ("Global PLC") in exchange for 92.6% of Global PLC's common stock. Upon the completion of this exchange transaction, Global PLC then completed the listing of its common stock for trading on the AIM Exchange in London, and placed 7.4% of such stock in a placement to investors, including certain affiliates of Harken and Global. Global PLC is seeking additional financing and acquisition activities using its shares of its newly listed common stock. At March 27, 2002, Harken, through Global, owned 92.6% of Global PLC common stock. Capital Sources During 2001, sales of certain domestic producing property interests generated cash proceeds of approximately $13.1 million. In February 2002, Harken sold certain additional domestic producing property interests for approximately $910,000. Harken is currently considering additional sales of producing properties that could generate additional cash proceeds. Harken's operating cash flows from its domestic oil and gas properties are being strengthened by recent successful drilling activity in southern Louisiana, which have begun to partially offset the reductions following the sales of producing properties consummated in late 2000 and during the first half of 2001. Recently completed wells, including the Thomas Cenac #1, the State Lease 1480 #2, the State Lease 14589 #3 and the State Lease 1480 #3, all began production in the last four months of 2001. In January 2002, a wholly- 38 owned subsidiary of Harken signed an agreement to acquire the Republic Properties from Republic Resources, Inc., subject to approval by Republic's shareholders and debenture holders. The Republic Properties consist of 15 producing property interests located in southern Louisiana and the Texas Gulf Coast region. The Republic Properties to be acquired by Harken are in exchange for up to 2,645,500 of Harken common stock. The acquisition of the Republic Properties will supplement Harken's domestic operating cash flows beginning in the second quarter of 2002. Harken's domestic operating cash flows are particularly dependent on the price of natural gas, which Harken is unable to predict. Certain Harken subsidiaries entered into a three-year loan facility with Bank One, N.A. ("Bank One"), which is secured by certain of Harken's domestic oil and gas properties and a guarantee from Harken. The Bank One facility provides borrowings subject to a borrowing base (as defined by the Bank One facility), which was $12,400,000 as of December 31, 2001. The Bank One facility requires the Borrowers, as well as Harken, to maintain certain financial covenant ratios and requirements. For the quarter ended December 31, 2001, Harken and the Borrowers were each not in compliance with its respective debt service coverage ratio requirement. In March 2002, Harken and the Borrowers received a letter from Bank One waiving the Borrowers debt service coverage ratio requirement for the fourth quarter of 2001 and the first quarter of 2002, and waiving Harken's debt service coverage ratio requirement for the fourth quarter of 2001, deleting the requirement beginning in the first quarter of 2002 and adding a current ratio requirement beginning in the first quarter of 2002. In exchange, among other requirements, Bank One reduced the current borrowing base to $7,937,000, the amount of the current balance outstanding under the facility. Such borrowing base is scheduled to be re-determined by Bank One on May 1 and November 1 of each year in accordance with the facility agreement. Global's operating cash flows continue to be provided by ongoing production from its Alcaravan and Bolivar Contract areas in Colombia. Following the notification from Ecopetrol permitting Global to proceed with the sole-risk development of the Palo Blanco and Buturama fields, Global is now receiving Ecopetrol's share of production after royalty from its Colombia producing wells. Global anticipates that cash flows from its Colombian assets will be adequate to fund the capital needs, as well as the operating, administrative and management costs of its Middle American operations. As described above, the March 2002 application to trade on the AIM Exchange in London enables Harken, through Global, to seek additional financing and acquisition activities using shares of Global PLC common stock. Global PLC's ability to effectively use its common stock will be dependent upon the market value of its shares on the AIM Exchange. Global is also pursuing raising additional capital through potential sales of assets. Additional capital raised by Global would be used exclusively for Global's capital needs, as transfers to Harken would be limited or restricted. In addition to the above sources, Harken has and may continue to raise capital through the issuance of equity and convertible debt instruments, or through the exchange of existing instruments through transactions that provide Harken with additional capital. Such transactions may be affected, however, by the market value of Harken common stock. If the price of Harken common stock remains low or decreases, Harken's ability to utilize its stock for raising capital could be negatively affected. 39 Capital Commitments In light of reduced oil and gas prices, Harken's domestic operating strategy now includes efforts to increase its oil and gas reserves in North America through acquisitions, with a decreased emphasis on exploration and development drilling activities. Accordingly, Harken's domestic capital expenditure plans have been greatly reduced compared to the prior two year period. However, Harken's prospect inventory includes acreage which may hold up to 170 billion cubic feet equivalent of risked net reserve potential. Certain of these prospects may be drilled through joint venture arrangements, which Harken is currently pursuing in order to reduce its capital commitment, while maintaining its exposure to the reserve potential. Harken is actively pursuing various North American acquisition opportunities. Harken has focused its operating strategy to acquire, explore, and produce oil and gas properties located in the Gulf Coast region of Texas and Louisiana. Harken's primary need for capital is to fund these planned domestic exploration and development efforts. Harken anticipates domestic capital expenditures will total approximately $1.5 million during 2002. A majority of Harken's planned domestic capital expenditures are discretionary and, as a result, will be curtailed if sufficient funds are not available. Such expenditure curtailments, however, could result in Harken losing certain prospect acreage or reducing its interest in future exploration and development projects. During the second quarter of 2001, Harken issued 325,150 shares of Series G1 Preferred stock in exchange for 5% European Notes in the face amount of $9.0 million. In addition, in July 2001, Harken issued 95,800 shares of Series G2 Preferred stock in exchange for 5% European Notes in the face amount of approximately $9.6 million. Including these most recent exchanges, Harken has retired 5% European Notes totaling approximately $44 million since February 2000. Harken continues to consider additional transactions with the 5% European Note holders whereby Harken may retire additional Notes in exchange for shares of Harken common stock, cash, convertible securities or other consideration. Operational Contingencies -- Harken has accrued approximately $6.8 million at December 31, 2001 relating to operational or regulatory liabilities related to Harken's North American operations. Harken and its subsidiaries currently are involved in various lawsuits and other contingencies, which in management's opinion, will not result in a material adverse effect upon Harken's financial condition or operations taken as a whole. Harken's operations are subject to stringent and complex environmental laws and regulations governing the discharge of materials into the environment or otherwise relating to environmental protection. These laws and regulations are subject to changes that may result in more restrictive or costly operations. Failure to comply with applicable environmental laws and regulations may result in the imposition of administrative, civil and criminal penalties or injunctive relief. Global's international oil and gas exploration and production operations, including well drilling and seismic activities, require specific governmental environmental licenses and permits, the acquisition of which in the past have been subject to extensive delays. Global may continue to experience similar delays in the future. Failure to obtain these licenses and permits in a timely manner may prevent or delay Harken's and Global's operational plans. International Commitments--Terms of certain of the Association Contracts entered into between Global's subsidiary Harken de Colombia, Ltd. and Ecopetrol commit Global to perform certain activities in Colombia in accordance with a prescribed timetable. In addition, Global has certain scheduled capital expenditure commitments related to its TEA Agreements in Peru and Panama. Failure by Global to perform these activities as required could result in Global losing its rights under the particular contract, which could potentially have a material adverse effect on Harken's business. As of March 27, 2002, Global was in 40 compliance with the requirements of each of the Association and TEA Contracts, as amended. In light of the political and regulatory developments in Costa Rica discussed above, Global is projecting no capital expenditure plans during 2002 with regard to the Costa Rica Contract. Consolidated Contractual Obligations -- The following table presents a summary of Harken's contractual obligations and commercial commitments as of December 31, 2001. The table excludes contractual obligations that are payable or redeemable with shares of Harken common stock. Harken has no off-balance sheet obligations other than those set forth below.
Payments Due by Period ----------------------------------------------------------------- Less than Contractual Cash Obligations one year 1-3 years 4-5 years Thereafter Total - ----------------------------- --------- ----------- ---------- --------- ----------- Bank Credit Facility (1) $ -- $ 7,900,000 $ -- $ -- $ 7,900,000 Operating Leases (2) 744,000 1,408,000 1,263,000 -- 3,415,000 International Commitments (3) -- 2,500,000 -- -- 2,500,000 Domestic Commitments -- -- -- -- -- -------- ----------- ---------- --------- ----------- Total Contractual Cash Obligations $744,000 $11,808,000 $1,263,000 $ -- $13,815,000 ======== =========== ========== ========= ===========
(1) Does not reflect impact of plans to modify or extend existing facility through refinancing. (2) Amount net of sublease arrangements in effect at December 31, 2001. (3) Harken has historically negotiated certain modifications to international work program obligations which have extended or reduced capital commitments. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market risk generally represents the risk that losses may occur in the values of financial instruments as a result of movements in commodity prices, interest rates and foreign currency exchange rates. As part of an overall risk management strategy, Harken considers the use of derivative financial instruments to manage and reduce risks associated with these factors. Commodity Price Risk -- Harken is a producer of hydrocarbon commodities, including crude oil, condensate and natural gas. Consistent with the prior year, Harken uses oil and gas derivative financial instruments, limited to swaps, collars and options with maturities of 24 months or less, to mitigate its exposure to fluctuations in oil and gas commodity prices on future crude oil and natural gas production. Consistent with the prior year, Harken enters into no commodity derivative financial instruments other than those which are designed to be effective in mitigating commodity price risk of Harken's oil and gas production, and does not participate in speculative derivative trading. Harken uses the sensitivity analysis method to disclose its 41 quantitative disclosure of commodity price risk exposure. Accordingly, Harken has evaluated the potential effect that near term changes in commodity prices would have had on the fair value of its commodity price risk sensitive financial instruments at year end 2001. Assuming a 20% increase in natural gas prices from actual prices at December 31, 2001, the potential decrease in the fair value of Harken's natural gas collar contract at December 31, 2001 would have been approximately $425,000. At December 31, 2001 Harken had no financial instrument risk exposure related to increases or decreases in crude oil prices. Interest Rate Risk - Consistent with the prior year, Harken invests cash in interest-bearing temporary investments of high quality issuers. Due to the short time the investments are outstanding and their general liquidity, these instruments are classified as cash equivalents in the consolidated balance sheet and do not represent a significant interest rate risk to Harken. Consistent with the prior year, Harken considers its interest rate risk exposure related to long-term debt obligations is also not significant, as at December 31, 2001 all but approximately $7,937,000 of Harken's financing obligations carry a fixed interest rate per annum. Harken has no open interest rate swaps agreements. Foreign Currency Exchange Rate Risk - Consistent with the prior year, Harken conducts international business in Colombia and Costa Rica and is subject to foreign currency exchange rate risk on cash flows related to sales, expenses, and capital expenditures. However, because predominately all material transactions in Harken's existing foreign operations are denominated in U.S. dollars, the U.S. dollar is the functional currency for all operations. Consistent with the prior year, exposure from transactions in currencies other than U.S. dollars is not considered material. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The following financial statements appear on pages 43 through 85 in this report. Page ---- Reports of Independent Auditors............................................. 43 Consolidated Balance Sheets -- December 31, 2000 and 2001................... 45 Consolidated Statements of Operations -- Years ended December 31, 1999, 2000 and 2001.............................. 46 Consolidated Statements of Stockholders' Equity -- Years ended December 31, 1999, 2000 and 2001.............................. 47 Consolidated Statements of Cash Flows -- Years ended December 31, 1999, 2000 and 2001.............................. 48 Notes to Consolidated Financial Statements.................................. 49 42 REPORT OF INDEPENDENT AUDITORS To the Stockholders and Board of Directors. Harken Energy Corporation We have audited the accompanying consolidated balance sheet of Harken Energy Corporation as of December 31, 2001, and the related consolidated statement of operations, stockholders' equity and cash flows for the year then ended. 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 auditing standards generally accepted in the United States. 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 audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Harken Energy Corporation at December 31, 2001, and the consolidated results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States. ERNST & YOUNG LLP Houston, Texas March 25, 2002 43 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Stockholders and Board of Directors of Harken Energy Corporation: We have audited the accompanying consolidated balance sheet of Harken Energy Corporation (a Delaware corporation) and subsidiaries as of December 31, 2000, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the two years in the period ended December 31, 2000. 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 audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. 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 financial statements referred to above present fairly, in all material respects, the financial position of Harken Energy Corporation and subsidiaries as of December 31, 2000, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States. ARTHUR ANDERSEN LLP Houston, Texas March 27, 2001 44 HARKEN ENERGY CORPORATION CONSOLIDATED BALANCE SHEETS ASSETS
December 31, ------------------------------- 2000 2001 ------------- ------------- Current Assets: Cash and temporary investments $ 19,763,000 $ 8,523,000 Restricted cash 910,000 944,000 Accounts receivable, net of allowance for uncollectible accounts 7,160,000 3,248,000 of $468,000 and $483,000 for 2000 and 2001, respectively Related party notes receivable 169,000 169,000 Prepaid expenses and other current assets 1,142,000 1,361,000 ------------- ------------- Total Current Assets 29,144,000 14,245,000 Property and Equipment: Oil and gas properties, using the full cost method of accounting: Evaluated 321,845,000 337,440,000 Unevaluated 17,666,000 3,472,000 Facilities and other property 22,048,000 25,000,000 Less accumulated depreciation and amortization (250,598,000) (287,577,000) ------------- ------------- Total Property and Equipment, net 110,961,000 78,335,000 Other Assets, net 5,242,000 3,226,000 ------------- ------------- $ 145,347,000 $ 95,806,000 ============= ============= LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Trade payables $ 3,106,000 $ 2,664,000 Accrued liabilities and other 8,819,000 6,197,000 Revenues and royalties payable 1,952,000 2,006,000 ------------- ------------- Total Current Liabilities 13,877,000 10,867,000 Convertible Notes Payable 69,940,000 51,388,000 Bank Credit Facilities 9,937,000 7,937,000 Accrued Preferred Stock Dividends 376,000 3,942,000 Other Long-Term Obligations 4,541,000 5,458,000 Commitments and Contingencies (Note 15) Stockholders' Equity: Series G1 Preferred Stock, $1.00 par value; $100 liquidation value; 240,000 and 700,000 shares authorized, respectively; 158,155 and 446,417 shares outstanding, respectively 158,000 446,000 Series G2 Preferred Stock, $1.00 par value; $100 liquidation value, 400,000 shares authorized; 95,300 shares outstanding at December 31, 2001 -- 95,000 Common stock, $0.01 par value; 225,000,000 shares authorized; 17,699,110 and 18,713,038 shares issued, respectively 177,000 187,000 Additional paid-in capital 371,546,000 385,710,000 Accumulated deficit (324,886,000) (369,087,000) Accumulated other comprehensive income 134,000 296,000 Treasury stock, at cost, 89,750 and 542,900 shares held, respectively (453,000) (1,433,000) ------------- ------------- Total Stockholders' Equity 46,676,000 16,214,000 ------------- ------------- $ 145,347,000 $ 95,806,000 ============= =============
The accompanying Notes to Consolidated Financial Statements are an integral part of these Statements. 45 HARKEN ENERGY CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31, ------------------------------------------------ 1999 2000 2001 ------------- ------------- ------------ Revenues: Oil and gas operations $ 19,745,000 $ 43,177,000 $ 31,642,000 Interest and other income 3,711,000 1,218,000 781,000 ------------- ------------- ------------ 23,456,000 44,395,000 32,423,000 ------------- ------------- ------------ Costs and Expenses: Oil and gas operating expenses 8,935,000 14,379,000 12,204,000 General and administrative expenses, net 11,043,000 13,223,000 10,830,000 Depreciation and amortization 6,848,000 13,649,000 15,254,000 Full cost valuation allowance -- 156,411,000 18,669,000 Provision for asset impairments 1,599,000 -- 14,102,000 Interest expense and other, net 7,296,000 5,297,000 4,663,000 Charge for European Note conversion -- 2,068,000 -- ------------- ------------- ------------ 35,721,000 205,027,000 75,722,000 ------------- ------------- ------------ Loss before income taxes $ (12,265,000) $(160,632,000) $(43,299,000) Income tax expense 30,000 39,000 699,000 ------------- ------------- ------------ Loss before extraordinary items $ (12,295,000) $(160,671,000) $(43,998,000) Extraordinary item-gain on repurchase of European Notes -- 7,745,000 2,975,000 Extraordinary item-charge for reduction of unamortized issuance costs (550,000) (7,000) -- ------------- ------------- ------------ Net loss $ (12,845,000) $(152,933,000) $(41,023,000) ============= ============= ============ Accretion/dividends related to preferred stock (8,427,000) (376,000) (3,178,000) ------------- ------------- ------------ Net loss attributed to common stock $ (21,272,000) $(153,309,000) $(44,201,000) ============= ============= ============ Basic and diluted loss per common share: Loss per common share before extraordinary items $ (1.44) $ (9.55) $ (2.61) Extraordinary item-gain on repurchase of European Notes -- 0.46 0.16 Extraordinary item-charge for reduction of unamortized issuance costs (0.04) (0.00) -- ------------- ------------- ------------ Loss per common share $ (1.48) $ (9.09) $ (2.45) ============= ============= ============ Weighted average shares outstanding 14,413,517 16,863,610 18,063,584 ============= ============= ============
The accompanying Notes to Consolidated Financial Statements are an integral part of these Statements. 46 HARKEN ENERGY CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Additional G1 Preferred G2 Preferred Common Paid-In Stock Stock Stock Capital ------------ ------------ --------- ------------- Balance, December 31, 1998 $ 15,000 $ -- $ 135,000 $ 328,711,000 Issuance of common stock, net -- -- 10,000 20,657,000 Conversions of Development Finance Obligation -- -- 11,000 22,096,000 Accretion of preferred stock -- -- -- 8,427,000 Treasury shares purchased -- -- -- -- Redemption of preferred stock (15,000) -- -- (25,269,000) Settlement of property purchase acquisition -- -- -- (3,985,000) Net loss -- -- -- -- --------- -------- --------- ------------- Balance, December 31, 1999 -- -- 156,000 350,637,000 Issuance of common stock, net -- -- 13,000 7,768,000 Exchange of European Notes -- -- 3,000 7,870,000 Issuance of preferred stock, net 158,000 -- -- 7,609,000 Preferred stock dividends -- -- -- -- Repurchase of Benz Convertible Notes -- -- -- 639,000 Treasury shares purchased -- -- -- -- Cancellations of treasury shares -- -- (2,000) (4,514,000) Conversions of Development Finance Obligation -- -- 7,000 1,537,000 Net loss -- -- -- -- --------- -------- --------- ------------- Balance, December 31, 2000 158,000 -- 177,000 371,546,000 Issuance of common stock, net -- -- 6,000 95,000 Issuance of preferred stock, net 336,000 96,000 -- 14,024,000 Preferred stock dividends -- -- -- -- Purchase of treasury stock -- -- -- -- Conversions of preferred stock (48,000) (1,000) 4,000 45,000 Comprehensive income: Cumulative effect of change in accounting principle -- -- -- -- Net change in derivative fair value -- -- -- -- Reclasification of derivative fair value into earnings -- -- -- -- Net loss -- -- -- -- --------- -------- --------- ------------- Balance, December 31, 2001 $ 446,000 $ 95,000 $ 187,000 $ 385,710,000 ========= ======== ========= ============= Accumulated Other Treasury Accumulated Comprehensive Stock Deficit Income Total ------------- ------------- ------------- ------------- Balance, December 31, 1998 $ (2,552,000) $(150,305,000) $ 134,000 $ 176,138,000 Issuance of common stock, net -- -- -- 20,667,000 Conversions of Development Finance Obligation -- -- -- 22,107,000 Accretion of preferred stock -- (8,427,000) -- -- Treasury shares purchased (1,964,000) -- -- (1,964,000) Redemption of preferred stock -- -- -- (25,284,000) Settlement of property purchase acquisition -- -- -- (3,985,000) Net loss -- (12,845,000) -- (12,845,000) ------------- ------------- ------------- ------------- Balance, December 31, 1999 (4,516,000) (171,577,000) 134,000 174,834,000 Issuance of common stock, net -- -- -- 7,781,000 Exchange of European Notes -- -- -- 7,873,000 Issuance of preferred stock, net -- -- -- 7,767,000 Preferred stock dividends -- (376,000) -- (376,000) Repurchase of Benz Convertible Notes -- -- -- 639,000 Treasury shares purchased (453,000) -- -- (453,000) Cancellations of treasury shares 4,516,000 -- -- -- Conversions of Development Finance Obligation -- -- -- 1,544,000 Net loss -- (152,933,000) -- (152,933,000) ------------- ------------- ------------- ------------- Balance, December 31, 2000 (453,000) (324,886,000) 134,000 46,676,000 Issuance of common stock, net -- -- -- 101,000 Issuance of preferred stock, net -- -- -- 14,456,000 Preferred stock dividends -- (3,178,000) -- (3,178,000) Purchase of treasury stock (980,000) -- -- (980,000) Conversions of preferred stock -- -- -- -- Comprehensive income: Cumulative effect of change in accounting principle -- -- (3,025,000) Net change in derivative fair value -- -- 1,553,000 Reclasification of derivative fair value into earnings -- -- 1,634,000 ------------- Net loss -- (41,023,000) 162,000 (40,861,000) ------------- ------------- ------------- ------------- Balance, December 31, 2001 $ (1,433,000) $(369,087,000) $ 296,000 $ 16,214,000 ============= ============= ============= =============
The accompanying Notes to Consolidated Financial Statements are an integral part of these Statements 47 HARKEN ENERGY CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31, ------------------------------------------------ 1999 2000 2001 ------------- ------------- ------------ Cash flows from operating activities: Net loss $ (12,845,000) $(152,933,000) $(41,023,000) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Depreciation and amortization 6,848,000 13,649,000 15,254,000 Full cost valuation allowance -- 156,411,000 18,669,000 Provision for asset impairments 1,599,000 -- 14,102,000 Charge for European Note conversion -- 2,068,000 -- Provision for doubtful acccunts -- -- -- Amortization of issuance and finance costs 765,000 1,785,000 1,084,000 Extraordinary items 550,000 (7,738,000) (2,975,000) Change in assets and liabilities, net of companies acquired: (Increase) decrease in accounts receivable (1,780,000) (2,307,000) 3,181,000 Increase (decrease) in trade payables and other (1,090,000) 1,774,000 (597,000) ------------- ------------- ------------ Net cash provided by (used in) operating activities (5,953,000) 12,709,000 7,695,000 ------------- ------------- ------------ Cash flows from investing activities: Proceeds from sales of assets 2,358,000 7,045,000 13,390,000 Capital expenditures, net (60,572,000) (28,073,000) (28,677,000) Deconsolidation of subsidiary -- -- (668,000) Cash received from acquired subsidiary 261,000 -- -- Proceeds from collection of notes receivable 98,000 -- -- ------------- ------------- ------------ Net cash used in investing activities (57,855,000) (21,028,000) (15,955,000) ------------- ------------- ------------ Cash flows from financing activities: Proceeds from issuances of common stock, net 47,000 7,710,000 -- Repayments of notes payable and long-term obligations (23,750,000) (12,003,000) (2,140,000) Proceeds from issuance of preferred stock, net -- 7,767,000 -- Proceeds from collection of note receivable -- -- 140,000 Redemption of preferred stock (25,284,000) -- -- Treasury shares purchased (1,964,000) (453,000) (980,000) Payments for financing costs (1,174,000) (551,000) -- ------------- ------------- ------------ Net cash provided by (used in) financing activities (52,125,000) 2,470,000 (2,980,000) ------------- ------------- ------------ Net decrease in cash and temporary investments (115,933,000) (5,849,000) (11,240,000) Cash and temporary investments at beginning of year 141,545,000 25,612,000 19,763,000 ------------- ------------- ------------ Cash and temporary investments at end of year $ 25,612,000 $ 19,763,000 $ 8,523,000 ============= ============= ============
The accompanying Notes to Consolidated Financial Statements are an integral part of these Statements. 48 HARKEN ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation and Presentation -- The Consolidated Financial Statements include the accounts of Harken Energy Corporation (a Delaware corporation) and all of its wholly-owned subsidiaries ("Harken") after elimination of significant intercompany balances and transactions. Data is as of December 31 of each year or for the year then ended and dollar amounts in tables are in thousands unless otherwise indicated. The Consolidated Financial Statements retroactively reflect the effect of the one-for-ten reverse stock split which was effective November 7, 2000. Accordingly, all disclosures involving the number of shares of Harken common stock outstanding, issued or to be issued, such as with a transaction involving Harken common stock, and all per share amounts, retroactively reflect the impact of the reverse stock split. The preparation of financial statements in conformity with accounting principles generally accepted in the United States 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 reported period. Actual results could differ from those estimates. Certain prior year amounts have been reclassified to conform with the 2001 presentation. Statement of Cash Flows -- For purposes of the Consolidated Statements of Cash Flows, Harken considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. Harken paid cash for interest in the amounts of $4,508,000, $5,046,000 and $3,720,000 during 1999, 2000 and 2001, respectively. All significant non-cash investing and financing activities are discussed in Notes 2, 7 and 8 - Mergers, Acquisitions and Dispositions, Convertible Notes Payable and Stockholders' Equity. Concentrations of Credit Risk -- Although Harken's cash and temporary investments, commodity derivative instruments and accounts receivable are exposed to potential credit loss, Harken does not believe such risk to be significant. Cash and temporary investments includes investments in high-grade, short-term securities, placed with highly rated financial institutions. Most of Harken's accounts receivable are from a broad and diverse group of industry partners, many of which are major oil and gas companies and, as a whole, do not in total represent a significant credit risk. Property and Equipment -- Harken follows the full cost accounting method to account for the costs incurred in the acquisition, exploration, development and production of oil and gas reserves. Gas plants and other property are depreciated on the straight-line method over their estimated useful lives ranging from four to twenty years. Production facilities are depreciated on a units of production method. In accordance with the full cost accounting method for oil and gas properties, Harken reflected valuation allowances during each of the two years ended December 31, 2001 related to the amount of net 49 capitalized costs of evaluated oil and gas properties in excess of the present value of Harken's oil and gas reserves. See Note 4 - Oil and Gas Properties for further discussion. Other Assets -- Harken includes in other assets certain deferred commissions and issuance costs associated with the European Convertible Notes Payable and bank credit facility, as well as oilfield material and equipment inventory. At December 31, 2000, other assets included $2,234,000 of deferred issuance costs, net of $2,626,000 of accumulated amortization, and $2,104,000 of oilfield material and equipment inventory. At December 31, 2001, other assets included deferred issuance costs of $771,000, net of $1,612,000 of accumulated amortization, $1,271,000 of oilfield material and equipment inventory and $767,000 of deferred transaction costs primarily related to Harken's international restructuring. Middle American Operations -- Harken's Middle American operations include oil and gas exploration and development efforts in Colombia, Costa Rica, Peru and Panama pursuant to certain Association and Concession Contracts. Such Middle American assets, obligations and operations were transferred to a new subsidiary, Global Energy Development Ltd. ("Global") during 2001 as part of a Restructuring Plan to allow Global to seek financing and capital plans on its own. See further discussion at Note 5 - Middle American Operations. Harken accounts for its Middle America activities using the United States dollar as the functional currency as significant exploration expenditures have typically been denominated in U.S. dollars. See further discussion at Notes 4 and 14 -- Oil and Gas Properties and Oil and Gas Disclosures. Capitalization of Interest -- Harken capitalizes interest on certain oil and gas exploration and development costs which are classified as unevaluated costs, or which have not yet begun production, and has capitalized interest on certain costs associated with facilities under construction. During 1999, Harken recorded interest expense of $7,169,000, net of $4,133,000 of interest which was capitalized to Harken's oil and gas properties. During 2000, Harken recorded interest expense of $5,353,000, net of $2,536,000 of interest which was capitalized to Harken's oil and gas properties. During 2001, Harken recorded interest expense of $4,435,000, net of $963,000 of interest which was capitalized to Harken's oil and gas properties. General and Administrative Expenses -- Harken reflects general and administrative expenses net of operator overhead charges and other amounts billed to joint interest owners. General and administrative expenses are net of $108,000, $362,000 and $372,000 for such amounts during 1999, 2000 and 2001, respectively. Provision for Asset Impairments -- Assets that are used in Harken's operations, or are not held for resale, are carried at cost, less any accumulated depreciation. Harken reviews its long-lived assets, other than its investment in oil and gas properties, whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. When evidence indicates that operations will not produce sufficient cash flows to cover the carrying amount of the related asset, and when the carrying amount of the related asset cannot be realized through sale, a permanent impairment is recorded and the asset value is written down to fair value. During the fourth quarter of 1999, Harken identified certain oilfield equipment assets in Colombia that would not be utilized during 2000 due to changes in Harken's Colombian drilling plans. In addition, Harken made the decision to sell such oilfield equipment during 2000. Accordingly, Harken reflected a provision for asset impairment of $1,599,000 during 1999 to reduce the carrying value of such oilfield equipment assets to its fair value of approximately $4,167,000. 50 In March 2002, the Costa Rica environmental agency SETENA denied its approval of the requested environmental permit related to Harken's Costa Rica Contract. HCRH has filed an appeal related to this ruling by SETENA. In January 2002, the Costa Rica Constitutional Court rendered a published opinion in a suit that had been filed against another oil and gas operator and the Costa Rican ministry of Environment and Energy ("MINAE") by certain environmental groups. In its opinion, in this case, the Constitutional Court of Costa Rica found, among other issues, that SETENA did not have the current authority to grant environmental permits. In addition, proposed legislation pending in the Costa Rica legislature seeks to abolish the Costa Rica government's rights to grant hydrocarbon exploration contracts. Due to the Costa Rica Constitutional Court decision, discussed above, even though it did not directly involve HCRH or the Moin #2 well, as well as the pending legislation described above, Harken and Global believe that HCRH's appeal to SETENA for reconsideration of its denial of the requested permit, or any similar recourse, will be unsuccessful. Further, recent political developments in Costa Rica, in the opinion of Harken and Global, severely limit the opportunity for future oil and gas exploration in Costa Rica. These significant adverse developments have resulted in Harken and Global fully impairing its investment in the Costa Rica project in its Consolidated Balance Sheet as of December 31, 2001. During the fourth quarter of 2001, Harken also reflected an impairment of approximately $3.2 million related to certain transportation facility costs related to Global's Bolivar Contract area in Colombia, as the carrying value of such facilities was in excess of estimates of future cash flows. Such estimated future cash flows were based on current production levels, future production expectations based on December 31, 2001 reserve estimates, projected locations of future wells to be drilled and the lack of a ready market to purchase such facilities. Harken continues to utilize transportation facilities related to its Alcaravan Contract area. Harken also reflected an impairment of approximately $1.6 million related to certain deferred transaction costs incurred by Global, primarily for certain merger transaction efforts related to the restructuring of Harken's international assets. Such merger transaction efforts were terminated during the fourth quarter of 2001 and the corresponding transaction costs were charged to earnings. In addition, Harken reflected an impairment of $620,000 on certain Colombia oilfield equipment held by Global, as based on reduced drilling plans by Global, and the current low industry demand for such equipment in light of heightened Colombia security concerns, the carrying value of such inventory was in excess of estimated future cash flows from sale or use of such equipment. A summary of Harken's Provision for Asset Impairments for the years ended December 31, 1999, 2000 and 2001 are as follows: Year Ended December 31, -------------------------------- 1999 2000 2001 ------ ------- ------- Colombia Oilfield Equipment $1,599 $ -- $ 620 Costa Rica Investment -- -- 8,761 Colombia Transportation Facilities -- -- 3,161 Transaction Costs -- -- 1,560 ------ ------- ------- $1,599 $ -- $14,102 ====== ======= ======= Revenue Recognition - Harken reflects its oil and gas operations revenues using the sales method. There are no significant gas balancing arrangements or obligations related to Harken's operations. Commodity Derivative Financial Instruments -- Harken has entered into certain commodity derivative instruments which are effective in mitigating commodity price risk associated with a portion of its crude oil and 51 natural gas production and cash flows. Accordingly, Harken applies hedge accounting for those commodity derivative instruments whereby monthly cash settlements of oil and gas price derivatives or the amortization of oil and gas option premiums paid are reported as a component of revenue and cash flows from operations. Settlements of oil and gas price derivatives are based on the difference between the fixed derivative price and the New York Mercantile Exchange closing prices for each month during the life of the contracts. Gains or losses attributable to the termination of a swap or option contract are deferred and recognized in revenue when the hedged crude oil or natural gas is sold. Effective January 1, 2001, Harken adopted Statement of Financial Accounting Standard No. 133, " Accounting for Derivative Instruments and Hedging Activities." For further discussion, see Note 12 -- Hedging Activities. Recently Issued Accounting Pronouncements -- In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement No. 141, "Business Combinations" and Statement No. 142 "Goodwill and Other Intangible Assets," which change the accounting for business combinations and for goodwill and intangible assets by eliminating the use of the pooling of interests method for all business combinations completed after June 30, 2001, and by eliminating amortization of goodwill. Statement No. 142 also establishes new criteria, effective for fiscal years beginning after December 15, 2001, to determine whether an acquired intangible asset should be recognized separately from goodwill. Harken will adopt the new rules on accounting for goodwill and other intangible assets in the first quarter of 2002. It is not anticipated that FASB Statement No. 141 or 142 will have a significant impact on Harken's results of operations or financial position. In June 2001, the FASB issued Statement No. 143 " Accounting for Asset Retirement Obligations" which will become effective for fiscal years beginning after June 15, 2002. The new standard requires companies to record a liability for the fair value of asset retirement obligations in the period in which the obligation arises. It is not anticipated that FASB Statement No. 143 will have a significant impact on Harken's results of operations or financial position. In August 2001, the FASB issued Statement No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets" which will become effective for fiscal years beginning after December 15, 2001. The new standard modifies and extends existing requirements for accounting for asset disposals to include disposals of a segment of a business accounted for as a discontinued operation. It is not anticipated that FASB Statement No. 144 will have a significant impact on Harken's results of operations or financial position. (2) MERGERS, ACQUISITIONS AND DISPOSITIONS Merger with XPLOR -- On August 19, 1999, Harken executed a merger agreement with XPLOR Energy, Inc. ("XPLOR") whereby XPLOR became a wholly-owned subsidiary of Harken. XPLOR explores for, develops and produces oil and gas reserves domestically. The assets of XPLOR consisted primarily of oil and gas property interests located along the Texas and Louisiana Gulf Coasts along with a significant amount of additional exploratory acreage. Under the terms of the merger agreement, the holders of the outstanding shares of the preferred stock of XPLOR converted their stock into 750,000 shares of Harken common stock, and also received 233,607 warrants for the purchase of Harken common stock at $25.00 per share. Additionally, Harken assumed $14,200,000 of bank debt secured by the oil and gas properties of XPLOR. No further consideration was issuable under this transaction to any other class of stock of XPLOR and all outstanding shares of XPLOR stock were cancelled under the merger agreement. The merger with XPLOR was accounted for under the purchase method of accounting. 52 Acquisition of Benz Prospects -- On December 30, 1999, pursuant to a Purchase and Sale Agreement and other related agreements, Harken, along with Harken Gulf Exploration Company, a wholly-owned subsidiary, purchased oil and gas leases covering nine exploration prospect areas (the "Benz Prospects") covering approximately 51,000 net acres plus certain other assets from Benz Energy, Incorporated ("Benz"). The prospects included interests in acreage in the Cotton Valley Reef, Wilcox and Frio Trends in Texas and the Salt Dome and Salt Ridge Basins of Mississippi. In exchange for the prospects, Harken issued 5% subordinated notes (the "Benz Convertible Notes") with a face value of $12 million, which are convertible into Harken common stock at a conversion price of $65.00 per share and originally were to mature on May 26, 2003. See Note 7 - Convertible Notes Payable for further discussion of the Benz Convertible Notes. Benz retained a 20% reversionary interest, subject to the Benz Prospects achieving payout as defined in the Purchase and Sale Agreement. Also, pursuant to the agreements, a former officer of Benz may annually earn additional purchase price consideration based on 20% of the project reserve value, as defined, as of December 31, 2000, 2001 and 2002 less total project costs, as defined, related to the Benz Prospects. Pursuant to the agreement, in April 2001 Harken issued 263,301 shares of Harken common stock relating to this additional purchase price consideration based on the reserve value of the Benz Prospects as of December 31, 2000. No such consideration will be required based on the reserve value of the Benz Prospects as of December 31, 2001. In addition, in connection with the acquisition of the Benz Prospects, Harken entered into a consulting agreement with a former officer of Benz whereby Harken paid a monthly consulting fee of $100,000 through December 31, 2000 in exchange for consulting services related to the Benz Prospects. See Note 11 -- Related Party Transactions for a discussion of the relationship that existed between Harken and Benz. Sale of Harken Southwest Corporation -- On December 21, 2000, a wholly-owned subsidiary of Harken sold its interest in Harken Southwest Corporation ("HSW") to Rim Southwest Holding Corporation (the "Buyer") for approximately $3,000,000 cash, subject to certain adjustments. HSW owned and operated interests in a total of 23 oil wells and six gas wells in the Paradox Basin in the Four Corners area of Arizona, Utah and New Mexico and owned a non-operated interest in the Aneth Gas Plant, a gas processing plant located in the Paradox Basin. HSW's operations were primarily concentrated on the 16 million acre Navajo Indian Reservation through two operating agreements with the Navajo Tribe of Indians. Sales of Certain Producing Property Interests -- During the fourth quarter of 2000, Harken, through certain wholly-owned subsidiaries, sold its interest in 30 selected oil and gas properties located in New Mexico, Texas and Louisiana for a total of approximately $2,362,000. During 2001, certain wholly-owned subsidiaries of Harken sold certain interests in oil and gas producing properties located in Texas, Arkansas, New Mexico and Louisiana for approximately $13,090,000 cash. Subsequent to December 31, 2001, in February 2002, Harken sold an additional interest in an oil and gas producing property located in Texas for approximately $910,000. Acquisition of Republic Properties -- On January 30, 2002, a wholly-owned subsidiary of Harken signed an agreement to acquire certain property interests (the "Republic Properties") from Republic Resources, Inc., ("Republic") subject to approval by Republic's shareholders and debenture holders. The Republic Properties consist of 15 producing property interests located in southern Louisiana and the Texas Gulf Coast region. The Republic Properties to be acquired by Harken are in exchange for Harken common stock having a value of $2,645,500 based on the average reported closing price for Harken common stock for the 20 trading days prior to the Closing Date, subject to a maximum of 2,645,500 shares to be issued. In addition, the Purchase and Sale Agreement also provides for contingent additional consideration of cash or additional shares 53 of Harken common stock to be paid within 45 days after December 31, 2003, based on a defined calculation to measure the appreciation of the reserve value of the Republic Properties. Pro Forma Information --The following unaudited pro forma combined condensed statement of operations for the year ended December 31, 1999 gives effect to the merger with XPLOR and the issuance of the Benz Convertible Notes as if each had been consummated at January 1, 1999. The following unaudited pro forma combined condensed statement of operations for the year ended December 31, 2000 gives effect to the acquisition of the Republic Properties, the sale of Harken Southwest Corporation and the sale of certain producing property interests consummated during 2000, 2001 and 2002 as if each had been consummated at January 1, 2000. The following unaudited pro forma combined condensed statement of operations for the year ended December 31, 2001 gives effect to the acquisition of the Republic Properties and the sale of certain producing property interests consummated during 2001 and 2002 as if each had been consummated at January 1, 2001. The unaudited pro forma data is presented for illustrative purposes only and is not necessarily indicative of the operating results that would have occurred had the transactions been consummated at the dates indicated, nor are they indicative of future operating results. The unaudited pro forma data does not reflect the effect of the capitalization of certain amounts of interest on the Benz Convertible Notes or the interest income earned from proceeds from asset sales. 54 Pro Forma Combined Condensed Statement of Operations For the Year Ended December 31, 1999 (unaudited)
Period from January 1, 1999 to Closing Date of Merger ---------------- Harken XPLOR Pro Forma Actual Actual Adjustments Pro Forma ------------ ---------------- ----------- ------------ Oil and gas revenue $ 19,745 $ 5,261 $ -- $ 25,006 Other revenues 3,711 79 -- 3,790 ------------ ------- ---------- ------------ Total Revenues 23,456 5,340 -- 28,796 ------------ ------- ---------- ------------ Oil and gas operating expenses 8,935 2,535 -- 11,470 General and administrative expenses, net 11,043 1,543 -- 12,586 Depreciation and amortization 6,848 2,735(1) (596) 8,987 Provision for asset impairments 1,599 -- -- 1,599 Interest expense and other, net 7,296 708(2) 600 8,604 ------------ ------- ---------- ------------ Total Expenses 35,721 7,521 4 43,246 ------------ ------- ---------- ------------ Income tax expense 30 -- -- 30 ------------ ------- ---------- ------------ Loss before extraordinary item $ (12,295) $(2,181) $ (4) $ (14,480) Extraordinary item (550) -- -- (550) ------------ ------- ---------- ------------ Net loss $ (12,845) $(2,181) $ (4) $ (15,030) ------------ ------- ---------- ------------ Accretion related to preferred stock (8,427) -- -- (8,427) ------------ ------- ---------- ------------ Net loss atributed to common stock $ (21,272) $(2,181) $ (4) $ (23,457) ============ ======= ========== ============ Basic and diluted loss per common share $ (1.48) $ (1.58) ============ ============ Weighted average common shares outstanding 14,413,517 14,886,119 ============ ============
Pro Forma Adjustments - Pro Forma Combined Condensed Statement of Operations - Year Ended December 31, 1999 (1) Pro forma entry to adjust actual depreciation and amortization expense on oil and gas properties for the acquired interests to the depreciation and amortization expense calculated on a consolidated basis. (2) Pro forma entry to reflect interest expense incurred on the Benz Convertible Notes. 55 Pro Forma Combined Condensed Statement of Operations For the Year Ended December 31, 2000 (unaudited)
Harken Pro Forma Actual Adjustments Pro Forma ------------ ------------ ------------ Oil and gas revenue $ 43,177 $ (4,512)(1) $ 33,236 (8,829)(2) 3,400 (3) Other revenues 1,218 1,218 ------------ --------- ------------ Total Revenues 44,395 (9,941) 34,454 ------------ --------- ------------ Oil and gas operating expenses 14,379 (1,787)(1) 10,915 (2,288)(2) 611 (3) General and administrative expenses, net 13,223 (235)(1) 12,988 Depreciation and amortization 13,649 (820)(1) 11,344 (2,241)(2) 756 (3) Valuation allowance 156,411 156,411 Interest expense and other, net 5,297 5,297 Charge for European Notes conversion 2,068 2,068 ------------ --------- ------------ Total Expenses 205,027 (6,004) 199,023 ------------ --------- ------------ Income tax expense 39 39 ------------ --------- ------------ Loss before extraordinary item $ (160,671) $ (3,937) $ (164,608) Extraordinary item, net 7,738 7,738 ------------ --------- ------------ Net loss $ (152,933) $ (3,937) $ (156,870) ------------ --------- ------------ Preferred stock dividends (376) (376) ------------ --------- ------------ Net loss atributed to common stock $ (153,309) $ (3,937) $ (157,246) ============ ========= ============ Basic and diluted loss per common share $ (9.09) $ (8.06) ------------ --------- ------------ Weighted average common shares outstanding 16,863,610 19,509,110 ============ ========= ============
Pro Forma Adjustments - Pro Forma Combined Condensed Statement of Operations - Year Ended December 31, 2000 (1) Pro forma entry to adjust oil and gas revenues, operating expenses, general and administrative expenses and depreciation and amortization to reflect the sale of Harken Southwest Corporation. (2) Pro forma entry to adjust oil and gas revenues, operating expenses and depreciation and amortization to reflect the sale of certain producing property interests. (3) Pro forma entry to adjust oil and gas revenues, operating expenses and depreciation and amortization to reflect the purchase of the Republic Properties. 56 Pro Forma Combined Condensed Statement of Operations For the Year Ended December 31, 2001 (unaudited)
Harken Pro Forma Actual Adjustments Pro Forma ------------ ------------ --------- Oil and gas revenue $ 31,642 $ (3,678)(1) $ 30,315 2,351 (2) Other revenues 781 781 ------------ ------------ ---------- Total Revenues 32,423 (1,327) 31,096 ------------ ------------ ---------- Oil and gas operating expenses 12,204 (927)(1) 11,700 423 (2) General and administrative expenses, net 10,830 10,830 Depreciation and amortization 15,254 (1,159)(1) 14,897 802 (2) Full cost valuation allowance 18,669 18,669 Provision for asset impairments 14,102 14,102 Interest expense and other, net 4,663 4,663 ------------ ------------ ---------- Total Expenses 75,722 (861) 74,861 ------------ ------------ ---------- Income tax expense 699 699 ------------ ------------ ---------- Loss before extraordinary item $ (43,998) $ (466) $ (44,464) Extraordinary item 2,975 2,975 ------------ ------------ ---------- Net loss $ (41,023) $ (466) $ (41,489) Preferred stock dividends (3,178) (3,178) ------------ ------------ ---------- Net loss atributed to common stock $ (44,201) $ (466) $ (44,667) ============ ============ ========== Basic and diluted loss per common share $ (2.45) $ (2.16) ------------ ---------- Weighted average common shares outstanding 18,063,584 20,709,084 ============ ==========
Pro Forma Adjustments - Pro Forma Combined Condensed Statement of Operations - Year Ended December 31, 2001 (1) Pro forma entry to adjust oil and gas revenues, operating expenses and depreciation and amortization to reflect sale of certain producing properties. (2) Pro forma entry to adjust oil and gas revenues, operating expenses and depreciation and amortization to reflect the purchase of the Republic Properties. 57 (3) INVESTMENTS Included within cash and temporary investments at December 31, 2000 and 2001 are certain investments in marketable debt securities and money market accounts having maturities of sixty days or less. The cost of such investments totaled $13,944,000 and $4,637,000 as of December 31, 2000 and 2001, respectively, with cost approximating fair value. Harken management determines the appropriate classification of debt securities at the time of purchase and reevaluates such designation as of each balance sheet date. Such debt securities are classified as held-to-maturity as Harken has the positive intent and ability to hold the securities to maturity. Held-to-maturity securities are stated at amortized cost, adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in interest and other income. During 2000 and 2001, Harken held no securities which were classified as available-for-sale or trading. In addition, at December 31, 2000 and 2001, Harken held an investment in 66,903 shares of Benz Series II preferred stock and Benz Notes with a face value of $3,967,000, but has reflected no carrying value for these securities. (4) OIL AND GAS PROPERTIES Harken follows the full cost accounting method to account for the costs incurred in the acquisition, exploration, development and production of oil and gas reserves. Under this method, all costs, including internal costs, directly related to acquisition, exploration and development activities are capitalizable as oil and gas property costs. Harken capitalized $5,411,000, $3,196,000 and $1,850,000 of internal costs directly related to these activities in 1999, 2000 and 2001, respectively. Such costs include certain office and personnel costs of Harken's international and domestic exploration field offices and do not include any corporate overhead. Harken also accrues costs of dismantlement, restoration and abandonment to the extent that such costs, in the aggregate, are anticipated to exceed the aggregate salvage value of equipment and facilities removed from producing wells and other facilities. See Note 14 -- Oil and Gas Disclosures for further discussion. The capitalized costs of oil and gas properties, excluding unevaluated properties, are amortized on a country-by-country basis using a unit of production method (equivalent physical units of 6 Mcf of gas to each barrel of oil) based on estimated proved recoverable oil and gas reserves. Such amortization of U.S. domestic oil and gas properties was $5.41, $6.43 and $9.10 per equivalent barrel of oil produced during 1999, 2000 and 2001, respectively. Amortization of certain Colombia oil and gas properties was $3.52, $9.45 and $8.66 per equivalent barrel of oil produced during 1999, 2000 and 2001, respectively. The evaluated costs, net of accumulated depreciation and amortization, at December 31, 2000 and 2001 include $11,695,000 and $12,623,000, respectively, related to Colombia (see Note 5 - Middle American Operations for a discussion of Colombian operations). Amortization of unevaluated property costs begins when the properties become proved or their values become impaired. Harken assesses realizability of unevaluated properties on at least an annual basis or when there has been an indication that an impairment in value may have occurred, such as for a relinquishment of Colombian Association Contract acreage. Impairment of unevaluated prospects is assessed based on management's intention with regard to future exploration and development of individually significant properties and the ability of Harken to obtain funds to finance such exploration and development. 58 Under full cost accounting rules for each cost center, capitalized costs of evaluated oil and gas properties, less accumulated amortization and related deferred income taxes, shall not exceed an amount (the "cost ceiling") equal to the sum of (a) the present value of future net cash flows from estimated production of proved oil and gas reserves, based on current economic and operating conditions, discounted at 10%, plus (b) the cost of properties not being amortized, plus (c) the lower of cost or estimated fair value of any unproved properties included in the costs being amortized, less (d) any income tax effects related to differences between the book and tax basis of the properties involved. If capitalized costs exceed this limit, the excess is charged to earnings. During the fourth quarter of 2001, Harken recorded non-cash valuation allowances of $14,353,000 related to its domestic oil and gas properties and $4,316,000 related to its Colombian oil properties. The valuation allowances were based upon the present value, discounted at ten percent, of Harken's proved oil and gas reserves, which declined due to reduced oil and gas prices at December 31, 2001. Prices at December 31, 2001 were based on NYMEX prices of $19.84/barrel and $2.57/mmbtu. Subsequent increases in oil and gas prices as of March 27, 2002 were not considered in the calculation of the full cost valuation allowance. During the fourth quarter of 2000, Harken recorded a non-cash valuation allowance on its Colombian oil properties of $156,411,000. The valuation allowance is based upon the present value, discounted at ten percent, of Harken's Colombian reserves, which declined primarily due to a reduction in Harken's proved undeveloped reserves on its Bolivar Association Contract following the unsuccessful Olivo #2 well in Colombia, which was drilled in late December 2000 and the early part of the first quarter 2001. Given the volatility of oil and gas prices, it is reasonably possible that the estimate of discounted future net cash flows from proved oil and gas reserves could change in the near term. If oil and gas prices decline further in the future, even if only for a short period of time, it is possible that additional impairments of oil and gas properties could occur. In addition, it is reasonably possible that additional impairments could occur if costs are incurred in excess of any increases in the present value of future net cash flows from proved oil and gas reserves, or if properties are sold for proceeds less than the discounted present value of the related proved oil and gas reserves. Capital Resources - Harken management believes that cash on hand, together with anticipated cash flows from operations, will be adequate to satisfy its capital expenditure plans for 2002. Harken will continue to seek to acquire additional producing properties, particularly for its domestic operations, in order to increase its cash flows from operations. A majority of Harken's planned domestic capital expenditures are discretionary and, as a result, will be curtailed if sufficient funds are not available. Such expenditure curtailments, however, could result in Harken losing certain prospect acreage or reducing its interest in future exploration and development projects. 59 (5) MIDDLE AMERICAN OPERATIONS Colombian Operations -- Harken's Colombian operations are conducted through Harken de Colombia, Ltd., a wholly-owned subsidiary of Global, which held four exclusive Colombian Association Contracts with Empresa Colombiana de Petroleos ("Ecopetrol") as of December 31, 2001. These Association Contracts include the Alcaravan Contract, awarded in 1992, the Bocachico Contract, awarded in 1994, the Bolivar Contract, awarded in 1996, and the Cajaro Contract, awarded in December 2001and effective February 2002. As of December 31, 2001, the Alcaravan Contract covers an area of approximately 24,000 acres in the Llanos Basin of Eastern Colombia. The Bocachico Contract covers approximately 54,700 acres in the Middle Magdalena Valley of Central Colombia and the Bolivar Contract covers an area of approximately 250,000 acres in the Northern Middle Magdalena Valley of Central Colombia. The Cajaro Contract covers approximately 83,000 acres in the Llanos Basin of Eastern Colombia, adjacent to the Alcaravan Contract area. Terms of each of the Association Contracts commit Global to perform certain activities in accordance with a prescribed timetable. As of December 31, 2001, Global was in compliance with the requirements of each of the Association Contracts, as amended and/or waived. As of March 27, 2002, Global is in negotiations with Ecopetrol whereby Global would relinquish 50% of the Bolivar contract area acreage in exchange for a release from the sixth year Bolivar Contract work obligations. The release of such acreage would not affect Harken's proved reserves on the Bolivar Contract area. Under the terms of the Association Contracts, if, during the first six years of each contract, Global discovers one or more fields capable of producing oil or gas in quantities that are economically exploitable and Ecopetrol elects to participate in the development of the field, or Global chooses to proceed with the development on a sole-risk basis, the term of that contract will be extended for a period of 22 years from the date of such election by Ecopetrol, subject to the entire term of the Association Contract being limited to no more than 28 years. Upon an election by Ecopetrol to participate in the development of a field and upon commencement of production from that field, Ecopetrol would begin to reimburse Global for 50% of Global's successful well costs expended up to the point of Ecopetrol's participation plus, in the case of the Bolivar and Cajaro Contracts, 50% of all seismic and dry well costs incurred prior to the point of Ecopetrol's participation. Ecopetrol, on behalf of the Colombian government, receives a 20% royalty interest (5% to 25% royalty interest on the Cajaro Contract depending on production levels) from all production. For fields in which Ecopetrol participates, all production (after royalty payments) will be allocated 50% to Ecopetrol and 50% to Global until cumulative production from all fields (or the particular productive field under certain of the Association Contracts) in the Association Contract acreage reaches 60 million barrels of oil. For certain Association Contracts, as cumulative production increases in excess of 60 million barrels of oil, Ecopetrol's share of production will increase progressively (to a maximum of 75% under certain of the Association Contracts) with a corresponding decrease in Global's share of production. After a declaration of Ecopetrol's participation, Global and Ecopetrol will be responsible for all future development costs and operating expenses in direct proportion to their interest in production. For any fields in which Ecopetrol declines to participate, Global is entitled to receive Ecopetrol's 50% share of production, after deduction of Ecopetrol's royalty interest, until Global has recovered 200% of its costs, after which time Ecopetrol could elect to begin to receive its share of production. Harken, through Global, has proved reserves attributable to two of its contracts, the Alcaravan and Bolivar Contracts. In the Alcaravan Contract, Global has proved reserves in the Palo Blanco field, and in the Bolivar Contract, Global has proved reserves in the Buturama field. Global submitted an application to Ecopetrol for their participation in both of these fields. In February and October 2001, respectively, Global was 60 notified by Ecopetrol that Global could proceed with the development and production of the Buturama and Palo Blanco fields on a sole risk basis. During the last part of 1999, pursuant to specific negotiations with Ecopetrol, Global began receiving Ecopetrol's working interest share of monthly Bolivar Contract area production as nonrefundable reimbursement for a portion of Ecopetrol's share of certain historical Bolivar Contract area costs. Global similarly began receiving Ecopetrol's working interest share of monthly Alcaravan area production in May 2000. Global reflected such nonrefundable reimbursement production as revenues during the time prior to Ecopetrol's notification that Global could proceed with the development and production of these fields on a sole-risk basis. Costa Rica Operations -- In August 1999, the Exploration and Production concession contract with the Republic of Costa Rica ("Costa Rica Contract") was signed by MKJ Xploration, Inc. ("MKJ"), which was originally awarded the concession under Costa Rica's bidding process that was finalized in October 1997. In the fourth quarter of 1998, Harken entered into an agreement with MKJ to participate in this anticipated Costa Rica Contract. The Costa Rica Contract covers approximately 1.4 million acres in the North and South Limon Back Arc Basin onshore and offshore Costa Rica in Central America. The formal Costa Rica Contract was signed by the President of Costa Rica and became effective October 1999. The Costa Rica Contract area is comprised of Blocks 2, 3, 4 and 12 from Costa Rica's initial bidding round in October of 1997. Two of the Blocks are located onshore and two are located offshore within Costa Rica's Caribbean territorial waters. Under the terms of the Costa Rica Contract, if during the first six years of the contract (the "Exploration Period") Harken Costa Rica Holdings LLC ("HCRH", a Nevada limited liability company) discovers one or more fields capable of producing oil or gas in quantities that are economically exploitable, the term of the contract will be extended for a period of 20 years. Production will be allocated whereby the Costa Rican government will receive up to a 15% royalty interest (sliding scale based on production), and the remaining interest will be paid to HCRH. Harken's participation in Costa Rica is structured whereby a wholly-owned Global subsidiary owns a share of the stock of HCRH, with an affiliate of MKJ owning the remaining stock of HCRH. Through June 30, 2001, Global owned 80% of the stock of HCRH. Under the terms of the agreement between Harken and MKJ, Harken paid approximately $3.7 million of the $4.2 million to be paid to MKJ to purchase its share of the Costa Rica Contract rights from MKJ after an agreement and approval of the assignment was signed and ratified with the Republic of Costa Rica. The remaining $500,000 of this purchase price is to be paid upon the mobilization of the rig related to the initial well to be drilled on the Costa Rica Contract acreage. In June 2000, the assignment of the Costa Rica Contract rights to HCRH was approved by the Costa Rican government. Additionally, $4 million was funded by Harken related to the Contract. In July 2001, Harken elected not to pay the $4 million of additional funds to be transferred to HCRH, which, in accordance with the contract between Harken and MKJ, resulted in Harken's ownership in HCRH being reduced from 80% to the current 40% (with MKJ's ownership being increased to 60%) and MKJ consequently assumed operations of HCRH and the Costa Rica Contract. As a result of Harken's reduced ownership in HCRH, beginning in July 2001, Harken reflected its investment in HCRH following the equity method of accounting whereby Harken's historical cost of its investment was presented as Investment in Equity Investee in its Consolidated Balance Sheets. This presentation represents a change in the accounting for Harken's investment in HCRH, which was previously consolidated. Due to the insignificant impact of this change in accounting, no pro forma disclosure is required. 61 In March 2002, the Costa Rica environmental agency SETENA denied its approval of the requested environmental permit related to Harken's Costa Rica Contract. HCRH has filed an appeal related to this ruling by SETENA. In January 2002, the Costa Rica Constitutional Court rendered a published opinion in a suit that had been filed against another oil and gas operator and MINAE by certain environmental groups. In its opinion, in this case, the Constitutional Court of Costa Rica found, among other issues, that SETENA did not have the current authority to grant environmental permits. In addition, proposed legislation pending in the Costa Rica legislature seeks to abolish the Costa Rica government's rights to grant hydrocarbon exploration contracts. Due to the Costa Rica Constitutional Court decision discussed above, even though it did not directly involve HCRH or the Moin #2 well, as well as the pending legislation described above, Harken and Global believe that HCRH's appeal to SETENA for reconsideration of its denial of the requested permit, or any similar recourse, will be unsuccessful. Further, recent political developments in Costa Rica, in the opinion of Harken and Global, severely limit the opportunity for future oil and gas exploration in Costa Rica. These significant adverse developments have resulted in Harken and Global fully impairing its investment in the Costa Rica project in its Consolidated Balance Sheet as of December 31, 2001. Peru Operations -- In April 2001, Harken, through a wholly-owned subsidiary of Global, signed a Technical Evaluation Agreement ("Peru TEA") with PeruPetro, the national oil company of Peru. The Peru TEA covers an area of approximately 6.8 million gross acres in northeastern Peru. Under the terms of the Peru TEA, Global has the option to convert the Peru TEA to a seven year exploration contract, with a twenty-two year production period. Terms of the Peru TEA allow Global to conduct a study of the area that will include the reprocessing of seismic data and evaluation of previous well data. Panama Operations -- In September 2001, Harken, through a wholly-owned subsidiary of Global, signed a Technical Evaluation Agreement ("Panama TEA") with the Ministry of Commerce and Industry for the Republic of Panama. The Panama TEA covers an area of approximately 2.7 million gross acres divided into three blocks in and offshore Panama. Under the terms of this Panama TEA, which extends for a period of 24 months, Global is to perform certain work program procedures and studies to be submitted to the Panamanian government with an option to negotiate and enter into one or more Contracts for the Exploration and Exploitation of Hydrocarbons with the Ministry of Commerce and Industry. Placement of Global Shares -- During 2001, Harken's Board of Directors approved a plan to restructure Harken's operations for the purpose of focusing Harken's resources more directly on its U.S. acquisition, exploration and development operations particularly in the Gulf Coast region of Texas and Louisiana. Pursuant to this restructuring plan, the Board determined it to be in the shareholders' interest to implement such a plan to move Harken's interests in Middle American operations, assets and obligations under a separate subsidiary which would have the ability and capability to seek financing and other capital plans on its own. During 2001, Harken transferred all of its international operations, assets and obligations into a new subsidiary, Global Energy Development Ltd. ("Global"), a Delaware corporation. In the past, Harken's international efforts focused principally on Colombian exploration projects. Global's new business strategy is to identify, develop and promote energy projects from throughout Latin America to industry and financial partners and to aggregate assets in Latin America through strategic acquisitions and alliances. In March 2002, Global transferred all of its interests in its international assets and operations to, and obligations relating to such assets and operations were assumed by, a new subsidiary, Global Energy Development PLC ("Global PLC", a United Kingdom company) in exchange for 92.6% of Global PLC's common stock. Upon the completion of this exchange transaction, Global PLC then completed the listing of its common stock for trading on the AIM Exchange in London, and placed 7.4% of such stock in a placement 62 to investors, including certain affiliates of Harken and Global. Global PLC is seeking additional financing and acquisition activities using its shares of its newly listed common stock. At March 27, 2002, Harken, through Global, owned 92.6% of Global PLC common stock. (6) BANK CREDIT FACILITY OBLIGATIONS A summary of long-term bank obligations follows: December 31, December 31, 2000 2001 ------------ ------------ Subsidiary notes payable to bank (A) $9,937,000 $7,937,000 Subsidiary project finance facility (B) -- -- ---------- ---------- 9,937,000 7,937,000 Less: Current portion -- -- ---------- ---------- $9,937,000 $7,937,000 ========== ========== (A) XPLOR, a wholly-owned subsidiary of Harken, had a three-year loan facility with Christiania og Kreditkasse ("Christiania") which was solely secured by the oil and gas properties and subsidiaries of XPLOR. The Christiania facility provided for interest based on the short-term London Interbank Offered Rate ("LIBOR") plus a margin of 1.125% to 1.875%, payable at the underlying LIBOR maturities or lender's prime rate plus 0.25%, and provided for a commitment fee of 0.375% on the unused amount. On August 11, 2000, certain Harken subsidiaries, including XPLOR (the "Borrowers"), entered into a new three year loan facility with Bank One Texas, N.A. ("Bank One") which is secured by certain of Harken's domestic oil and gas properties and a guarantee from Harken. The Bank One facility provides borrowings limited by a borrowing base (as defined by the Bank One facility) which was $12,400,000 as of December 31, 2001. Such borrowing base, which is net of outstanding letters of credit, is re-determined by Bank One on May 1 and November 1 of each year in accordance with the facility agreement. The Bank One facility provides for interest based on LIBOR plus a margin of 2.350% (4.36625% as of December 31, 2001), payable at the underlying LIBOR maturities or lender's prime rate, and provides for a commitment fee of 0.375 % on the unused amount. At December 31, 2001 Harken has $7,937,000 outstanding pursuant to the facility. 63 The Bank One facility requires the Borrowers, as well as Harken, to maintain certain financial covenant ratios and requirements as calculated on a quarterly basis. Such financial covenant ratios and requirements for the Borrowers include a current ratio, as defined, of not less than 1.0 to 1.0, a total liabilities to net capital investment ratio, as defined, of not more than 1.15 to 1.0 and a debt service coverage ratio, as defined, of not less than 1.5 to 1.0. Required financial covenants for Harken include a ratio of total liabilities to net worth, as defined, of not more than 0.6 to 1.0, and a debt service coverage ratio, as defined, of not less than 1.25 to 1.0. For the quarter ended December 31, 2001, Harken and the Borrowers were each not in compliance with its respective debt service coverage ratio requirement. In March 2002, Harken and the Borowers received a letter from Bank One waiving the Borrowers debt service coverage ratio requirement for the fourth quarter of 2001 and the first quarter of 2002 and reducing the requirement to 1.15 to 1.0 beginning in the second quarter of 2002. Bank One also waived Harken's debt service coverage ratio requirement for the fourth quarter of 2001, deleted the requirement beginning in the first quarter of 2002 and added a current ratio requirement, as defined, for Harken of 1.15 to 1.0, beginning in the first quarter of 2002. In exchange, Harken entered into certain commodity derivative instruments hedging an additional portion of the Borrower's future natural gas production, and the current borrowing base was reduced to $7,937,000, the amount of the current balance outstanding under the facility. (B) Effective September 1, 1999, Harken de Colombia, Ltd. entered into a project finance loan agreement with the International Finance Corporation ("IFC") to be utilized in the development of the Bolivar Association Contract block in Colombia. No borrowings were drawn by Harken de Colombia, Ltd. under the facility. During the second quarter of 2001, Harken de Colombia, Ltd. and IFC agreed to terminate the project finance loan agreement. (7) CONVERTIBLE NOTES PAYABLE A summary of convertible notes payable is as follows: December 31, December 31, 2000 2001 ------------ ------------ 5% European Notes $59,810,000 $40,980,000 Benz Convertible Notes 10,130,000 10,408,000 ----------- ----------- 69,940,000 51,388,000 Less: Current portion -- -- ----------- ----------- $69,940,000 $51,388,000 =========== =========== 5% European Notes -- On May 26, 1998, Harken issued to qualified purchasers a total of $85 million in 5% European Notes which mature on May 26, 2003. In connection with the sale and issuance of the 5% European Notes, Harken paid approximately $4,256,000 from the 5% European Notes proceeds for 64 commissions and issuance costs. Interest incurred on these notes is payable semi-annually in May and November of each year to maturity or until the 5% European Notes are converted. Such 5% European Notes are convertible into shares of Harken common stock at an initial conversion price of $65.00 per share, subject to adjustment in certain circumstances (the "5% European Note Conversion Price"). Other than the February 2000 transaction discussed below, none of the bondholders have exercised their conversion option as of March 27, 2002. The 5% European Notes are also convertible by Harken into shares of Harken common stock if for any period of thirty consecutive days commencing on or after May 26, 1998, the average of the closing prices of Harken common stock for each trading day during such thirty-day period shall have equaled or exceeded 125% of the 5% European Note Conversion Price (or $81.25 per share of Harken common stock). The 5% European Notes may be redeemed for cash, at Harken's option, at par, in whole or in part, at any time after May 26, 2002, upon not less than 30 days notice to the holders. In addition, beginning November 26, 2002, Harken may redeem up to 50% of the 5% European Notes in exchange for shares of Harken common stock at a defined conversion price based on an average market price of Harken common stock. Beginning May 26, 2003, Harken may similarly redeem all remaining 5% European Notes for shares of Harken common stock. The remaining 5% European Notes are listed on the Luxembourg Stock Exchange and had an aggregate market value of approximately $25,000,000 as of December 31, 2001. In February 2000, Harken entered into an agreement with a holder of certain of the 5% European Notes in which the holder exchanged Notes in the face amount of $6,000,000, plus accrued interest, for 300,000 shares of Harken common stock plus a cash payment of $50,000. Although the 300,000 shares of Harken common stock issued had a total fair value of approximately 50% of the face value of the Notes exchanged, accounting for the transaction required Harken to reflect a charge of $2,068,000 in the accompanying Consolidated Statement of Operations related to the fair value of the shares of Harken common stock issued in excess of the number of shares which would have been issued pursuant to the $65.00 per share conversion price of the 5% European Notes. During 2000, Harken repurchased 5% European Notes in the face amount of $19,190,000 from certain holders in exchange for cash of approximately $10,680,000 plus transaction expenses. During the first quarter of 2001, Harken repurchased additional 5% European Notes in the face amount of $250,000 from certain holders in exchange for cash of approximately $140,000 plus transaction expenses. Harken has reflected an extraordinary item gain from the cash purchase of outstanding 5% European Notes in the accompanying Consolidated Statements of Operations. During May 2001, Harken issued 325,150 newly-issued shares of Series G1 Preferred stock in exchange for 5% European Notes in the face amount of $9,000,000. Harken has reflected an extraordinary item gain of $1,147,000 in the accompanying Consolidated Statements of Operations for the difference between the face amount of the 5% European Notes exchanged and the fair value of the Series G1 Preferred shares issued, less transaction expenses. During July 2001, Harken issued 95,800 shares of a new series of convertible preferred stock (the "Series G2 Preferred") in exchange for 5% European Notes in the face amount of $9,580,000. Harken has reflected an extraordinary item gain of $1,722,000 in the accompanying Consolidated Statements of Operations for the difference between the face amount of the 5% European Notes exchanged and the fair value of the Series G2 Preferred shares issued, less transaction expenses. Commissions and issuance costs associated with the 5% European Notes are deferred and are included in Other Assets and are amortized to interest expense over the period until conversion or maturity of the 5% 65 European Notes. As 5% European Notes are repurchased for cash, or exchanged for preferred stock, a pro rata portion of the deferred costs are included in the calculation of the extraordinary item gain. Benz Convertible Notes -- On December 30, 1999 (the "Closing Date"), Harken issued the Benz Convertible Notes in exchange for certain prospects acquired from Benz. See Note 2 - Mergers, Acquisitions and Dispositions for further discussion of the acquisition of the Benz Prospects. The Benz Convertible Notes originally were to mature May 26, 2003 and bear interest at 5% per annum, payable semi-annually in May and November of each year to maturity or until the Benz Convertible Notes are converted. The Benz Convertible Notes are convertible into shares of Harken common stock at a conversion price of $65.00 per share, subject to adjustment in certain circumstances (the "Benz Notes Conversion Price"). The Benz Convertible Notes are also convertible by Harken into shares of Harken common stock, if for any period of thirty consecutive days the average of the closing prices of Harken common stock for each trading day during such thirty-day period shall have equaled or exceeded 125% of the Benz Notes Conversion Price (or $81.25 per share of Harken common stock). The Benz Convertible Notes may be redeemed for cash, or shares of Harken common stock, at Harken's option, at par, in whole or in part, at any time after May 26, 2002, upon not less than 30 days notice to the holders. In addition, beginning November 26, 2002 Harken may redeem up to 50% of the Benz Convertible Notes in exchange for shares of Harken common stock at a conversion price to be calculated based on an average market price of Harken common stock. For a period of up to nine months following the Closing Date (the "Restricted Put Period"), Benz could have required Harken to redeem the Benz Convertible Notes into Harken's option of either cash or Harken common stock, provided that such consideration was used to retire obligations of Benz at a discount, which is acceptable to Harken at Harken's sole discretion, to the face amount of such obligations. In addition, for a period of nine months, beginning no later than the end of the Restricted Put Period, the Benz Convertible Notes could have been redeemed at Benz's option for an amount equal to 50% of the then outstanding principal amount, plus accrued interest, of the related Benz Convertible Notes, payable at Harken's option either in cash or Harken common stock. In March 2000, Harken and Benz entered into an agreement whereby Harken prepaid the approximately $243,000 interest payment due May 26, 2000 on the Benz Convertible Notes and repurchased Benz Convertible Notes having a face amount of $1,125,000 for $375,000 cash. In addition, the May 26, 2003 maturity date for certain of the Benz Convertible Notes was extended to November 26, 2003. No gain was recorded on this transaction due to the related party relationship that existed between Harken and Benz at the time of this transaction. Harken has reflected the Benz Convertible Notes on its Consolidated Balance Sheet at the fair value of the Notes on the Closing Date. The difference between the fair value and the remaining face amount of the Benz Convertible Notes outstanding is accreted into interest expense over the term of the notes. 66 (8) STOCKHOLDERS' EQUITY Reverse Stock Split -- On November 7, 2000, Harken effected a one-for-ten reverse stock split that has been retroactively reflected in the consolidated financial statements. Common Stock -- Harken currently has authorized 225,000,000 shares of $.01 par common stock. At December 31, 2000 and 2001, Harken had issued 17,699,110 shares and 18,713,038 shares, respectively. Treasury Stock -- At December 31, 2000 and 2001, Harken had 89,750 and 542,900 shares, respectively, of treasury stock. During 1999, Harken purchased 145,300 shares of Harken common stock in the open market at a cost of approximately $1,964,000. During 2000, Harken cancelled all of the 215,300 shares of treasury stock it held as of December 31, 1999. In addition, during 2000, Harken purchased 89,750 shares of Harken common stock at a cost of approximately $453,000. During 2001, Harken purchased 453,150 shares of Harken common stock at a cost of approximately $980,000. Issuance of Convertible Notes Payable -- In May 1998, Harken issued to qualified purchasers a total of $85 million of 5% European Notes which mature on May 26, 2003. Such 5% European Notes are convertible into shares of Harken common stock at an initial conversion price of $65.00 per share, subject to adjustment in certain circumstances. For further discussion of the 5% European Notes, see Note 7 - Convertible Notes Payable. In February 2000, Harken entered into an agreement with a holder of certain of the 5% European Notes where the holder exchanged Notes in the face amount of $6,000,000, plus accrued interest, for 300,000 shares of Harken common stock. On December 30, 1999, Harken issued the Benz Convertible Notes in exchange for certain prospects acquired from Benz. See Note 2 - Mergers, Acquisitions and Dispositions for further discussion of the acquisition of the Benz Prospects. Such Benz Convertible Notes are convertible into shares of Harken common stock at the Benz Notes Conversion Price, subject to adjustment in certain circumstances. For further discussion of the Benz Convertible Notes, see Note 7 - - Convertible Notes Payable. Merger with XPLOR-- In August 1999, Harken entered into a merger agreement with XPLOR whereby XPLOR became a wholly-owned subsidiary of Harken. As consideration for the merger, Harken issued 750,000 shares of Harken common stock and issued 233,607 warrants for the purchase of shares of Harken common stock at $25.00 per share, which were exercisable through February 2002. See Note 2 - Mergers, Acquisitions and Dispositions for further discussion. Acquisition of Republic Properties - On January 30, 2002, a wholly-owned subsidiary of Harken signed an agreement to acquire certain property interests from Republic, subject to approval by Republic's shareholders and debenture holders, in exchange for Harken common stock having a value of $2,645,500, subject to a maximum of 2,645,000 shares to be issued. See Note 2 - Mergers, Acquisitions and Dispositions for further discussion. Development Finance Agreements -- During late 1997 and early 1998, Harken entered into Development Finance Agreements relating to certain of its Colombian operations. Pursuant to these Development Finance Agreements, certain investors exercised their options to convert their beneficial interest in a specific operating area into shares of Harken common stock. In addition, certain of these investors were 67 issued shares of Harken common stock at the time of entering into a Development Finance Agreement with Harken. In October 1999, Harken repurchased for $20 million a significant majority of the remaining Development Finance Agreements. During 1999, 2000 and 2001, Harken also issued to the Development Finance Agreement investors a total of 1,082,872, 687,826 and 318,907, respectively, of Harken common stock pursuant to, and in full satisfaction of, the Development Finance Agreements. Private Placements of Harken Common Stock -- In March 2000, Harken issued 200,000 shares of Harken common stock to two institutional investors in exchange for $1,500,000 cash and 5,000 shares of Benz Series II preferred stock having a face value of $500,000. In May 2000, Harken issued 246,154 shares of Harken common stock to institutional investors in exchange for $1,500,000 cash and 5,000 shares of Benz Series II preferred stock having a face value of $500,000. During the third quarter of 2000, Harken issued 910,476 shares of Harken common stock to institutional investors in exchange for $4,971,000 cash and 13,380 shares of Benz Series II preferred stock having a face value of $1,338,000 and Benz Notes with a face value of $412,000. No value has been assigned to the Benz securities held by Harken. Series F Preferred Stock -- On April 9, 1998, Harken entered into a Securities Purchase Agreement with RGC International Investors, LDC ("RGC"), pursuant to which Harken issued to RGC 15,000 shares of its Series F Convertible Preferred Stock (the "Series F Preferred") in exchange for $15,000,000. The Series F Preferred was convertible into shares of Harken common stock at a conversion price based upon the market price of Harken common stock at the time of conversion. The number of shares of Harken common stock issuable upon conversion of the Series F Preferred also included a premium amount equal to an increase calculated on the face value of the Series F Preferred at 5% per annum. Harken reflected this 5% per annum increase throughout 1998 as accretion related to preferred stock in the accompanying Consolidated Statements of Operations. Such accretion amount is reflected in Harken's calculation of net loss attributable to common stock. The Series F Preferred did not pay dividends. In January 1999, RGC elected to present its Series F Preferred for conversion and Harken elected to pay cash of approximately $25,273,000 to RGC in lieu of issuing shares of Harken common stock. Harken reflected an additional amount of approximately $1,302,000 of accretion during 1998 related to Series F Preferred which represents the portion of the ultimate redemption value generated in December 1998 and has reflected the additional accretion amount of approximately $8,427,000 in 1999 which represents the ultimate redemption value generated in the first quarter of 1999. Series G1 Preferred Stock -- The Harken Board of Directors approved the authorization and issuance of up to 700,000 shares of a new series of convertible preferred stock. The Series G1 Convertible Preferred Stock (the "Series G1 Preferred"), which was issued in October 2000, has a liquidation value of $100 per share, is non-voting, and is convertible at the holder's option into Harken common stock at a conversion price of $12.50 per share, subject to adjustment in certain circumstances (the "Series G1 Preferred Conversion Price"). The Series G1 Preferred is also convertible by Harken into shares of Harken common stock if for any period of twenty consecutive trading days, the average of the closing prices of Harken common stock during such period shall have equaled or exceeded the Target Price. Such Target Price shall initially be defined as the Series G1 Preferred Conversion Price multiplied by 110% (or $13.75 per share of Harken common stock) and shall be reduced by an additional $1.10 per share on each anniversary of the closing date, but not less than a minimum Target Price of $8.10 per share of Harken common stock. The Series G1 Preferred holders shall be entitled to receive dividends at an annual rate equal to $8 per share when, as and if declared by the Harken Board of Directors. All dividends on the Series G1 Preferred are 68 cumulative and payable semi-annually in arrears, payable on June 30 and December 30. At Harken's option, dividends may also be payable in Harken common stock valued at $12.50 per share. The Series G1 Preferred dividend and liquidation rights shall rank junior to all claims of creditors, including holders of outstanding debt securities, but senior to Harken common stockholders and to any subsequent series of Harken preferred stock, unless otherwise provided, except for the Series G2 Preferred, which shall rank equal to the Series G1 Preferred. As of December 31, 2001, Harken had accrued approximately $3,598,000 of dividends in arrears related to the Series G1 Preferred stock, approximately $8.06 per share of such preferred stock outstanding. Harken also may redeem the Series G1 Preferred in whole or in part for cash at any time at $100 per share plus any accrued and unpaid dividends. In addition, on or after June 1, 2004, Harken may further elect, in any six-month period, to redeem up to 50% of the outstanding Series G1 Preferred with shares of Harken common stock valued at an average market price, and using a redemption value of the Series G1 Preferred that includes a 5% to 10% premium based on the market capitalization of Harken at the time of redemption. During 2000, Harken received consideration consisting of approximately $7,767,000 cash, 43,523 shares of Benz Series II preferred stock having a face value of $4,352,300 and Benz Notes with a face value of $3,555,000 in exchange for 158,155 shares of Series G1 Preferred which were issued in October 2000. No value has been assigned to the Benz securities held by Harken. As discussed in Note 7 - Convertible Notes Payable, during May 2001, Harken issued 325,150 additional newly-issued shares of Series G1 Preferred stock in exchange for 5% European Notes in the face amount of $9,000,000. During 2001, holders of 48,048 shares of Series G1 Preferred stock elected to exercise their conversion option, and such holders were issued 415,053 shares of Harken common stock. In March 2002, additional holders of 7,770 shares of Series G1 Preferred stock elected to exercise its conversion option, and such holders were issued 68,775 shares of Harken common stock. Series G2 Preferred Stock -- As discussed in Note 6 - Convertible Notes Payable, in July 2001, Harken issued 95,800 shares of a new series of convertible preferred stock, the Series G2 Preferred, in exchange for 5% European Notes in the face amount of $9,580,000. Harken's Board of Directors approved the authorization and issuance of up to 400,000 shares of Series G2 Preferred, which has a liquidation value of $100 per share, is non-voting, and is convertible at the holder's option into Harken common stock at a conversion price of $3.00 per share, subject to adjustment in certain circumstances (the "Series G2 Preferred Conversion Price"). The Series G2 Preferred is also convertible by Harken into shares of Harken common stock if for any period of twenty consecutive calendar days, the average of the closing prices of Harken common stock during such period shall have equaled or exceeded $3.75 per share. The Series G2 Preferred holders shall be entitled to receive dividends at an annual rate equal to $8 per share when, as and if declared by the Harken Board of Directors. All dividends on the Series G2 Preferred are cumulative and payable semi-annually in arrears, payable on June 30 and December 30. At Harken's option, dividends may also be payable in Harken common stock at $3.00 per share of Harken common stock. The Series G2 Preferred dividend and liquidation rights shall rank junior to all claims of creditors, including holders of outstanding debt securities, but senior to Harken common stockholders and to any subsequent series of Harken preferred stock, unless otherwise provided. The Series G2 Preferred shall rank equal to the Series G1 Preferred. At December 31, 2001, Harken had accrued approximately $344,000 of dividends in arrears related to the Series G2Preferred stock, approximately $3.61 per share of such preferred stock outstanding. Harken may also redeem the Series G2 Preferred in whole or in part for cash at any time at $100 per share plus 69 any accrued and unpaid dividends. In addition, on or after June 1, 2004, Harken may further elect, in any six month period, to redeem up to 50% of the outstanding Series G2 Preferred with shares of Harken common stock valued at an average market price, and using a redemption value of the Series G2 Preferred that includes a 5% to 10% premium based on the market capitalization of Harken at the time of redemption. During 2001, a holder of 500 shares of G2 Preferred stock elected to exercise its conversion option, and such holder was issued 16,822 shares of Harken common stock. In February 2002, additional holders of 1,000 shares of G2 Preferred stock elected to exercise their conversion option, and such holders were issued 34,763 shares of Harken common stock. Stockholder Rights Plan -- In April 1998, Harken adopted a rights agreement (the "Rights Agreement") whereby a dividend of one preferred share purchase right (a "Right") was paid for each outstanding share of Harken common stock. The Rights will be exercisable only if a person acquires beneficial ownership of 15% or more of Harken common stock (an "Acquiring Person"), or commences a tender offer which would result in beneficial ownership of 15% or more of such stock. When they become exercisable, each Right entitles the registered holder to purchase from Harken one one-thousandth of one share of Series E Junior Participating Preferred Stock ("Series E Preferred Stock"), at a price of $35.00 per one one-thousandth of a share of Series E Preferred Stock, subject to adjustment under certain circumstances. Upon the occurrence of certain events specified in the Rights Agreement, each holder of a Right (other than an Acquiring Person) will have the right to purchase, at the Right's then current exercise price, shares of Harken common stock having a value of twice the Right's exercise price. In addition, if, after a person becomes an Acquiring Person, Harken is involved in a merger or other business combination transaction with another person in which Harken is not the surviving corporation, or under certain other circumstances, each Right will entitle its holder to purchase, at the Right's then current exercise price, shares of common stock of the other person having a value of twice the Right's exercise price. Unless redeemed by Harken earlier, the Rights will expire on April 6, 2008. Harken will generally be entitled to redeem the Rights in whole, but not in part, at $.01 per Right, subject to adjustment. No Rights were exercisable under the Rights Agreement at December 31, 2001. The terms of the Rights generally may be amended by Harken without the approval of the holders of the Rights prior to the public announcement by Harken or an Acquiring Person that a person has become an Acquiring Person. In addition, Harken has agreements with certain members of management whereby such employees would receive compensation amounts in the event of a change, as defined in the agreements, in the ownership of Harken. Per Share Data -- Basic loss per common share was computed by dividing net loss attributed to common stock by the weighted average number of shares of Harken common stock outstanding during the year and retroactively reflects the effect of the one-for-ten reverse stock split that was effective November 7, 2000. The impact of unconverted Convertible Notes was not included in any of the years presented as their effect would have been antidilutive. The impact of the unconverted Development Finance Agreements, the unconverted Series F Preferred, the unconverted Series G1 Preferred and the unconverted G2 Preferred were not included for any of the years presented as their effect would have been antidilutive. 70 Summary of Outstanding Warrants -- At December 31, 2001, Harken has the following outstanding warrants available to be exercised (not in thousands):
Year of Issuance Number of Shares Exercisable Price Expiration Date - ---------------- ---------------- ----------- ----- --------------- 1999 233,607 233,607 $25.00 2002
(9) STOCK OPTION PLAN Harken has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related Interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123") requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, because the exercise price of Harken's employee stock options equals or exceeds the market price of the underlying stock on the date of grant, no compensation expense is recognized. Harken's 1993 Stock Option and Restricted Plan has authorized the grant of options to Harken employees and directors for up to 400,000 shares of Harken common stock. Harken's 1996 Stock Option and Restricted Stock Plan has authorized the grant of 1,852,500 shares of Harken common stock. All options granted have 10-year terms and vest and become fully exercisable at the end of 4 years of continued employment. Pro forma information regarding net loss and loss per share is required by SFAS 123 and has been determined as if Harken had accounted for its employee stock options under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for 1999, 2000 and 2001, respectively: risk-free interest rates of 5%; dividend yields of 0%; volatility factors of the expected market price of Harken common stock of .898, .929, and 1.38; and a weighted-average expected life to the option of 4 years. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because Harken's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. 71 For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. Harken's pro forma information follows (in thousands except for earnings per share information):
Year Ended December 31, ---------------------------------------------- 1999 2000 2001 ----------- ----------- ----------- Pro forma net loss attributed to common stock $ (25,596) $ (156,968) $ (46,778) Pro forma basic and diluted loss per share $ (1.78) $ (9.31) $ (2.59)
The weighted average fair value of the options issued in 1999, 2000 and 2001 was $8.30, $2.32, and $2.40 per share, respectively. A summary of Harken's stock option activity, and related information for the years ended December 31, 1999, 2000 and 2001 follows (not in thousands):
Year Ended December 31, --------------------------------------------------------------------------------------------- 1999 2000 2001 ---------------------------- --------------------------- --------------------------- Weighted- Weighted- Weighted-Average Average Average Options Exercise Price Options Exercise Price Options Exercise Price ------- -------------- ------- -------------- ------- -------------- Outstanding-beginning of year 1,117,674 $35.80 1,404,748 $ 30.65 1,618,326 $21.17 Granted 338,237 $13.80 509,500 $ 3.41 15,000 $ 7.07 Exercised -- -- -- -- Forfeited (51,163) $31.10 (295,922) $ 35.59 (80,074) $25.53 --------- ------ --------- --------- --------- ------ Outstanding-end of year 1,404,748 $30.65 1,618,326 $ 21.17 1,553,252 $20.81 Exercisable-end of year 670,362 $30.30 721,864 $ 30.97 980,246 $27.95
Exercise prices for options outstanding as of December 31, 1999 ranged from $8.125 to $64.375. Exercise prices for options outstanding as of December 31, 2000 ranged from $3.3125 to $64.375. Exercise prices for options outstanding as of December 31, 2001 ranged from $1.2200 to $64.375. (10) INCOME TAXES At December 31, 2001, Harken had available for U.S. federal income tax reporting purposes, net operating loss (NOL) carryforward for regular tax purposes of approximately $86,000,000 which expires in 2002 through 2021, alternative minimum tax NOL carryforward of approximately $71,000,000 which expires in 2001 through 2020, and statutory depletion carryforward of approximately $2,400,000 which does not have an expiration date. In recent years, Harken has undertaken numerous transactions that have impacted its capital structure and shareholder base. Accordingly, Harken may have undergone one or more ownership changes within the meaning of Internal Revenue Code Section 382 that may significantly restrict Harken's ability to utilize these NOLs. In addition, certain of these net operating loss carryforward has been acquired with the purchase of subsidiaries and must be used to offset future income from profitable operations within those subsidiaries. At December 31, 2001, Harken had available for Colombian income tax reporting purposes NOL carryforward of approximately $25,000,000 which expires in 2004 through 2006. 72 The following is a reconciliation of the reported amount of income tax expense for the years ended December 31, 1999, 2000 and 2001 to the amount of income tax expense that would result from applying domestic federal statutory tax rates to pretax income: Year Ended December 31, ---------------------------------- 1999 2000 2001 --------- ------ ------- Tax expense using statutory rate $ -- $ -- $ -- Alternative minimum tax provision -- 39 79 State income taxes 30 -- -- Colombia presumptive income taxes -- -- 620 --------- ------ ------- Current tax expense $ 30 $ 39 $ 699 ========= ====== ======= Total deferred tax liabilities, relating primarily to U.S. oil and gas properties as of December 31, 2000, were approximately $3,557,000. Total deferred tax assets, primarily related to the net operating loss carryforwards and Colombian oil and gas properties, were approximately $81,733,000. The total net deferred tax asset is offset by a valuation allowance of approximately $78,176,000 at December 31, 2000, resulting in no impact to results of operations. Total deferred tax liabilities, relating primarily to U.S. oil and gas properties as of December 31, 2001, were approximately $2,675,000. Total deferred tax assets, primarily related to the net operating loss carryforwards and Colombian oil properties, were approximately $80,779,000 at December 31, 2001. The total net deferred tax asset is offset by a valuation allowance of approximately $78,104,000 at December 31, 2001, resulting in no impact to results of operations. (11) RELATED PARTY TRANSACTIONS Prior to his resignation in July 2000, Harken had on its Board of Directors a director who is also a managing director of EnCap Investments L.C. ("EnCap"). EnCap has historically provided financial consulting and investment banking services to Harken. In October 1997, Harken entered into a Development Finance Agreement with investors affiliated with EnCap (the "EnCap Investors"). EnCap serves as the general partner of three of the EnCap Investors and the former Harken director serves as a director of the fourth EnCap Investor. In October 1999, Harken purchased all the interests and rights held by the EnCap Investors for $20,000,000 cash. In addition, in December 1999, Harken acquired the Benz Prospects from Benz, which is an affiliate of EnCap. Harken believes that the above transactions were made at terms at least as favorable to Harken as those that could have been secured with an unrelated party. During 1997, 1998 and 1999, Harken made secured short-term loans to certain members of Harken's Management, certain of whom also served on the Board of Directors. Such notes receivable are reflected in Harken's Consolidated Balance Sheet at December 31, 2000 and December 31, 2001 as Related Party Notes Receivable. In January 2001, Harken forgave the repayment of a short-term loan to a former director and former member of management and reflected the forgiveness as a charge to earnings in 2000. 73 In November 2001, Global elected to its Board of Directors a director who is also a director of RP&C International Inc. ("RP&C"). RP&C has historically provided financial and transaction consulting services to Harken, including with regard to Harken's Convertible European Notes, and Series G1 Preferred and Series G2 Preferred stock. In addition, RP&C has served as a financial advisor in connection with Harken's restructuring of its international assets, obligations and operations through its Global subsidiary. In connection with these services provided, RP&C has earned consulting and transaction fees and may continue to earn such fees in the future. Harken believes that arrangements for financial and consulting services provided by RP&C are made at terms at least as favorable to Harken as those that could be secured with an unrelated party. (12) HEDGING ACTIVITIES Harken holds certain commodity derivative instruments which are effective in mitigating commodity price risk associated with a portion of its future monthly natural gas production and related cash flows. Harken's oil and gas operating revenues and cash flows are highly dependent upon commodity product prices, which are volatile and cannot be accurately predicted. Harken's objective for holding these commodity derivatives is to protect the operating revenues and cash flows related to a portion of its future oil and gas sales from the risk of significant declines in commodity prices. During 1999, 2000 and 2001, Harken, through XPLOR, held natural gas price swaps resulting in the subsidiary receiving fixed prices of approximately $2.20 per MMBTU covering a total of 75,000 MMBTUs per month over the life of the swaps, which terminated December 31, 2001. Upon the January 1, 2001 adoption of Statement of Financial Accounting Standards ("SFAS") No. 133, Harken reflected an increase in its accrued liabilities of approximately $3,025,000 in order to fully record the fair value of these natural gas swaps. As such derivatives qualify as cash flow hedges under SFAS No. 133, the offsetting impact upon adoption was a charge to Other Comprehensive Income within Harken's stockholders' equity. Of this initial adoption amount, approximately $1,634,000 was reclassified into earnings during the year ended December 31, 2001, to match with the corresponding hedged production cash flows. In January 2001, Harken purchased a put option for crude oil with a fixed price of $25 per barrel, covering 6,000 barrels per month through June 30, 2001. In November 2001, Harken entered into a zero-cost collar consisting of a fixed price floor option of $2.50 per MMBTU and a fixed price cap option of $3.8225 per MMBTU, covering 115,000 MMBTUs per month over the period of the contract, beginning January 1, 2002 through December 31, 2002. Harken has reflected the current fair value of this collar contract, approximately $162,000 at December 31, 2001, in Prepaid Expenses and Other Current Assets in the accompanying Consolidated Balance Sheet. In March 2002, Harken modified the remaining term of its zero-cost collar, adjusting it to a fixed price floor option of $2.75 per MMBTU and a fixed price cap option of $3.47 per MMBTU and increasing the monthly hedged volume to 135,000 MMBTUs. In addition, Harken also entered into a new zero-cost collar consisting of a fixed price floor option of $2.75 per MMBTU and a fixed price cap option of $5.12 per MMBTU, covering 60,000 MMBTUs per month over a period from January 1, 2003 through December 31, 2003. The above derivatives have each been designated as a cash flow hedge of the exposure to variability of cash flows related to future sales of specified production from certain of Harken's domestic property operations. Gains and losses from commodity derivative instruments, even if terminated, are reclassified into earnings when the associated hedged production occurs. Harken holds no derivative instruments which are designated as either 74 fair value hedges or foreign currency hedges. Settlements of commodity derivatives are based on the difference between fixed swap or option strike prices and the New York Mercantile Exchange closing prices for each month during the life of the contracts. Harken monitors its natural gas production prices compared to New York Mercantile Exchange prices to assure its commodity derivatives are effective hedges in mitigating its commodity price risk. Harken reflects in earnings any increase or decrease in the fair value of its commodity derivative instruments that is not correlative with a change in the fair value of the future hedged production cash flows. For option and collar derivative contracts, Harken excludes the time value component from the assessment of hedge effectiveness. During the year ended December 31, 2001, Harken reflected a net loss of $75,000 related to the time value component from commodity derivative instruments, which is included in Interest and Other Expense in the accompanying Consolidated Statements of Operations. Harken reflected no gain or loss related to hedge ineffectiveness during the year ended December 31, 2001. As of December 31, 2001, Harken has a value of $162,000 included in Other Comprehensive Income related to its commodity hedging activities. Risk management policies established by Harken management limit Harken's derivative instrument activities to those derivative instruments which are effective in mitigating certain operating risks, including commodity price risk. In addition to other restrictions, the extent and terms of any derivative instruments are required to be reviewed and approved by executive management of Harken. 75 (13) OTHER INFORMATION Quarterly Data -- (Unaudited) -- The following tables summarize selected quarterly financial data for 2000 and 2001 expressed in thousands, except per share amounts:
Quarter Ended ------------------------------------------------------- Total March 31 June 30 September 30 December 31 Year -------- -------- ------------ ----------- --------- 2000 Revenues $ 10,272 $ 11,077 $ 11,592 $ 11,454 $ 44,395 Gross profit 6,611 7,095 7,710 7,382 28,798 Net income (loss) (2,189) 1,740 4,037 (156,521) (152,933) Basic and diluted loss per common share $ (0.14) $ 0.10 $ 0.22 $ (8.87) $ (9.09) 2001 Revenues $ 9,192 $ 10,982 $ 6,432 $ 5,817 $ 32,423 Gross profit 5,661 7,465 3,329 2,983 19,438 Net income (loss) (1,412) 75 (1,208) (38,478) (41,023) Basic and diluted loss per common share $ (0.10) $ (0.03) $ (0.13) $ (2.18) $ (2.45)
Significant Customers -- In 1999, 2000 and 2001, Ecopetrol, which purchases Harken's Colombia oil production, represented 13%, 24% and 26%, respectively, of Harken's consolidated revenues. Harken has secured and maintains letters of credit with certain significant domestic commercial purchasers. In addition, management does not feel that the loss of a significant domestic purchaser would significantly impact the operations of Harken due to the availability of other potential purchasers for its oil and gas production. Operating Segment Information -- Harken divides its operations into two operating segments which are managed and evaluated by Harken as separate operations. Harken's North American operating segment currently relates to Harken's exploration, development, production and acquisition efforts in the United States whereby production cash flows are discovered or acquired, and operates primarily through traditional ownership of mineral interests in the various states in which it operates. Harken's North American production is sold to established purchasers and generally transported through an existing and well-developed pipeline infrastructure. Harken's Middle American operating segment currently relates to Global's exploration, development, production and acquisition efforts in Colombia, Costa Rica, Peru and Panama. Middle American segment production cash flows have been discovered through extensive drilling operations conducted under Association Contract or Concession arrangements with the state-owned oil and gas companies/ministries in the respective countries. Global's Middle American production is currently sold to Ecopetrol. In addition, Global seeks to identify, develop and promote energy projects from throughout Latin America to industry and financial partners and to aggregate assets in Latin America through strategic acquisitions and alliances. During the three-year period ended December 31, 2001, none of Harken's Middle American segment revenues related to Costa Rica, Peru or Panama. 76 In March 2002, Global transferred all of its interests in its Middle American assets and operations to, and obligations relating to such assets and operations were assumed by, a new subsidiary, Global PLC, in exchange for 92.6% of Global PLC's common stock. Upon the completion of this exchange transaction, Global PLC then completed the listing of its common stock for trading on the AIM Exchange in London, and placed 7.4% of such stock in a placement to investors, including certain affiliates of Harken and Global. Global PLC is seeking additional financing and acquisition activities using its shares of its newly listed common stock. At March 27, 2002, Harken, through Global, owned 92.6% of Global PLC common stock. Harken's accounting policies for each of its operating segments are the same as those described in Note 1 - Summary of Significant Accounting Policies. There are no intersegment sales or transfers. Revenues and expenses not directly identifiable with either segment, such as certain general and administrative expenses, are allocated by Harken based on various internal and external criteria including an assessment of the relative benefit to each segment. 77 Harken's financial information for each of its operating segments is as follows for each of the three years in the period ended December 31, 2001:
North Middle America America Total -------- --------- --------- For the year ended December 31, 1999: Operating revenues $ 16,719 $ 3,026 $ 19,745 Interest and other income 1,831 1,880 3,711 Depreciation and amortization 5,591 1,257 6,848 Provision for asset impairments -- 1,599 1,599 Interest expense and other, net 2,918 4,378 7,296 Income tax expense 30 -- 30 Segment loss before extraordinary item (2,811) (9,484) (12,295) Capital expenditures 53,448 44,005 97,453 Total assets at end of year 99,534 199,251 298,785 For the year ended December 31, 2000: Operating revenues $ 32,528 $ 10,649 $ 43,177 Interest and other income 617 601 1,218 Depreciation and amortization 8,200 5,449 13,649 Full cost valuation allowance -- 156,411 156,411 Interest expense and other, net 3,304 1,993 5,297 Income tax expense 39 -- 39 Segment income (loss) before extraordinary item 863 (161,534) (160,671) Capital expenditures 14,015 12,950 26,965 Total assets at end of year 97,683 47,664 145,347 For the year ended December 31, 2001: Operating revenues $ 23,351 $ 8,291 $ 31,642 Interest and other income 548 233 781 Depreciation and amortization 8,871 6,383 15,254 Full cost valuation allowance 14,353 4,316 18,669 Provision for asset impairments -- 14,102 14,102 Interest expense and other, net 2,761 1,902 4,663 Income tax expense 79 620 699 Segment income (loss) before extraordinary item (16,902) (27,096) (43,998) Capital expenditures 11,892 10,721 22,613 Total assets at end of year 65,732 30,074 95,806
78 (14) OIL AND GAS DISCLOSURES Costs Incurred in Property Acquisition, Exploration and Development Activities: Year Ended December 31, ------------------------------- 1999 2000 2001 ------- ------- ------- Domestic costs incurred: Acquisition of properties Evaluated $34,720 $ -- $ -- Unevaluated 14,481 161 -- Exploration 815 10,837 2,200 Development 3,432 3,017 9,692 ------- ------- ------- Total domestic costs incurred $53,448 $14,015 $11,892 ======= ======= ======= Middle American costs incurred: Acquisition of properties Evaluated $ 3,761 $ -- $ 100 Unevaluated 72 -- 869 Exploration 40,172 12,950 9,752 Development -- -- -- ------- ------- ------- Total Middle American costs incurred $44,005 $12,950 $10,721 ======= ======= ======= Middle American costs incurred during 1999 and 2000 include $2,037,000 and $5,122,000 of Costa Rica costs, respectively. Middle American costs during 2001 include $891,000, $635,000 and $166,000 of costs related to Costa Rica, Peru and Panama, respectively. 79 Capitalized Costs Relating to Oil and Gas Producing Activities:
December 31, ----------------------------------------- 1999 2000 2000 --------- --------- --------- Capitalized costs: Unevaluated Colombia properties $ 44,767 $ 588 $ 68 Unevaluated Peru properties -- -- 635 Unevaluated Panama properties -- -- 166 Unevaluated Costa Rica properties 2,037 7,159 -- Unevaluated domestic properties 17,111 9,919 2,603 Evaluated Colombia properties 121,351 173,358 182,945 Evaluated domestic properties 131,159 148,487 154,495 Production facilities 11,455 13,228 15,393 --------- --------- --------- Total capitalized costs 327,880 352,739 356,305 Less accumulated depreciation and amortization (75,071) (243,955) (280,357) --------- --------- --------- Net capitalized costs $ 252,809 $ 108,784 $ 75,948 ========= ========= =========
Oil and Gas Reserve Data -- (Unaudited) -- The following information is presented with regard to Harken's proved oil and gas reserves. The reserve values and cash flow amounts reflected in the following reserve disclosures are based on prices as of year end. Harken has reflected proved reserves in Colombia related to its Alcaravan and Bolivar Association Contracts. As Harken identifies proved reserves associated with other Association Contracts, or identifies proved reserves from additional prospects within its Alcaravan and Bolivar Association Contracts, such reserves will be added in the year of their discovery. Harken has reflected no proved reserves related to its Costa Rica, Peru or Panama operations. During 1999, Harken applied to Ecopetrol for a declaration of commercial discovery related to the Palo Blanco field on the Alcaravan Association Contract and the Buturama field on the Bolivar Association Contract. In February and October 2001, Harken was notified by Ecopetrol that Harken could proceed with the development and production of the Buturama and Palo Blanco fields, respectively, on a sole-risk basis. As such, Harken is entitled to receive Ecopetrol's share of production after royalty, until Harken has recovered 200% of its costs, after which time Ecopetrol could elect to begin to receive its share of production. In light of Ecopetrol's election not to participate in these fields, Harken has reflected its 80% share of future net cash flows from the Buturama field in its proved reserves as of December 31, 2001. All Colombian proved reserves are net of Ecopetrol's 20% royalty pursuant to each related Association Contract. Harken's Colombian reserves in the Bolivar and Alcaravan Contract Blocks have been reviewed by Ryder Scott Company. For further discussion of Harken's Colombian operations, see Note 5 - Middle American Operations. Harken's domestic reserves reflect reductions for certain producing properties which were sold for cash during 2000 and 2001. See Note 2 - Mergers, Acquisitions and Dispositions for further discussion. Harken's domestic reserves at December 31, 2001 have been prepared by Netherland, Sewell & Associates, Inc. 80 Proved oil and gas reserves are defined as the estimated quantities of crude oil, natural gas, and natural gas liquids which geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions. Reservoirs are considered proved if economic productibility is supported by either actual production or conclusive formation tests. The area of a reservoir considered proved includes that portion delineated by drilling and defined by gas-oil and/or oil-water contacts, if any, and the immediately adjoining portions not yet drilled, but which can be reasonably judged as economically productive on the basis of available geological and engineering data. Reserves which can be produced economically through application of improved recovery techniques are included in the "proved" classification when successful testing by a pilot project, or the operation of an installed program in the reservoir, provides support for the engineering analysis on which the project or program was based. The reliability of reserve information is considerably affected by several factors. Reserve information is imprecise due to the inherent uncertainties in, and the limited nature of, the data base upon which the estimating of reserve information is predicated. Moreover, the methods and data used in estimating reserve information are often necessarily indirect or analogical in character rather than direct or deductive. Furthermore, estimating reserve information, by applying generally accepted petroleum engineering and evaluation principles, involves numerous judgments based upon the engineer's educational background, professional training and professional experience. The extent and significance of the judgments to be made are, in themselves, sufficient to render reserve information inherently imprecise. 81 "Standardized measure" relates to the estimated discounted future net cash flows and major components of that calculation relating to proved reserves at the end of the year in the aggregate and by geographic area, based on year end prices, costs, and statutory tax rates and using a 10% annual discount rate.
(Unaudited) ----------------------------------------------------------------------------- United States Colombia Total Worldwide --------------------- ---------------------- ---------------------- Oil Gas Oil Gas Oil Gas (Barrels) (Mcf) (Barrels) (Mcf) (Barrels) (Mcf) --------- ----- --------- ----- --------- ----- (in thousands) Proved reserves: As of December 31, 1998 3,640 28,331 27,882 80,120 31,522 108,451 Extensions and discoveries 1 3,814 -- -- 1 3,814 Revisions 842 (2,621) (5,456) (80,120) (4,614) (82,741) Production (510) (2,847) (248) -- (758) (2,847) Sales of reserves in place (119) (2,734) -- -- (119) (2,734) Purchases of reserves in place 2,504 28,875 1,142 -- 3,646 28,875 ------- ------- ------- ------- ------- -------- As of December 31, 1999 6,358 52,818 23,320 -- 29,678 52,818 Extensions and discoveries 79 7,035 -- -- 79 7,035 Revisions (677) 370 (20,833) -- (21,510) 370 Production (529) (4,012) (460) -- (989) (4,012) Sales of reserves in place (464) (1,375) -- -- (464) (1,375) ------- ------- ------- ------- ------- -------- As of December 31, 2000 4,767 54,836 2,027 -- 6,794 54,836 Extensions and discoveries 463 4,650 4,171 -- 4,634 4,650 Revisions (1,041) (5,830) (686) -- (1,727) (5,830) Production (273) (3,851) (500) -- (773) (3,851) Sales of reserves in place (1,302) (10,412) -- -- (1,302) (10,412) ------- ------- ------- ------- ------- -------- As of December 31, 2001 2,614 39,393 5,012 -- 7,626 39,393 ======= ======= ======= ======= ======= ======== Proved developed reserves at: December 31, 1999 3,777 28,289 5,001 -- 8,778 28,289 December 31, 2000 3,006 30,430 540 -- 3,546 30,430 December 31, 2001 1,583 23,673 872 -- 2,455 23,673
82 Standardized Measure of Discounted Future Net Cash Flows Relating to Proved Oil and Gas Reserves:
(Unaudited) -------------------------------------------------- United States Colombia Total Worldwide ------------- -------- --------------- (in thousands) December 31, 2000: Future cash inflows $ 705,638 $ 37,932 $ 743,570 Production costs (127,348) (8,440) (135,788) Development costs (42,871) (14,070) (56,941) --------- --------- --------- 535,419 15,422 550,841 Future net inflows before income tax Future income taxes (128,719) (488) (129,207) --------- --------- --------- 406,700 14,934 421,634 Future net cash flows 10% discount factor (153,698) (3,239) (156,937) --------- --------- --------- Standardized measure of discounted future net cash flows $ 253,002 $ 11,695 $ 264,697 ========= ========= ========= December 31, 2001: Future cash inflows $ 170,105 $ 56,963 $ 227,068 Production costs (54,458) (12,868) (67,326) Development costs (30,095) (20,567) (50,662) --------- --------- --------- 85,552 23,528 109,080 Future net inflows before income tax Future income taxes (568) (4,346) (4,914) --------- --------- --------- 84,984 19,182 104,166 Future net cash flows 10% discount factor (34,310) (6,559) (40,869) --------- --------- --------- Standardized measure of discounted future net cash flows $ 50,674 $ 12,623 $ 63,297 ========= ========= =========
83 Changes In Standardized Measure of Discounted Future Net Cash Flows Relating to Proved Oil and Gas Reserves (in thousands):
(Unaudited) ----------------------------------------- 1999 2000 2001 --------- --------- --------- Worldwide Standardized measure -- beginning of year $ 144,851 $ 280,427 $ 264,697 Increase (decrease) Sales, net of production costs (10,470) (28,130) (19,665) Net change in prices, net of production costs 330,402 177,332 (211,359) Development costs incurred 11,098 251 5,358 Change in future development costs (1,633) 9,886 (10,829) Change in future income taxes (27,288) (20,958) 64,304 Revisions of quantity estimates (216,447) (198,243) (18,752) Accretion of discount 14,485 28,042 26,470 Changes in production rates, timing and other (20,447) (28,397) (8,222) Extensions and discoveries, net of future costs 9,835 48,029 19,748 Sales of reserves-in-place (2,789) (3,542) (48,453) Purchases of reserves-in-place 48,830 -- -- --------- --------- --------- Standardized measure -- end of year $ 280,427 $ 264,697 $ 63,297 ========= ========= =========
(15) COMMITMENTS AND CONTINGENCIES Operating Leases -- Harken leases its corporate and certain other office space and certain field operating offices. Total office and operating lease payments during 1999, 2000 and 2001 were $1,437,000, $1,270,000 and $750,000 respectively, net of applicable sublease arrangements. Future minimum rental payments required under all leases that have initial or remaining noncancellable lease terms in excess of one year as of December 31, 2001, net of sublease reimbursements of $554,000 and $92,000 in 2002 and 2003, respectively, are as follows: Year Amount - ---- ------ $ 744 2002 2003 720 2004 688 2005 689 2006 574 Thereafter -- Total minimum payments required -- ------ $3,415 ====== 84 Operational Contingencies -- The exploration, development and production of oil and gas are subject to various, federal and state laws and regulations designed to protect the environment. Compliance with these regulations is part of Harken's day-to-day operating procedures. Infrequently, accidental discharge of such materials as oil, natural gas or drilling fluids can occur and such accidents can require material expenditures to correct. Harken maintains levels of insurance customary in the industry to limit its financial exposure. Management is unaware of any material capital expenditures required for environmental control during the next fiscal year. Search Acquisition Corp. ("Search Acquisition"), also know as Harken Texas Acquisition Corp., a wholly-owned subsidiary of Harken, is a defendant in a lawsuit filed by Petrochemical Corporation of America and Lorken Investments Corporation (together, "Petrochemical"). This lawsuit arises out of Petrochemical's attempt to enforce a judgment of joint and several liability entered in 1993 against a group of twenty limited partnerships known as the "Odyssey limited partnerships." Petrochemical claims that Search Exploration, Inc. is liable for payment of the judgment as the successor-in-interest to eight Odyssey limited partnerships. Search Acquisition was the surviving corporation in the 1995 acquisition of Search Exploration, Inc. On February 28, 1996, the court granted Search Acquisition's motion for summary judgment. On July 3, 1998, the Fifth District Court of Appeals for the State of Texas reversed the trial court's summary judgment and remanded the case to the trial court. In late 2001, a jury trial was held in this matter. The jury returned a verdict finding for Petrochemical in the amount of $1.5 million of actual damages and $3 million in punitive damages. As of March 27, 2002 the court had not yet decided on Search Acquisition's various motions to overturn the verdict. Search Acquisition anticipates that it will appeal if this verdict is not overturned in full. Should the verdict be overturned in full, Search Acquisition anticipates that Petrochemical will appeal. In Harken management's opinion at this time, the ultimate outcome of this matter against Search Acquisition, a wholly-owned subsidiary that has minimal oil and gas reserves, will not have a material adverse effect upon Harken's financial condition or operations taken as a whole. 420 Energy Investment, Inc. and ERI Investments, Inc. (collectively "420 Energy") filed a lawsuit against XPLOR, a wholly-owned subsidiary of Harken, on December 21, 1999 in the New Castle County Court of Chancery of the State of Delaware. 420 Energy alleges that they are entitled to appraisal and payment of the fair value of their common stock in XPLOR as of the date XPLOR merged with Harken. Harken has relied on an indemnity provision in the XPLOR merger agreement to tender the costs of defense in this matter to certain third parties. Although the outcome of this litigation is uncertain, Harken believes that any liability to Harken as a result of this litigation will not have a material adverse effect on Harken's financial condition. In February 2002, 420 Energy filed a new lawsuit against XPLOR, Harken and other defendants in state court in Dallas, Texas. Harken intends to pursue and enforce, through whatever steps are necessary, the indemnification from the third parties discussed above with regard to the extension of this suit also. In Harken management's opinion, the ultimate outcome of this litigation will not have a material adverse effect on Harken's financial condition. Harken has accrued approximately $6,779,000 at December 31, 2001 relating to certain other operational or regulatory liabilities related to Harken's domestic operations. A significant majority of this accrued amount relates to future abandonment costs of certain of Harken's producing properties, which will be incurred at the end of the properties' productive life. Harken and its subsidiaries currently are involved in other various lawsuits and contingencies, which in management's opinion, will not result in significant loss exposure to Harken. 85 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE On August 28, 2001, Harken dismissed Arthur Andersen LLP ("Arthur Andersen") as Harken's independent accountants. Harken engaged Ernst and Young LLP ("Ernst & Young") as its new independent accountants. The decision to change Harken's independent accountants was made by Harken's Audit Committee of the Board of Directors. Arthur Andersen's reports on Harken's consolidated financial statements for the years ended December 31, 2000 and 1999 did not contain an adverse opinion or disclaimer of opinion, nor were such reports qualified or modified as to uncertainty, audit scope, or accounting principles. During the two years ended December 31, 2000 and the subsequent interim period preceding the decision to change independent accountants, there were no disagreements with Arthur Andersen on any matters of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreement(s), if not resolved to the satisfaction of Arthur Andersen, would have caused the former accountant to make a reference to the subject matter of the disagreement(s) in connection with its reports covering such periods. During the two years ended December 31, 2000 and the subsequent interim period preceding the decision to change independent accountants, there were no "reportable events" (hereinafter defined) requiring disclosure pursuant to Item 304 (a) (1) (v) of Regulation S-K. As used herein, the term "reportable events" means any of the items listed in paragraphs (a) (1) (v) (A) - (D) of Item 304 of Regulation S-K. Effective September 5, 2001, Harken engaged Ernst & Young as its independent accountants. During the two years ended December 31, 2000 and the subsequent interim period preceding the decision to change independent accountants, neither Harken nor anyone on its behalf consulted Ernst & Young regarding either the application of accounting principles to a specified transaction, either completed or proposed, or the type of audit opinion that might be rendered on Harken's consolidated financial statements, nor has Ernst & Young provided to Harken a written report or oral advice regarding such principles or audit opinion. Harken requested and obtained a letter from Arthur Andersen addressed to the Securities and Exchange Commission stating that it agrees with the above statements. 86 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The Directors of Harken The Directors of Harken as of December 31, 2001, their ages and business experience during the past five years are listed below: Director Name, Age and Business Experience Since --------------------------------- -------- Mikel D. Faulkner (Age - 52) - Chairman of the Board of 1982 Harken since February 1991; CEO of Harken since 1982, and President of Harken from 1982 until February 1993. Effective May 2001, Mr. Faulkner also became the Chairman and Chief Executive Officer of Global. Bruce N. Huff (Age - 51) - President and Chief Operating 1996 Officer of Harken since March 1998 and Chief Financial Officer from February 1999 to June 2000; Senior Vice President and Chief Financial Officer of Harken from 1990 to March 1998. Stephen C. Voss (Age - 52) - Managing Director of Global 1997 Energy Development PLC since November 2001; Vice Chairman of the Board of Harken from May 2000 to November 2001; from September 1998 to May 15, 2000, he served as Executive Vice President and Chief Operating Officer of Harken and from 1990 to September 1998, as Senior Vice President of Harken. Effective May 2001, Mr. Voss also became a director and President and Chief Operating Officer of Global. Larry G. Akers (Age - 63) - From 1996 to the present, Mr. 2000 Akers has acted as an independent energy advisor/consultant. From 1978 to 1988, he served as Chairman, President and CEO of ESCO Energy, Inc. From 1969 to 1978, Mr. Akers served as exploration and development manager for Laclede Gas. Michael M. Ameen, Jr. (Age - 77) - From 1989 to 1999, Mr. 1994 Ameen served as a part time consultant to Harken with regard to Middle Eastern exploration projects; Independent Consultant on Middle East Affairs for the past seven years; Director of American Near East Refugee Aid (a charitable organization); Past director of Amideast (a charitable organization); Past director of Middle East Institute; Past director of International College in Beirut, Lebanon; Past vice president of government relations and director of Washington office of Aramco; Past president of Mobil Middle East Development Corporation. James H. Frizell (Age - 68) - From 1985 to 1987 and from 2001 1989 to the present, Mr. Frizell has acted as an independent petroleum consultant. From 1987 to 1989, he served as a Vice President of Pike Petroleum Corporation. From 1983 to 1985, he served as a Vice President of Valero Producing Company. From 1981 to 1983, he served as Vice President- 87 Exploration and Senior Vice President at Freeport-McMoran. Dr. J. William Petty (Age - 59) - Professor of Finance and 2000 the W.W. Caruth Chairholder of Entrepreneurship at Baylor University from 1990 to the present; Served as dean of the Business School at Abilene Christian University from 1979 to 1990; served as a subject matter expert on a best-practices study by the American Productivity and Quality Center on the topic of shareholder value based management; served on a research team for the Australian Department of Industry to study the feasibility of establishing a public equity market for small and medium-sized enterprises in Australia. H. A. Smith (Age - 63) - From June 1991 to the present, Mr. 1997 Smith has served as a consultant to Smith International Inc., an oil field service company; previously Mr. Smith served as Vice President Customer Relations for Smith International, Inc. Executive Officers of Harken The officers of Harken are elected annually by the Board of Directors following each Annual Meeting of Stockholders, or as soon thereafter as necessary and convenient. Each officer holds office until the earlier of such time as his or her successor is duly elected and qualified, his or her death or he or she resigns or is removed from office. Any officer elected or appointed by the Board of Directors may be removed by the Board of Directors whenever, in its judgment, the best interests of Harken will be served thereby, but such removal will be without prejudice to the contract rights, if any, of the person so removed. The executive officers of Harken as of December 31, 2001, their ages and positions held with Harken and their business experience for the past five years are listed below.
Name Age Position Held with Harken - ---- --- ------------------------- Mikel D. Faulkner 52 Chairman of the Board of Directors and Chief Executive Officer Bruce N. Huff 51 President, Chief Operating Officer and Director James W. Denny, III 54 Executive Vice President - Operations Anna M. Williams 31 Executive Vice President - Finance and Chief Financial Officer Larry E. Cummings 49 Executive Vice President, Secretary and General Counsel Richard O. Cottle 46 Senior Vice President - Production A. Wayne Hennecke 43 Senior Vice President - Finance
Mikel D. Faulkner has served as Chairman of the Board of Harken since February 1991 and Chief Executive Officer of Harken since 1982. Mr. Faulkner previously served as President of Harken between 1982 and 1993. 88 Bruce N. Huff has served as a Director of Harken since August 1996. Mr. Huff has served as President of Harken since April 1998 and as Chief Operating Officer since June 2000. Mr. Huff had previously served as Senior Vice President and Chief Financial Officer since 1990. James W. Denny, III has served as Executive Vice President - Operations since October 1999. From 1998 to October 1999, Mr. Denny served as Senior Engineer/Operations Manager for XPLOR Energy, Inc. From 1995 to 1998, Mr. Denny served as Vice President, Operations & Exploration for Polaris Exploration Corporation. Anna M. Williams has served as Executive Vice President - Finance and Chief Financial Officer since June 2001. Ms. Williams has served as Senior Vice President - Finance and Chief Financial Officer since June 2000 and as Vice President - International Finance since from 1998 to 2000 and as International Finance Manager from 1996 to 1998. Prior to joining Harken, Ms. Williams worked with Arthur Andersen, LLP in the audit division. Larry E. Cummings has served as Executive Vice President, Secretary and General Counsel of Harken since June 2001. Mr. Cummings previously served as Vice President, Secretary and General Counsel from 1983 to 2001 and as Senior Legal Counsel and Vice President of Land for Harken from 1978 to 1983. Richard O. Cottle has served as Senior Vice President - Production since October 1999. Since joining Harken in 1994, Mr. Cottle has served as Vice President of Operations and as Operations Manager for Harken Southwest Corporation, a wholly-owned subsidiary of Harken. Wayne Hennecke has been employed with Harken since 1988. Mr. Hennecke has served as Vice President - Finance of Harken since January 1999. Mr. Hennecke had previously served as Vice President - Finance and Chief Financial Officer of Harken since April 1998 and Vice President and Treasurer of Harken since June 1995. Compliance with Section 16(a) of the Securities Exchange Act of 1934 Section 16(a) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), requires Harken's Directors and Executive Officers, and any persons who own more than ten percent of a registered class of Harken's equity securities, to file with the SEC initial reports of ownership and reports of changes in ownership of common stock and other equity securities of Harken. Directors, executive officers and greater than ten percent stockholders are required by SEC regulations to furnish Harken with copies of all Section 16(a) forms they file. Based solely on its review of the copies of such forms and written representations from certain reporting persons, Harken believes that all filing requirements applicable to its Directors and Executive Officers have been complied with during 2001. 89 ITEM 11. EXECUTIVE COMPENSATION COMPENSATION OF DIRECTORS In 2001, each non-employee Director of Harken received an annual retainer of $20,000 plus $2,000 for attendance at each regular meeting. In addition, Directors serving on Committees received $4,000 for chairmanship and $1,000 per Committee meeting attended. Employee Directors do not receive any additional fees for meetings attended. COMPENSATION OF EXECUTIVE OFFICERS The following table sets forth certain information regarding the compensation paid during fiscal years 2001, 2000, and 1999 to Harken's Chief Executive Officer and Harken's four most highly compensated executive officers other than the Chief Executive Officer (the "named executive officers"). SUMMARY COMPENSATION TABLE
- ------------------------------------------------------------------------------------------------------------------------------------ Annual Compensation Long Term Compensation - ------------------------------------------------------------------------------------------------------------------------------------ Securities Underlying Name and Principal Fiscal Other Annual All Other Options/SARs Other Position Year Salary Bonus Compensation Compensation (#) Compensation - ------------------------------------------------------------------------------------------------------------------------------------ Mikel D. Faulkner 2001 $301,442(1) $ 2,414 $ 5,356(2) $ 2,983(3) -- -- Chairman and Chief 2000 $255,000 $25,000 $ 1,915(4) $ 10,858(5) 200,000 -- Executive Officer 1999 $264,808(6) $84,904 $ 2,616(4) $ 10,000(7) 73,000 -- - ------------------------------------------------------------------------------------------------------------------------------------ Bruce N. Huff 2001 $229,327(8) $31,013 $13,351(9) $ 2,983(3) -- -- President and Chief 2000 $213,750(10) $17,700 $39,112(11) $ 10,858(5) 95,000 -- Operating Officer 1999 $206,250(12) $55,000 $ 7,875(4) $ 60,725(13) 460,000 -- - ------------------------------------------------------------------------------------------------------------------------------------ Stephen C. Voss 2001 $223,269(14) $25,000 $22,800(15) $ 2,983(3) -- -- Vice Chairman 2000 $205,000 $10,347 $30,936(16) $ 10,858(5) -- -- 1999 $195,000 $55,000 $12,000(4) $ 10,000(7) 460,000 -- - ------------------------------------------------------------------------------------------------------------------------------------ James Denny 2001 $175,000 $ 521 $16,400(17) $ 2,970(18) -- -- Executive Vice President 2000 $151,442 $30,000 $ 3,000(4) $ 10,789(19) 60,000 -- 1999 -- -- -- -- -- -- - ------------------------------------------------------------------------------------------------------------------------------------ Guillermo Sanchez 2001 $189,909(20) $25,000 -- $ 3,654(21) -- -- President of Harken 2000 $176,640 -- -- $ 11,143(22) -- -- International, Ltd. 1999 $169,399(23) $11,500 -- $ 10,000(7) 160,000 -- - ------------------------------------------------------------------------------------------------------------------------------------
90 (1) Includes $16,442 for unused vacation time. (2) Includes $556 relating to use of company car and $4,800 club allowance. (3) Includes $2,625 of 401(k) matching and $358 in group term life premiums. (4) Relating to use of company car. (5) Includes $10,500 of 401(k) matching and $358 in group term life premiums. (6) Includes $9,808 for unused vacation time. (7) Relates to 401(k) matching. (8) Includes $4,327 for unused vacation time. (9) Includes $8,551 relating to use of company car and $4,800 club allowance. (10) Includes $3,750 for unused vacation time. (11) Includes $13,745 relating to use of a company car and debt forgiveness in the amount of $25,367. (12) Includes $11,250 for unused vacation time. (13) Includes $10,000 relating to 401(k) matching and $50,725 relating to relocation expenses. (14) Includes $8,269 for unused vacation time. (15) Includes $18,000 relating to use of company car and $4,800 club allowance. (16) Includes $15,716 relating to use of company car and debt forgiveness in the amount of $15,220. (17) Includes $11,600 relating to use of company car and $4,800 club allowance. (18) Includes $2,625 of 401(k) matching and $345 in group term life premiums. (19) Includes $10,500 of 401(k) matching and $289 in group term life premiums. (20) Includes $7,034 for unused vacation time. (21) Includes $2,625 of 401(k) matching and $1,029 in group term life premiums. (22) Includes $10,500 of 401(k) matching and $643 in group term life premiums. (23) Includes $6,394 for unused vacation time. OPTION/SAR GRANTS IN LAST FISCAL YEAR There were no grants of options nor stock appreciation rights made to any members of the Company's executive officers including the members of this reporting group during the last fiscal year. AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR END OPTION/SAR VALUES
- ----------------------------------------------------------------------------------------------------------------------------------- Value of Unexercised Number of Number of Securities Underlying In-The-Money Shares/SAR's Unexercised Options/SAR's at Option/SAR's at Acquired on Value Fiscal Year End Fiscal Year End (1) ==================================================================================================================================== Name Exercise Realized Exercisable Unexercisable Exercisable Unexercisable - ------------------------------------------------------------------------------------------------------------------------------------ Mikel D. Faulkner -- -- 349,375 195,250 $ -- $ -- - ------------------------------------------------------------------------------------------------------------------------------------ Bruce N. Huff -- -- 164,625 99,375 $ -- $ -- - ------------------------------------------------------------------------------------------------------------------------------------ Stephen C. Voss -- -- 158,625 84,375 $ -- $ -- - ------------------------------------------------------------------------------------------------------------------------------------ Jim Denny -- -- 17,500 47,500 $ -- $ -- - ------------------------------------------------------------------------------------------------------------------------------------ Guillermo Sanchez -- -- 78,000 18,000 $ -- $ -- - ------------------------------------------------------------------------------------------------------------------------------------
91 (1) The closing price for the Common Stock as reported on the American Stock Exchange as of December 31, 2001 was $1.23. Value was calculated on the basis of the difference between the option exercise price and such closing price multiplied by the number of shares of Common Stock underlying the option. REPORT ON CHIEF EXECUTIVE COMPENSATION The Board of Directors (the "Board"), sitting in lieu of a Compensation Committee as of December 31, 2001, develops and oversees Harken's compensation strategy. The strategy is implemented through policies designed to support the achievement of Harken's business objectives and the enhancement of stockholder value. The Board reviews the annual compensation package on an ongoing basis throughout the year. The Company's compensation policies and programs are designed to align the annual compensation with the annual and long-term performance of Harken and to maintain a significant portion of that total compensation at risk, tied primarily to the creation of stockholder value. The Board annually reviews and sets the base salary of the Chief Executive Officer ("CEO"). In establishing annual compensation for the CEO, the Board takes into consideration many factors in making a determination of aggregate compensation. Such factors during 2001 included: (i) the financial results of Harken during the prior year; (ii) the performance of the Common Stock in the public market; (iii) compensation of chief executive officers employed by companies comparable to Harken; (iv) the achievements of management in completing significant projects during the year; (v) Harken's performance during the past year as compared to its peer companies in this industry; (vi) the impact that the dramatic fluctuations in the prices of crude oil and natural gas have had on the Company during this past year; and (vii) management's dedication and commitment in support of Harken. The Board exercises its judgment based upon the above criteria and does not apply a specific formula or assign a weight to each factor considered. In setting the CEO's compensation for 2001, the Board took note of the fact that Harken achieved significant success in 2001 toward implementing its overall business strategy and accomplishing goals that had been set by the Board. Harken completed certain key objectives which enhanced Harken's domestic oil and gas reserve base and consolidated its areas of emphasis of operations in the domestic United States. No cash bonus, other than certain minor compensation allowance items, was granted to the CEO during 2001. The CEO's base salary was increased by $30,000 in 2001 compared to his base salary for 2000. Harken's long-term incentive compensation consists of Harken's Stock Option Plans. The Board views the granting of stock options and restricted stock awards as a significant method of aligning management's long-term interests with those of the stockholders. The Board encourages executives, individually and collectively, to maintain a long-term ownership position in Harken's Common Stock. The Board did not grant to the CEO any additional stock options during 2001. Federal Income Tax Considerations In 1993, the Internal Revenue Code was amended to place a $1.0 million cap on the deductibility on compensation paid to individual executives of publicly held corporations. The Board took this into account, however, upon review of the available regulations and interpretations, decided that it would not make the deductibility of Harken's compensation for federal income tax purposes a criterion to be used in establishing 92 compensation of the named executives during the present review cycle. The Board took into consideration the belief that the current compensation levels of the CEO, would not be subject to the cap. The Board continues to recognize that compensation should meet standards of reasonableness and necessity, which have been part of the Internal Revenue Code for many years. By: Mikel D. Faulkner Bruce N. Huff Stephen C. Voss Larry G. Akers Michael M. Ameen James H. Frizell Dr. J. William Petty H. A. Smith PERFORMANCE OF THE COMMON STOCK The table below compares the cumulative total stockholder return on the Common Stock for the last five fiscal years with the cumulative total return on the S&P 500 Index and the Dow Jones Secondary Oils Stock Index over the same period (assuming the investment of $100 in the Common Stock, the S&P 500 Index and the Dow Jones Secondary Oils Stock Index on December 31, 1996 and reinvestment of all dividends).
1996 1997 1998 1999 2000 2001 ---- ---- ---- ---- ---- ---- Harken Energy Corp. $100 $233 $ 67 $ 27 $ 11 $ 4 S&P 500 Index 100 105 71 89 126 121 Dow Jones Secondary Oils Stock Index 100 133 171 208 189 166
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Security Ownership of Certain Beneficial Owners As of March 27, 2002, the only person known by Harken to beneficially own five percent 5% or more of Harken common stock was: Name Shares Percent Ownership - ---- ------ ----------------- Michael B. Rohlfs, Attorney in Fact for Traco International N.V. 1,210,056 6.56% 93 Security Ownership of Directors and Management The following table sets forth information regarding the number of shares of Common Stock beneficially owned by each Director, each named executive officer, and all of Harken's Directors and executive officers as a group as of March 27, 2002.
Number of Shares ---------------- Name Beneficially Owned Percent of Class - ---- ------------------ ---------------- Michael M. Ameen, Jr. 22,100(1) (2) Larry G. Akers 3,500(3) (2) James Denny 20,500(4) (2) Mikel D. Faulkner 419,375(5) 2.27% James H. Frizell 18,000(2) Bruce N. Huff 167,125(6) (2) Dr. J. William Petty 9,750(7) (2) Guillermo Sanchez 9,751(8) (2) H. A. Smith 27,930(9) (2) Stephen C. Voss 159,625(10) (2) All Directors and Executive Officers as a group (16 persons) 925,833(11) 5.04%
(1) Includes 20,000 shares issuable within 60 days upon exercise of options issued by Harken. (2) Less than one percent (1%) (3) Includes 2,500 shares issuable within 60 days upon exercise of options issued by Harken. (4) Includes 17,500 shares issuable within 60 days upon exercise of options issued by Harken. (5) Includes 349,375 shares issuable within 60 days upon exercise of options issued by Harken. (6) Includes 164,625 shares issuable within 60 days upon exercise of options issued by Harken. (7) Includes 1,250 shares issuable within 60 days upon exercise of options issued by Harken. (8) Includes 7,800 shares issuable within 60 days upon exercise of options issued by Harken. (9) Includes 20,000 shares issuable within 60 days upon exercise of options issued by Harken. (10) Includes 158,625 shares issuable within 60 days upon exercise of options issued by Harken. (11) Includes 803,685 shares issuable within 60 days upon exercise of options issued by Harken. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS NONE. 94 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) The following documents are filed as a part of this report: (1) Financial Statements included in Part II of this report:
Page ---- Harken Energy Corporation and Subsidiaries -- Report of Independent Auditors............................................................ 43 -- Selected Financial Information and Other Data for the five years ended December 31, 2001........................................................................ 28 -- Consolidated Balance Sheets -- December 31, 2000 and 2001................................. 45 -- Consolidated Statements of Operations for the three years ended December 31, 2001 ....................................................................... 46 -- Consolidated Statements of Stockholders' Equity for the three years ended December 31, 2001........................................................................ 47 -- Consolidated Statements of Cash Flows for the three years ended December 31, 2001........................................................................ 48 -- Notes to Consolidated Financial Statements................................................ 49
(2) The information required by Schedule I is either provided in the related financial statements or in a note thereto, or is not applicable to the Company. The information required by all other Schedules is not applicable to the Company. (3) Exhibits 3.1 Certificate of Incorporation of Harken Energy Corporation as amended (filed as Exhibit 3.1 to Harken's Annual Report on Form 10-K for fiscal year ended December 31, 1989, File No. 0-9207, and incorporated by reference herein). 3.2 Amendment to Certificate of Incorporation of Harken Energy Corporation (filed as Exhibit 28.8 to the Registration Statement on Form S-1 of Tejas Power Corporation, file No. 33-37141, and incorporated by reference herein). 3.3 Amendment to the Certificate of Incorporation of Harken Energy Corporation (filed as Exhibit 3 to Harken's Quarterly Report on Form 10-Q for fiscal quarter ended March 31, 1991, File No. 0-9207, and incorporated by reference herein). 3.4 Amendments to the Certificate of Incorporation of Harken Energy Corporation (filed as Exhibit 3 to Harken's Quarterly Report on Form 10-Q for fiscal quarter ended June 30, 1991, File No. 0-9207, and incorporated by reference herein). 95 3.5 Amendments to the Certificate of Incorporation of Harken Energy Corporation (filed as Exhibit 3.5 to Harken's Annual Report on Form 10-K for the fiscal year ended December 31, 1996, File No. 0-9207, and incorporated herein by reference). 3.6 Amendment to the Certificate of Incorporation of Harken Energy Corporation (filed as Exhibit 3.6 to Harken's Annual Report on Form 10-K for the fiscal year ended December 31, 1997, File No. 0-9207, and incorporated by reference herein). 3.7 Amendment to the Certificate of Incorporation of Harken Energy Corporation (filed as Exhibit 3.6 to Harken's Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 1998, File No. 0-9207, and incorporated by reference herein). 3.8 Bylaws of Harken Energy Corporation, as amended (filed as Exhibit 3.2 to Harken's Annual Report on Form 10-K for fiscal year ended December 31, 1989, File No. 0-9207, and incorporated by reference herein). 4.1 Form of certificate representing shares of Harken common stock, par value $.01 per share (filed as Exhibit 1 to Harken's Registration Statement on Form 8-A, File No. 0-9207, and incorporated by reference herein). 4.2 Certificate of Designations, Powers, Preferences and Rights of Series A Cumulative Convertible Preferred Stock, $1.00 par value, of Harken Energy Corporation (filed as Exhibit 4.1 to Harken's Annual Report on Form 10-K for the fiscal year ended December 31, 1989, File No. 0-9207, and incorporated herein by reference). 4.3 Certificate of Designations, Powers, Preferences and Rights of Series B Cumulative Convertible Preferred Stock, $1.00 par value, of Harken Energy Corporation (filed as Exhibit 4.2 to Harken's Annual Report on Form 10-K for the fiscal year ended December 31, 1989, File No. 0-9207, and incorporated by reference herein). 4.4 Certificate of the Designations, Powers, Preferences and Rights of Series C Cumulative Convertible Preferred Stock, $1.00 par value of Harken Energy Corporation (filed as Exhibit 4.3 to Harken's Annual Report on Form 10-K for fiscal year ended December 31, 1989, File No. 0-9207, and incorporated by reference herein). 4.5 Certificate of the Designations of Series D Preferred Stock, $1.00 par value of Harken Energy Corporation (filed as Exhibit 4.3 to Harken's Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 1995, File No. 0-9207, and incorporated by reference herein). 4.6 Rights Agreement, dated as of April 6, 1998, by and between Harken Energy Corporation and ChaseMellon Shareholder Services L.L.C., as Rights Agent (filed as Exhibit 4 to Harken's Current Report on Form 8-K dated April 7, 1998, file No. 0-9207, and incorporated by reference herein). 4.7 Certificate of Designations of Series E Junior Participating Preferred Stock (filed as Exhibit B to Exhibit 4 to Harken's Current Report on Form 8-K dated April 7, 1998, file No. 0-9207, and incorporated by reference herein). 96 4.8 Certificate of Designations, Preferences and Rights of Series F Convertible Preferred Stock (filed as Exhibit 4.8 to Harken's Quarterly Report on Form 10-Q for the period ended June 30, 1998, File No. 0-9207, and incorporated by reference herein). 4.9 Certificate of Designations of Series G1 Convertible Preferred Stock (filed as Exhibit 4.9 to Harken's Annual Report on Form 10-K for fiscal year ended December 31, 2000, File No. 09207, and incorporated by reference herein). *4.10 Certificate of Designations of Series G2 Convertible Preferred Stock. 10.1 Seventh Amendment and Restatement of Harken's Amended Stock Option Plan (filed as Exhibit 10.1 to Harken's Annual Report on Form 10-K for the fiscal year ended December 31, 1991, File No. 0-9207, and incorporated by reference herein). 10.2 Amended and Restated Non-Qualified Incentive Stock Option Plan of Harken adopted by Harken's stockholders on February 18, 1991 (filed as Exhibit 10.2 to Harken's Annual Report on Form 10-K for the fiscal year ended December 31, 1991, File No. 0-9207, and incorporated by reference herein). 10.3 Form of Advancement Agreement dated September 13, 1990, between Harken and each director of Harken (filed as Exhibit 10.38 to Harken's Annual Report on Form 10-K for the fiscal year ended December 31, 1989, File No. 0-9207, and incorporated by reference herein). 10.4 Harken Energy Corporation's 1993 Stock Option and Restricted Stock Plan (filed as Exhibit 4.3 to Harken's Registration Statement on Form S-8, and incorporated by reference herein). 10.5 Harken Energy Corporation's Directors Stock Option Plan (filed as Exhibit 4.3 to Harken's Registration Statement on Form S-8, and incorporated herein by reference). 10.6 Association Contract (Bolivar) by and between Harken de Colombia, Ltd. and Empresa Colombia de Petroleos (filed as Exhibit 10.4 to Harken's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1996, and incorporated herein by reference). 10.7 Harken Energy Corporation 1996 Incentive and Nonstatutory Stock Option Plan (filed as Exhibit 10.1 to Harken's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1996, and incorporated herein by reference). 10.8 Association Contract (Alcaravan) dated as of December 13, 1992, but effective as of February 13, 1993, by and between Empresa Colombia de Petroleos (filed as Exhibit 10.1 to Harken's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, File No. 0-9207, and incorporated herein by reference). 10.9 Association Contract (Bocachico) dated as of January 1994, but effective as of April 1994, by and between Harken de Colombia, Ltd. and Empresa Colombia de Petroleos (filed as Exhibit 10.1 to Harken's Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1994, File No. 0-9207, and incorporated herein by reference). 97 10.10 Trust Indenture dated June 11, 1997, by and between Harken and Marine Midland Bank plc (filed as Exhibit 10.1 to Harken's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1997, File No. 0-9207, and incorporated herein by reference). 10.11 Placing Agreement Dated June 3, 1997, by and among Harken and the other signatories thereto (filed as Exhibit 10.2 to Harken's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1997, File No. 0-9207, and incorporated herein by reference). 10.12 Credit Agreement between Harken Exploration Company, XPLOR Energy, Inc. Harken Energy West Texas, Inc. , Harken Southwest Corporation, South Coast Exploration Co., Xplor Energy SPV-1, Inc., McCulloch Energy, Inc. and Bank One, Texas, N.A. dated August 11, 2000 and as amended December 21, 2000 and December 31, 2000 (filed as Exhibit 10.20 to Harken's Annual Report on Form 10-K for fiscal year ended December 31, 2000, File No 0-9207, and incorporated by reference herein). 10.13 Third Amendment to Credit Agreement between Harken Exploration Company, XPLOR Energy, Inc., Harken Energy West Texas, Inc., South Coast Exploration Co., XPLOR Energy SPV-1, Inc., McCulloch Energy, Inc., Harken Gulf Exploration Company, and Bank One, N.A. dated May 11, 2001 (Filed as Exhibit 10.13 to Harken's Quarterly Report on Form 10-Q for the quarter ended June 30, 2001, File No. 0-9207, and incorporated herein by reference). *10.14 Association Contract (Cajaro) dated as of December 2001, but effective as of February 2002, by and between Harken de Colombia, Ltd. and Empresa Colombia de Petroleos. *10.15 Purchase and Sale Agreement dated January 31, 2002 between Republic Resources, Inc. and Harken Energy Corporation. 10.16 Letter from Arthur Andersen LLP pursuant to Item 304(a)(3) of Regulation S-K (filed as Exhibit 16.1 in Harken's current report on Form 8-K, filed on September 5, 2001, File No. 0-9207, and incorporated by reference herein). *21 Subsidiaries of Harken. *23 Consents of Independent Public Accountants and Independent Reserve Engineers. *24 Power of Attorney. * Filed herewith (b) Reports on Form 8-K NONE. 98 SIGNATURES Pursuant to the requirements of the Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Houston, State of Texas, on March 29, 2002. HARKEN ENERGY CORPORATION * _______________________________ Mikel D. Faulkner, Chairman of the Board of Directors and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Signature Title Date --------- ----- ---- * Chairman of the Board of Directors - ------------------------ and Chief Executive Officer Mikel D. Faulkner (Principal Executive Officer) March 29, 2002 * President, Chief Operating Officer - ------------------------ and Director Bruce N. Huff March 29, 2002 * Vice Chairman and Director March 29, 2002 - ------------------------ Stephen C. Voss * Director March 29, 2002 - ------------------------ Larry G. Akers * Director March 29, 2002 - ------------------------ Michael M. Ameen, Jr. 99 * Director March 29, 2002 - ------------------------ James H. Frizell * Director March 29, 2002 - ------------------------ Dr. J. William Petty * Director March 29, 2002 - ------------------------ Hobart A. Smith *Anna M. Williams by signing her name hereto, does hereby sign this Annual Report on Form 10-K for the year ended December 31, 2001 on behalf of Harken Energy Corporation and each of the above-named officers and directors of such Company pursuant to powers of attorney, executed on behalf of the Company and each officer and director. /s/ Anna M. Williams - -------------------- Anna M. Williams Attorney-in-Fact 100 EX-4.10 3 dex410.txt G2 CERTIFICATE Exhibit 4.10 CERTIFICATE OF DESIGNATIONS OF SERIES G2 CONVERTIBLE PREFERRED STOCK OF HARKEN ENERGY CORPORATION Harken Energy Corporation, a Delaware corporation, DOES HEREBY CERTIFY: That, pursuant to the authority conferred upon the Board of Directors of said corporation by virtue of its certificate of incorporation as amended and in accordance with Section 151 of the General Corporation Law of the State of Delaware (the "DGCL"), said Board of Directors has duly adopted a resolution at a special meeting of the Board of Directors held on May 30, 2001, providing for the issuance of a series of preferred stock, par value $1.00 per share, designated as Series G2 Convertible Preferred Stock, which resolution reads as follows: "RESOLVED, that the Board of Directors (the "Board of Directors") of Harken Energy Corporation (the "Corporation") hereby authorizes the issuance of a series of preferred stock and fixes its designation, powers, preferences and relative, participating, optional or other special rights, and qualifications, limitations and restrictions thereof, as follows: Section 1. Designation. The distinctive serial designation of said series ---------------------- shall be "Series G2 Convertible Preferred Stock" (hereinafter called "Series G2 Preferred Stock"). Each share of Series G2 Preferred Stock shall be identical in all respects with all other shares of Series G2 Preferred Stock. Section 2. Number of Shares. The number of authorized shares of Series G2 --------------------------- Preferred Stock shall be, in aggregate, 100,000 shares. The number of authorized shares of Series G2 Preferred Stock may be increased or reduced by the Board of Directors of the Corporation by the filing of a certificate pursuant to the provisions of the DGCL stating that the change has been so authorized. When shares of Series G2 Preferred Stock are purchased or otherwise acquired by the Corporation or converted into Common Stock, par value $0.01 per share, of the Corporation (the "Common Stock"), the Corporation shall take all necessary action to cause the shares of Series G2 Preferred Stock so purchased or acquired to be canceled and reverted to authorized but unissued shares of Series G2 Preferred Stock undesignated as to series. Section 3. Rank. The Series G2 Preferred Stock shall, with respect to --------------- dividend rights and rights on liquidation, winding-up and dissolution, rank (i) junior to all claims of creditors, including holders of the Corporation's outstanding debt securities, (ii) junior to all obligations of the Corporation's Subsidiaries (as defined in Section 13 below), (iii) senior to all classes of Common Stock and to each other class of preferred stock established hereafter by the Board of Directors of the Corporation, the terms of which expressly provide that it ranks junior to the Series G2 Preferred Stock as to dividend rights and rights on liquidation, winding-up and dissolution of the Corporation (collectively referred to, together with all classes of Common Stock of the Corporation, as "Junior Stock"), and (iv) on a parity with each other class of preferred stock established or issued hereafter by the Board of Directors of the Corporation the terms of which expressly provide that such class or series shall rank on a parity with the Series G2 Preferred Stock as to dividend rights and rights on liquidation, winding-up and dissolution (collectively referred to as "Parity Stock"). The Corporation may authorize the issuance of any amount of Parity Stock (which may provide for the payment of dividends in additional shares of Parity Stock in lieu of cash dividends) without the approval of the holders of the Series G2 Preferred Stock. The Series G2 Preferred Stock shall rank as Parity Stock to the Series G1 Preferred Stock, previously authorized by the Board. Section 4. Dividends. --------------------- (a) The holders of record, as of the Record Date therefor, of the outstanding shares of Series G2 Preferred Stock shall be entitled to receive, when, as and if declared by the Board of Directors of the Corporation, out of funds legally available therefor, dividends on the Series G2 Preferred Stock at an annual rate equal to $8.00 per share (equivalent to 8% of the liquidation preference annually), payable semi-annually in arrears in cash or, at the option of the Corporation, in Freely Tradeable shares of the Corporation's Common Stock. If and when the Corporation shall elect from time to time to pay such dividends in shares of Common Stock, such shares will be valued at $3.00 per share; provided, however, that the Corporation may elect to pay such dividends in shares of the Corporation's Common Stock only if such shares of Common Stock would upon issuance be Freely Tradeable (as defined in Section 13 below) by the Corporation; and, provided further, that (i) if the outstanding shares of Common Stock shall be subdivided into a greater number of shares of Common Stock, such $3.00 per share valuation shall be proportionately reduced on the day upon which such subdivision becomes effective, and (ii) if the outstanding shares of Common Stock shall be combined into a smaller number of shares of Common Stock, such $3.00 per share valuation shall be proportionately increased on the day such combination becomes effective. In case the Corporation shall take any action affecting the Common Stock, other than the aforementioned adjustments, which in the Board of Directors would materially adversely affect the conversion right of the holders of the shares of Series G2 Preferred Stock, such $3.00 valuation may be adjusted, to the extent permitted by law, in such manner, if any, and at such time, as the Board of Directors may determine to be equitable in the circumstances; provided, however, that in no event shall the Board of Directors be required to take such action. (b) All dividends shall be cumulative, whether or not earned or declared, and shall accrue from the date of issuance of the Series G2 Preferred Stock and shall be payable semi-annually in arrears, when, as and if declared by the Board of Directors. Such dividends will be payable on December 30 and June 30 of each year (a "Dividend Payment Date"), commencing on December 31, 2001; provided, however, that if a Dividend Payment Date is not a Stock Exchange Business Day, then the dividend shall be payable on the first immediately succeeding Stock Exchange Business Day. Dividends shall be paid to the holders of record of the Series G2 preferred Stock as their names appear on the stock transfer records of the Corporation on the date designated by the Board of Directors ("Record Date"), provided, however, that such Record Date may not precede the date upon which the resolution fixing the Record Date is adopted, and which Record Date may not be more than sixty (60) days prior to the Dividend Payment Date. The amount of the dividends payable on the Series G2 Preferred Stock for each semi-annual dividend period shall be computed by dividing by two (2) the annual rate per share set forth in subsection (a) above. Dividends shall be computed on the basis of a 360-day year of twelve 30-day months. (c) No dividends may be declared or paid or funds set apart for the payment of dividends on any Parity Stock for any period unless full cumulative dividends shall have been or contemporaneously are declared and paid in full or declared and a sum in cash or shares of Common Stock sufficient for such payment set apart for such payment on the Series G2 Preferred Stock except in the event of the conversion of any such Parity Stock into Common Stock. If full dividends are not so paid, the Series G2 Preferred Stock shall share dividends pro rata with the Parity Stock. No dividends may be paid or set apart for such payment on Junior Stock (except dividends on Junior Stock payable in additional shares of Junior Stock) and no Junior Stock or Parity Stock may be repurchased or otherwise retired for value nor may funds be set apart for payment with respect thereto, if cumulative dividends have not been paid in full on the Series G2 Preferred Stock in cash or shares of Common Stock; provided, however, that the Corporation may repurchase Junior Stock (i) in the open market from time to time as and to the fullest extent permitted by Rule 10b-18 promulgated under the Securities Exchange Act of 1934, as amended (240 C.F.R. Section. 10b-18), or corresponding rule from time to time in effect, and (ii) in a private purchase or in an "issuer tender offer" as defined in Rule 13e-4 under the Exchange Act from time to time so long as such repurchases do not exceed ten percent (10%) of the then outstanding shares of Junior Stock. Dividends on account of arrears for any past dividend period may be declared and paid at any time without reference to any regular Dividend Payment Date, to holders of record on a date not more than forty-five (45) calendar days prior to the payment thereof, as may be fixed by the Board of Directors of the Corporation. No interest shall be payable with respect to any dividend payment that may be in arrears. Except as provided above, so long as any shares of the Series G2 Preferred Stock are outstanding, the Corporation shall not make payment on account of the purchase or other retirement of any Parity Stock or Junior Stock, and shall not permit any corporation or other entity directly or indirectly controlled by the Corporation to purchase any Parity Stock, Junior Stock or any warrants, rights, calls or options unless full cumulative dividends determined to be in accordance herewith on the Series G2 Preferred Stock have been paid (or are deemed paid) in full. (d) All dividends payable on the Series G2 Preferred Stock shall be paid net of withholding tax, if any, under all applicable laws (including applicable income tax treaties). The Corporation will, subject to certain exceptions and limitations set forth below, pay, as additional dividends, such additional amounts (the "Additional Amounts") to the holder of any Series G2 Preferred Stock as may be necessary in order that every net payment of the principal or dividends on such Series G2 Preferred Stock, after withholding for or on account of any present or future tax, duty, assessment or governmental charge imposed or levied upon or as a result of such payment by or on behalf of the United States (or any political subdivision, authority or agency thereof or therein having the power to tax) (collectively, "Taxes"), will not be less than the amount such holder would have received if such Taxes had not been withheld, provided that no Additional Amounts will be payable with respect to a payment which is subject to such Taxes by reason of such holder being 2 connected with the United States (or any political subdivision thereof) otherwise than by the mere holding of the Series G2 Preferred Stock or the receipt of payments made under or with respect to the Series G2 Preferred Stock. In addition, the Corporation will indemnify and hold harmless each holder of the Series G2 Preferred Stock (subject to the exclusion set forth above) and will, upon written request of each holder (subject to the exclusion set forth above), and provided that reasonable supporting documentation is provided, reimburse each other holder for the amount of any Taxes levied or imposed by the United States and paid by or on behalf of the holder as a result of payments made under or with respect to the Series G2 Preferred Stock. Any payment made pursuant to this paragraph shall be considered and Additional Amount. If the Corporation becomes generally subject at any time to any taxing jurisdiction other than or in addition to the United States, references in this Certificate of Designations to the United States shall be read and construed as reference to the United States and/or such other jurisdiction. Section 5. Preference on Liquidation. ------------------------------------- (a) Upon any voluntary or involuntary liquidation, dissolution or winding-up of the Corporation, holders of Series G2 Preferred Stock shall be entitled to be paid, out of the assets of the Corporation available for distribution to stockholders, the liquidation preference of $100.00 per share of Series G2 Preferred Stock, plus, without duplication, an amount in cash equal to all accrued and unpaid dividends thereon to the date fixed for liquidation, dissolution or winding-up (including an amount equal to a prorated dividend for the period from the last Dividend Payment Date, or if such event is prior to the first Dividend Payment Date, from the Closing Date, to the date fixed for liquidation, dissolution or winding-up), before any distribution is made on any Junior Stock, including, without limitation, any class of common stock of the Corporation. (b) If, upon any voluntary or involuntary liquidation, dissolution or winding-up of the Corporation, the amounts payable with respect to the Series G2 Preferred Stock and all Parity Stock are not paid in full, then the assets of the Corporation available for distribution among the holders of the Series G2 Preferred Stock and any Parity Stock shall bear to each other the same ratio that the full amounts payable on liquidation, dissolution or winding-up of the Corporation to the holders of shares of Series G2 Preferred Stock and any Parity Stock bear to each other. (c) After payment of the full amount of the liquidation preference and accumulated and unpaid dividends to which they are entitled, the holders of shares of Series G2 Preferred Stock shall not be entitled to any further participation in any distribution of assets of the Corporation. (d) Neither the sale, conveyance, exchange or transfer (for cash, shares of stock, securities or other consolidation) of all or substantially all of the property or assets of the Corporation nor the consolidation or merger of the Corporation with one or more entities shall be deemed to be or constitute a liquidation, dissolution or winding-up of the Corporation. (e) Notice of any payment to the holders of Series G2 Preferred Stock as a result of the liquidation, dissolution or winding-up of the Corporation, stating the payment date or dates when and the place or places where the amounts distributable in such circumstances shall be payable, shall be given not more than sixty (60) but not less than thirty (30) days prior to any payment date stated therein, to the holders of shares of Series G2 Preferred Stock as provided in Section 11 herein. Section 6. Voting. The holders of Series G2 Preferred Stock shall have no ----------------- voting rights except as required by law. In exercising any voting rights, each outstanding share of Series G2 Preferred Stock shall be entitled to one vote. 3 Section 7. Holder Conversion Rights. ------------------------------------ (a) Each holder of shares of Series G2 Preferred Stock shall have the right ("Conversion Right"), subject as provided herein and to any applicable laws and regulations, at any time and from time to time at the holder's option to convert each share of Series G2 Preferred Stock into shares of Common Stock at the conversion price (subject to adjustment as described in Section 8 below) of $3.00 per share of underlying Common Stock (the "Conversion Price") for each $100.00 liquidation value per share of Series G2 Preferred Stock plus the amount of any accrued and unpaid dividends (whether or not earned or declared) on the Series G2 Preferred Stock delivered for conversion as specified herein (including an amount equal to a prorated dividend from the immediately preceding Dividend Payment Date to the date of such conversion, or, if such conversion is prior to the first Dividend Payment Date, from the Closing Date to the date of such conversion); provided, however, that the Corporation may, at its sole discretion, pay any or all of such accrued and unpaid dividends in cash. Subject to the provisions of the DGCL, no fractional shares of Common Stock shall be issued upon conversions, but the number of shares shall be rounded up or down to the nearest whole number. (b) If the Corporation elects to pay any accrued and unpaid dividends in cash, the amount of any such accrued and unpaid dividends shall be promptly sent to the holder thereof by means of check or other means provided by the Corporation after the receipt of the notice and funds, if any, referred to in Sections 7(d) and 7(e) below. (c) As promptly as practicable after the surrender of certificates for shares of the Series G2 Preferred Stock for conversion and the receipt of the notice and funds, if any, as described in Sections 7(d) and 7(e) below, the Corporation shall issue and shall deliver to such holder, or on such holder's written order, a certificate or certificates for the number of shares of Common Stock issuable upon the conversion of such shares of the Series G2 Preferred Stock in accordance with the provisions of this Section 7, together with certificates representing the number of shares of Common Stock in payment of any accrued but unpaid dividends if the Corporation elects to pay such dividends in Common Stock. Each conversion with respect to such shares of the Series G2 Preferred Stock shall be deemed to have been effected immediately prior to the close of business on the date on which the certificates for shares of the Series G2 Preferred Stock shall have been surrendered and such notice shall have been received by the Corporation as aforesaid, and the Person or Persons entitled to receive the Common Stock issuable upon such conversion shall be deemed for all purposes to be the record holder or holders of such Common Stock upon that date. (d) In order to exercise the conversion right, the holder of each share of Series G2 Preferred Stock to be converted shall surrender that certificate representing such shares, duly endorsed or assigned to the Corporation or in blank, at the office of the transfer agent for the Series G2 Preferred Stock and shall give written notice to the Corporation in the form of Exhibit A attached --------- hereto. Such notice shall also state the name or names (with address) in which the shares of Common Stock that shall be issuable upon such conversion shall be issued. Each share surrendered for conversion shall, unless the shares issuable on conversion are to be issued in the same name as the name in which such shares of the Series G2 Preferred Stock is registered, be duly endorsed by, or accompanied by, instruments of transfer (in each case, in form reasonably satisfactory to the Corporation), duly executed by the holder or such holder's duly authorized attorney-in-fact. (e) If a holder converts shares of the Series G2 Preferred Stock, the Corporation shall pay any and all documentary, stamp or similar issue or transfer tax payable in respect of the issue or delivery of the shares of the Series G2 Preferred Stock (or any other securities issued on account thereof pursuant hereto) or Common Stock upon the conversion; provided, however, the Corporation shall not be required to pay any such tax that may be payable because any such shares are issued at the request of the holder in a name other than the name of the holder. In the event that the shares are to be issued in a name other than that of the holder, the holder shall provide funds necessary to pay any and all of the foregoing taxes, if any shall be applicable. (f) The Corporation shall reserve out of its authorized but unissued Common Stock or its Common Stock held in treasury enough shares of Common Stock to permit the conversion of all of the outstanding shares of the Series G2 Preferred Stock, but in no event shall the Corporation be required to reserve sufficient shares of Common Stock to permit the conversion of any accrued and unpaid dividends on the Series G2 Preferred Stock. The Corporation shall from time to time, in accordance with the DGCL, increase the authorized amount of its Common Stock if at any time the authorized amount of its Common Stock remaining unissued shall not be sufficient to permit the conversion of all shares 4 of the Series G2 Preferred Stock at the time outstanding. If any shares of Common Stock required to be reserved for issuance upon conversion of shares of the Series G2 Preferred Stock hereunder require registration with or approval of any governmental authority under any federal or state law before the shares may be issued upon conversion, the Corporation shall in good faith and as expeditiously as possible endeavor to cause the shares to be so registered or approved. All shares of Common Stock delivered upon conversion of the shares of the Series G2 Preferred Stock will, upon delivery, be duly authorized and validly issued, fully paid and nonassessable, free from all taxes, liens and charges with respect to the issue thereof. Section 8. Conversion Price Adjustments. ---------------------------------------- (a) Subdivision of Common Stock. In case outstanding shares of Common Stock --------------------------- shall be subdivided into a greater number of shares of Common Stock, the Conversion Price in effect at the opening of business on the day following the day upon which such subdivision becomes effective shall be proportionately reduced, and, conversely, in case outstanding shares of Common Stock shall each be combined into a smaller number of shares of Common Stock, the Conversion Price in effect at the opening of business on the day following the day upon which such combination becomes effective shall be proportionately increased, such reduction or increase, as the case may be, to become effective immediately after the opening of business on the day following the day upon which such subdivision or combination becomes effective. (b) Certificate of Adjustment and Notice. Whenever the Conversion Price is ------------------------------------ adjusted as herein provided, the Corporation shall promptly file with the transfer agent for the Series G2 Preferred Stock a certificate of an officer of the Corporation setting forth the Conversion Price after the adjustment and setting forth a brief statement of the facts requiring such adjustment and a computation thereof. The Corporation shall promptly cause a notice of the adjusted Conversion Price be given to the holders of shares of the Series G2 Preferred Stock as provided in Section 11 herein. (c) Adjustment in Conversion Price in Case of Certain Events. In case the -------------------------------------------------------- Corporation shall take any action affecting the Common Stock, other than actions described in Section 7 or this Section 8, which in the opinion of the Board of Directors would materially adversely affect the conversion right of the holders of the shares of the Series G2 Preferred Stock, the Conversion Price may be adjusted, to the extent permitted by law, in such manner, if any, and at such time, as the Board of Directors may determine to be equitable in the circumstances; provided, however, that in no event shall the Board of Directors be required to take any such action. (d) Registration of Conversion Shares. Following receipt by the Corporation --------------------------------- of the first notice of conversion from a holder of Series G2 Preferred Stock, the Corporation shall file a registration statement on Form S-3 (or such other form as the Corporation may determine is appropriate) with respect to all the Common Stock that may be issuable at any time upon the conversion or redemption of any of the Series G2 Preferred Stock ("Conversion Shares") at the earliest practicable date, but in any event prior to 90 days following the receipt by the Corporation of the first notice of conversion from a holder of Series G2 Preferred Stock. The Corporation shall use its best efforts to cause the Commission to declare such registration statement (and any necessary amendments thereto) effective. The Corporation shall also use its best efforts to maintain the effectiveness of such registration statement, and to refile such a registration statement from time to time in the event its effectiveness lapses, until all Conversion Shares either issued or that may be issued are Freely Tradeable (as defined in Section 13 below) in the United States. Section 9. Mandatory Conversion by Corporation. ----------------------------------------------- (a) At any time after the earlier of (i) the registration statement referred to in subsection (d) above has been declared effective, or (ii) the Conversion Shares are Freely Tradeable, the Corporation may, at its option, cause all of the outstanding Series G2 Preferred Stock to be converted into shares of Common Stock, in accordance with Section 9(b), at any time and from time to time, if the average of the Market Prices of the Common Stock over the Stock Exchange Business Days in any twenty (20) consecutive calendar day period ending not more than five (5) days prior to the giving of the notice referred to below equaled or exceeded $3.75. Notwithstanding the preceding, if the outstanding shares of Common Stock shall be subdivided into a greater number of shares of Common Stock or if the outstanding shares of Common Stock shall be combined into a smaller 5 number of shares of Common Stock, such $3.75 amount shall be proportionately adjusted on the day such combination becomes effective. In case the Corporation shall take any action affecting the Common Stock, other than the aforementioned adjustments, which in the Board of Directors would materially adversely affect the conversion right of the holders of the shares of Series G2 Preferred Stock, such $3.75 valuation may be adjusted, to the extent permitted by law, in such manner, if any, and at such time, as the Board of Directors may determine to be equitable in the circumstances; provided, however, that in no event shall the Board of Directors be required to take such action. (b) Each share of Series G2 Preferred Stock shall be converted into a number of shares of Common Stock equal to: (x) each $100.00 liquidation value per share of Series G2 Preferred Stock plus the amount of any accrued and unpaid dividends (whether or not earned or declared) on the Series G2 Preferred Stock (including an amount equal to a prorated dividend from the immediately preceding Dividend Payment Date, or if such conversion is prior to the first Dividend Payment Date, from the Closing Date, to the date of such conversion) divided by (y) the Conversion Price. Notwithstanding the preceding, the Corporation may, at its sole discretion, pay any or all of the accrued and unpaid dividends in cash. Subject to the provisions of the DGCL, no fractional shares of Common Stock shall be issued the optional conversion, but the number of shares shall be rounded up or down to the nearest whole number. The amount of any accrued and unpaid dividends that the Corporation elects to pay in cash shall be promptly sent to the holder thereof by means of check or other means provided by the Corporation. (c) The Corporation shall give thirty (30) days notice as provided in Section 11 hereof of its intent to convert in accordance with this Section 9 no later than thirty (30) calendar days from the end of the twenty (20) day period described above. Upon the giving of the notice referred to above, the Corporation shall be bound to convert the Series G2 Preferred Stock as to which notice has been provided. During the 30 day notice period, holders of the Series G2 Preferred Stock will retain their right to convert their shares of Series G2 Preferred Stock in accordance with Section 7 above. Section 10. Optional Redemption by Corporation. ----------------------------------------------- (a) Optional Redemption. In addition to its right to redeem the Series G2 Preferred Stock as provided in Section 9 above, the Corporation shall have the option to redeem the Series G2 Preferred Stock in whole or in part in cash at any time, and from time to time, unless the holder thereof shall have converted such stock into Common Stock pursuant to Section 7 prior to the date of redemption hereof, at a redemption price ("Redemption Price") equal to (i) $100.00 per share and (ii) accrued and unpaid dividends (whether or not declared), such dividends being payable in cash or Freely Tradeable Common Stock (including an amount equal to a prorated dividend from the immediately preceding Dividend Payment Date, or if such conversion is prior to the first Dividend Payment Date, from the Closing Date, to the redemption date). (b) Procedures for Redemption. ------------------------- (i) In case of redemption of less than all shares of Series G2 Preferred Stock at the time outstanding, the shares to be redeemed shall be selected pro rata, at random, or by lot or a method that complies with the requirements of any national stock exchange on which Series G2 Preferred Stock is listed as determined by the Board of Directors in its sole discretion. (ii) Notice of any redemption shall be given as provided in Section 11 by or on behalf of the Corporation not more less than thirty (30) days prior to the date of redemption hereof; provided, however, that such notice of redemption may be a conditional notice of redemption which may condition the redemption upon making the redemption subject to the prior conversion of the Series G2 Preferred Stock before the redemption date; and provided further, that no failure to give such notice or any defect therein or in the transmission or mailing thereof shall affect the validity of the proceedings for the redemption of any shares of Series G2 Preferred Stock except as to the holder to whom the Corporation has failed to give notice or except as to the holder to whom notice was defective. In addition to any information required by law, such notice shall state: such redemption is being made pursuant to the optional redemption provisions hereof; the date of redemption; the Redemption Price; 6 the number of shares of Series G2 Preferred Stock to be redeemed and, if less than all shares held by such holder are to be redeemed; the number of such shares to be redeemed; the place or places where certificates for such issued shares are to be surrendered for payment of the Redemption Price; and that dividends on the shares to be redeemed shall cease to accrue on the date of redemption. Upon the expiry of the notice so given, except with respect to the conditions specified above, the Corporation shall become obligated to redeem at the time of redemption specified thereon all shares called for redemption. (iii) If notice has been given in accordance with Section 10(b)(ii) above and provided that on or before the date of redemption specified in such notice, all funds necessary for such redemption shall have been set aside by the Corporation, separate and apart from its other funds in trust for the pro rata benefit of the holders of the shares so called for redemption, so as to be, and to continue to be available therefor, then, from and after the date of redemption, dividends on the shares of the Series G2 Preferred Stock so called for redemption shall cease to accrue, and said shares shall no longer be deemed to be outstanding and shall not have the status of shares of Series G2 Preferred Stock, and all rights of the holders thereof as shareholders of the Corporation (except the right to receive from the Corporation the Redemption Price) shall cease. Upon surrender, in accordance with said notice, of the certificates for any issued shares so redeemed (properly endorsed or assigned for transfer, if the Corporation shall so require and the notice shall so state), such shares shall be redeemed by the Corporation at the Redemption Price by mailing a check to such holder's last registered address listed on the stock transfer records of the Corporation, or as otherwise agreed by the holders of Series G2 Preferred Stock and the Corporation. In case fewer than all the shares represented by any such certificate are redeemed, a new certificate or certificates shall be issued representing the unredeemed shares without cost to the holder thereof. (iv) Any funds deposited with a bank or trust corporation for the purpose of redeeming Series G2 Preferred Stock shall be irrevocable except that: the Corporation shall be entitled to receive from such bank or trust company the interest or other earnings, if any, earned on any money so deposited in trust, and the holders of any shares redeemed shall have no claim to such interest or other earnings; and any balance of monies so deposited by the Corporation and unclaimed by the holders of the Series G2 Preferred Stock entitled thereto at the expiration of two years from the applicable date of redemption shall be repaid, together with any interest or other earnings earned thereon, to the Corporation, and after any such repayment, the holders of the shares entitled to the funds so repaid to the Corporation shall look only to the Corporation for payment without interest or other earnings. (v) No Series G2 Preferred Stock may be redeemed except with funds legally available for the payment of the Redemption Price. (vi) Holders of Series G2 Preferred Stock shall retain the conversion rights described in Section 7 hereof until the date of any redemption of the shares of Series G2 Preferred Stock in accordance with this Section 10. (c) Redemption by Conversion. In addition to the rights of conversion ------------------------ pursuant to Section 9 hereof, on or after June 1, 2004, the Corporation may further elect, in any six (6) month period, to redeem up to 50% of the outstanding Series G2 Preferred Stock in accordance with this Section 10(c) by requiring their redemption on thirty (30) days notice pursuant to the terms of this Section 10(c) (the "Redemption by Conversion Option"). The redemption price for purposes of this Section 10(c) shall be equal to the average Market Price of the Common Stock during the twenty (20) consecutive Stock Exchange Business Days ending not more than five (5) Stock Exchange Business days prior to the date notice is given by the Corporation concerning its exercise of this Redemption by Conversion Option, subject to appropriate adjustments to account for the effects of dividends, distributions, stock splits, recapitalizations and similar events. If the Market Capitalization of the Corporation is less than $300 million on the date the notice by the Corporation of its exercise of this Redemption by Conversion Option is given, then each share of Series G2 Preferred Stock will be redeemed for the number of shares of Common Stock equal to 110% of the $100.00 liquidation value per share (the "Redemption Value") divided by the redemption price. If the Market Capitalization of the Corporation is $300 million 7 or more on the date the notice by the Corporation of its exercise of this Redemption by Conversion Option is given, then each share of Series G2 Preferred Stock will be redeemed for the number of shares of Common Stock equal to 105% of the Redemption Value divided by the redemption price. The amount of the accrued and unpaid dividends (whether or not earned or declared) accrued by the Series G2 Preferred Stock delivered for redemption as specified above (computed to the end of the day the Series G2 Preferred Stock is so redeemed) shall be sent to the holder thereof by means of check or other means established by the Corporation, if the dividend is in cash, or if the dividend is in shares of Common Stock, each as determined by the Corporation, by such means as selected by the Corporation. All Common Stock issued pursuant to the Redemption by Conversion Option shall be Freely Tradeable. Section 11. Notice. Where this Certificate of Designations provides for ------------------ notice of any event to the holders of the Series G2 Preferred Stock by the Corporation or any other Person, such notice shall be sufficiently given (unless otherwise herein specifically provided) if published in the Authorized Newspapers. Section 12. General Provisions Relating to the Series G2 Preferred Stock. ------------------------------------------------------------------------- (a) Form. The Series G2 Preferred Stock shall be issued in fully registered ---- form in the form satisfactory to the Corporation. (b) Compliance with United States Securities Laws. Nothing contained herein --------------------------------------------- shall be deemed to authorize any transfers of certificates of the Series G2 Preferred Stock otherwise than in accordance with the Securities Act. Neither the Corporation or its transfer agent shall recognize or give effect to any attempt to transfer (by book entry or otherwise) or convert any Series G2 Preferred Stock or any interest therein in violation of either the Securities Act. The certificates representing the Series G2 Preferred Stock and the Conversion shares shall bear restrictive legends thereon recommended by legal counsel for the Corporation regarding the restrictions on the transferability thereof to ensure compliance the Securities Act until the Series G2 Preferred Stock and/or the Conversion Shares, as the case may be become Freely Tradeable. Section 13. Certain Definitions. ------------------------------- "Alternative Stock Exchange" means any other national or regional stock exchange or quotation service such as the Nasdaq Market System or any similar quotation service maintained by the National Quotation Bureau or any successor thereto. "Authorized Newspapers" means the Luxembourg Wort of Luxembourg and The Financial Times (European Edition) of London, England. If either such newspaper shall cease to be published, the Corporation shall substitute for it another newspaper in Europe, customarily published at least once a day for at least five (5) days in each calendar week, of general circulation. If, because of temporary suspension of publication or general circulation of either such newspaper or for any other reason, it is impossible or, in the opinion of the Corporation, impracticable to make any publication of any notice required by this Certificate of Designations in the manner herein provided, such publication or other notice in lieu thereof which is made by the Corporation in the exercise of its reasonable discretion shall constitute a sufficient publication of such notice. "Capital Stock" of any Person means the Common Stock or preferred stock of such Person. Unless otherwise stated herein or the context otherwise requires, "Capital Stock" means Capital Stock of the Corporation "Closing Date" means the date of which the Series G2 Preferred Stock is sold to the holders thereof. "Commission" means the Securities and Exchange Commission. "Conversion Agent" means any Person (including the Corporation acting as Conversion Agent) authorized by the Corporation to effect conversions of the Series G2 Preferred Stock on behalf of the Corporation. "Dividend Payment Date" has the meaning given to it in Section 4(b) hereof. 8 "Freely Tradeable" means, with respect to the Common Stock issuable upon the conversion of or the payment of a dividend upon the Series G2 Preferred Stock, that under the Securities Act the holders thereof may then offer and sell any amount of such outstanding securities to the public in the United States in transactions that are not brokers' transactions (as defined in the Securities Act) either (i) pursuant to an effective registration statement then in effect or (ii) pursuant to Rule 144(k). For purposes of determining whether such securities are Freely Tradeable, it shall be assumed that no affiliate of the issuer has ever held such securities from and after their issuance. "Group" means the Corporation and all its Principal Subsidiaries. "Market Capitalization" means, on any date, the average, over the thirty (30) calendar day period commencing thirty-five (35) calendar days prior to such date, of the product of the Market Price of the Common Stock and the number of shares of Common Stock of the Corporation issued and outstanding on such date; provided, however, that appropriate adjustments shall be made to the Market Prices and number of shares used in determining such Market Capitalization to account fairly for the effect of dividends payable in equity securities of the Corporation or any other Person, spin-offs of subsidiaries, mergers in which the Corporation or a Principal Subsidiary is a constituent party, and similar events. "Market Price" means the closing sales price on the American Stock Exchange or any Alternative Stock Exchange on any Stock Exchange Business Day. "Person" means any individual, corporation, partnership, association, trust or other entity or organization, including a government or political subdivision or any agency or instrumentality thereof. "Principal Subsidiary" means a Subsidiary of either the Corporation or any Principal Subsidiary: (a) whose gross assets represent 10 percent or more of the consolidated gross assets of the Group as calculated by reference to the then latest audited financial statements of the Group; or (b) to which is transferred all or substantially all of the business, undertaking and assets of a Subsidiary of the Corporation which immediately prior to such transfer is a Principal Subsidiary, whereupon the transferor Subsidiary shall immediately cease to be a Principal Subsidiary and the transferee Subsidiary shall cease to be a Principal Subsidiary under the provisions of this sub-paragraph (b) (but without prejudice to the provisions of sub-paragraph (a) above), upon publication of its next audited financial statements. "Property" means any kind of property or asset, whether real, personal, mixed, or tangible or intangible, and any interest therein. "Securities Act" means the United States Securities Act of 1933 as in effect on the date of the filing of this Certificate with the Secretary of State of Delaware or as such act may hereafter be amended. "Series G2 Preferred Stock" means the Corporation's Series G2 Convertible Preferred Stock, $1.00 par value. "Stock Exchange Business Day" means any day (other than a Saturday or Sunday) on which the American Stock Exchange or the Alternative Stock Exchange, as the case may be, is open for business. "Subsidiary" of any Person means any Corporation of which at least a majority of the shares of stock having by the terms thereof ordinary voting power to elect a majority of the Board of Directors of such Corporation (irrespective of whether or not at the time stock of any other class or classes of such Corporation shall have voting power by reason of the happening of any contingency) is directly or indirectly owned or controlled by any one of or any combinations of the Corporation or one or more of its Subsidiaries." IN WITNESS WHEREOF, the Corporation has caused this Certificate to be duly executed on its behalf by its undersigned Secretary this 20th day of July, 2001. 9 HARKEN ENERGY CORPORATION, a Delaware corporation By: ----------------------- Name: Larry E. Cummings Title: Secretary 10 EXHIBIT A NOTICE OF CONVERSION -------------------- To: Harken Energy Corporation To: [Conversion Agent] The undersigned holder of the Series G2 Convertible Preferred Stock, par value U.S. $1.00 (the "Preferred Stock") of Harken Energy Corporation (the "Corporation") in the aggregate liquidation preference value of U.S. $100.00 irrevocably exercises the option to convert [insert number] shares of Preferred Stock into shares of Common Stock of the Corporation, par value U.S. $0.01 (the "Common Stock"), in accordance with the terms of the Certificate of Designations relating to the issuance by the Corporation of the Preferred Stock and directs that the Common Stock issuable and deliverable upon such conversion be issued and delivered to the undersigned in the name and at the address set forth below. If the Common Stock is not Freely Tradeable at the date hereof, the undersigned holder hereby certifies to the Corporation that it: (1)(a) is an "accredited investor" (as defined in Rule 501 of Regulation D under the U.S. Securities Act of 1933, as amended (the "Securities Act")), or (b) is acquiring the Common Stock in a transaction exempt from the registration requirements of the Securities Act; and (2) acknowledges that the Common Stock has not been registered under the Securities Act and are "restricted securities" within the meaning of the Securities Act; and (3) understands and agrees that if within two years after the date of the original issuance of the Preferred Stock or within three months after it ceases to be an affiliate (within the meaning of Rule 144 under the Securities Act) of the Corporation, upon conversion thereof the Common Stock may be resold, pledged, or transferred only (i) to the Corporation, (ii) pursuant to an exemption from the registration requirements of the Securities Act provided by Rule 144 (if applicable) under the Securities Act, or (iii) pursuant to an effective registration statement under the Securities Act, in each case in accordance with any applicable securities law of any state of the United States; and (4) it understands that the certificates representing the Common Stock will bear a restrictive legend describing the foregoing restriction on transfer, unless otherwise agreed by the Corporation. If the Common Stock is to be issued in the name of a person other than the undersigned or a nominee of the undersigned, the undersigned will pay all transfer taxes payable with respect thereto and is delivering herewith a certificate in proper form that the applicable restrictions on transfer have been complied with. All terms not otherwise defined herein shall have the respective meanings set forth in the Certificate of Designations relating to the Preferred Stock. * * * * DATE: --------------------- ------------------------------------ Name of Holder ------------------------------------ Signature(s) of Holder Address for Delivery of Shares: ------------------------------------- ------------------------------------- ------------------------------------- ------------------------------------- Name for Registration of Shares (if different than Holder): ------------------------------------- A-2 EX-10.14 4 dex1014.txt CAJARO CONTRACT 1 EXHIBIT 10.14 EMPRESA COLOMBIANA DE PETROLEOS ECOPETROL "CAJARO" ASSOCIATION CONTRACT ASSOCIATION CONTRACT ASSOCIATE : HARKEN DE COLOMBIA LIMITED SECTOR : CAJARO EFFECTIVE DATE : February 18, 2002 ----------------- The contracting parties, as such: on one Part, the Empresa Colombiana de Petroleos hereinafter referred to as ECOPETROL, an industrial and commercial State-owned enterprise authorized by law 165 of 1948, actually ruled by its by-laws, reformed by Decrees 1209 of June 15, 1994 and 2933 of December 10, 1997, with head office in Bogota, D.C., represented by ALBERTO CALDERON ZULETA, of legal age, bearer of citizenship card No. 19'248.238 issued in Bogota, based in Bogota, D.C., who states: 1. That in his capacity as President of ECOPETROL, acts in representation of this Company, and 2. That for the execution of this contract he has been authorized by the Board of Directors of ECOPETROL, as witnessed in Minutes No. 2264 of December 14, 2001, and on the other hand HARKEN DE COLOMBIA LIMITED, company organized pursuant to the laws of the Caiman Islands, with a branch established in Colombia and with head offices in Bogota, D.C., pursuant to Public Deed No. 406 of February 19, 1993, executed in Notary Eleven (11) of Bogota, represented by GABRIEL GUSTAVO CANO VELASQUEZ, of legal age, Colombian citizen, bearer of citizenship card number 8'265.559, who declares: 1. That in his capacity as the Main Legal Representative he acts as the representative HARKEN DE COLOMBIA LIMITED, 2. That to execute this contract he is fully authorized as per the Certificate of Incorporation and Legal Representation issued by the Chamber of commerce of Bogota, D.C., and 3. That THE ASSOCIATE assures to have the financial capacity, technical competence and the professional abilities necessary to execute the activities to which this contract refers to. Under the above conditions, ECOPETROL and THE ASSOCIATE declare that they have entered into the contract contained in the following Clauses: CHAPTER I - GENERAL PROVISIONS CLAUSE 1 - OBJECT OF THIS CONTRACT 1.1 The object of this contract is the exploration of the Contract Area and the exploitation of such nationally owned hydrocarbons that may be found therein, described in Annex A that is part of this contract. 1.2 Pursuant to Article 1o. of Decree 2310 of 1974, the exploration and exploitation of nationally owned hydrocarbons are entrusted to ECOPETROL, company that may, directly or under contracts with Private Parties, carry out such activities. Based on such provision mentioned, ECOPETROL has agreed with THE ASSOCIATE to explore the Contract Area and to exploit such Hydrocarbons as may be found therein, under the terms and conditions set 2 forth in herein, in Annex "A", Annex "B" (Operating Agreement) and Annex "C" (Lineaments for the Preparation of the Development Plan) that make part of this contract. 1.3 Without prejudice of the provisions hereunder, it is understood that THE ASSOCIATE shall have the same rights and obligations in respect to the Hydrocarbons produced in the contract area and to its share of the same as are assigned under the Colombian Laws to anyone exploiting nationally owned Hydrocarbons in this country. 1.4 ECOPETROL and THE ASSOCIATE agree to carry out the exploration and exploitation operations within the terms of this contract in the Contract Area, that they shall share between themselves the costs and risks thereof in the proportion and under the terms set forth in this contract and that the Hydrocarbons produced shall belong to each Party pursuant to the proportions set forth in this contract. CLAUSE 2 - APPLICATION OF THE CONTRACT This contract applies to the Contract Area, identified, and the boundaries of which are described in Clause 3 and Annex A of this contract, or to such portion thereof, when areas have been restituted pursuant to this contract. CLAUSE 3 -CONTRACT AREA The area Contract comprises thirty four thousand one hundred and ninety five (34.195) hectares with seven thousand fifty eight (7.058) square meters and is located within the municipal jurisdiction of Mani in the department of Casanare. The cartographic information was taken from the Political Map of Colombia, digital file of the I.G.A.C., on scale 1:1'500.000. This area is described on Annex "A" that is part of this contract. Paragraph 1. - Whenever a person files a claim pretending to be the owner of the property of the subsurface Hydrocarbons in the Contract Area, ECOPETROL shall handle the case and assume the obligations required. Paragraph 2.- In the case in which part of the Contract Area extends over the areas that are or that have been reserved and declared to be within a system of National Parks, THE ASSOCIATE is obliged to obey the conditions ruled by the corresponding authorities, without it being considered that this contract has been modified and without there being a right to make any claim against ECOPETROL, pursuant to that agreed on in Clause 30 (numeral 30.2) of this contract. CLAUSE 4 - DEFINITIONS For the purpose of this contract, the terms mentioned hereinafter, shall have the following meaning: 4.1 Contract Area: Is the land described in Clause 3 hereinabove, and described in Annex "A" of this contract. 3 4.2 Field: Such portion of the Contract Area in which there are one or more structures and/or stratigraphic traps totally or partially overlaid, with one or more productive Reservoirs or that the capacity to produce Hydrocarbons in commercial amounts has been verified. Such reservoirs may be found vertically and/or laterally separated by geological barriers or impervious stratums, or both. 4.3 Commercial Field: Is the field accepted by ECOPETROL able to produce Hydrocarbons in economically exploitable quantity and quality, in one or more of the Production Objectives defined by ECOPETROL at the time of acceptance of the commerciality, without prejudice that during the exploitation phase other Production Objectives may be found. 4.4 Gas Field : Is such that based on the information supplied by THE ASSOCIATE, is classified by ECOPETROL as a Non Associated Natural Gas Producer (or free natural gas) in the definition of its commerciality . 4.5 Executive Committee: Is the body established within thirty (30) days following the acceptance of the first Commercial Field, to supervise, control and approve all the operations and actions that are carried out during the term of the contract. 4.6 Direct Exploration Costs: Are the monetary expenses reasonably incurred in by THE ASSOCIATE through the acquisition of seismic and the drilling of Exploratory Wells, as well as for the locations, termination, equipment and testing of such wells. The Direct Exploration Costs do not include administrative or technical support from the head office or central offices of the Company. 4.7 Joint Account: Are the records to be kept by means of books of accounts pursuant to the Colombian laws, for crediting or debiting the Parties for their share in the Joint Account of each Commercial Field. 4.8 Budget Execution: Are the resources actually committed and/or spent in each of the programs and projects approved for a given calendar year. 4.9 Structure: It is the geometrical form with geological closing (anticlinal, synclinal, etc.) that present the formations in which fluid accumulations are found. 4.10 Effective Date: It is the day in which the sixty (60) calendar day period expires, as from the date of this contract is signed, as of which all the terms agreed upon therein shall be counted, independently from the date of approval of the contract by the Ministry of Mines and Energy. 4.11 Cash Flow: It is constituted by the movement of monies (income and disbursements) to be made by the Joint Account in order to meet the different obligations Contracted by the Operator for the normal progress of the operations. 4.12 Associate Natural Gas: Mixture of light Hydrocarbons in a gaseous state or in solution in the Reservoir and that is produced jointly with liquid hydrocarbons. 4.13 Non Associated Natural Gas (Production of): Are those Hydrocarbons produced in a gaseous state on surface and reported to standard conditions, with average values 4 (pondered by production), of initial relation Gas/Oil greater than 15.000 standard cubic feet of gas per barrel of liquid Hydrocarbon and one molar composition of heptane plus (C7 +) less than 4.0%. 4.14 Direct Expenses: Are all expenditures payable by the Joint Account for payments of personnel directly engaged in the Company, purchase of materials and supplies, contracting of services with third parties and other general expenses required by the Joint Operation in the normal performance of its activities. 4.15 Indirect Expenses: Are those expenditures payable by the Joint Account for technical and/or administrative support, which the operator with his own organization, gives to the joint operation. 4.16 Commercial Interest Rate: When referring to pesos, it shall be the current interest rate at the time of the delay; in dealing with dollars of the United States of America, it shall be the prime rate fixed by the LIBOR (London Interbank Borrowing Offered Rate), three (3) months for dollar deposits, increased by four percentage points (LIBOR +4%). 4.17 Interest in the Operation: Is the share in the obligations and rights acquired by each party in the exploration and exploitation of the Contract Area. 4.18 Development Investment: The sums of money invested in goods and equipment capitalized assets for the joint operations in a Commercial Field upon acceptance of the existence by the parties. 4.19 Hydrocarbons: All organic compounds constituted mainly by the natural mixture of carbon and hydrogen as well those substances that accompany them or that are derived from them with the exception of helium and strange gases. 4.20 Gaseous Hydrocarbons: All Hydrocarbons produced in a gaseous state in surface and reported to standard conditions (1. absolute pressure atmosphere and a temperature of 60(0)F.) 4.21 Liquid Hydrocarbons: Crude and condensed oil and those produced in such state as a result of the gas treatment when required, reported to standard conditions. 4.22 Production Objectives: Are the reservoirs located in the commercial field discovered and tested as commercial producers. 4.23 Joint Operation: The activities and work performed or in the process of being performed, on behalf of the parties and on their own account. 4.24 Operator: The person designated by the parties to directly carry out, on their behalf, and without representing them, the operations necessary to explore and exploit the Hydrocarbons found in the Contract Area. 4.25 Parties: On the Effective Date, ECOPETROL and THE ASSOCIATE. Subsequently and at any time, ECOPETROL on the one hand, and THE ASSOCIATE and/or its assignees on the other. 5 4.26 Exploration Period: The time available to THE ASSOCIATE for complying with the obligations set forth in Clause 5 of this contract, which shall not exceed six (6) years as from the Effective Date, except in the cases contemplated in Clauses 5 (numeral 5.4), 9 (numeral 9.3) and 34. 4.27 Exploitation Period: The time elapsing from the end of the exploration period, or that of retention when necessary, to the end of this contract. 4.28 Retention Period: The time required by THE ASSOCIATE and granted by ECOPETROL to being the exploitation period of each gas field discovered in the Contract Area, that due to its particular conditions is not able to be developed in a short term, requiring an additional term for the execution of feasibility studies, of construction of infrastructure and/or marketing development. 4.29 Development Plan: Is the guide document to perform technical, efficient and economical exploitation operations of each field and shall contain, among other aspects, the development strategy, the environmental considerations, the activities to be developed, the Production forecasts for short and medium term, an estimate of the investment and expenses for the following five years and specifically, a description of the projects, the operations program and the Budget for the remaining of the present year or of the following year, as is the case. The lineaments for this development plan are described in Annex "C" that is part of this contract. 4.30 Exploration Well: Any well designated as such by THE ASSOCIATE to be drilled or deepened on its behalf, in the Contract Area in search of new reservoirs or to verify the extension of a reservoir or to determine the stratigraphy of an area. For the fulfillment of the obligations contemplated in Clause 5 of this contract, the corresponding drilling well shall be previously classified between ECOPETROL and THE ASSOCIATE. 4.31 Discovery Well: Is that exploration well in which the existence of one or more reservoirs is discovered or confirmed and that may require subsequent evaluation to determine whether such reservoir or reservoirs may be commercially exploited. 4.32 Exploitation Well (or of Development): Any well previously scheduled as such by the Executive Committee for the production of Hydrocarbons discovered in the objectives of production in the area of each commercial field. 4.33 Budget: The basic planning instrument whereby the resources are allocated for specific projects to be applied within a calendar year or part of a year, in order to achieve the goals and objectives proposed by THE ASSOCIATE or by the Operator. 4.34 Extensive Production Tests: The operations performed in one or more producing Exploration Wells, to evaluate the production and behavior conditions of the reservoir with temporary production installations. 4.35 Reimbursement: Is the payment of fifty percent (50%) of the Direct Exploration Costs incurred in by THE ASSOCIATE. 6 4.36 Exploration Operations. The operations performed by THE ASSOCIATE as related to the search and discovery of Hydrocarbons within the Contract Area. 4.37 Reservoir: All rocks under the surface where Hydrocarbons in their porous space are accumulated, under production or that has the capacity to produce Hydrocarbons and that behaves as an independent unit as far as its petrophysical and fluid properties and that has a common pressure system throughout its entire extension. CHAPTER II - EXPLORATION CLAUSE 5 - TERMS AND CONDITIONS 5.1 THE ASSOCIATE is committed to carry out the exploration operations pursuant to the regulations and modern practices commonly accepted and in use by the international oil industry and to fulfill the legal and regulatory provisions in force. The exploration period shall be divided in three (3) phases, the first with a duration of twelve (12) months, the second phase with a duration of twelve (12) months and the third phase with a duration of twelve (12) months. The first phase begins on the Effective Date and the following on the calendar day immediately following the conclusion of the previous phase. During the exploration period, THE ASSOCIATE is obliged to carry out, as a minimum, the following exploration operations: during the first phase, THE ASSOCIATE must carry out the drilling of one (1) Exploration Well until reaching the formations that can produce Hydrocarbons in the Contract Area. With this well, the exploratory obligation corresponding to the fifth year of the exploration period of the Bocachico Association Contract is fulfilled. At the end of the first phase, THE ASSOCIATE shall have the option to resign from the Association Contract, provided having previously complied with the exploratory commitments agreed on for the present phase. During the second phase, THE ASSOCIATE must carry out the drilling of one (1) exploration well until reaching the formations that may produce Hydrocarbons in the Contract Area. At the end of the second phase, THE ASSOCIATE shall have the option to resign from the Association Contract provided having previously fulfilled the exploratory commitments agreed on for the present phase. During the third phase, THE ASSOCIATE shall drill one (1) Exploratory Well to depth so as to reach the formations capable of producing Hydrocarbons in the Contract Area. At the expiration of the exploration period, the contract shall end if the extension thereof has not been requested and authorized pursuant to Numeral 5.2 of this Clause, or if a field has not been discovered. 7 5.2 If THE ASSOCIATE has satisfactorily complied with the obligations stipulated in Clause 5.1, ECOPETROL, at the request of THE ASSOCIATE, shall annually extend the exploration period, up to three (3) additional years, for such purpose, THE ASSOCIATE must inform its intention to continue with the exploration in the Contract block with an anticipation not lower than ninety (90) days of the date of termination of the Exploration Period, accompanying such request with the proposal of the Exploration Operations Program to be performed during each extension period. Within ninety (90) days following the date of receipt of the request of THE ASSOCIATE in ECOPETROL, the PARTIES shall be able to agree on the Exploration Operations Programs to be performed during such extensions. If no agreement is reached, THE ASSOCIATE is obliged to carry out as a minimum, Exploration Operations in the Contract Area, consisting in the drilling of one (1) Exploration Well per year. At the end of each of the extensions, which duration is one year, THE ASSOCIATE, shall have the option to resign from the Association Contract having previously fulfilled the exploratory commitment agreed on for each of them. 5.3 At its judgment, and at its own cost and risk, THE ASSOCIATE may perform additional Exploration Operations to those agreed on for the Phase or Stage of the Exploration Period under development. However, if THE ASSOCIATE wishes to have such additional Exploration Work accredited to the fulfillment of the exploratory commitments of the following phase or stage of the Exploration Period, it must request ECOPETROL to issue the corresponding approval. If the request is accepted by ECOPETROL, it shall determine the form and amount in which the transfer of the mentioned commitments is to be made. 5.4 If at the end of the six (6) year Exploration Period, THE ASSOCIATE has drilled one or several Discovery Wells that show the possible existence of a Commercial Field, previous written request by THE ASSOCIATE, ECOPETROL may authorize the extension of the Exploration Period for the time necessary, that shall not exceed two (2) years, so that THE ASSOCIATE may have the opportunity to prove the existence of such Commercial Field. To bring into effect that herein set forth, before finishing the Exploration Period and simultaneously with the request, THE ASSOCIATE must provide ECOPETROL with the maps and other descriptions of the area considered as capable of producing Hydrocarbons, the Exploration Operations program and other operations that THE ASSOCIATE plans to carry out and the budget to carry out such work at its own cost and risk, to determine the extension of the Reservoir or Reservoirs discovered and to show the existence of a Commercial Field, without prejudice of that established in Clause 8. To give application to the partial restituted of the areas during this extension of the Exploration Period, THE ASSOCIATE shall retain the area that is the largest between fifty percent (50%) of the Contract Area and the area it considers capable of producing Hydrocarbons plus its zone of reserve of two and a half (2.5) kilometers wide around the previous one, within the limits of the Contract Area. If the operations program proposed adjusts to the international standards and has the object to show the commerciality of the discovered Reservoirs within the term established, ECOPETROL shall issue its authorization for the execution of this program. 5.5 During the life of this contract and observing that established in Clause 7 of the same, THE ASSOCIATE may carry out the Exploration Operations in the areas it keeps pursuant to Clause 8 and THE ASSOCIATE shall be the only one responsible for the risks and costs of these activities, and, therefore, it shall have the complete and exclusive control of such activities without the maximum duration of the contract being modified for such cause. 8 CLAUSE 6 - SUPPLY OF INFORMATION DURING THE EXPLORATION 6.1 ECOPETROL shall supply THE ASSOCIATE, whenever the latter may so request, with any information in its possession within the Contract Area. The costs of reproduction and supply of such information shall be charged to THE ASSOCIATE. 6.2 During the Exploration Period, THE ASSOCIATE shall give ECOPETROL, as it is obtained and pursuant to ECOPETROL' s manual on information supply, all the geological and geophysical information, cores, magnetic tapes edited, processed seismic sections and all the information on the field supporting it, magnetic and gravimetric profiles, all in reproducible originals, copies of the geophysical reports, reproducible originals of all well logs drilled by THE ASOCIATE, including a final composite graph for each well and copies of the final drilling report that includes the analyses of core samples, the results of production tests and any other information related to the drilling, survey or interpretation of any nature done by THE ASSOCIATE for the Contract Area without any type of limitations. ECOPETROL is entitled to, at any time and by the procedures it considers appropriate, to witness all the operations and verify all information previously mentioned. 6.3 The Parties agree that all geological, geophysical and engineering information obtained from the Contract Area in force during the development of this contract is confidential during the three (3) years following the date of acquisition or up to the termination of the contract, whatever happens first. The information made known is, but is not limited to seismic information, of potential methods, of remote sensors and geochemical, with its corresponding supports, surface and subsurface cartography, well reports, electric logs, formation tests, biostratigraphic, petrophysical and fluid analyses, and production background. Regardless of the confidentiality herein established, the Parties agree that in each case they may interchange with companies that are or not associated with ECOPETROL. It is understood that that agreed to herein shall take place without prejudice of the obligation to supply the Ministry of Mines and Energy with all information requested by it pursuant to the legal and Reglementary provisions in force. Nevertheless, it is understood and thus agreed, that the Parties may at their own discretion supply the information required by their affiliates, consultants, contractors, financial entities and that are required by the competent authorities with jurisdiction on the Parties or their affiliates, or by regulations of any stock markets in which the stocks of the Parties or corporations related are registered. 6.4 Within the ninety (90) days following the date of termination of the drilling operations of each Exploration Well, THE ASSOCIATE shall inform ECOPETROL in writing of the condition of the corresponding well, its classification as to the results obtained (dry or discovery) and the type of fluids produced, if it is the case. CLAUSE 7 - BUDGET AND EXPLORATION PROGRAMS Observing that established in this contract, THE ASSOCIATE is obliged to prepare the programs, the chronogram of activities to be developed and the Budget to be executed in a short term (the following calendar year) and the vision for the following two (2) years with an estimated Budget, to carry out the exploration in the Contract Area. Such vision, programs, chronograms and Budgets 9 shall be presented for the first time to ECOPETROL, within the sixty (60) days following the date of the signing of this contract, and subsequently, December fifteen (15) of each year, the latest. Every semester THE ASSOCIATE shall present a technical and financial report to ECOPETROL, including the different exploratory activities performed, and the perspectives of the area based on the information obtained, the Budget assigned and the exploration costs incurred in up to the time of the presentation of the report, commenting in each case the causes that originated the main deviations presented. Upon request by ECOPETROL, THE ASSOCIATE shall supply the necessary explanations to the report, in meetings programmed for such purposed. The information presented by THE ASSOCIATE in the reports and the explanations to which the present Clause refers to, shall in any case be understood as accepted by ECOPETROL. The financial information shall be subject to auditing by of ECOPETROL pursuant to that established in Clause 22 of Annex "B" (Operating Agreement) of this contract. CLAUSE 8 - RESTITUTION OF AREAS 8.1 Upon termination of the First Phase of three years of the Exploration Period or of such extensions thereof obtained by THE ASSOCIATE pursuant to Clause 5 (numeral 5.2), if a Commercial Field has been discovered and accepted by ECOPETROL in the Contract Area, said area shall be reduced to fifty percent (50%); two (2) years later the area shall be reduced to an extension equal to fifty percent (50%) of the remaining Contract Area and two (2) years later such area shall be reduced to the area of the Commercial Field or Fields under production or development plus one reserve zone of two and a half (2.5) kilometers wide surrounding each Commercial Field, and this shall be the only part of the Contract Area that shall be subject to the terms of this contract. Within the areas retained by THE ASSOCIATE pursuant to the present numeral, the Commercial Fields discovered shall be included. 8.2 Notwithstanding the obligation to relinquish the areas referred to in Clause 8 (numeral 8.1), THE ASSOCIATE is not obliged to return the Commercial Fields that are under development or production, or in a Retention Period, including the reserve zones of two and a half (2.5) kilometers wide that surround such areas, except in the case in which by motives attributable to THE ASSOCIATE, the development or production operations are suspended continuously for more than one year without just cause, case in which such Commercial Fields shall be restituted to ECOPETROL, terminating the contract for said areas or part of the area. These stipulations are also applicable to the fields exploited under the modality of Sole Risk. Paragraph: To show just cause, THE ASSOCIATE must present to ECOPETROL the reasons and fundaments of the same for its acceptance. 8.3 Retention Period: If THE ASSOCIATE has achieved the discovery of a Gas Field and presents a request for commerciality for such Field pursuant to that established in Clause 9 numeral 9.1, simultaneously with such application it may request ECOPETROL to issue a Retention Period, fully justifying the reasons to obtain such period. 10 8.3.1 The Retention Period must be requested by THE ASSOCIATE and granted by ECOPETROL previous to the date in which the last restitution of areas to which numeral 8.1 of this clause refers to. In the case in which the Retention Period is granted, it is understood that the term set forth in Clause 9 (numeral 9.1) for ECOPETROL to speak out with respect to the acceptance or not of the existence of the Commercial Gas Field shall be postponed for the same term of the Retention Period. 8.3.2 The Retention Period may not exceed four (4) years. If the term initially granted as a Retention Period is insufficient, ECOPETROL, previous written and duly justified request by THE ASSOCIATE, may extend the Retention Period for an additional term, without having the sum of the initial retention period and its extensions exceed four (4) years. The Retention Period applies exclusively to the Gas Field area that ECOPETROL determines as capable of producing Hydrocarbons, including the reserve zone of two and a half (2.5) kilometers wide surrounding such area. CHAPTER III - EXPLOITATION CLAUSE 9- TERMS AND CONDITIONS 9.1 To initiate the Joint Operation hereunder, it is considered that the exploitation operations start on the date the Parties accept the existence of the first Commercial Field or upon compliance with the provisions of Clause 9 (numeral 9.5). The existence of a Commercial Field shall be determined by the drilling, by THE ASSOCIATE, within the proposed Commercial field of a number of Exploration Wells sufficiently to reasonably define the area and commerciality of the field capable of producing Hydrocarbons. If after evaluating the results obtained from the Discovery Wells, THE ASSOCIATE considers that it has discovered a possible Commercial Field, it must inform ECOPETROL in writing, supplying all the surveys on which this conclusion and the corresponding Development Plan are based on. ECOPETROL within the term of ninety (90) days as of the date in which THE ASSOCIATE turns in all the back-up information and makes a technical presentation to ECOPETROL, must accept or object the existence of the Commercial Field. ECOPETROL may request any additional information considered necessary within thirty (30) days following the date of submission of the first back-up information. 9.2 Should ECOPETROL accept the existence of the Commercial Field, it shall, in this sense, notify THE ASSOCIATE within the term established in Clause 9 (numeral 9.1) specifying the area and the Production Objectives in the Commercial Field, and shall start to participate, under the terms of this contract, in the exploitation of the Commercial Field discovered by THE ASSOCIATE. 9.2.1 ECOPETROL shall reimburse THE ASSOCIATE for fifty percent (50%) of the Direct Exploration Costs carried out by THE ASSOCIATE on its own account and risk within the Contract Area previous to the date of acceptance of the commerciality by ECOPETROL of each new Commercial Field discovered, pursuant to numeral 9.1 of the present Clause and that have not been previously charged to an other Field. 9.2.2 The amount of such costs shall be determined in dollars of the United States of America, taking as a reference the date in which THE ASSOCIATE made such disbursements; 11 therefore, the costs incurred in Colombian pesos shall be liquidated at the market exchange rate in effect on such date, certified by the Superintendencia Bancaria or by the corresponding entity. Paragraph: Once the amount of the Direct Exploration Costs to be reimbursed in dollars of the United States of America is defined, this value shall be updated on a monthly basis pursuant to the average consumer index price of the industrialized countries, as of the date of its disbursement, to constant dollars on the date in which ECOPETROL begins the Reimbursement in the manner described on the Operating Agreement (Annex B) of this contract. The balances to be reimbursed shall be equally updated up to the date in which ECOPETROL fully reimburses its participation in the corresponding Commercial Field. 9.2.3 The Reimbursement of the Direct Exploration Costs, pursuant to that established on Clause 9 (numerals 9.2.1) shall be made by ECOPETROL to THE ASSOCIATE, as of the moment in which the Field is put in production by the Operator, with the amount in dollars equivalent to fifty percent (50%) of its direct participation in the total production of the respective field, after deducting the corresponding percentage from the royalties. Paragraph: If concerning a Commercial Gas Field, such reimbursement shall be made by ECOPETROL to THE ASSOCIATE, as of the moment in which the Field is put under production by the Operator, with the amount in dollars equivalent to one hundred percent (100%) of its direct participation in the total production of such Field, after deducting the corresponding percentage from the royalties. 9.3 If with the information supplied ECOPETROL cannot accept the existence of a Commercial Field to which Clause 9 (numeral 9.1) refers to, it may advise THE ASSOCIATE about the presentation and execution of a program for additional operations to demonstrate the existence of a commercial field, operations that will be carried out at the risk and cost of THE ASSOCIATE that may not require a term longer than two (2) years for its execution, and if it is the case, the Exploration Period for the Contract Area shall be extended automatically for a term equal to that already agreed on between the Parties, as necessary to execute the additional work in this Clause, but without prejudice of that stated with relation to the reduction of areas in Clause 8 (numeral 8.1). THE ASSOCIATE may present and execute a work program that meets the objective required or submit for expert analysis the requirement of additional information, pursuant to Clause 28 of this contract. In the event that the definition of the expert analysis is favorable to ECOPETROL, THE ASSOCIATE must fulfill the requirements and once again submit the studies of commerciality and the revised Development Plan to ECOPETROL for its consideration. In the event that the definition of the expert analysis is favorable to THE ASSOCIATE, it is understood that ECOPETROL has the necessary information and as a consequence, the term of ninety (90) days to which clause 9.1 refers to, to accept or to object the existence of a Commercial Field shall begin on the date in which ECOPETROL receives the report from the experts. 9.4 If, after the completion of the additional work or the disagreement solved by the expert analysis to which the previous numeral refers to, ECOPETROL accepts the existence of the Commercial Field to which Clause 9 (numeral 9.1) refers to, it will start to participate in the development operations of the field above mentioned in the terms established in this contract and shall reimburse THE ASSOCIATE as set forth in Clause 9 (numerals 9.2.2 and 12 9.2.3) for fifty percent (50%) of the cost of the additional work requested and referred to in Clause 9 (numeral 9.3) and the work executed shall become the property of the Joint Account. 9.5 Modality of Sole Risk: If ECOPETROL does not accept the existence of a Commercial Field, after having performed the additional work referred to in Clause 9 (numeral 9.3), THE ASSOCIATE shall be entitled to execute such work as it may consider necessary in or to exploit such field and to reimburse itself two hundred percent (200%) of the total cost of the work executed at its own account and risk in the such field and up to fifty percent (50%) of the Direct Exploration Costs carried out by THE ASSOCIATE before the date of the presentation of the commerciality surveys of such field. For the effects of this Clause the reimbursement shall be done with the value of the produced Hydrocarbons, less the royalties referred to in Clause 13, deducting the costs of production, gathering, transportation and sale. If THE ASSOCIATE abides to the modality of sole risk, it is understood that the term of the exploitation begins on the date in which ECOPETROL informs THE ASSOCIATE of the nonexistence of a Commercial Field. For the purposes of liquidation of the value in dollars of the disbursements done in pesos, it shall be liquidated at the representative market rate certified by the Superintendencia Bancaria or by the corresponding authority, on the date in which THE ASSOCIATE has made such disbursements. For the purpose of this Clause, the value of each barrel of Hydrocarbons produced in such Field during a calendar month shall be the average price per barrel that THE ASSOCIATE receives from the sales of its participation in the Hydrocarbons produced in the Contract area during the same month. With reference to the reimbursement of the Direct Exploration Costs, that established in paragraph of clause 9 (numeral 9.2.3) shall be applied. When THE ASSOCIATE has reimbursed itself of the percentage established in the present clause, all drilled wells, installations and all types of goods acquired by THE ASSOCIATE for the exploitation of the field and paid for as indicated in the present clause, shall become the property of a Joint Account without any cost, previous the acceptance by ECOPETROL to participate in the development of such field. 9.6 ECOPETROL may, at any time, start to participate in the operation of the field discovered and developed by THE ASSOCIATE without prejudice to THE ASSOCIATE' s right to reimburse itself for the investments it made at its expense, in the form and percentage stipulated in Clause 9 (numeral 9.5). Once THE ASSOCIATE is reimbursed, ECOPETROL shall enter to participate in the economic results of the wells developed at the exclusive expense of THE ASSOCIATE. 9.7 The demarcation of the boundaries of a Commercial Field shall take into consideration all the geological and geophysical information and that of the wells drilled within said field or related to the same. 9.8 If after the commerciality of one or more fields is accepted, THE ASSOCIATE continues to fulfill the exploratory obligations established in Clause 5, it may continue to simultaneously carry out the exploitation of such fields before the expiration of the Exploration Period established in Clause 4, but only as of the date of its termination shall the Exploitation Period begin. When concerning Gas Fields, and ECOPETROL has granted a Retention 13 Period, the Exploitation Period for each Field shall begin on the date of expiration of the respective Retention Period. 9.9 If as a result of the drilling of Exploratory Wells, after confirming the existence of a Commercial field, THE ASSOCIATE proves the presence of additional accumulations of Hydrocarbons associated to such Field, it must request ECOPETROL to extend the area of the Commercial Field and its commerciality, following the procedure set forth in Clause 9 (numeral 9.1). If ECOPETROL accepts its commerciality, it shall reimburse THE ASSOCIATE fifty percent (50%) of the Direct Exploration Costs exclusively related with the expansion of the area of the Commercial Field, in the terms established in numerals 9.2.2 and 9.2.3. If ECOPETROL does not accept the commerciality, THE ASSOCIATE is entitled to reimburse itself up to two hundred percent (200%) of the total cost of the work executed on its own cost and risk for the exploitation of the Exploratory Wells that have resulted productive and up to fifty percent (50%) of the direct Exploration Costs carried out by THE ASSOCIATE exclusively related to the expansion of the area requested before the date in which ECOPETROL notifies on the same. Such reimbursement shall be done with the production originated from the Exploratory Wells that have resulted productive, after deducting royalties, following the procedure set forth in Clause 21 (numeral 21.2) up to the percentages herein defined. CLAUSE 10 - OPERATOR 10.1 The Parties agree that HARKEN DE COLOMBIA LIMITED is the Operator and, as such, with the limitations set forth in this contract, shall have the control of all the operations and activities it may consider necessary for an efficient technical and economic development of the exploitation of the hydrocarbons found within the area of the Commercial Field. They also agree that, nevertheless that in this contract - executed for the commercial purposes established in Clause 1 of the same, HARKEN DE COLOMBIA LIMITED is the Operator, it is understood by the Parties, and thus determined, that for all labor legal effects, HARKEN DE COLOMBIA LIMITED does not act as a representative of the Parties, but as an only and true employer of the workers he contracts for the operation of the Commercial Field and, as a consequence, shall be responsible for the labor obligations that arise from the respective relations or work contracts, such as salary payments and social benefits, para-fiscal contributions, affiliation and payment of bids or contributions for pensions, health and professional risks to the Sistema de Seguridad Social Integral, to which Law 100 of 1993 refers to and its Reglementary decrees or those regulations that substitute or modify it. 10.2 The Operator has the obligation to carry out all of the development and production operations pursuant to the standards and practices generally accepted by the industry using the best technical methods and systems required for the economic and efficient exploitation of the Hydrocarbons and fulfilling the legal and regulatory provisions on the issue. Also, he must present on time, to the parties, the reports and documents mentioned in the contract, as well as any other information required by the Executive Committee with respect to the Joint Account and/or Operation. 10.3 Due to the afore mentioned, and in view that for the execution and fulfillment of the operation of the Commercial Field, HARKEN DE COLOMBIA LIMITED shall perform all the activities with its own resources, with liberty and technical and directive autonomy, for all the 14 purposes of this contract, such Operator shall be considered an entity different from The Parties hereto as well as for the purposes of the implementation of civil, labor and administrative legislation and for the Operator's relations with the personnel at his service, as set forth in clause 32. 10.4 The Operator shall have the right to resign as such, by written notification to the Parties six (6) months in advance of the effective date of such resignation. The Executive Committee shall then assign a new Operator pursuant to Clause 19 (numeral 19,3,5). In case the Operator assigned by the Executive Committee is a third person different from the Parties, a contract must be executed between the Parties and the new Operator. 10.5 The Operator shall carry out the operations described in this contract in a diligent, responsible, efficient and technically and economically adequate manner, being understood that at no time shall he be responsible for mistakes in criteria, or for losses or damages that are not the result of a serious fault by the Operator. 10.6 The Operator shall have the right to execute any type of work by means of contractors, subject to the faculty that the Executive Committee has, pursuant to Clause 11 (numeral 11.1). To fulfill that herein established, the Operator shall carry out the contracting operations following the procedure described in Annex "B" and subject to the principles of good faith, transparency, economy, equity, responsibility, planning, quality, celerity and social and environmental responsibility that must rule in the contracting. CLAUSE 11 - EXPLOITATION PROGRAMS AND BUDGETS 11.1 Within the three (3) months following the acceptance of a Commercial Field in the Contract Area, the Operator shall present to the parties, a proposal for projects, programs and budget for the Development Plan of the commercial field for the remaining of the corresponding Calendar year, to be agreed on by the Executive Committee. In case there are less than six months and a half (6 - 1/2) for the expiration of such year, the Operator shall prepare and present a proposal for projects, programs and Budget for the following calendar year, within a term of three (3) months. 11.1. The projects, programs and the Budget contained in the Development Plan of the Commercial Field shall be checked and adjusted on a yearly basis and presented by the Operator to the Parties during the month of May of each calendar year, for which the Operator shall send his proposal within the first ten (10) days of the month of May. Within the twenty (20) days following the receipt of the proposal of the projects, programs, and Budget of the Development Plan of the Commercial Field, the Parties shall inform the Operator in writing on the changes they wish to propose. When this occurs, the Operator shall consider the observations and proposed reforms made by the Parties for the elaboration of the revised Development Plan, that shall be submitted for final approval of the Executive Committee, at the ordinary meeting during the month of July of each year. In case the total Budget of the Commercial Field has not been approved before the month of July, those aspects of the Budget of the Commercial Field on which an agreement has been reached, shall be approved by the Executive Committee, and those aspects not approved shall be submitted immediately to the Parties, for study and final decision, as set forth in Clause 20. 15 11.2. The Parties may propose additions or revisions to the projects, programs and the annual Budget approved for each Commercial Field, but, except in cases of emergency, these must not be formulated with a frequency of less than three (3) months. The Executive Committee shall decide on the proposed additions or revisions at a meeting called within thirty (30) days following the presentation of the same. 11.3. The main objectives of the projects, programs and Budgets are: 11.3.1 Determine the operations to be carried out and the expenses and investments (Budget) that the Operator is authorized to execute in each Commercial field during the following calendar year. 11.3.2 Maintain a vision of the development of each field in a horizon of medium and long term. 11.4 The projects, programs and annual Budget approved by the Executive Committee and contained in the Development Plan of each Commercial Field constitute the work plan shown and the expenses and investments estimated to be carried out by the Operator in the different aspects of the operation, such as: 11.4.1 Capital investments in production: drilling for the development of Reservoirs, well workover or recovery, and specific production constructions. 11.4.2 General construction and equipment: industrial and camp facilities, transportation equipment, drilling and production equipment. Other construction and equipment. 11.4.3 Maintenance and operating expenses: production expenses, geological expenses, administration expenses for the operation. 11.4.4 Working capital requirements. 11.4.5 Funds for contingencies 11.5 The Operator shall make all expenditures and investments and shall carry out the development and production operations set forth in the projects, programs and annual Budgets approved in the Development Plan for each Commercial Field referred to in Clause 11 (numeral 11.1), pursuant to the Operating Agreement (Annex B) that is part of this contract, without exceeding the total Budget for each year, except by authorization of the parties in special cases. 11.6 The Operator is authorized to carry out expenditures not contemplated expressly in the Budget of each Commercial field and chargeable to the Joint Account, without previous authorization of the Executive Committee, in the event of emergency measures aimed at safeguarding personnel or the property of the Parties, emergency expenses originating in fires, floods, storms or other disasters; emergency expenses essential for the operation and maintenance of the production facilities, including maintenance of the wells in a condition to produce with a maximum efficiency; emergency expenses essential for the protection and preservation of materials and equipment necessary in the operations. In such cases, the Operator shall call the Executive Committee to a special meeting as soon as possible, to obtain their approval in order to continue with the emergency measures. 16 11.7 From the amount of the expenditures incurred in by and the contracts executed by the Operator for amounts that exceed the annual Budget approved by the Executive Committee for each Commercial Field, as set forth in Clause 19 (numeral 19.3.9), without them having been opportunely authorized by the Executive Committee, except the assumptives set forth in Clause 11 (numeral 11.6), the Operator shall be the only one responsible, who shall assume the totality of the corresponding value. When the expense or contract in question is confirmed by the Executive Committee, the corresponding value shall be paid to the operator, pursuant to the rules defined by the Executive Committee. In case in which the expenditure or contract is not accepted by the Executive Committee, the Operator, if possible, may withdraw the good in question reimbursing the Parties for any cost that its withdrawal may cause them. When it is impossible for the Operator to withdraw such goods, or he rejects doing so, the benefit or patrimonial increase resulting from these expenses or contracts, shall belong to the Parties in proportion to their Interest in the Operation. CLAUSE 12 - PRODUCTION 12.1 Whenever necessary, the Operator shall determine, with the approval of the Executive Committee, the Maximum Efficiency Rate (MER) for each commercial Field. This Maximum Efficiency Rate (MER) shall be the maximum producing rate of Hydrocarbons that may be extracted from a Reservoir for the purpose of obtaining a maximum economic benefit in the final recovery of Reservoirs. In agreement with the economic and engineering principles and the practices and procedures generally used and in use in the international oil industry, in conditions and circumstances similar to those experienced in the activities under this contract. The estimated production must be adjusted as necessary to compensate the real or anticipated conditions of the operation, such as wells under repair that are not producing, limitations in the capacity of the collecting lines, in the pumps, in the separators, in the tanks, in the pipelines and in other facilities. 12.2 The Operator shall determine periodically, at least once a year, with the approval of the Executive Committee, the area deemed capable of producing Hydrocarbons in a commercial quantity in each Commercial Field. 12.3 The Operator shall prepare and deliver to each Party, at regular three (3) month intervals, a program showing each Party's share of production, and another one showing the distribution of each Party's production for the following six (6) months. The forecast for the production must be based on the Maximum Efficiency Rate (MER,) as set forth in Clause 12 (numeral 12.1) and adjusted to each party's rights according to this contract. The Production Distribution Program shall be determined based on each party's periodic requests, and, set forth in Clause 14 (numeral 14.2) with the corrections deemed necessary to ensure that none of the Parties, while being able to withdraw, will receive less than the quantity to which it is entitled to under provisions of Clause 14 and without prejudice to the stipulations of Clauses 21 (numeral 21.2) and 22 (numeral 22.5). 12.4 If either of the Parties foresees a reduction in its capacity to receive Hydrocarbons compared to the forecast given to the Operator, the Party must inform the Operator as soon as possible, and if such reduction is due to an emergency situation, the Party shall inform the Operator within the twelve (12) hours following the occurrence of the event that causes 17 the reduction. As a consequence, such Party shall give the Operator a new receipt schedule based on the appropriate reduction. 12.5 The Operator may use the Hydrocarbons that are consumed in the development of the production operations in the Contract Area and these consumptions shall be exempt from the royalties to which Clause 13 (numeral 13.1) refer to. CLAUSE 13 - ROYALTIES 13.1 For the payment of the royalties for the exploitation of the nationally owned Hydrocarbons, the Operator shall give ECOPETROL the percentage of the production established by Law. The delivery of this production shall be carried at the same place and time in which the Parties distribute the production that corresponds them pursuant to Clause 14 of this contract. In the case of Fields under exploitation in the modality of Sole Risk, THE ASSOCIATE shall give ECOPETROL the percentage of the production that corresponds to the royalties in the place agreed on by the Parties. 13.2 From the percentage of the production given to ECOPETROL in the terms of the previous numeral, ECOPETROL, in the way and terms established by law, shall pay those entities mentioned by law the royalties that are caused in favor of the Nation on the total of the production of the Field and, in no case, shall THE ASSOCIATE be responsible for any type of payment before these entities. CLAUSE 14 - DISTRIBUTION AND AVAILABILITY OF THE HYDROCARBONS 14.1 The Hydrocarbons produced, except those that have been used in benefit of the operations of this contract and those that are inevitably wasted in these functions, shall be transported to the jointly owned tanks or to other measuring facilities agreed upon by the Parties. If there is no agreement, to the measuring site nearest to the control site established by the Ministry of Mines and Energy. The Hydrocarbons shall be measured pursuant to the regulations and methods accepted by the oil industry, and based on this measurement, the volumes to which Clause 13 refer to shall be determined. As of this moment, the remaining Hydrocarbons shall be the property of each Party in the proportions specified in this contract. 14.2 Distribution of Production 14.2.1 After having deducted the percentage that corresponds to the royalties, the rest of the Hydrocarbons produced by each Commercial Field are the property of the Parties in the proportion of fifty percent (50%) for ECOPETROL and fifty percent (50%) for THE ASSOCIATE, until the cumulative controlled production of the corresponding Commercial Field reaches the amount of sixty (60) million barrels of liquid Hydrocarbons or the amount of four hundred twenty (420) cubic gigafeet of gaseous Hydrocarbons to standard conditions, what ever occurs first (1 cubic gigafoot = 1 X 109 cubic feet). 14.2.2 Independently from the classification of the Commercial Field given by ECOPETROL in the definition of commercialization, exceeding the limits set forth in numeral 14.2.1, the distribution of the production of each Commercial Field (previous the deduction of the 18 percentage corresponding to royalties) is the property of the Parties in the proportion that results from applying factor R as follows: 14.2.2.1 If the Hydrocarbon that reached first the limit established in numeral 14.2.1 of the present Clause was the liquid Hydrocarbon, the following table shall be applied: R FACTOR Distribution of Production After Royalties (%) ASSOCIATE ECOPETROL 0.0 to 1.0 50 50 1.0 to 2.0 50/R 100 - 50 R 2.0 or more 25 75 14.2.2.2. If the Hydrocarbon that reached first the limit established in numeral 14.2.1 of the present Clause was the gaseous Hydrocarbon, the following table shall be applied: R FACTOR Distribution of Production After Royalties (%) ASSOCIATE ECOPETROL 0.0 to 2.0 50 50 2.0 to 3.0 50/(R-1) 100 - [50 /(R-1)] 3.0 or more 25 75 14.2.3 For the effects of the previous tables, factor R shall be defined as the relation of cumulative incomes, expressed in constant terms, over the cumulative expenses, equally expressed in constant terms, corresponding to THE ASSOCIATE for each Commercial Field in the following terms: IA R = --------------------------- ID + A - B + GO Where: IA (Cumulative Income of THE ASSOCIATE): Is the valuation of the cumulative incomes corresponding to the volume of THE ASSOCIATE' s Hydrocarbons produced, after royalties, at the reference priced agreed on by the Parties, excluding re-injected Hydrocarbons in the Fields in the Contract Area, those consumed in the operation and the flared gas. The average reference price of the Hydrocarbons shall be determined by mutual agreement between the Parties. To determine the cumulative incomes, the Monthly Incomes shall be taken as a base, which shall be determined as a result of multiplying the monthly average reference price by the production of the month pursuant to the formats established for such effect by the Ministry of Mines and Energy. 19 ID (Cumulative Development Investments): Are fifty percent (50%) of the Cumulative Development Investments approved by the Executive Committee of the Association for each Commercial Field. The cumulative Development Investments done previous to the date of the initiation of the exploitation defined by the Ministry of Mines and Energy for the respective Field, shall be adjusted up to the present date in the same manner in which the Direct Exploration Costs are adjusted in the Paragraph of Clause 9 (numeral 9.2.2.). A: Are the Direct Exploration Costs in which THE ASSOCIATE has incurred in, pursuant to Clause 9 of this contract and adjusted pursuant to that established in Paragraph of clause 9 (numeral 9.2.2) B: Is the cumulative Reimbursement of the Direct Exploration Costs, previously mentioned, pursuant to Clause 9 of this contract. GO: (Cumulative Operation Expenses): Are the cumulative operation expenses approved by the Executive Committee of the Association, in the proportion that corresponds THE ASSOCIATE, plus the cumulative transportation costs of THE ASSOCIATE. As transportation costs it is understood, the investment and operation expenditures for the transportation of Hydrocarbons produced in the Commercial Fields located in the Contract Area, from it to the port of export or site where it is agreed to take the price to be used in the calculation of incomes IA. Such transportation costs shall be determined by the parties in mutual agreement once the exploitation stage of the Fields begins, which commerciality has been accepted by ECOPETROL. Within the Operation Expenses the Special Contributions are included or those similar that have direct application on the production of Hydrocarbons in the Contract Area. All values that, with posteriority to the date of initiation of the exploitation defined by the Ministry of Mines and Energy, included in the determination of factor R shall be taken in current dollars. For such effect, the expenses in pesos must be converted into dollars at the market rate certified by the Superintendencia Bancaria or by the corresponding authority, in charge on the date in which the corresponding disbursements have been done. 14.2.4 Calculation of factor R: The distribution of the production based on factor R shall begin to be applied as of the first day of the third calendar month after which the cumulative production of each Commercial Field reaches the amount of sixty (60) million barrels of liquid Hydrocarbons or to the amount of four hundred twenty (420) cubic gigafeet of gaseous Hydrocarbons at standard conditions, pursuant to numeral 14.2.1 of this clause. The calculation of factor R for each Commercial Field shall be done based on the accounting closing corresponding to the calendar month in which the cumulative control production of sixty (60) million barrels of liquid Hydrocarbons was reached or the amount of four hundred twenty (420) cubic gigafeet of gaseous Hydrocarbons at standard conditions, pursuant to numeral 14.2.1. The resulting distribution of the production shall be applied until June 30 of the following year. As of that moment, the distribution of the production with the application of factor R shall be done in one year terms (from July 1 to June 30), over its liquidation, based on the 20 cumulative values to December 31 of the year immediately preceding pursuant to the corresponding accounting closing. 14.3 In addition to the tanks and other jointly owned facilities, each Party shall have the right to build its own production facilities in the Contract Area for its own and exclusive use in compliance with the legal regulations. The transportation and delivery of Hydrocarbons by each Party to the pipeline and to other storage facilities that are not jointly owned shall be done on the sole account and risk of the Party that receives the Hydrocarbons. 14.4 When production is obtained in places not connected by pipelines, the Parties may agree to install pipelines up to a point in which the Hydrocarbons may be sold, or to a place that connects with the pipeline. If the parties agree on the construction of such pipelines, they shall enter the contracts they consider suitable for this purpose and appoint the Operator pursuant to the legal provisions in force. 14.5 Each Party shall be the owner of the Hydrocarbons produced and stored as a result of the Operation hereunder and that are made available to it pursuant to the provisions of this contract, and on its account each Party must receive them in kind or sell them or dispose of them separately, according to that established in Clause 14 (numeral 14.3). 14.6 Should any of the Parties be unable for any reason to dispose of or separately withdraw from the tanks Jointly Account all or part of the Hydrocarbons it is entitled to pursuant to this contract, the following procedure must be followed: 14.6.1 If ECOPETROL is the Party unable to withdraw, in all or in part, its quota of Hydrocarbons (share plus royalties), pursuant to clause 12 (numeral 12.3), the Operator may continue to produce the field and delivering to the ASSOCIATE, in addition to the portion that the quota of THE ASSOCIATE represents in the operation on the basis of one hundred percent (100%) of the MER, all those Hydrocarbons that THE ASSOCIATE decides to and in the capacity of withdrawing up to a limit of one hundred percent (100%) of the MER, crediting ECOPETROL for subsequent delivery, the volume of Hydrocarbons that ECOPETROL had the right to withdraw but that did not do so. With regard to the not withdrawn volume of Hydrocarbons to which ECOPETROL is entitled to during the month for royalties, THE ASSOCIATE, at the request of ECOPETROL, shall pay ECOPETROL in dollars of the United States of America, the difference that exists between the amount of Hydrocarbons that for the concept of royalties ECOPETROL has lifted and the amount of Hydrocarbons that it is entitled to for the concept of the royalties to which Clause 13 refers to, being understood that any withdrawal of Hydrocarbons done by ECOPETROL shall be applied, in first place to royalty payment in kind, and subsequently, any additional withdrawals of Hydrocarbons performed shall be applied to the share that it is entitled to pursuant to Clause 14 (numeral 14.2). 14.6.2 Should THE ASSOCIATE be the Party unable to withdraw, in all or in part, its quota assigned under Clause 12 (numeral 12.3), the Operator shall deliver to ECOPETROL, on the basis of one hundred percent (100%) of MER, not only the share and the quota that corresponds to ECOPETROL, but also the Hydrocarbons that ECOPETROL is in the capacity of withdrawing up to a limit of one hundred percent (100%) of MER, accrediting THE ASSOCIATE for its subsequent delivery, the part that corresponds to its quota and that it has been unable to withdraw. 21 14.7 When both parties are in the capacity to receive the Hydrocarbons assigned under Clause 12 (numeral 12.3), the Operator shall deliver to the Party that was previously unable to receive its quota of the production and, upon such Party's request, besides its share in the operation, a minimum of ten percent (10%) per month of the production that corresponds to the other Party on a monthly basis and, by mutual agreement, up to one hundred percent (100%) of the quota that was not received, up to the time in which the total amounts that were credited to the Party that was unable to received its Hydrocarbons, are cancelled. 14.8 Without prejudice of the legal provisions that rule the mater, each Party shall be free, at any moment, to sell or export its quota of the Hydrocarbons obtained, as agreed to in this contract, or to dispose of the same in any manner. CLAUSE 15 - USE OF THE ASSOCIATED NATURAL GAS In the case in which one or more fields of associated natural gas are discovered, the Operator shall, within the three (3) years following to the date of the initiation of the exploitation of the Field defined by the Ministry of Mines and energy, submit a project on the use of the Natural Gas for benefit of the Joint Operation. The Executive committee shall approve the project and, if necessary, decide on the chronogram for the execution thereof. If the Operator fails to present any project within the three (3) following years or does not execute the project previously approved, within the time limits set by the Executive Committee, ECOPETROL may take, free of charge, for itself, all the associated natural gas available from the Reservoirs in exploitation, which is not required for the efficient exploitation of the Field. CLAUSE 16 - UNIFICATION When an economically exploitable Reservoir extends continuously into other area or areas outside the Contract Area, the Operator shall implement, in agreement with the Parties and with any other interested parties, upon approval of the Ministry of Mines and Energy, a unified exploitation program that meets the Hydrocarbons exploitation engineering techniques. CLAUSE 17 - SUPPLY OF INFORMATION AND INSPECTION DURING THE EXPLOITATION 17.1 The Operator shall deliver to the parties, as they are obtained, reproducible originals (sepias), and copies of the electric, radioactive and sonic logs of the wells drilled, historical records, core analysis, cores, production tests, reservoir surveys and other relevant technical information, as well as all routine reports made or received in connection with the operations and activities carried out in the Contract Area. 17.2 Each Party, at its own cost, expense and risk, shall have the right to inspect, through authorized representatives, the wells and the facilities in the Contract Area and the activities related thereto. Such representatives shall have the right to examine cores, samples, maps, logs for wells drilled, liftings, books and any other source of information connected with the performance of this contract. 17.3 To enable ECOPETROL to comply with the provisions of Clause 29, the Operator shall prepare and deliver to ECOPETROL all reports required by the National Government. 22 17.4 The information and data connected with exploitation operations shall be treated as confidential, in the same way as set forth in Clause 6 (numeral 6.3) of this contract. CHAPTER IV - EXECUTIVE COMMITTEE CLAUSE 18 - CONSTITUTION 18.1 Within the thirty (30) calendar days from the acceptance of the first commercial Field, each Party must appoint a representative and corresponding first and second alternates, who shall form the Executive Committee, notifying the other Party in writing of the names and addresses of its representatives and alternates. Each Party may replace its representative or alternates at any time, but shall give written notice thereof to the other Party. The vote or decision of the principal representative of each Party shall be binding upon such Party. If the principal representative of any of the Parties is unable to attend a Committee meeting, the alternate, in its order first or second, shall attend, and shall have the same authority as the principal. 18.2 The Executive Committee will hold ordinary meetings during the months of March, July and November, during which the exploitation program carried out by the Operator shall be reviewed as well as the development program and the immediate plans. Every year, at the July ordinary meeting, the Operator shall present the Executive Committee with the annual operating program and the investment and expenses Budget for each Commercial Field, for the next calendar year, and if it is the case, the Revised Development Program. 18.3 The Parties and the Operator may request a special Executive Committee Meeting to analyze specific conditions of the operation. The representative of the interested Party shall notify the date of the meeting and the issues to be discussed with a ten (10) calendar day's notice. Any issue not included in the agenda of the meeting may be discussed during the meeting, upon acceptance of the representatives of the Parties on the Committee. 18.4 Each Party's representative shall have a vote in all matters discussed in the Executive Committee, equivalent to the percentage of that Party's total Interests in the Joint Operation. However, the decisions of the Executive Committee on the issues set forth in numerals 19.3.4 through 19.3.9 of Clause 19 of this contract, shall be adopted by a unanimous vote of the Parties. Any decisions taken by the Executive Committee, set forth in the procedure established in this clause, shall be binding and final upon the Parties and the Operator. CLAUSE 19 - FUNCTIONS 19.1 The representatives of the Parties shall form the Executive Committee which shall have full authority and responsibility to establish and adopt exploitation, development and operations programs and Budgets in relation with this contract. A representative of the Operator shall attend the meetings of the Executive Committee. 23 19.2 The Executive Committee shall designate a Secretary for each session. The Secretary shall take full, detailed records and minutes of all the meetings, including a summary of the discussions and decisions taken by the Committee. The Minutes shall be approved and signed by the representatives of the Parties within the ten (10) working days following the adjournment of the meeting and delivered to the Parties as soon as possible. 19.3 The responsibilities of the Executive Committee are, amongst others, as follows: 19.3.1 Adopt its own regulations. 19.3.2 Decide on those issues that the Operator submits for its consideration. 19.3.3 Supervise the performance of the Joint Account and of the Joint Operation 19.3.4 Create the necessary sub-committees and establish the functions they must perform under its direction. 19.3.5 Appoint the Operator in case of resignation or discharge, and dictate the regulations that the Operator must fulfill when he is a third person different from the Parties, definitely stating the motives for his discharge. 19.3.6 Appoint an External Auditor of the Joint Account. 19.3.7 Approve or reject the Development Plans and any subsequent modification or revision. 19.3.8 Determine the rules and policies on expenditures. 19.3.9 Approve or reject the projects, programs and the annual Budget of each Commercial Field and authorize extraordinary expenditures not included in the approved Budgets. 19.3.10 In general, to carry out all the functions authorized in this contract that do not correspond to the Operator, to any other entity or person under the specific clause hereof or under a legal or regulatory provision. CLAUSE 20 - DECISION IN CASE OF DISAGREEMENTS 20.1 Any disagreement that cannot be solved in the Executive Committee, shall be directly submitted to the highest ranking executive of each of the Parties resident in Colombia, in order to reach a joint decision. If within the sixty (60) calendar days following the submission of the consultation, the Parties reach an agreement or a decision on the issue under discussion, they shall so advise the Operator, who, within the fifteen (15) calendar days following the receipt of the communication, shall call the Executive Committee to an extraordinary meeting, during which the agreement or decision adopted shall be approved. 20.2 If within the sixty (60) calendar days following to the date of the presentation of the consultation to the highest ranking executive of each of the Parties resident in Colombia, the Parties fail to agree on the issue, the procedures set forth in Clause 28 of this contract must 24 be followed, except if concerning issues related to the operations, in which case they may be executed pursuant to Clause 21. CLAUSE 21 - OPERATIONS UNDER RISK OF ONE OF THE PARTIES 21.1 If at any time one of the Parties wishes to drill an Exploitation Well not approved in the operations program, it shall notify the other Party written notice not less than thirty (30) calendar days in advance of the next Executive Committee meeting, of its wish to drill such well, including information such as location, recommendation to drill, and estimated depth and costs. The Operator shall include such a proposal among the issues to be discussed in the next Executive Committee Meeting. If such proposal is approved by the Executive Committee such well shall be drilled at the expense of the Joint Account. If such proposal is not accepted by the Executive Committee, the Party wishing to drill such well, hereinafter called participating Party, shall have the right to drill, complete, produce or abandon such well at its sole cost and risk. The Party not wishing to participate in the previous operation shall be called the non-participating Party. The participating Party must begin the drilling of such well within one hundred eighty (180) days following its rejection by the Executive Committee. If the drilling is not commenced within said period, it must again be submitted to the Executive Committee for its consideration. Upon request of the participating Party, the Operator shall drill the previously mentioned well on account and risk of the participating Party, provided that by judgment of the Operator such operation does not interfere with the normal development of the operations of the field, upon advance payment to the Operator by the Participant Party of such amounts as the Operator may deem necessary in order to drill. If said well is unable to be drilled by the Operator without interfering in the normal development of the operations, the participating Party shall have the right to drill such well directly or through a competent service company and, in this case, the participating Party shall be responsible for such operation, without interfering with the development of the normal operations in the Field. 21.2 If the well referred to in Clause 21 (numeral 21.1) is completed as a producing well, it shall be administered by the Operator and the production of such well, after deducting the royalties referred to in Clause 13, it shall become the property of the participating Party, who shall pay for all the operation costs of such well until the net production value, after deducting the production costs, gathering, storage, transportation and similar costs, as well as sale costs, is equal to two hundred percent (200%) of the drilling and completing cost of such well, which thereupon and for the purposes of this contract shall become the property of the holders of the Joint Account in the proportion established, as if it had been drilled with the approval of the Executive Committee for the account of both Parties; for such purpose the investments done and the costs incurred, in the exploitation of this well shall become part of Factor R of the Commercial Field. For the purpose of the present Clause, the value of each barrel of Hydrocarbons produced in such well, during a calendar month, before deducting the previously mentioned costs, shall be the reference price agreed by the Parties. 21.3 If at any time one of the Parties decides to workover, deepen up to the Production Objectives or plug a well that is not in commercial production or a dry well drilled by the Joint Account, and if such operations have not been included in a schedule approved by the Executive Committee, such Party shall notify the other Party of its intention to workover, 25 deepen or plug such well. If in the location there is no equipment, the procedure mentioned in Clause 21 (numerals 21.1 and 21.2) shall be enforced. If at the well site there is adequate equipment to perform the operations proposed, the Party that receives the notification of the operations that the other Party wishes to carry out, shall have a term of forty eight (48) hours following the receipt of the notice, to approve or disapprove the operation, if during such term no answer whatsoever is received, it is understood that the operation shall be done on account and at the risk of the Joint Account. If the work proposed is carried out on account and sole risk of one participating Party, the well shall be administered pursuant to Clause 21 (numeral 21.2). 21.4 If at any time one of the Parties wishes to build new facilities for the extraction of liquids from the gaseous Hydrocarbons and for the transportation and export of the Hydrocarbons produced, to be called additional facilities, such Party shall so advise the other in writing giving the following information: 21.4.1 General description, design, specifications and estimated costs of the additional facilities. 21.4.2 Projected capacity. 21.4.3 Approximate date of the initiation of the construction and duration of the same. Within ninety (90) calendar days from the date of notification, the other Party, by written notice, has the right to decide if it participates in the additional facilities projected. In case in which such Party decides not to participate in the additional facilities, or gives no answer to the proposal of the participating Party, from hereinafter referred to as the constructing Party, it may proceed with the additional installations and order the Operator to build, operate and maintain such facilities at the exclusive cost and risk of the constructing Party, without prejudice to the normal development of the Joint Operations. The constructing Party may negotiate with the other Party the use of such facilities for the Joint Operation. During the time in which the facilities are operated on the constructing Party sole account and risk, the Operator shall charge this party all operation and maintenance costs of the additional facilities pursuant to the accounting standards generally accepted. CHAPTER V - JOINT ACCOUNT CLAUSE 22 - HANDLING 22.1 Without prejudice to any provisions contained herein, the expenses covering Exploration Operations shall be on account and risk of THE ASSOCIATE. 22.2 As from the time ECOPETROL accepts the existence of a Commercial Field and subject to the provisions in Clause 5 (numeral 5.2) and of Clause 13 (numerals 13.1 and 13.2), the property of the rights or Interest in the Operation of the Contract Area, shall be divided as follows: ECOPETROL fifty percent (50%), THE ASSOCIATE fifty percent (50%). From the moment of such acceptance, all expenses, payments, investments, costs and obligations incurred in and contracted for the development of the Joint Operation, in agreement with this contract, shall be charged to the Joint Account and the Direct Exploration Costs done by THE ASSOCIATE before a Commercial Field is accepted and its extensions, pursuant to Clause 9 (numeral 9.9), shall be registered in the Joint Account. Except for that established 26 in Clauses 14 (numerals 14.3) and 21, all properties acquired or used from there on for the fulfillment of the operation activities of the Commercial Field shall be paid for and belong to the Parties, in the same proportion established in the present clause. 22.3 Within the first five (5) days of each month, the Parties shall supply the Operator, in the bank account of the Joint Account, the quota that corresponds them in the Budget of each Commercial Field pursuant to the needs and in the currency in which the expenses must be made in, meaning, in Colombian pesos or in dollars of the United States of America, as per request of the Operator pursuant to the programs and Budgets approved by the Executive Committee. When THE ASSOCIATE has insufficient Colombian pesos to cover the quota that corresponds it from its share in this currency, ECOPETROL shall have the right to supply such pesos and to receive a credit for the contributions it must make in dollars, liquidated at the market rate certified by the Superintendencia Bancaria or by the corresponding authority, of the day in which ECOPETROL must make the corresponding contribution, when such transaction is allowed by the legal provisions. 22.4 The Operator shall present a monthly statement to the Parties within the ten (10) calendar days following the termination of each month, showing the funds advanced, expenses incurred, outstanding liabilities and a report on other debits and credits made to Joint Account; this report that shall be done as set forth in Annex "B", and in an independent Annex, the parameters and calculation of factor R as mentioned in Clause 14 (numerals 14.2.3 and 14.2.4). If the payments to which Clause 22 (numeral 22.3) refer to are not made within the term therein set forth and the Operator decides to cover the same, the Debtor Party shall pay the commercial interest in the same currency in which the payment has been incurred for the period of time for which the payment has been delayed. 22.5 Should either party, in a timely manner, fails to supply the Joint Account with the sums due and payable, as of the due at date such Party shall be considered as a Debtor Party, and the other Party, as the Prompt Party. If the Prompt Party has made the corresponding share to the Debtor Party, in addition to its own, after sixty (60) calendar days of delay such Party shall have the right to have the Operator issue it the total participation of the Debtor Party, in the Contract Area (excluding the percentage that corresponds to the royalty), up to an amount of production that shall allow the Prompt Party a net income for the sales made equal to the sums not paid by the Debtor Party, plus an annual interest equal to the Interest in Arrears after of commencement of default.. By "net income" it is understood the difference between the sales price of the Hydrocarbons taken by the Prompt Party, less cost for transportation, storage, loading and other reasonable expenses incurred in by the Prompt Party in the sale of the products taken. The right of the Prompt Party may be exercised at any time after thirty (30) calendar days from having notified the Debtor Party in writing of its intention to take part or all of the production shares that correspond to the Debtor Party. 22.6 Direct and Indirect Expenses. 22.6.1 All Direct Expenses of the Joint Operation shall be charged to the Parties in the same proportion in which the production is distributed after the royalties. 22.6.2 The indirect Expenses shall be charged to the Parties in the same proportion established in numeral 22.6.1 of the present Clause for Direct Expenses. The amount of these 27 expenditures shall be the result of taking the total annual value of the investments and direct expenditures (excluding the technical and administrative supports) and apply the equation a + m (X-b). In this equation "X" is the total value of the annual investments and expenditures, and "a", "m" and "b" are constants which values are shown in the following chart with relation to the amount of annual investments and expenditures: AMOUNT OF INVESTMENTS AND EXPENSES VALUES OF THE CONSTANT "X" (US$) "a" (US$) M (frac.) "b"(US$) 1. 0 to 25.000.000 0 0.10 0 2. 25.000.001 to 50.000.000 2.500.000 0.08 25.000.000 3. 50.000.001 to 100.000.000 4.500.000 0.07 50.000.000 4. 100.000.001 to 200.000.000 8.000.000 0.06 100.000.000 5. 200.000.001 to 300.000.000 14.000.000 0.04 200.000.000 6. 300.000.001 to 400.000.000 18.000.000 0.02 300.000.000 7. 400.000.001 on 20.000.000 0.01 400.000.000 The equation shall be applied only one time per year, in each case with the value of the constants that correspond to the total value of the annual investments and expenditures. 22.7 The monthly statements of the account referred to in Clause 22 (numeral 22.4) may be revised or objected by any of the Parties from the time they are received by the Parties up to two (2) years counted from the end of the calendar year to which they pertain to, clearly specifying the corrected or questioned entries and the reason thereof. Any account that has not been corrected nor objected within this period, shall be considered as final and correct. 22.8 The Operator shall keep the accounting records, vouchers and reports for the Joint Account in Colombian pesos pursuant with the Colombian laws and every debit or credit to the Joint Account shall be made pursuant to the accounting procedure established in Annex "B", that is part of this contract. In case of disagreement between such accounting procedure and that established in this contract, that stipulated in this later one shall prevail. 22.9 The Operator may sell materials or equipment during the first twenty (20) years of the Exploitation Period or the first twenty eight (28) years of the Exploitation Period, if it concerns a Gas Field, for the benefit of the Joint Account, when the value of that sold does not exceed five thousand dollars of the United States of America (US$5.000) or its equivalent in Colombian pesos. This type of operations, per calendar year may not exceed the amount of fifty thousand dollars of the United States of America (US$50.000) or its equivalent in Colombian currency. The sales in excess of these amounts or sales of real property shall be approved by the Executive Committee. The sale of such material or equipment shall be done at a reasonable commercial price pursuant to the conditions wear of the asset. 28 22.10 Any machinery, equipment and other assets or personal property acquired by the Operator for the execution of this contract, charged to the Joint Account, shall be the property of the Parties in the same proportion to their Interest in the Operation. However, if one of the Parties has decided to terminate its interest in the contract prior to the end of the first seventeen (17) years of the Exploitation Period, with the exception of that established in Clause 25, such Party is obliged to sell its interest in such items to the other Party, at a price commercially reasonable or at book value, which ever is lower. Should the other Party not wish to purchase such items within the ninety (90) calendar days following the formal offer of sale made to it, the Party wishing to withdraw shall have the right to yield to a third person the Interest that corresponds it in such machinery, equipment and items. If THE ASSOCIATE decides to withdraw after seventeen (17) years of the Exploitation Period, its rights in the Joint Operation shall pass to ECOPETROL free of charge, previous its acceptance. CHAPTER VI - DURATION OF THE CONTRACT CLAUSE 23 - MAXIMUM DURATION This contract shall have a maximum duration of twenty eight (28) years, counted as from its Effective Date distributed as follows: up to six (6) years as an Exploration Period pursuant to Clause 5 without prejudice of that set forth in Clause 5 (numeral 5.4) and in Clause 9 (numeral 9.3); and twenty two (22) years as an Exploitation Period as from the date of the termination of the Exploration Period. It is understood that in the events contemplated in this contract, in which the Period of Exploration is extended, in no case, shall the total term of twenty eight (28) years be extended. Paragraph 1: The Exploitation period for the Gas Fields that are discovered within the Contract Area shall have a maximum duration of thirty (30) years as from the date of expiration of the Exploration Period or of the Retention Period granted. In any case, the total term of the contract for such Fields may not exceed forty (40) years from its Effective Date. Paragraph 2: Notwithstanding the afore mentioned, ECOPETROL and THE ASSOCIATE, with an anticipation not less than five (5) years to the date of expiration of the Exploitation Period of each Field, shall study the conditions to continue with its exploitation subsequent to the term to which this Clause refers to. In such case in which the Parties agree to continue such exploitation, they shall define the terms and conditions within which it shall be performed. CLAUSE 24 - TERMINATION This contract shall be terminated in any of the cases hereinafter mentioned and in which the rights of THE ASSOCIATE mentioned in this contract shall stop, both as interested Party, and in its character of Operator, if at the time of the expiration the two qualities mentioned concur in THE ASSOCIATE. 24.1 Due to the expiration of the Exploration Period without THE ASSOCIATE having discovered a Commercial Field, except for that provided in Clauses 5 (numeral 5.4), 9 (numerals 9.5) and 34. 29 24.2 Upon expiration of the term of the duration of the contract as set forth in Clause 23. 24.3 At any time at THE ASSOCIATE' s will, upon fulfillment of its obligations as set forth in Clause 5 and of any others entered into hereunder, up to the date of its expiration. 24.4 If THE ASSOCIATE assigns this contract, fully or in part, without having fulfilled that set forth in Clause 27. 24.5 By not fulfilling the obligations acquired by THE ASSOCIATE pursuant to this contract. 24.5.1 ECOPETROL may not end this contract until after sixty (60) calendar days of having notified THE ASSOCIATE or its assignees in writing, clearly specifying the causes invoked to make such a declaration and only if the other Party has not presented the satisfactory explanations to ECOPETROL or if THE ASSSOCIATE has not corrected the failure in the fulfillment of the contract, without prejudice of the right of THE ASSOCIATE to present the legal resources it considers convenient. 24.5.2 If within the term previously mentioned THE ASSOCIATE presents the satisfactory explanations to ECOPETROL and the remaining term to complete the time of sixty (60) calendar days is insufficient to fulfill the pending obligations pursuant to the good oil industry practices, the Parties may agree on an additional term to allow such fulfillment, without prejudice of the right of ECOPETROL to demand the necessary guarantees to support it. If at the end of this term the operations agreed on have not been fulfilled, ECOPETROL shall terminate the contract. 24.6 At any time by mutual agreement of the Parties. 24.7 By the unilateral causes for termination mentioned in Clause 25. CLAUSE 25 - CAUSES FOR UNILATERAL TERMINATION 25.1 ECOPETROL may unilaterally declare this contract terminated, at any time before the expiration of the period set forth in Clause 23, in the following instances. 25.1.1 By death or permanent physical disability or judicial interdiction of THE ASSOCIATE, if a natural person. 25.1.2 By initiation of a process of liquidation of THE ASSOCIATE if a juridical person. 25.1.3 By legal injunction of THE ASSOCIATE that seriously affects the fulfillment of the contract. 25.1.4 When THE ASSOCIATE is conformed by several legal and/or natural persons, the causes in numerals 25.1.1 and 25.1.2 shall be applied when they seriously affect the fulfillment of the contract. 25.2 In the case of declaration of a unilateral termination, the rights of THE ASSOCIATE mentioned in this contract shall end, both as interested Party to the Contract, and as 30 operator, if at the time of the declaration of a unilateral termination the two qualities mentioned concur in THE ASSOCIATE. CLAUSE 26 - OBLIGATIONS IN CASE OF TERMINATION 26.1 Upon termination of the contract pursuant to Clause 24, either in the Exploration, Retention or Exploitation periods, THE ASSOCIATE shall leave in production any wells that are then producing and restitute the facilities, transfer pipelines and other real property of the Joint Account (located in the Contract Area), all of which, shall pass free of charge to ECOPETROL with the any rights of ways and assets obtained to the exclusive benefit of the contract, even though the former or the latter be located outside of the Contract Area. 26.2 If this contract is terminated for any reason after the first seventeen (17) years of the Exploitation Period, all Interest of THE ASSOCIATE in the machinery, equipment or other assets or facilities used or obtained by THE ASSOCIATE or by the Operator for the execution of this contract, shall pass to ECOPETROL free of charge. 26.3 If this contract is terminated before the seventeen (17) years of the Exploitation Period, that set forth in Clause 22 (numeral 22.10) shall be applied. 26.4 In case this contract is terminated by a declaration of a unilateral termination issued at any time, all the real and personal property acquired for the sole benefit of the Joint Account shall pass to ECOPETROL free of charge. 26.5 Upon termination of this contract by any cause and at any time, the Parties are obliged to satisfactorily fulfill their legal obligations between each other and before Third Parties and those acquired in this contract. CHAPTER VII - VARIOUS PROVISIONS CLAUSE 27 - RIGHTS OF ASSIGNMENT 27.1 THE ASSOCIATE shall be entitled to assign or transfer all or part of its interests, rights and obligations originated from this contract, with the previous written authorization of ECOPETROL, to another person, company or group that has the financial capacity, the technical competence, the necessary professional abilities and legal capacity to act in Colombia. For such purpose, THE ASSOCIATE shall submit a written request to ECOPETROL, indicating the essential elements of the negotiation, such as the name of the possible assignee, information on his legal, financial, technical and operational capacities, the cost of the rights and obligations to be assigned, scope of the operation, etc. Within the sixty (60) working days following the receipt of the request, submitted in a complete form, ECOPETROL, shall exercise the discretional faculty to study the information supplied by THE ASSOCIATE, after which it shall adopt its determination, without being obliged to motivate it. 27.1.1 When the assignments are in favor of companies that control or direct THE ASSOCIATE, or of any one of the companies that integrate it or their affiliates or subsidiaries, or between 31 companies that conform the same economic group, it shall be sufficient to previously and timely notify ECOPETROL on the essential elements of the negotiation previously mentioned. 27.1.2 The operations performed under the development of this clause, and that pursuant to the Colombian Legal Tax legislation, are taxable, shall cause the payment of the corresponding taxes. Paragraph: When THE ASSOCIATE is conformed by more than one company and one of them wishes to totally or partially assign its interests, rights and obligations in the contract pursuant to this clause, it must give preference to the other companies that integrate THE ASSOCIATE, offering them, before doing so to Private Parties, the interests, rights and obligations it wishes to assign, unless the companies that conform THE ASSOCIATE have agreed otherwise. CLAUSE 28 - DISAGREEMENTS 28.1 In the event of any discrepancies or inconsistencies in the interpretation of the Clauses of this contract with relation to those set forth in Annex "B" called the "Operating Agreement", those stipulations of the first shall prevail. 28.2 The disagreements that arise between the Parties on matters of rights related with the interpretation and execution of the contract and that cannot be solved in a friendly way, are subject to the knowledge and decision of the legal branch of the Colombian public authorities. 28.3 Any difference as to the facto or technical matters that may arise between the parties hereto as a result of the interpretation or application of this contract and that cannot be solved in a friendly manner, shall be subject to a final decision of experts appointed as follows: one by each Party and, the third one, appointed by mutual agreement by the principal experts appointed. Should these two fail to reach an agreement as to the appointing of the third, the latter shall be designated upon request of either Parties by the Board of Directors of the Sociedad Colombiana de Ingenieros "SCI" (Colombian Society of Engineers), with offices in Bogota, D.C. 28.4 Any differences of an accounting nature that may arise between the Parties hereto by reason of the interpretation and implementation of the contract, which cannot be solved in a friendly manner, shall be referred for the decision of experts who shall be professional public accountants designated as follows: one by each Party and, the third appointed by the two principal experts; should these fail to reach an agreement and by request of any of the Parties, such third expert shall be designated by the Central Board of Accountants of Bogota (Junta Central de Contadores de Bogota). 28.5 Both parties declare that the experts decision shall have all the full effect of a settlement between them and in consequence, such decision shall be final. 28.6 In case of disagreement between the Parties on the technical, accounting or legal nature of the controversy, it shall be considered legal and Clause 28 (numeral 28.2) shall be applied. 32 CLAUSE 29 - LEGAL REPRESENTATION Without prejudice to THE ASSOCIATE's legal rights and as a consequence of the legal provisions or of the clauses of this contract, ECOPETROL shall represent the Parties before the Colombian authorities on any matters concerning the exploitation of the Contract Area whenever it is necessary, and shall supply the officers and government entities with all the data and reports that may be legally required. The Operator shall be obliged to prepare and supply ECOPETROL with the corresponding reports. Any expenses incurred in by ECOPETROL to attend any matter to which this Clause refers to, shall be charged to the Joint Account, and when such expenses exceed five thousand dollars of the United States of America (US$5.000) or its equivalent in Colombian currency, the previous approval of THE ASSOCIATE is required. The Parties declare, for any relation with Third Parties, that neither that established in this Clause nor in any other of this contract, shall imply the granting of a general power of attorney, moreover that the Parties have constituted a civil or commercial association or any other relationship under which, any of the Parties may be considered as jointly and severally liable for the acts or omissions of the other party or as having authority or mandate that may be binding upon the other Party in relation to any obligation. This contract is concerned to the activities within the territory of the Republic of Colombia, and even though ECOPETROL is a Colombian State-Owned and industrial company, the Parties agree that THE ASSOCIATE, given the case, may choose to be excluded from the enforcement of all the provisions of Sub-chapter K titled PARTNERS AND PARTNERSHIPS of Internal Revenue Code of the United States of America. THE ASSOCIATE shall make such election on its behalf and in the appropriate manner. CLAUSE 30 - RESPONSIBILITIES 30.1 The liabilities Contracted hereunder by ECOPETROL and by THE ASSOCIATE with relation to Third Parties shall not be joint and, in consequence, each Party shall be separately liable for its share in the expenses, investments and obligations that may result as a consequence of such liabilities. 30.2 Environmental Management. During the performance of all of the activities provided for in the contract, THE ASSOCIATE or the Operator, shall on time comply with the provisions of the National Code on Natural Renewal Resources and Environmental Protection, issued by the Colombian Government, as well as with all other relevant legal regulations. Also, motivate among their contractors, suppliers, intermediaries, and/or workers working in benefit of this contract, the conservation of a healthy environment, taking the necessary precautions to protect the environment, human life and property of others and prevent the contamination of the Contract Area. From the beginning of this contract, THE ASSOCIATE shall elaborate a general diagnostic on the environmental and social reality of the zones where the Exploration Operations shall be executed and shall establish the communication channels with the authorities and communities of the area. THE ASSOCIATE is obliged to execute a permanent preventive program to guarantee the preservation and restoration of the natural resources within the zones where the operations of Exploration, exploitation and transportation set forth in this contract are carried out. Such plans and programs must be made known by THE ASSOCIATE to the national and regional communities and entities related to this issue. Also, specific contingency programs must be established to face those emergencies that may occur and to carry out the 33 necessary remedial actions. For such effect, THE ASSOCIATE must coordinate such plans and actions with the competent authorities. The respective programs and Budgets must be prepared by THE ASSOCIATE pursuant to the corresponding Clauses of this contract. All costs caused shall be assumed by THE ASSOCIATE during the Exploration Period and in the exploitation under the modality of sole risk, and by both Parties with charge to the Joint Account in the Exploitation period. CLAUSE 31 - TAXES, CHARGES AND OTHERS The taxes and charges accrued after the opening of the Joint Account and before the Parties receive their production share, chargeable to the exploitation of Hydrocarbons, shall be charged to the Joint Account. Income, patrimony and supplementary or presumptive taxes, shall be to the sole account of each of the Parties as applicable to each of them. CLAUSE 32 - PERSONNEL 32.1 When THE ASSOCIATE is the Operator, the assignment of the Manager of the Operator shall be previously consulted with ECOPETROL. 32.2 Pursuant to the terms of this contract and subject to the regulations established, the Operator in his condition as the sole and true employer, shall have the autonomy to assign the personnel required for the operations hereunder, being able to set the salaries, duties, ranks and conditions. The Operator shall adequately and diligently train the Colombian personnel required to replace the foreign personnel that the Operator considers necessary for the performance of the operations of this contract. In any case, the Operator must fulfill all the legal provisions that show the proportion of national and foreign employees and workmen. 32.3 Technological Transfer - THE ASSOCIATE is obliged to pay for or perform at its cost the training programs for the professionals of ECOPETROL in areas related to the development of the contract. For the fulfillment of this obligation in the Exploration Period, the training may also be in the areas of geology, geophysics and related areas, evaluation of Reservoirs and characterization of reservoirs, drilling and production. The supervised training shall be done throughout the entire Exploration Period of six (6) years and during its extensions, by integrating the professionals that are assigned by ECOPETROL, to the work group organized by THE ASSOCIATE for the Contract Area or for other activities handled by THE ASSOCIATE. To be able to choose to resign as set forth in Clause 5 of this contract, THE ASSOCIATE must have previously fulfilled the training programs herein mentioned. During the Exploitation Period, the scope, duration, place, participants, training conditions and other aspects, shall be established by the Executive Committee of the Company. 34 All costs for guided training, with the exception of those of work caused in favor of the professionals that receive it, shall be assumed by THE ASSOCIATE in the Exploration Period and by both parties with charge to the Joint Account in the Exploitation Period. PARAGRAPH: To fulfill all of the Technological Transference obligations pursuant to that herein mentioned, during the first three (3) years of the Exploration Period and for each year, THE ASSOCIATE is committed to carry out programs of guided training and technical exchanges for professionals of ECOPETROL in the areas of joint interest up to a value of forty thousand dollars (US$40.000) per year. The subject and type of program shall be previously agreed to between ECOPETROL and THE ASSOCIATE. In the event that the Exploration Period is extended, the guided training shall consist of similar programs to that herein considered. CLAUSE 33 - INSURANCES THE ASSOCIATE or the Operator shall obtain all the insurances required by the Colombian laws. Also, it shall require that each contractor performing any type of work during the development of this contract obtain all the insurances considered necessary, that must be maintained in force. Also, the Operator shall take all other insurances that the Executive Committee considers necessary. At the expiration of this contract, at any moment during the exploitation period or by expiration of a term set forth in clause 23, the Operator and/or THE ASSOCIATE shall constitute an insurance policy that guarantees the payment of salaries, benefits and indemnifications and other working credits for eventual legal sentences derived from claims of the workers contracted by the Operator in his condition as a sole and true employer of the same and during the time of operation of the Commercial Field. The life of the policy shall not be less than three (3) years as of the date of the termination of the Association Contract and the sum insured shall be decided by the Executive Committee, subject to that ordered in the labor regulations that apply to the respective labor contracts. CLAUSE 34 - FORCE MAJEURE OR ACT OF GOD The obligations to which this contract refer to shall be suspended for the time in which any of the Parties is unable to fulfill them in whole or in part, due to unforeseeable events that constitute a force majeure or Act of God, such as strikes, lockouts, wars, earth quakes, floods or other catastrophes, laws or government regulations or decrees that hinder the provision of essential material and, in general, any non financial motive that really impedes the work, even when not previously mentioned, but that affects the Parties and that is out of their control. Should either Party be unable to fulfill its obligations with this contract due to force majeure or Act of God, it must immediately notify the other Party, for its consideration, specifying the causes of its impediment. In no case can the events of force majeure or Act of God extend or prolong the total period of exploration, retention and exploitation beyond a maximum duration of the contract pursuant to that set forth in Clause 23, but any impediment of force majeure during the period of six (6) years of exploration set forth in Clause 5, which duration is more than sixty (60) consecutive days, shall extend this period of six (6) years for the same period of the duration of the impediment. 35 CLAUSE 35 - APPLICATION OF THE COLOMBIAN LAWS The Parties set the city of Bogota, D.C., Republic of Colombia for any purposes hereunder. This contract is governed ruled in all of its parts by the Colombian laws and THE ASSOCIATE abides by the jurisdiction of the Colombian Courts and waives any diplomatic claim in respect to its rights and obligations hereunder, except in the case of denial of justice. Denial of justice shall not be deemed to exist when THE ASSOCIATE in its condition as a Party or as Operator has had access to all the resources and ways of action that, pursuant to the Colombian laws, may be used before a jurisdictional branch of the public power. CLAUSE 36 - NOTIFICATIONS Notices or communications between the Parties hereto in relation to this contract, shall require for their validity mentioned or the pertinent clauses and shall be sent to the representatives or delegates assigned by the Parties to the following addresses: ECOPETROL: Carrera 13 No. 36.24, Bogota, D.C., Colombia. To THE ASSOCIATE: Calle 114 No. 9-01 Bogota, D.C., Colombia. The change of address and of representative shall be notified to the other Party in advance. CLAUSE 37 - VALUATION OF THE HYDROCARBONS The payments or Reimbursements set forth in Clauses 9 (numerals 9.2 and 9.4) and 22 (numeral 22.5), shall be made in dollars of the United States of America, or in Hydrocarbons based on the price in effect and with the limitations established or that may be established by the Colombian legislation for the sale of that portion of the Hydrocarbons payable in dollars, originated from the Contract Area, and to be refined within the national territory. CLAUSE 38 - PRICES FOR HYDROCARBONS 38.1 The Hydrocarbons to which THE ASSOCIATE is entitled to in the development of this contract, to be refined or used in internal supply, shall be paid when situated at the refinery where they shall be processed or at the station where they are received as agreed to by the Parties, pursuant to the government rules and regulations in force or those that substitute them. 38.2 The differences that arise from the application of this Clause shall be solved through the systems established in this contract. CLAUSE 39 - DELEGATION AND ADMINISTRATION The PRESIDENT of EMPRESA COLOMBIANA DE PETROLEOS - ECOPETROL appoints the administration of this contract in the Vice-President of Exploration and Production, pursuant to the rules and Reglementary provisions of ECOPETROL, with faculties to execute all the matters concerning the development of this Contract. The Vice-President of Exploration and Production is authorized to perform this assignment through the Assistant Vice-Presidents of Exploration and Production. 36 CLAUSE 40 - LANGUAGE For all effects and acts related to this contract, the official language is Spanish. CLAUSE 41 - VALIDITY To be valid, this contract requires the approval of the Ministry of Mines and Energy. In witness whereof, it is signed in Bogota, D.C., before witnesses, on the twentieth (20) day of the month of December of the year two thousand (2001). EMPRESA COLOMBIANA DE PETROLEOS ECOPETROL (Signed) illegible ALBERTO CALDERON ZULETA President HARKEN DE COLOMBIA LIMITED (Signed) illegible GABRIEL GUSTAVO CANO VELASQUEZ Principal Legal Representative WITNESSES (Signed) Illegible (Signed) Illegible VICTOR EDUARDO PEREZ ALBERTO TOVAR 37 CAJARO SECTOR ANNEX A 38 ANNEX A CONTRACT AREA ANNEX TO THE ASSOCIATION CONTRACT OF THE CAJARO SECTOR The area of the polygon formed by the vertices mentioned hereinafter is of thirty four thousand one hundred ninety five (34.195) hectares with seven thousand fifty eight (7.058) square meters and is located within the municipal jurisdiction of Mani in the department of Casanare. The cartographic information was taken from the Political Map of Colombia, digital file of the I.G.A.C., at a scale of 1:1'500.000. The Contract Area is described as follows and, as it appears on the map enclosed as Annex "A", that is part of this contract, as well as the corresponding charts: The Geodesic Vertex "RECREO- 912" of the Agustin Codazzi Geographical Institute has been taken as the point of reference, which flat GAUSS coordinates with origin Bogota are: N-1'051.829,47 meters, E-1'158.055,62 meters, that correspond to the geographic coordinates Latitude 05(0) 03'58"0,207 to the North of the Equator, Longitude 72(0) 39'20"0,698 West of Greenwich. From this vertex it bears S 50(0) 43'3"0,552 E for a distance of 70.494,393 meters until reaching point "A" start off point of boundaries which coordinates are N-1007.196,48 meters, E-1'212.620,77 meters. From this point it bears S 67(0) 33'25"0.116 E for a distance of 3.709,75 meters until reaching point "B", which coordinates are N- 1'005.780,23 meters, E-1'216.049,54 meters. The line "A-B" is contiguous in all of its extension with line "C-B" of the Alcaravan Association Contract operated by Harken. From this point it bears S 58(0) 57'42"0.358 E for a distance of 18.968, 27 meters until reaching point "C" which coordinates are N-996.000,00 meters, E 1'232.302,00 meters. From this point it bears S 54(0) 42'41"0.066 W for a distance of 22.725,46 meters until reaching point "D" which coordinates are N-982.871,61 meters, E- 1'213.752,28 meters. The point "D" is contiguous with point "D" of the Vuelta Laraga Association Contract operated by the Emerald company. From this point it bears N 23(0) 38'28"0.601 W for a distance of 9.395,40 meters until reaching point "E" which coordinates are N-991.478,49 meters, E- 1'209.984,64 meters. From this point it bears N 51(0) 1'59"0.565 W for a distance of 9.036,48 meters until reaching point "F", which coordinates are N- 997.161,26 meters, E- 1'202.958,68 meters. From this point it bears N 43(0) 54'53"0.153 E for a distance of 13.930,60 meters until reaching point "A" start off point and closure of the boundaries. Lines "D-E", "E-F" and "F-A" are contiguous in all their extension with lines "O-N", "N-M" and "M-L" of the Bicudo Association Contract operated by the Braspetro company. 39 ANNEX -A EMPRESA COLOMBIANA DE PETROLEOS Calculation of Area, courses and Distances as of Gauss Coordinates. Origin Bogota Data and Results Chart for the CAJARO Sector Municipal Jurisdiction of Mani in the Department of Casanare POINT Coord. N. Coord. E. Distance Dif.N. Dif. East Courses 40 ANNEX B TO THE OPERATIONS AGREEMENT ANNEX TO THE ASSOCIATION CONTRACT FOR THE "CAJARO" SECTOR Entered into by the Empresa Colombiana de Petroleos - ECOPETROL and HARKEN DE COLOMBIA LIMITED, with effective date February eighteenth (18th) year two thousand two (2002), which hereinafter shall be known as The Contract. PART 1 - TECHNICAL ASPECTS Section One - Exploration The geological and geophysical information that THE ASSOCIATE is to provide to ECOPETROL, shall be provided following the international norms accepted by the industry, compatible with the norms used by ECOPETROL (included in ECOPETROL's information provision manual) in order to allow for regional assessments of the sedimentary basins. As a supplement of what is provided for in Clause 6 (number 6.2) in The Contract, THE ASSOCIATE or the Operator shall deliver to ECOPETROL, as it becomes available, the following information with respect to the exploratory activities that are undertaken by THE ASSOCIATE. 1.1 The geological, geophysical, magnetometric, gravimetric information from remote sensors, electrical methods and, in general, from any Exploration Work performed by THE ASSOCIATE in the development of The Contract shall be submitted in magnetic media, in a reproducible original and one copy, with its respective support information, including the maps related with the acquisition and interpretation of the acquisition, processing and interpretation reports for the data acquired. 1.2 Processed seismic sections for each line, obtained in two scales, together with an interpretation report to contain: information used, background, seismic programs, geological information and geophysical, geological and economic considerations that back up the conclusions and technical recommendations. 1.3 Two (2) sets of magnetic tapes corresponding to the seismic lines, one with the de- multiplexed information and the other with the stacked information, with their support information and processing report. For the case of vibrators, a copy of the field tape is to be delivered in lieu of the de- multiplexed tape. 1.4 One seismic shot-point map, in reproducible sepia and copy, with the information of coordinates and elevations. This information shall also be delivered on magnetic tapes. 1.5 Magnetic, gravimetric profiles and residual maps in reproducible originals, copies and magnetic tapes, with all of the support information generated. 1.6 Report on the seismic, gravimetric and magnetometric interpretation, together with all of the sections, profiles and maps interpreted, submitted set forth in the norms that ECOPETROL has established for this information. 1.7 Geological, structural, isopach, isolithic, facies, seismic, etc. maps for The Contract area, in reproducible sepias and copies, with the scales established by ECOPETROL for each basin. 1.8 Before starting to drill the well: Intention to Drill (Form 4- CR of the Ministry of Mines and Energy), drilling program, well location map, isochronic or structural map of the prospective 41 area and the geological drilling prognosis, duly approved by the Ministry of Mines and Energy. In the event of Exploratory Wells, the following shall also be submitted in three scenarios: the calculation for the Reservoirs in the prospective area to be drilled and the forecast of investments and production. The location of the Exploratory Wells shall be referenced to the seismic maps that served as the basis for the definition of the prospect. For each of the Exploratory Wells that is drilled in The Contract area, a geodesic precision point shall be materialized, duly accepted by the Agustin Codazzi Geographical Institute - "IGAC," obtained by satellite and with its respective azimuth line. 1.9 Daily drilling and geology reports: These reports shall be delivered to ECOPETROL, preferably by telefax, and shall contain the basic information on the well, the drilling conditions, the properties of the drilling fluid, the manifestations of Hydrocarbons that are being obtained, the geological description of the formations penetrated, the daily and cumulative cost and the program to be carried out. The ASSOCIATE or the Operator shall advise ECOPETROL with sufficient advance notice on the performance of electrical logs, cores and testing, so that the latter can send a representative to attend and witness all of the operations. 1.10 Copy of the reports sent to the Ministry of Mines and Energy (Form 5- CR) every two weeks. 1.11 Final Geological Report: This report is compulsory for any well that is drilled in the country, whether it be exploratory, stratigraphic, or development, and shall be submitted in Spanish, by a registered geologist, latest ninety (90) days after the date of termination or abandonment of the well, and shall include the following information by chapters: 1.11.1 Summary of all activities performed during the drilling operations 1.11.2 Location of the well and maps at a 1:250,000 scale. 1.11.3 Stratigraphy: shall include the stratigraphic column, determination of environments and age for each of the formations drilled. 1.11.4 Biostatigraphy: The dispersion charts, analyses performed and possible correlations are to be submitted. 1.11.5 Geochemistry: All of the analyses performed shall be included, both for the ditch samples and for each of the cores recovered. 1.11.6 Electrical logs: All of the calculations performed for the determination of RW, SW shall be included. The analysis of log velocity shall be included in this chapter. 1.11.7 Formation testing: All of the results obtained for each of the tests performed shall be included, as well as the results of the analyses performed in the laboratories for water and Hydrocarbons. 1.11.8 The Final Geological Report shall contain the following Annexs: Annex A: Description of the ditch samples at every ten (10) feet. Annex B: Detailed description of the cores and side wall samples that may have been recovered. Annex C: All of the laboratory analyses that are performed on the cores and side wall samples. 42 Annex D: Composite graphic log, in reproducible sepia and copy at a 1:500 scale. The symbols that are used by the American Association of Petroleum Geologists (AAPG) for these cases shall be used for the various lithologies included in the composite graphic log. Annex E: Final report issued by the company that performed the "logging" for the well, including the "Grapholog" log. 1.12 Reproducible sepias and copies of each and every log run in the well, including the velocity log, in 1:200 and 1:500 scales. In addition, the magnetic tapes in LIS format for each of the logs shall be delivered, together with the computer tabulations in the formats established by ECOPETROL for these cases. 1.13 Report on the formation and/ or production tests performed, including the analysis of bottom hole pressure (both open well and closed). 1.14 Two sets of ditch samples shall be delivered to ECOPETROL, one unwashed every thirty (30) feet and a dry one every ten (10) feet, with the detailed lithological description. 1.15 Coring report, whenever performed, including the detailed description for it, as well as on all of the analyses that are carried out. With this report, THE ASSOCIATE is to deliver photographs to ECOPETROL, as well as 50% of the core. 1.16 A report on all of the materials used during drilling. 1.17 Biostratigraphic analyses with their dispersion chart: These analyses shall be performed for Exploratory Wells, since the sedimentation environments and the age of each of the formations drilled are defined with this information. This type of analysis can also be performed on the various recovered cores. 1.18 Geochemical analyses performed on the ditch, side wall and core samples. 1.19 Official completion, plugging or abandonment report for the well (Form 6- CR or 10A- CR) and, in general, any other report related with the termination of the well (further work, multiple termination). 1.20 Final Well Report. Shall include all of the engineering information and a summary of the Final Geological Report. It shall be submitted in the Spanish language, latest ninety (90) days after the date of termination or abandonment of the well, with the approval of a duly registered petroleum engineer. 1.21 Copy of the Annual Technical Report (Geology and Geophysics and of the Engineering Report), with their respective support, submitted to the Ministry of Mines and Energy, set forth in the existing legal provisions. 1.22 Any other engineering or geology study that may be performed. CLAUSE 2 - RESTITUTED OF AREAS 2.1 The areas that THE ASSOCIATE shall restitute to ECOPETROL, set forth in Clause 8 of The Contract shall be, inasmuch as possible, regular lots with a polygon shape, attempting to facilitate the demarcation of borders, without prejudice of the areas in the existing Fields. For such purpose, an imaginary grid or grille shall be superimposed upon the initially Contract area, divided into ten rows and columns in a north- south direction, the limits of which shall be given by the maximum and minimum border north and east coordinates, 43 which shall define the base cells for the areas to be restituted herein. Every time an area is restituted, the imaginary grid or grille shall be adjusted, based on the new coordinates for the Contract Area. 2.2 THE ASSOCIATE shall determine the areas that it shall restituted to ECOPETROL, based on the imaginary grid or grille mentioned in the above point. For such purpose, it shall carry out the restitution of up to two lots made up by one or more cells that are contiguous and adjacent on their sides, and trying to conserve a sole polygon, unless THE ASSOCIATE demonstrates that this is not possible or convenient, for which purpose it shall require ECOPETROL's approval. CLAUSE 3 - EXTENSIVE PRODUCTION TESTS The following is the established procedure for performing Extensive Production Testing for Exploratory Wells and for the handling of Hydrocarbons from such tests, prior acceptance or not of the existence of a Commercial Field by ECOPETROL, set forth in Clause 9 of The Contract: 3.1 THE ASSOCIATE is entitled to perform Extensive Production Tests for the Exploratory Wells that turn out to be producers, with the purpose of assessing in the best manner, the Reservoir or Reservoirs discovered and prepare the Development Program for the possible Field. Before initiating the Extensive Production Tests THE ASSOCIATE shall obtain ECOPETROL's approval and subsequently, permission from the Ministry of Mines and Energy. Such tests shall be performed with temporary production facilities and shall not require more than ninety (90) calendar days, unless THE ASSOCIATE proves the contrary and obtains timely approval from ECOPETROL and from the Ministry of Mines and Energy, respectively. 3.2 THE ASSOCIATE, on its own account and risk, shall, set forth in international oil industry recommended rules and practices, carry out the Extensive Production Tests accepted by ECOPETROL and authorized by the Ministry of Mines and Energy, set forth in the operations program. In order to obtain such approvals, THE ASSOCIATE shall prepare and submit to ECOPETROL the operations program for the Extensive Production Testing, which shall contain, among others, the following aspects: 3.2.1 Information of the completion of the Exploratory Well and of the Reservoirs to be tested. 3.2.2 Specific objectives for the Extensive Production Tests. 3.2.3 Information to be compiled on the Reservoirs and fluids, periodicity for sampling, analyses and data on the possible Field, such as type, quality and properties of rocks and fluids, pressures, volumes of "in situ" and recoverable Hydrocarbons, maximum economic Hydrocarbons production rate, production mechanism, etc. 3.2.4 Information on the subsurface equipment and temporary surface facilities to be used to handle and decant the volumes of fluids obtained and other equipment required to ensure the safety of the operations, including the location diagram for the temporary surface facilities on site. 3.2.5 Detailed chronogram on the main activities to be performed in order to achieve the specific objectives referred to in number 3.2.2. mentioned above. 3.2.6 Budget for the main activities to be carried out and the estimated disbursement schedule. 44 3.2.7 Destination of the Hydrocarbons and other fluids to be recovered from the Extensive Production Testing. 3.2.8 Evacuation and marketing scheme for the Hydrocarbons from the Extensive Production Tests (including the volume the corresponds to royalties) and reference price proposal subject to be agreed upon with ECOPETROL for the valuation of such Hydrocarbons. 3.2.9 Draft contract and proposals (at least three) for the transport of the Hydrocarbons to be produced corresponding to the royalties set forth in Clause 13 of The Contract, from the Exploratory Well to the delivery point of such Hydrocarbons to ECOPETROL. 3.2.10 Any other information that THE ASSOCIATE may consider necessary. 3.3 ECOPETROL may request clarification or suggest adjustments to the operations program submitted by THE ASSOCIATE for the execution of the Extensive Production Tests. When this occurs, THE ASSOCIATE shall submit the explanations to ECOPETROL and, if required, shall bear in mind the comments proposed by ECOPETROL, it being understood that, in any case, the responsibility and the risk for any operation that is included in the operations program for the Extensive Production Tests shall be the responsibility of THE ASSOCIATE. Once the operations program is accepted by ECOPETROL and the appropriate agreements have been reached, it shall be submitted to the Ministry of Mines and Energy by THE ASSOCIATE in order to obtain the corresponding permission. 3.4 THE ASSOCIATE shall be responsible for one hundred percent (100%) of the disbursements incurred during the Extensive Production Tests, including the costs of transporting the volumes of hydrocarbons corresponding to the royalties, if this were the case, from the Exploratory Well to the delivery point that the Parties agree to, set forth in the transportation proposal accepted by ECOPETROL. The costs incurred on account of Extensive Production Testing for each Exploratory Well shall be charged as an increased value for the respective Exploratory Well and shall be considered as Direct Exploration Costs (without including administrative or technical support from Head Office, nor from the central headquarters of the Company) for purposes of their recovery or Reimbursement, set forth in the origin of their disbursement. 3.5 The volumes produced during the Extensive Production Tests shall be those recovered from the respective Exploration Well during the maximum time period for testing approved by the Ministry of Mines and Energy in the corresponding permit, discounting any volume of the Hydrocarbons that may be used as consumption in the testing operations. The remaining production, once the percentage corresponding to royalties has been discounted, which shall be paid directly by ECOPETROL, shall be taken by THE ASSOCIATE, and the income stemming from the valuation of such Hydrocarbons at the reference price agreed to by the Parties, shall be deducted from the Direct Exploration Costs for the respective Exploratory Well, up to a maximum of fifty percent (50%) of such costs, for purposes of their recovery or Reimbursement in the following order: i) Direct Exploration Costs in the Extensive Production Tests; ii) Direct Exploration Costs in the drilling and completion of the respective Exploratory Well; and iii) Direct Exploration Costs incurred in Exploration Work undertaken before the drilling of the respective Exploratory Well. Once fifty percent (50%) of the Direct Exploration Costs has been recovered, the production from the Extensive Production Tests shall be distributed between the parties in a proportion of fifty percent (50%) for ECOPETROL and fifty percent (50%) for THE ASSOCIATE. 45 3.6 Prior consent by ECOPETROL, THE ASSOCIATE may carry out the sale of the portion of production of Hydrocarbons from the Extensive Production Tests corresponding to the royalties and to ECOPETROL. In this case, the Parties shall previously enter into the corresponding agreement. 3.7 THE ASSOCIATE shall keep at the disposal of ECOPETROL the daily logs of the production and consumption measurements of Hydrocarbons and fluids, the disbursements incurred and the valuation of the produced Hydrocarbons at the agreed to reference price, with their respective support documentation and the balance in the recovery of Direct Exploration Costs in the development of the Extensive Production Tests for each Exploratory Well. In addition to the periodic reports on the progress of the Extensive production Tests for each Exploratory Well, THE ASSOCIATE shall, within the first ten (10) days each month, submit to ECOPETROL, a report wherein the development of the operations program for the Extensive Production Tests, the results obtained in the fulfillment of the specific objectives for the tests and the status of income and disbursements are reflected, taking as the basis the cumulative values for the accounting closure for the month prior to that for which the report is submitted. The information that THE ASSOCIATE submits in the periodic reports shall be subject to audit by ECOPETROL under the terms provided for in Clause 22 of this agreement. Section Two - Exploitation CLAUSE 4 - COMMERCIAL FIELD 4.1 THE ASSOCIATE, once it has obtained sufficient information related to the development of the Field, shall carry out the necessary studies to define the criteria on the petrophysical parameters, improved demarcation of the productive area, calculation of Reservoirs and commercial feasibility of the Field. Such studies shall be carried out by THE ASSOCIATE at its own expense, using the technical methods available in country or abroad; when the circumstances require it, the appropriate reviews shall be performed. 4.2 For new facilities, expansions or modifications, the basic production designs and detail engineering shall be submitted to the consideration of the Technical Subcommittee. 4.3 The engineering for the production facilities shall be Contract with national companies, unless, in the decision of the Technical Subcommittee, their technological complexity requires the involvement of a foreign company, preferably in a consortium with a national company. 4.4 The final mechanical completion of the wells passing to the Joint Account's property must agree upon by the Technical Subcommittee. The Reimbursement for such completion for the Exploratory Wells shall be made as set forth in Clause 9 (numbers 9.2.1 through 9.2.3) herein. 4.5 With respect to the dry Exploratory Wells, THE ASSOCIATE shall abandon them as set forth in the actual legal and environmental provisions. CLAUSE 5 - SOLE RISK 46 5.1 The Reimbursement corresponds to two hundred percent (200%) of the total cost of the work executed on the account and risk of THE ASSOCIATE in the exploitation of the corresponding Field and of up to fifty percent (50%) of the Direct Exploration Costs made by THE ASSOCIATE on its own account and risk within the Contract Area before the date on which ECOPETROL makes a statement with respect to the commerciality of the Field, which have not been previously charged to a different Field. ECOPETROL shall carry out an audit to determine the amount of the reimbursable investments. 5.2 In the same manner as set forth in Clause 11 numeral 11.1 of The Contract, THE ASSOCIATE shall submit to ECOPETROL the proposal on the projects, programs and Budget, set forth in the Field Development Program, for the first time, within sixty (60) calendar days following the date of the notification to ECOPETROL by THE ASSOCIATE with respect to its intention to exploit the Field under the sole risk method and subsequently, latest on the fifteenth (15th) of November of each year. ECOPETROL may, with the corresponding justification, request clarification or suggest adjustments to the programs, projects and Budget submitted by THE ASSOCIATE. When this were to occur, THE ASSOCIATE shall submit the explanations to ECOPETROL and, if this were the case, shall bear in mind the comments proposed by ECOPETROL in the preparation of the revised Development Plan, being understood that in all cases, the responsibility and the risk for any operation shall fall upon THE ASSOCIATE. The Development Plan for the Fields that are exploited under the sole risk method shall be reviewed annually and shall be consistent with international oil industry standards for the technical, efficient and economic exploitation of each field. 5.3 During the exploitation of a Field under the sole risk method, THE ASSOCIATE shall deliver to ECOPETROL, within the first ten (10) days of each quarter, a report listing all of the technical, economic, legal, administrative and accounting information for the previous quarter, such as the entering into of contracts, well completion, flow lines, production facilities, measuring systems, storage capacity, wells in production, restriction orifices, production reports, economic studies, etc. It is understood that the various Clauses in The Contract and the clarification in this document are fully applicable in the case of Clause 21 of The Contract, Operations for the Risk of one of the Parties, for purposes of timely information, the technical control of Reservoirs and other administrative aspects. 5.4 Within the first three (3) months of each year, THE ASSOCIATE shall contract an external auditor, accepted by ECOPETROL, to review the total costs of the work executed for the account and risk of THE ASSOCIATE for the exploitation of the respective field and the Direct Exploration Costs. The cost of the audit shall be part of the expenses that THE ASSOCIATE shall recover. THE ASSOCIATE shall deliver to ECOPETROL, immediately after having received them, the reports issued by the external auditor and shall maintain at its disposal all of the documentation on the costs in which THE ASSOCIATE has incurred in the exploitation of the respective field. CLAUSE 6 - INSPECTION OF THE OPERATIONS For the inspection and audit of the activities that are carried out in the Contract Area, ECOPETROL may send its representatives. During their stay in the area, THE ASSOCIATE or the Operator shall provide lodging and other conditions designated by ECOPETROL, equal to those provided for its engineers. 47 CLAUSE 7 - PRODUCTION 7.1 The Operator shall also transmit to the Parties any information of improvements in production techniques that it may develop during the Exploitation Period. 7.2 For the control and prevention of Hydrocarbon losses and damage to the environment, the Operator and the Parties shall apply the appropriate measures, with the generally accepted methods used by the oil industry in order to avoid Hydrocarbon losses or spills in any way during the drilling, production, transport and storage operations. 7.3 The Operator shall maintain a daily control of consumption of Hydrocarbons for the operation and shall submit a monthly report of these to the Parties, attaching the forms that the Ministry of Mines and Energy has for this purpose. CLAUSE 8 - DISTRIBUTION AND AVAILABILITY OF HYDROCARBONS 8.1 As per Clause 14 (number 14.1) of The Contract, the Operator shall carry out the measurement, sampling and quality control of the Hydrocarbons produced and maintain the measuring equipment or instruments calibrated, as set forth in the standards and methods accepted by the oil industry (ASTM, AGA and API) and the legal and regulatory provisions in force, performing the appropriate analyses and performing the pertinent corrections for the settlement of the net volumes of Hydrocarbons received and delivered under standard conditions. In order to preserve the integrity, reliability and safety of the facilities and the equipment or instruments for control, the Operator shall adopt all of the necessary actions and shall maintain, for purposes of review by the Parties, the records of periodic calibration of such equipment or instruments and of the daily measurements of production and consumption of Hydrocarbons and fluids. For the case of Extensive Production Testing and for Fields exploited under the sole risk, it shall be THE ASSOCIATE's responsibility to abide by the obligations assigned to the Operator in this number. The volumes of Hydrocarbons that the Operator accepts for its transportation shall be determined with the measuring equipment that the Operator shall have installed for this purpose at the receiving stations or delivery points. 8.2 If at any time the Parties were to ascertain that there has been an error in the calculation of the R Factor set forth in Clause 14 (numbers 14.2.3 and 14.2.4) herein, and that on account of this error it turns out that a different R Factor than the one applied is to be applied, or that it should have been applied at a different time than the one it was applied at, the corresponding correction shall then be made, with effect for the year in which the error was incurred in, adjusting the percent participation that corresponds to each Party as of that year. To perform the respective corrections with regard to the distribution of production, a similar procedure to the one described in Clause 14 (number 14.7) of The Contract shall be followed. CLAUSE 9 - SUPPLY OF HYDROCARBONS FOR EXPORT For purposes of Clause 14 of The Contract, in order to proceed with the export of Hydrocarbons, THE ASSOCIATE's priority shall be the domestic requirements of the country, before performing any export of Hydrocarbons, set forth in the legal provisions that may be in force regarding this matter. 48 PART II - ACCOUNTING AND FINANCIAL ASPECTS Section One - Programs, Projects and Budgets CLAUSE 10 - EXPLORATION BUDGET AND PROGRAMS 10.1 With respect to the Budget set forth in Clause 7 herein, THE ASSOCIATE shall differentiate and detail it, according to the type of Exploration Work and to the indication of the currency in which the disbursement is forecast to be made. With respect to the reports every six months, these shall be submitted within the first ten (10) calendar days of the months of January and July. The January report shall refer fully to the previous year and the July report to the first half of the current calendar year. CLAUSE 11 - EXPLOITATION PROGRAMS AND BUDGETS 11.1 For purposes of Clause 11 herein, the Operator shall submit the proposal for projects, programs and annual Budget, set forth in the Development Plan for each Commercial Field, with a detail short- term and medium- term outlook. The short- term Budget shall be submitted annually and by quarters, in order to facilitate its execution and for the preparation of the corresponding treasury flows. 11.2 The Operator shall submit to ECOPETROL the organization chart for the operation of each Commercial Field, which shall be agreed to at Subcommittee level and approved by the Executive Committee. CLAUSE 12 - BUDGET PREPARATION AND PRESENTATION The following norms and procedures constitute the guidelines for the preparation, presentation and control of the Budgets during the exploitation of each Commercial Field that may be discovered in the development of The Contract. The Budget shall be divided into three (3) parts, namely: 12.1 Income Budget 12.2 Expenditures Budget 12.3 Other provisions CLAUSE 13 - INCOME BUDGET This Budget, is in turn, broken down into two (2) sections: Current income Budget and Capital contributions. 13.1 Current Income: All funds which regularly accrue in the Joint Account and which the Operator can forecast. Such income includes the following items, when applicable: 13.1.1 Product sales: Income from the sale of Hydrocarbons that the Operator may perform on behalf of the Parties, to one of the Parties, or to Third Parties (it shall be understood that these sales are different from those made by each of the Parties of the production to which they are entitled to). 49 13.1.2 Services Furnished: All services that the Operator furnishes to one of the Parties or to a Third Party, in accordance with the rates established by the Sub-Committees and approved by the Executive Committee. 13.1.3 Sales of assets or materials: Sales of equipment or materials which the Operator makes to the Parties or to third parties as provided in Clause 20 (numeral 20.2) of this Agreement. 13.1.4 Other income: All funds received by the Operator on account on behalf of the Joint Account, for items such as the yield on temporary financial investments and other income that may be forecast by the Operator. 13.2 Capital Contributions: All funds received by the Operator on account of advances made by each of the Parties according to their share in The Contract. This income is given the name of advances or advance payments (cash calls) and shall be handled as set forth in the procedures in Clause 15 (number 15.5) in this Agreement. CLAUSE 14 - EXPENSE BUDGET As a prior step to its preparation, the Executive Committee, through the respective Subcommittees, shall set the policies and general parameters to be borne in mind when elaborating the Budget for the respective Commercial Field. The expense or appropriations Budget is made by the Operational Expenses Budget and by the Investment Budget, each of which shall be prepared in the currency of origin for its disbursement in pesos and in dollars of the United States of America, and shall be consolidated in dollars. 14.1 Operations expense Budget. The operations expense budget shall be prepared by the Operator as set forth in the norms and policies established by the Executive Committee as per Clause 19 (number 19.3.8) of The Contract, and taking as the base parameters and economic indicators, that the respective Subcommittee has defined as being the most representative for the budget execution term. 14.1.1. Preparation Procedure The Operator shall submit the Operating Expenses Budget, identifying the requirements of the Joint Operation, and shall detail the expense items set forth in the classification indicated in Clause 14 (number 14.1.2) of this Agreement. The cost factors for the assessment of the various activities that it plans to carry out during the year to which the Budget refers to, shall correspond to the true figures known at the time of preparation or, to the best information available. In all cases, the operating expense Budget shall be calculated bearing in mind the costs that are required by the entities that, 50 directly, render services to the Joint Account and, as such, are to be assumed one hundred percent (100%) by the Joint Account and charged back to the Parties in the proportion that Clause 22 (number 22.6.1) of The Contract refers to. The Indirect Expenses that are to be assumed by the Joint Account shall be charged to the Parties and shall be determined as set forth in Clause 22 (number 22.6.2) of The Contract. 14.1.2 Classification for the operating expenditure Budget For all presentation purposes, the operating expenditure Budget shall be broken down into programs, groups and expenditure concept. The expenditure programs within the Budget represent homogeneous activities necessary for the development of the Joint Operation, including those programs related with the investment projects. The expenditure groupings in numerical and continuous order within each program and project represent the object of the expense, shall be duly supported and explained, and shall be expressed in expenditure concepts. Following is a listing of the groups and the main expenditure concepts to be used: 14.1.2.1 Personnel expenses - organization chart Salaries Social Benefits Parafiscal contributions 14.1.2.2 Material and operation supplies Repair and maintenance materials 14.1.2.3 Contracted Services Technical services for the operation and Field maintenance Services given by the Operator Other Services 14.1.2.4 General Expenditures Equipment and office rental Shared expenses. Insurances. Public Utilities. Community relations Other general expenses. 14.1.2.5 Environmental Management Materials Contracted services Well abandonment Area restoration Other expenses 14.1.2.6 Added tax value (IVA) 51 14.1.2.7 Indirect expenses 14.1.3 Calculation base. Calculation for the operating expenses Budget shall be based on the following: The salary and social benefits Budget shall be calculated as set forth in the organization charts approved by the Executive Committee and their estimate shall be made as set forth in Clause 18 (number 18.1.1) herein. The calculation of salaries, social benefits and other special extra-legal bonuses originated by national and foreign personnel shall be presented separately, according to the origin of the disbursement, to be presented to the Subcommittees and the Executive Committee. The estimate of the cost of materials and supplies shall be made based on actual prices or updated quotations and, in general, with the best available information. Importation expenses shall be based on the FOB price calculations for the materials and/or equipment to be imported, and in their preparation the following factors shall be considered: freight, insurance, taxes for the use of Colombian ports, import duties and all other import expenses. The value of maintenance and operational services contracted shall be estimated on contracts formalized or to be formalized that the Joint Operation may have at the time the Budget is prepared. Indirect expenses chargeable to he Joint Account for services that are or may be provided by the Operator shall be calculated as set forth in Clause 22 (number 22.6.2) of The Contract). The purpose for the Budget for environmental expenses is to appropriate the annual funds that are required to fulfill environmental norms. General expenses shall be calculated taking into account the specific need of the Joint Operation in the normal course of its work. Shared expenses are those expenditures that are to be assumed by the Joint Account as a result of the use of facilities and/or services that are shared between Fields in the same Contract or with other areas. The Budget and the charges made to the Joint Account for general expenses shall be recommended by the Subcommittees and approved by the Executive Committee. Community Assistance will be budgeted on both the request of the interested parties and according to the policies that for such effect are established by the Executive Committee. In special duly-justified circumstances, the Operator may deal with requests according to its procedures, after first notifying each of the Parties on such matters 14.1.4 Budget Execution Execution of the operations expense Budget shall be made as follows: 14.1.4.1 All services, purchases or contracts that are charged to the Joint Account on account of operations expenses shall be budgeted and fully justified. 14.1.5 Budget execution control 52 The Operator is responsible for controlling the expense budget execution and must see that expenses are properly managed. Within the first ten (10) calendar days following the end of the respective quarter, the Operator shall prepare and submit to the Parties a report explaining the results obtained in the Budget execution, which shall contain: 14.1.5.1 Expenses accrued to date, itemized as per expense categories set forth Clause 14 (number 14.1.2) in this Agreement. 14.1.5.2 Special comments on items which deviate significantly from budget average or quarterly estimate. 14.1.5.3 Estimated expenses forecast for disbursements per quarter or for the rest of the year. 14.1.5.4 Justification for possible budget additions, adjustments or transfers that the Operator may deem necessary or that are proposed by one of the Parties. 14.2 Investment Budget Constitutes the basic planning, execution and control tool for each of the investment programs and projects that the Joint Operation foresees it shall carry out, and acts as means to estimate the required funds in the execution of the various programs that are approved by the Executive Committee. 14.2.1 The investment Budget is composed of items allotted for the following items: 14.2.1.1 Purchase of durable goods, materials and services required for the execution of the different projects approved by the Executive Committee. 14.2.1.2 Purchase of major maintenance equipment and tools destined for the Joint Operation shops, in order to ensure the normal development of the operations. 14.2.1.3 Construction and/ or expansion of buildings that the operation may require, including the facilities destined for workers in the Commercial Field's organization chart. 14.2.2 Classification of the Investment Budget For all presentation purposes, the Investment Budget shall be grouped into programs and projects. Programs, in numerical order within each Budget, represent a set of projects to be undertaken which, on account of their technical, operational and administrative characteristics, merit being controlled in a connected manner and which the Joint Operation shall execute through the Operator. Projects, in a numerical and continuous order within each program, constitute the set of activities that are common to a specific work or job and shall be duly supported and explained. Following are the main programs and projects to be used: 14.2.2.1 Development Wells Locations Drilling Completion Surface equipment, artificial lifting, recompletion and services that are capitalizable to the wells. 14.2.2.2 Surface facilities 53 Collection system and transfer lines Separation and treatment system Storage system DISPOSAL OF WATER AND CONTAMINANTS Pressure maintenance and/ or improved recovery system Pump Stations Hydrocarbon transport and transfer system Other support systems 14.2.2.3 Civil Work Roads Bridges Constructions (camp, workshops, warehouses and offices) 14.2.2.4 Other assets Automotive equipment Firefighting equipment Communications equipment Office equipment Electromechanical maintenance equipment Major tools Cleaning or workover equipment 14.2.2.5 Special programs Environmental management Reservoir studies Simulation studies Pressure, interference, etc. tests Others 14.2.2.6 Warehouses For projects. For maintenance materials. 54 14.2.2.7 Each one of the above projects can be broken down into sub-projects as needed, using a uniform identification. Final presentation thereof shall be made on a project by project basis, according to the classification given above and using forms two (2) and four (4) established by ECOPETROL for such purpose which may be adapted by previous agreement between the Parties, through the corresponding Subcommittee. In order to achieve increased clarity in the preparation and structuring of the investment Budget, the following considerations are to taken into account: 14.2.2.7.1 Maintenance investments All investments made in equipment, materials and construction for the purpose of keeping facilities in good operating condition as well as their original capacity and performance limits. 14.2.2.7.2 Enlargement Investment The investments are to be classified as such if their objective is to increase the facility capacity, increase the authorized provision of automotive equipment, office equipment, etc. 14.2.2.7.3 Special investments These include all of those investments which, on account of their amount, their importance for the industrial activities or their impact on a social or ecological level, merit being classified as special. 14.2.3 Preparation and presentation of the Budget Each and every one of the projects within the various programs that make up the Investment Budget shall be fully justified and analyzed before being included in the general Budget. In this sense, the Operator shall prepare an investment draft which shall contain the following general information: a) Analysis of needs b) Project justification c) General project description d) Estimated amount of the investment e) Execution chronogram f) Critical path for the project g) Economic evaluation The draft with the aforementioned information, plus any other information that may be considered necessary for its assessment that the Operator may submit, shall be studied jointly by the respective Subcommittees, which shall recommend or object to the viability of the project, as set forth in the policies drawn up by the Executive Committee. Once such Subcommittees recommend that a specific project be undertaken, the project shall then be included in the Budget to be approved by the Executive Committee for the respective Commercial Field. 55 All of the general information that is submitted to justify each project will be compiled in a Technical-Financial Annex, which shall serve as support when presenting the Budget for each Commercial Field for the approval of the Executive Committee. 14.3 Budget Consolidation. Once the Joint Operation's requirements have been defined, the Operator will consolidate the Operations Expense and Investment Budget for each of the Commercial fields, as set forth in classification in Clause 14 of this Agreement (numerals 14.1.2 and 14.2.2 respectively) and shall present it to the Executive Committee for final approval. The Operation Expense Budget and the investment Budget, will be submitted in four columns that will contain the accrual origin in United States of America dollars, accrual origin in pesos, a consolidated statement in dollars and one in pesos, using the forecast of the exchange rate for the respective year for this purpose. In addition, the Operator shall prepare, for information purposes, a disbursement chronogram that indicates the cash requirements in the short term, itemized by quarter and by currency origin, at the level of expense group, program and investment project. 14.4 Budget Execution In all cases, the Operator is authorized to make all of the operations and investment expenses that the Joint Operation requires, set forth in the approved Budget and subject to the procedures in this Agreement, and those that the Executive Committee may establish. The execution of the budget shall be performed by the Operator through its various departments and set forth in the previously established execution schedules. The appropriations assigned to each project shall be identified with a previously defined code, which shall be used on all documents that originate in carrying out its budgetary execution. 14.5 Budget Control. The Operator shall be responsible for carrying out each of the investment programs and projects and shall be accountable for the execution of these within the conditions under which they were approved. Similarly, it shall be responsible for the verification that the corresponding steps for the performance of the projects are taken adequately and on a timely basis. In the event that any problem is encountered that prevents the normal development of the projects, it shall immediately report it in writing to each of the Parties, in order to seek the solution to the difficulty that has been encountered. The Operator, as the responsible party for the Development Plan, the programs, projects and Budget, shall prepare the quarterly reports regarding the budget and technical advance of these, which it shall send to each of the Parties for their study and subsequent approval by the Executive Committee. The quarterly report that is to be prepared and presented by the Operator within the ten (10) days following the end of each quarter, shall contain the following information: a) Period covered by the report. b) Project code and description. c) Total project budget. d) Financial advances from its start to final date. Investments per current-year, accumulated to date. 56 e) Technical progress of the work. f) Quarterly projection of work to be carried up to year-end, for information purposes. CLAUSE 15 - OTHER PROVISIONS 15.1 Budget Additions If, during the execution of the Budget, it were necessary to add supplementary items above and beyond the appropriations approved by the Executive Committee, the Operator shall request the corresponding modifications from the Parties in an extraordinary manner and their ratification shall be made in the next ordinary meeting of the Executive Committee. On a periodic basis, requests for budget transfers or additions for expenses and investments may be submitted, studied and approved, every time the Executive Committee meets on an ordinary basis. However, the Executive Committee may meet in an extraordinary manner to deal with budgetary issues any time a special situation may so merit. Every time that a budget addition is requested, the Operator shall initiate, with due lead time, the corresponding procedures, submitting the requests to the respective Subcommittee for its study and subsequent recommendation to the Executive Committee. In any event, the requests for budget additions shall be fully justified, explaining the reasons that gave rise to the variation in the appropriated items, with their respective technical and financial Annex, as specified in Clause 14 (number 14.2.3) in this Agreement. 15.2 Budget transfers Those appropriations that are carried over from one year to another as a result of those projects that could not be concluded during the term for which they were budgeted for reasons such as the lack of availability of equipment, importation procedures, bad weather, among others, shall be considered to be budget transfers. When a project is not totally completed, the value of the budget shall become part of the Budget for the immediately following year and shall be subjected to approval by the Executive Committee. The presentation of these projects within the Budget shall be singled out and specifically identified and shall be considered in the preparation of the disbursement schedule that Clause 15 (number 15.4) in this Agreement refers to. In addition, budget transfers shall give rise to an Annex wherein the cause for the budget transfer shall be explained, as well as the way in which it is to be executed during the following term. 15.3 Approvals The Executive Committee shall be entity entrusted with approving the programs, projects and the Budget recommended by the Subcommittees, and with authorizing the Operator to purchase or contract, for the account of the Joint Account, all of those goods and services that are required by Joint Operation. 15.4 Disbursement Schedule Together with the overall Budget, the Executive Committee shall approve the Budget by quarters submitted by the Operator and recommended by the Subcommittees for the immediately following year, and which shall constitute the basis on which the monthly cash calls shall be calculated. 57 15.5 Cash Calls The requests for advances of funds or cash calls shall be made by the Operator to each of the Parties, based on the obligations entered into by the Joint Operation for the month immediately following the one of the request, referring to the quarterly Budget approved by the latest Executive Committee and the forecast cash flows. The management of the advances or cash calls that this Clause refers to shall be made through a bank account that the Operator shall establish for such purpose, for the exclusive use by the Joint Operation. In the preparation of the requests for advances or cash calls, the following requirements are to be followed: 15.5.1 Preparation Based on the approved Budget and the obligations entered into on behalf of the Joint Operation for the following month, the Operator shall prepare the requests for advances, bearing in mind the following conditions: 15.5.1.1 The request shall be made by the Operator separately for each of the Commercial Fields being exploited in the Contract Area, identifying operations and investment expenses, in pesos and in United States of America dollars, depending on the origin in which the disbursement is forecast to be made. 15.5.1.2 The request shall be by programs and projects, in the case of investments, and by group and expense item in the case of expenses, in the same manner in which they are listed in the Budget approved by the Executive Committee. 15.5.1.3 For each of the projects and expense items listed in the request for advance funds to be considered, they must be included in the Budget; otherwise, they shall be deducted from the total amount requested. 15.5.1.4 The projects and expense groups shall necessarily have a sufficient Budget. 15.5.2 Presentation The request for funds (cash call) shall be made by the Operator within the first twenty (20) days of the immediately preceding month to the month in which the contributions are to be made. If the Operator were to have to make extraordinary disbursements, that are not provided for at the time that the monthly advance cash call is made, it shall request special advances in writing from the Parties, covering their respective share in such disbursements. Every request for an advance or cash calls shall be submitted for processing in the form previously agreed to by the Parties in the respective Subcommittee and shall show the actual and estimated charges for investments and expenses and shall comprise the following documents: 15.5.2.1 Letter of Request 15.5.2.2. Request format, wherein the financial status for each of the programs, projects and expense items is shown on the date on which the request is made. 15.5.2.3. General comments of a technical nature in which the destination of the requested funds is identified, within the main projects or expense items. 58 Section Two - Accounting Procedure CLAUSE 16 - ACCOUNTING PROCEDURE In each half- yearly report that Clause 10 (number 10.1) in this Agreement refers to, THE ASSOCIATE shall submit to ECOPETROL the direct Explorations Costs for the period of the report that could be subject to reimbursement in agreement with Clause 9 of The Contract, with the indication of the currency in which the disbursement was made and a consolidated statement in United States of America dollars. In addition, in this same report, THE ASSOCIATE shall submit the preliminary cumulative value that is to be included as variable "A" for the calculation of the R Factor that Clause 14 (numbers 14.2.3 and 14.2.4) in The Contract refers to, clearly showing the parameters used for the calculation, It is understood that the Direct Exploration Costs shall only be definitive once they have been audited and accepted by ECOPETROL. During exploitation of each Commercial Field, the credits and charges incurred in by the Operator in development of the Joint Operation, shall be charged to the Joint Account set forth in the provisions of Clause 22 of The Contract. The Joint Account shall be divided into three main items, as stated below, for each Commercial Field discovered in performance of The Contract, and the consolidated statement, when there is more than one Commercial Field in the Contract Area: 16.1 General Joint Account (clarification, charges and entries). This account shall reflect all of the movements, as is expressed later on, and shall be fully distributed on a monthly basis between the Parties, in a share of fifty percent (50%) for ECOPETROL and fifty percent (50%) for THE ASSOCIATE with respect to the investments, and in the proportion that is set out in Clause 22 (numbers 22.6.1 and 22.6.2) in The Contract for Direct Expenses and Indirect Expenses. That is to say, it shall serve as the basis for monthly billing, set forth in the provisions of this procedure, ending every month with a balance of zero (0). All of the accounting operations related with this account shall be booked by the Operator in Colombian pesos, set forth in the laws of the Republic of Colombia, but the Operator may, in turn, keep ledgers wherein it shows the disbursements it may incur in any currency other than Colombian pesos. 16.2 Joint operations current account. This account shall record the cash calls received from the Parties and the charges or credits corresponding to the invoicing of these and, at all times, shall show a balance in favor or against each of the Parties, as appropriate. This account shall be divided into two sub- accounts, set forth in the monetary origin of the transaction, namely: Colombian pesos and United States of America dollars. 16.3 Joint property records. Through the Joint Account, the Operator shall keep a record of all of the assets acquired that are subject to inventory, indicating in detail the kind of asset, the date of purchase and its original cost. The accounts mentioned in Clause 16 (numbers 16.1, 16.2 and 16.3) of this Agreement shall constitute part of the Operator's official accounting records, but without mixing them with accounting records other than those of the Joint Account. The three aforementioned records shall be subject to Clause 22 of this Agreement. 59 16.4 The Operator shall send to ECOPETROL on a monthly basis, together with the information cited in Clause 17 (number 17.2.2) of this Agreement, in an independent Annex, the parameters and the calculation of the R Factor, set forth in the provisions of Clause 14 (number 14.2.3 and 14.2.4) of the Contract. The Operator shall keep in its files and at the disposal of the Parties, all of the support documentation for the charges made to the variables that are included in the calculation of the R Factor for each Commercial Field. CLAUSE 17 - ADVANCES, INVOICES AND ADJUSTMENTS 17.1 Advances. Despite the fact that the Operator shall pay and clear, initially, all of the costs and expenses incurred set forth in The Contract, charging each Party with its percentage share, it is agreed that, to finance such share, each Party, at the Operator's request, shall advance to the latter, from the moment of acceptance by the Parties of the existence of a Commercial Field and, latest within the first five (5) days of every month, the proportion of the disbursements for the account of each and that were estimated for the operations of the given month. These advances shall be made in United States of America dollars and in Colombian pesos, set forth in the requirements established in the approved Budget by quarter and in the forecast cash flow for each Commercial Field and in the requests for advances (cash calls) prepared by the Operator, set forth in Clause 15.5 in this Agreement. 17.2 Invoices. 17.2.1 The Operator shall prepare an initial invoice for ECOPETROL after the acceptance of the existence of each Commercial Field, in the amount of fifty percent (50%) of the Direct Exploration Costs incurred in before the date of ECOPETROL's statement regarding the commerciality of each new Commercial Field discovered, that is audited and accepted by ECOPETROL set forth in Clause 22 of this Annex and that has not previously been charged to another Field. In the Direct Exploration Costs for the Exploratory Wells, all of the direct costs incurred in drilling, termination and testing shall be included for the case of Exploratory Wells that are producers, and the cost of drilling and abandonment of the Exploratory Wells that are dry. Such invoice shall also include fifty percent (50%) of the costs of additional work that Clause 9 (number 9.3) in The Contract refers to, if applicable. For the monthly update of the values that the paragraph in Clause 9 (number 9.2.2) in The Contract refers to, one twelfth (1/12th) of the value resulting from averaging the percent annual variation available for the last two (2) years in the consumer price index for industrialized countries shall be used, taken from the "International Financial Statistics" of the International Monetary Fund (page S63 or its replacement) or, if not available, the publication that may be agreed to by the Parties. This invoice shall include a summary of the costs, expressing separately the currency in which the investments and the expenses were made, that is to say, in Colombian pesos or in United States of America dollars. 17.2.2 Set forth in Clause 22 (number 22.2) of The Contract, the Operator shall charge the Parties, within the ten (10) days following the last day of each month, their proportional share of the investments and operational expenses during that month. In the invoices, the details that may be available in the Operator's accounting procedures shall be noted, including a detailed summary of accounts, expressing separately the investments and operational expenses originating in pesos and those originating in United States of America dollars. 60 17.2.3 Investments and expenses during the Retention Period. The costs and expenses made by THE ASSOCIATE during the Retention Period to establish the commercial viability of a Gas Field shall be assumed by THE ASSOCIATE in their entirety. 17.3 Adjustments The invoices shall be adjusted between the Operator and the Parties after deducting the advances in United States of America dollars and in Colombian pesos. When the advances made by either of the Parties differ from their share in the actual costs determined for each period, the difference in pesos and/ or in dollars shall be adjusted in the invoices for the following month. 17.4 Acceptance of the invoices. The payment of the invoices shall not affect the right of the Parties to protest or inquire about the accuracy of these, set forth in the terms of Clause 22 (number 22.7) of The Contract. CLAUSE 18 - CHARGES Subject to the limitations that are set forth below, the Operator shall charge the Joint Account and invoice each Party, set forth in the percentages established in Clause 16 (number 16.1) of this Agreement, for the following expenses: 18.1 Labor. 18.1.1 National and foreign employees 18.1.1.1 The salaries of the Operator's employees or workers that are working directly for the benefit of the Joint Operation, including the payment for overtime, nighttime surcharge, payment of Sundays and holidays and their respective compensatory rest periods and, in general, all payments that constitute salary. 18.1.1.2 Social benefits, compensation, insurance, subsidies, bonuses and, in general, any benefit that is not salary and that is awarded to the workers and/ or their relatives or dependents, whether it is granted individually or collectively, or whether it is granted to them by virtue of the labor contract, the law, arbitration conventions or sentences, with the exception of housing plans, with respect to which a special agreement shall be required. Among the aforementioned, one can cite, among others, the following: severance pay, vacation, retirement and disability pensions, benefits to retirees and their relatives, benefits and aid caused on account of professional or non- professional illnesses and accidents, service bonuses, life insurance, compensation or indemnity on account of contract cancellation, labor union benefits, all types of bonuses, subsidies and aid, for savings, health, education and, in general, for social security. In addition, the contributions to the Colombian Family Welfare Institute (ICBF), National Vocational Training Service (SENA), Social Security Institute (ISS) and other similar ones that may be established. 18.1.1.3 All expenses incurred for the benefit of the Joint Operation with respect to the maintenance and operation of the camp, its offices and service facilities at the site. Among these, the following expenses are also included, not in a restrictive manner but rather as a listing, as indicated below, whether the services are rendered for free or for payment, or 61 whether they be for the workers, their dependents or relatives, of that these be provided in a voluntary or compulsory manner. Such services include the following: 18.1.1.3.1 Medical, pharmaceutical, surgical and hospital services. 18.1.1.3.2 Camp and full services thereof, including its repairs and sanitation. 18.1.1.3.3. Training and educational expenses. 18.1.1.3.4 Workers recreation. 18.1.1.3.5 Maintenance of schools for the workers, their children and dependent relatives. 18.1.1.3.6 Safety, social work and camp surveillance. 18.1.1.4 It is understood that the expenses and services outlined in the aforementioned Clause 18 (numbers 18.1.1.1, 18.1.1.2 and 18.1.1.3) shall be for the account of the Joint Account when, by provisions of law, labor agreements and/ or arbitration sentences or voluntarily, they are applicable in a direct or by extension to contractors, subcontractors, intermediaries and/ or their workers who are working for the benefit of the operation. 18.1.1.5 With respect to retirement pensions and disability compensation, the Executive Committee shall proceed set forth in the provisions of the Social Security and Pension System established by Law 100 issued in 1993 and other norms that regulate it or substitute it. 18.2 Materials, equipment and supplies The materials and supplies that are necessary to undertake the operations shall be charged to the Joint Account. The materials and supplies shall be purchased for warehouse inventories for the projects or for the maintenance materials warehouse when it is convenient for the operation and shall be credited to it, at cost in the books, as they are withdrawn from the warehouse to be used. The capital equipment units shall be charged directly to the Joint Account. The book cost is determined as follows: 18.2.1 Book cost It is understood that book cost means the last average price of the inventory in the warehouse, based on the cost obtained in the import liquidation sheets, or the local cost, as follows: 18.2.1.1 For imported materials, equipment and supplies, the book cost shall include the net price on the manufacturer or vendor's invoices, the cost of purchases, freight and delivery charges between the supply point and the loading point, freight to the entry port, insurance, import duties or any other tax, handling from the vessel to the customs warehouse and transport to the site of operations. 18.2.1.2 For materials, equipment and supplies purchased locally, the book cost shall include the seller's net invoice, plus sales taxes, procurement expenses, transport, insurance and other similar costs paid to Private Parties, from the purchase location to the site of operations. 18.2.1.3 the materials shall be charged to the Joint Account set forth in the monetary purchase origin, so that it can similarly be charged to each Party. 62 18.2.2 Return of materials to Joint Operation's warehouses, as the case may be. The materials, equipment and supplies that are returned to the warehouses of the Joint Operation shall be valued as follows: 18.2.2.1 New materials, at book cost. 18.2.2.2 Second- hand materials, in good condition and that can render service, as well as equipment that can subsequently be used without repairs, can be reincorporated by the Operator to the corresponding warehouse at one hundred percent (100%) of their cost on the books, crediting the respective project in the Joint Account. 18.2.2.3 Second- hand equipment and materials which, when repaired, can be used, can be reincorporated by the Operator to the corresponding warehouse at one hundred percent (100%) of their cost on the books. These materials, upon being used again, shall be charged at the new book value. 18.2.3 Sales by the Parties. The materials, equipment and supplies sold by the Parties to the Joint Operations shall be valued at the replacement price agreed to by the Parties. The corresponding transport costs shall be for the account of the Joint Operation. In the cases of sales by the Joint Operation to one of the Parties, these shall be valued at the replacement price agreed to by the Parties, and the transport costs shall be for the account of the purchasing Party. 18.2.4 Local transport of materials 18.2.4.1 For materials shipped through an external transporter, at cost, set forth in the invoice issued by the transportation company. 18.2.4.2 For materials sent in transportation units owned by the Parties, at the fees calculated to cover the actual costs, pursuant to the procedure established in Clauses 18 (number 18.4) and 23 (number 23.1.1) in this Agreement. 18.2.5 Materials for projects that have been cancelled, postponed or changed. When there is an accumulation of inventory in the warehouse on account of the change, deferral or cancellation of projects approved by the Parties, the cost of such materials shall be charged to the warehouse account. These materials may be sold to Private Parties set forth in the provisions of Clause 20 (number 20.2.1) in this Agreement and what is obtained shall be credited to the Joint Account. Surplus materials from projects, purchased with direct charge. Once the project has been finalized, these should be reincorporated to the warehouse and credited to the corresponding projects. The Operator shall advise the Parties of this operation at the ordinary meetings of the Financial Subcommittee when this were to occur. 18.3 Travel expenses All travel expenses incurred on behalf of the Joint Operation for Colombian or foreign personnel, such as transport, hotels, food, etc. 18.4 Service units and facilities The value of the service rendered for equipment and facilities that are owned by any of the Parties shall be charged to the Joint Account at reasonable rates, as provided for in Clause 23 of this Agreement. The rates that are established shall be applied until such time as they are modified by mutual agreement. 63 18.5 Service Services rendered by Private Parties, including contractors, to the Joint Operation, at their actual cost. Similarly, technical services, such as laboratory analyses and special studies, require the recommendation of the Technical Subcommittee and approval by the Executive Committee. 18.6 Repairs Expenses for repairs made to the equipment or elements of either of the Parties, destined for use by the Joint Operation, unless these costs have already been charged through leasing or in another manner. 18.7 Litigation Expenses to the Joint Operation regarding the threat of effective lawsuits (including the investigation and collection of evidence), lifting encumbrances, sentences, legal claims and procedures for claims, compensation for accidents, settlement for death and funeral expenses, provided that these charges have not been recognized by an insurance company or covered by the proportional surcharges mentioned in Clause 18 (number 18.1.1) in this Agreement. When legal services are provided in these matters by permanent or external counsel, whose total or partial compensation is included in indirect costs, no additional charges shall be made for their services, but rather, these shall be charged to Direct Expenses incurred in such procedures. 18.8 Damages and losses of Joint Operation property and equipment. All costs and expenses necessary to replaced or repair damage or losses caused by fire, flood, storm, theft, accident or any other similar event. The Operator shall notify the Parties in writing regarding the damages or losses occurred, as soon as possible. 18.9 Taxes and rentals The value of all taxes paid or accrued in carrying out the Joint Operation shall be charged to the Joint Account, in keeping with the existing legal provisions. The value of leases, right of way and indemnity for improvements, the occupation of land, etc. shall also be charged to the Joint Account. 18.10 Insurance 18.10.1 Premiums paid for insurance taken out for the benefit of the operations that The Contract refers to, together with all of the expenses and indemnities accrued and paid, an all losses, claims and other expenses that have not been covered by the insurance companies, including the legal services mentioned in Clause 18 (number 18.7) in this Agreement, shall be charged to the Joint Account. 18.10.2 When no insurance exists, the actual costs incurred, mentioned above, and paid for by the Operator, shall also be charged to the Joint Account. CLAUSE 19 - CREDITS 19.1 Incomes The Operator shall credit the Joint Account for incomes resulting from the following items: 64 19.1.1 Collection of insurance with respect to the Joint Operation, the premiums for which have been charged to such operation. 19.1.2 Sale of geological information, when previously authorized by the Parties, provided that the collection of such information was charged to the Joint Operation. 19.1.3 Sale of property, plants, equipment and materials owned by the Joint Operation. 19.1.4 Rental payments received, the reimbursement for claims of customs duties and tax or transportation, etc. shall be credited to the Joint Operation if such lease payments or reimbursements pertain thereto. 19.1.5 Any other income from operations or contractual income authorized by the Executive Committee on behalf of and for the service of the Joint Account. 19.2 Warranty In the event of defective equipment, once the Operator has received the corresponding adjustment from the manufacturer or its agents, credit shall be made to the Joint Account. CLAUSE 20 - DISPOSAL OF EXCESS MATERIALS AND EQUIPMENT. 20.1 Excess materials and equipment The Operator shall advise the Parties in writing regarding the Joint Operation's surplus materials and equipment, thirty (30) days after finalizing the inventory that Clause 21 of this Annex refers to. Each of the Parties shall designate a representative to review the status and establish which materials or equipment are to be put up for sale. For the purchase of the useable materials or equipment, ECOPETROL shall have the first option and THE ASSOCIATE the second option; these options shall be exercised within sixty (60) days following the date of notification. In the event that they are not purchased by these, the Operator shall report it in writing and they shall be put up for auction. 20.2 Disposal of capital equipment and materials. Set forth in Clause 22 (number 22.9) of The Contract, the Operator may sell the materials and equipment owned by the Joint Account under the following conditions: 20.2.1 The sale by the Operator to Private Parties of major materials and capital equipment that may have been charged to the Joint Account shall only be made with the approval of the Executive Committee. The revenue shall be credited to the Joint Account. Only for this particular purpose, major materials are defined as any asset that has an estimated sales value that is greater than the amount that is approved by the Executive Committee for such purpose, as a result of the request submitted in advance by the Operator, set forth in Clause 19 (number 19.3.2) of The Contract. 20.2.2 Minor materials charged to the Joint Account and not required for the operation or which are returned to the warehouse, may be sold by the Operator and its proceeds shall be credited to the Joint Account. 20.2.3 For any abandonment and dismantling of the assets whose cost or estimated value is greater than the amount approved by the Executive Committee for this purpose, as a result of a request presented beforehand by the Operator set forth in Clause 19 (number 19.3.2) of The Contract, prior authorization by the Executive Committee is required. 65 20.2.4 Neither of the parties is under the obligation to purchase the interest of the other in surplus materials, whether they are new or second- hand. The withdrawal of major items of surplus materials, such as towers, tanks, motors, pumping units and piping shall be subject to approval by the Executive Committee. However, the Operator shall have the right to dispose of the damaged or useless materials in any manner. 20.2.5 All of the taxes that may be caused on account of the sale or transfer of materials or assets from the Joint Account shall be the Operator's responsibility, for the account of the Joint Account. CLAUSE 21 - INVENTORY At ECOPETROL's request, the Operator shall submit the necessary information to perform the inventory analyses in warehouses and the Parties shall agree upon their joint participation in inventory control. The Operator shall provide the ease and cooperation that ECOPETROL may require to carry out the physical task of accounting for the fixed assets at the facilities at each Commercial Field, prior agreement with the respective Subcommittee, regarding the date, time and number of persons who are to perform the inventory. 21.1 Inventory and Audit Set forth in the existing norms and, at least once every three (3) years, the Operator shall perform an inventory of all of the Joint Operation assets. 21.2 The notification of the intention of carrying out an inventory shall be given by the Operator to the Parties in writing with at least one (1) month advance notice to the date on which it is to commence, so that the latter can be present. However, non- attendance by one of the Parties to carry out the inventory does not jeopardize or reduce the validity and effectiveness of the inventory thus carried out by the Operator. 21.3 The Operator shall provide the Parties with a copy of each inventory, with a copy of its reconciliation, and shall submit the results to the Subcommittees of the Joint Operation, which shall study the report and shall propose the actions to be taken in this regard. 21.4 Inventory adjustments for surpluses or shortfalls shall be brought to the attention of the Executive Committee for its consideration and approval. 21.5 With due timing and through midnight of the last day of the term set forth as the Exploitation Period, the Parties shall carry out inventories of the materials that are in the warehouses and that are the property of the Joint Account, as well as of the products produced that are in the collection batteries, the pipes that lead from them to the storage tanks and in the storage tanks, all within the exploitation sites, and such inventories shall be distributed between the Parties, after having deducted the royalties, in the same manner provided for in Clause 13 of The Contract. CLAUSE 22 - AUDIT Subject to Clause 17 (number 17.4) in this Agreement, the Parties may, through their own auditors or their representatives, examine and control the Operator's records related to the joint properties and the operation of these. Similarly, ECOPETROL may carry out audits to the records of the Fields exploited by THE ASSOCIATE under the sole risk method. In order to facilitate the review of the Direct Exploration Costs that Clause 17 (number 17.2.1) of this Agreement refers to, once THE ASSOCIATE or the Operator advises the Parties regarding the date on which any reimbursable 66 Exploration Work is to commence, THE ASSOCIATE or the Operator shall allow that, prior timely notification, ECOPETROL auditors periodically examine the accounts for such Exploration Work, in such a way that, when the existence or not of a Commercial Field is accepted, the aforementioned review has already been performed under the best conditions of timing and location. In the audit reviews that are provided for in this Agreement, in addition to the representatives for the Parties, representatives from the Comptroller General of the Republic may also intervene, if such organization deems it convenient for this to be the case. The costs and expenses of such review shall be for the account of the interested Party. 22.1 Once the audit report is delivered, THE ASSOCIATE or the Operator shall have a maximum six (6) month term in order to respond and support the objections made. Once this term expires, without the Operator having responded, it shall be considered that the objections have been accepted and consequently, all shall proceed accordingly. The notes or observations from the audit that are not resolved within the three (3) months following this term shall be resolved set forth in Clause 20 of The Contract. CLAUSE 23 - RATE AND FEE CHARTS 23.1 Subject to the aforementioned limitations, the services rendered to the Joint Operation for facilities that are ECOPETROL or THE ASSOCIATE's exclusive property, shall be charged at the corresponding rates, in order to allow for the recovery of the actual costs. Such costs shall include the normal costs for work, salaries, social benefits, depreciation and other operational expenses, bearing the following in mind: 23.1.1 The rate for transportation units that is normally calculated, using as a basis the time of operation, shall include the time required for loading and unloading, the time elapsed waiting to be loaded, and the waiting time for unloading to take place. Charges for transportation units assigned to the operation shall include Sundays and holidays, except when the vehicles are out of service for repairs. 23.1.2 When the material for aforementioned operations is transported together with other materials by river or land fleet that is the exclusive property of ECOPETROL or of THE ASSOCIATE, the charge shall be made based on the tonnage transported, at rates that are not any higher than commercial ones. 23.2 Rates for the lease of equipment and tools The procedure to calculate the lease rate for equipment and tools that are the property of the Parties, excluding drilling equipment and major equipment, where the rates are to be calculated separately and approved by the Executive Committee, shall comprise a value for depreciation plus a value for maintenance, and the procedure shall be as follows: 23.2.1 Description, model, number, date of purchase and original cost of the equipment. 23.2.2 Site where the equipment is to be used, reasons for leasing it and estimated time of use. 23.2.3 Value of the annual depreciation for the equipment, calculated based on the depreciated book value and its estimated remaining useful life (the minimum book value considered shall be ten percent (10%) of the original cost, that is to say, the salvage value). 23.2.4 The annual maintenance value shall be a percentage of the original cost, which may vary between five percent (5%) for new equipment and up to fifteen percent (15%) for equipment 67 that has already been depreciated, depending on the time it has been depreciated. For example: Equipment A: (Five [5] years of life) Time (in years) 1, 2, 3, 4, 5: equipment one hundred percent (100%) depreciated Maintenance: 5, 6, 7, 8, 9: 15%. Equipment B: (Ten [10] years of life) Time (in years) 1, 2, 3, 4, 5, 6, 7, 8, 9, 10: equipment one hundred percent (100%) depreciated. Maintenance: 5, 6, 7, 8, 9, 10, 11, 12, 13, 14, 15: 15%. Note: The time for useful life and depreciation shall be those that are established by accounting techniques applicable to oil operations. 23.2.5 The rate for annual lease is equal to the value provided for in Clause 23 (number 23.2.3) of this Agreement, plus the one established in number 23.2.4 of this same Clause. 23.2.6 The rate for monthly or daily lease of equipment shall be equal to the provided for in Clause 23 (number 23.2.5) in this Agreement, divided by twelve (12) or by three hundred and sixty five (365), as appropriate. 23.2.7 No lease charge shall be made for "stand by," but it shall be charged to Private Parties. 23.2.8 The aforementioned lease rates do not include transport, installation, operation, lube and fuel costs, which shall be charged to the operation that the equipment is destined for. 23.2.9 The aforementioned lease rates shall be applied to the possible use of one hundred percent (100%) equipment and tools owned by the operation, THE ASSOCIATE or the Operator, and vice versa. 23.2.10 In every case, the Subcommittees shall recommend to the Executive Committee the use of leased equipment and may apply the rate system that the latter may recommend. 23.2.11 The lease rate for equipment shall be calculated in United States of America dollars, but for the respective collection, it shall be invoiced in Colombian pesos, at the rate that the Parties may agree to. 23.3 Rate for rental for warehouses and fixed assets For the calculation of the lease rate for warehouses that are the property of one of the Parties or of the Joint Account, for their complete or partial use, a procedure shall be followed which shall be agreed to by the respective Subcommittee. CLAUSE 24 - CONTRIBUTIONS IN KIND ECOPETROL or THE ASSOCIATE shall contribute in kind, those materials that they may consider convenient, set forth in the agreements that may be established by the Parties. 68 PART III - ADMINISTRATIVE ASPECTS AND OTHER PROVISIONS Section One - Executive Committee CLAUSE 25 - CONDITIONS FOR FUNCTIONING For the exercise of its functions, the Executive Committee shall fulfill the conditions provided for in Clause 19 of The Contract, as indicated below: 25.1 The Executive Committee shall be alternately chaired by the Parties, beginning with ECOPETROL. 25.2 The Executive Committee shall name its Secretary, alternating between the persons designated by ECOPETROL and by THE ASSOCIATE. The Chair and the Secretary shall fall n the same Party. 25.3 The Executive Committee shall meet in an ordinary manner during the months of March, July and November, and in an extraordinary manner every time that the Parties and/ or the Operator may consider it necessary. At such meetings, the exploitation strategy being carried out by the Operator shall be reviewed, as well as the Development Plan and the immediate programs and plans. The Executive Committee may be attended by the advisors that each of the Parties may consider convenient, it being understood that each of the Parties shall bring along the smallest possible number of persons. 25.4 For the ordinary meetings of the Executive Committee, the representative entrusted with presiding the following meeting shall notify the other representatives (the principal and his alternates) of the other Party and of the Operator, with ten (10) days advance notice of the date of the meeting, the venue and the issues to be discussed (agenda). 25.5 Pursuant to Clause 18 (number 18.3) of The Contract, both for the regular meetings as well as the extraordinary meetings of the Executive Committee, the issues to be discussed that have not been included in the agenda may be considered during the meeting, prior acceptance by the representatives of the Parties on the Committee. Section Two - Sub Committees CLAUSE 26 - CREATION OF THE SUBCOMMITTEES In development of the function provided for in Clause 19 (number 19.3.4) of The Contract, the Executive Committee may create the advisory Subcommittees that it may consider necessary. In any case, the Executive Committee shall designate a Technical Subcommittee and Financial Subcommittee. These Subcommittees shall be the organizations established to control and define the technical, financial and legal considerations of The Contract before the Executive Committee and shall be governed by The Contract and this Agreement. Each Subcommittee shall establish its own internal regulation, approved by the Executive Committee. CLAUSE 27 - RIGHTS AND OBLIGATIONS 69 27.1 Set forth in Clause 10 of The Contract, the Operator shall conduct the Joint Operations itself, or through its contractors, under the overall guidance of the Executive Committee. In any event, the Operator shall be responsible for the Joint Operation, set forth in the provisions of The Contract. 27.2 The following are among the Operator's obligations: 27.2.1 The preparation, presentation and implementation of the Development Plan, the Budgets and Exploration and Exploitation Programs, as well as for the approval of expenses. 27.2.2 The direction and control of all statistics and accounting services. 27.2.3 Planning and obtaining all services and materials required for the proper development of the Joint Operation. 27.2.4 Providing all the technical skill and consulting required for the efficient development of the Joint Operation. 27.2.5 Planning the tax effects and fulfilling all tax obligations that may be derived from the operations performed and providing the timely report to the Parties for the proportion that corresponds to each of them. 27.2.6 Establishing a bank account for the exclusive management of the Joint Account resources. 27.3 The Operator may not establish any encumbrance whatsoever on the properties of the Joint Operation. 27.4 The resignation or removal of the Operator may be made without prejudice of any right, obligation or responsibility acquired during the time in which the Operator acted as such; if the Operator resigns or is removed before fulfilling the obligations established in The Contract, it may not charge the Joint Account for the costs and expenses in which it incurred on account of the change. But if the Executive Committee were to approve them, these charges and expenses may then be charged to the Joint Account. 27.5 Once the Operator is notified of his removal or of the acceptance of its resignation, for the transfer or responsibilities, ECOPETROL shall audit the Joint Account and shall perform an inventory of all of the properties of the Joint Operation. Such inventory shall be used for purposes or return and accounting for the procedure of such transfer or responsibilities. All costs and expenses incurred with respect to such inventory and audit shall be for the account of the Joint Account. 27.6 The Operator shall not be responsible for any loss or damage on account of the Joint Operation, unless such damages or losses are the result of: 27.6.1 Gross negligence by the Operator 27.6.2 Failure to obtain and maintain any of the insurance required in Clause 33 of The Contract, except when the Operator has made all possible efforts to obtain it and maintain them, and the results of such efforts have been fruitless, a situation which the Operator must first communicate to the Parties in writing. 70 Section Four - Contracting Procedure CLAUSE 28 - SUPPLIER REGISTRATION AND BIDDERS LIST 28.1 It shall be the Operator's responsibility to maintain an updated registration of vendors, classified pursuant to the various activities that the operation may require, as well as to establish the qualification criteria for the firms to be included in the bidders' list. The respective Subcommittee may request a review of the criteria before approving the bidders' list. 28.2 ECOPETROL may review the Operator's vendor registration on an annual basis and may suggest to it, through the respective Subcommittee, that vendors be included or excluded from the registration. Despite the above, ECOPETROL may, at any time, by means of a request that duly explains the motives, request the withdrawal of persons or entities from the registration. 28.3 In all cases that imply soliciting proposals to contract, the vendor registration shall be consulted, recording a statement on the corresponding document. 28.4 The persons or entities that are included in the vendor registration shall accredit technical, moral and economic solvency, in addition to the experience, not only of the company but that of its partners as well, and also that of its technicians that are permanently hired by it. 28.5 Set forth in the aforementioned criteria, the Operator shall establish a registration of qualified vendors, which shall be updated periodically, set forth in their performance. 28.6 In the Fields that are exploited under the sole risk, THE ASSOCIATE shall have the right that is provided for in Clause 10 (number 10.6) of The Contract. CLAUSE 29 - BIDDING PROCESS 29.1 Responsibility: The Operator shall be responsible for preparing the Request for Proposals in due time, and shall submit it to consideration by the corresponding Subcommittee. 29.2 The list of those invited to submit proposals shall be prepared based on the information in the Registration of Vendors. 29.3 In every bidding process, the Operator shall invite at least three companies. If this were not to be possible, a statement shall be made with respect to the justification in the report of recommendations to the respective Subcommittee. 29.4 It shall be endeavored not to invite more than six (6) companies, in order to avoid additional costs in the assessment of the proposals and, similarly, to provide a greater opportunity to the participating companies to successfully obtain the respective contract. 29.5 All other factors being the same, the order of priorities to be included in the list of bidder shall be as follows: - Companies registered and with headquarters in the department or departments where the Commercial Field or Fields are located, but with a branch established in such department. - Colombian companies whose headquarters are outside the department or departments where the Commercial Field or Fields are located, but with a branch established in such department. - Foreign companies with a branch in Colombia. - Foreign companies that do not have a branch in Colombia. 71 29.6 In the list of companies to be invited to submit proposals, those companies that are technically and commercially qualified and that have not had the opportunity to participate in similar bids in the past shall also be kept in mind. 29.7 The Operator shall prepare the bid documents and shall submit these to the consideration of the respective Subcommittee with sufficient advance notice. 29.8 It shall be clearly expressed in the bidding documents that: 29.8.1 Cost shall be one of the criteria to be considered, though not the sole one, for the award of the contract; 29.8.2 The assessment of the bid shall bear in mind other factors other than cost, which shall be included in the bid documents; 29.8.3 All proposals that exceed the range of real cost for this activity shall be disqualified; 29.8.4 The proposals are to be submitted set forth in the terms of the invitation, and the failure to observe this requirement may lead to not being considered as valid proposals; 29.8.5 The request for proposals shall include a table with the details of the prices which is to be filled out by the bidders, in order to facilitate comparing the proposals; 29.9 The list of bidders shall be reviewed and approved by the Technical Subcommittee before the invitations to bid are sent out. 29.10 Once the bid documents have been distributed, the following rules shall apply: 29.10.1 Any information, modification or clarification of the original bid documents shall be sent out to all the bidders. The Procurement and Supplies Department of the Operator shall be responsible for these changes. The changes shall be duly justified by means of a document in writing. 29.10.2 No bidders can be added or deleted from the list of bidders originally approved by the corresponding Subcommittee. 29.10.3 Any bidder that does not abide by the bid procedures and rules, or that may violate the Operator's business ethics code shall be disqualified immediately. 29.11 The content and format for all of the materials in a request for proposals shall fulfill the requirements of the procedure known as "Documentation format submitted to the Technical Subcommittee" and shall be submitted to the consideration of the corresponding Subcommittee. 29.12 The internal approvals that are required by the Operator and by ECOPETROL depend on the estimated value of the contract, set forth in the internal procedures of the former and the latter. CLAUSE 30 - AWARDS OF CONTRACTS AND PURCHASE ORDERS 30.1 The Operator is responsible for awarding bids for contracts and purchase orders. For this purpose, it shall submit its recommendation to the respective Subcommittee, subject to the procedures that have been established by the Executive Committee for this purpose. 72 30.2 Value: The awards shall be based on the best global (overall) value. The lowest price does not always mean the best proposal, since, in addition to the amount, other aspects are borne in mind, such as scheduling and quality, experience, reputation and the Colombian content submitted by the bidder. In the event that the contract is not awarded to the lowest amount proposal, such decision should be justified. 30.3 Justification in writing: The Operator shall present a recommendation in writing to the corresponding Subcommittee, justifying the contract and purchase order award, subject to the procedures that are established for such purpose by the Executive Committee. Such justification shall include a summary of the commercial and technical assessments of the proposals received and the basis for the Operator's recommendation. 30.4 Direct contracting: Direct contracting shall be supported and presented in writing to the respective Subcommittees, clearly identifying their justification. The Operator may contract directly, without having to go through a bidding process, in any of the following events: 30.4.1 When only one vendor can be obtained, within the time frame required to satisfy the project schedule; 30.4.2 When an item or service Contract before in a direct manner does not have an equivalent or satisfactory substitute; 30.4.3 When a service or work is derived from a previous one or is an extension to an existing contract or work order issued during the last ninety days and the commercial conditions are not modified, or when the evidence stemming from a recent bid justify contracting without undergoing a bidding process; 30.4.4 When the Operator has standardized a specific item or service for all of the applications within its are of operations and there is only one known vendor for such item or service; 30.4.5 When it is considered that a sole item or service fulfills the Operator's requirements within a specified delivery time period; 30.4.6 When an item or service is obtained for testing or assessment; 30.4.7 When there is an emergency. The Operator shall notify ECOPETROL at the corresponding Subcommittee's immediately next meeting after such emergency. 30.5 Partial awards: A bid can be awarded partially to two or more bidders, provided that all of the following conditions are met: 30.5.1 The possibility of a partial award is specifically indicated in the request for proposals; 30.5.2 The successful bidders have fulfilled the requirements established in the Request for Proposals; 30.5.3 The partial award represents the best value for the items or services that shall be obtained; 30.5.4 Any change in the scope of work or in the award criteria shall be clearly communicated to all of the bidders before the partial award. 30.6 Rejection of proposals: The Operator may declare a bid null and void when the respective Subcommittee finds motives to justify such decision and/ or when the proposals are out of line with the actual costs. 30.7 Notification to the unsuccessful bidders: The result of the award shall be communicated in writing to all participants. 73 30.8 Clarification: During the assessment period, the Operator may request clarification from the bidders. The Technical Subcommittee shall approve the significant commercial clarifications. No new approval shall be required by the respective Subcommittee when clarifications refer to technical issues. Clarifications that may affect the bid shall be communicated in writing to all of the bidders. CLAUSE 31 - MANAGEMENT OF CONTRACT AND WORK ORDER 31.1 The Operator shall be responsible for managing the contracts and purchase orders during their execution. 31.2 The bases for contract or purchase order management are their execution itself, which shall include all of the agreed- to prices, schedule and quality requirements. 31.3 The Operator shall maintain a written record of all modifications to the original contract. The cost impact for each change to the contract shall be assessed by the Operator and negotiated with the vendor or contractor before the contract price is changed. 31.4 Any change in the initially approved value of the contract shall be subject to consideration by the respective Subcommittees and, if required, shall be approved by the Executive Committee, set forth in the procedure that is established for such purpose by the Executive Committee. 31.5 The Operator is responsible for cost control. 31.6 Any additional work or job under the terms of the contract shall be authorized by the Operator's Project Manager or Operations Manager, who shall consult with the Procurement and Logistics Manager or with the departments that fulfill these functions, before making any modification to the contract. This dual responsibility ensures control for the integrity of the change process. In the event that the changes imply modifications to the text of the contract, these shall be submitted to approval by the Operator's Legal Department. 31.7 Quality control shall be managed with the QA/QC (Quality Control / Quality Assurance) process, which shall include the independent inspection and verification of the work and shall be performed at appropriate moments during the execution of the work. 31.8 The processes used by the Operator for cost control shall be described in a cost control procedure. 31.9 The Parties shall receive a monthly report on work progress, with cost documentation and schedule, including the analysis of the variations with respect to the originally agreed- to Budget for the main contracts and purchase orders. 31.10 Once the main contracts and purchase orders have been executed, a detailed analysis shall be undertaken to assess the experiences learned that could be applied to similar contracts or work orders, and also in order to allow for improvements in their control. CLAUSE 32 - INSURANCE For purposes of Clause 33 in the Contract, with respect to Insurance, the Operator shall deliver the following information to ECOPETROL, for the latter to insure fifty percent (50%) of the assets corresponding to the Commercial Field: 74 32.1 Description of the assets, differentiated, inasmuch as possible, as follows: 32.1.1 Offices, camps and other non- industrial facilities 32.1.2 Collection stations, specifying tanks (number and capacity) and other equipment. 32.1.3 Diverse warehouses and other facilities Note: The external pipelines and the wells are not insured under the fire policy, since, in this case, ECOPETROL assumes the risk directly. 32.2 Value of the assets, indicating only the value of the part that belongs to ECOPETROL and indicating the percentage of the value that it represents. 32.2 Geographic location. 32.4 Date of receipt, as of which the risk is transferred to the Joint Operation. CLAUSE 33 - FORCE MAJEURE OR ACTS OF GOD 33.1 Clause 34 of The Contract only suspends fulfillment of those specific obligations whose performance becomes impossible on account of events that constitute force majeure or acts of God. Similarly, it only interrupts the obligations on the assets, properties, production facilities, etc. that are affected by the aforementioned circumstance. The affected Party shall notify the termination of the force majeure, providing details on the magnitude of the damages and the corrective actions that affect the system. 33.2 If one of the Parties cannot, on account of force majeure or acts of God, fulfill the obligations of this Contract, it shall notify this to the other Party for its consideration, within ten (10) working days following the date on which the cause was produced, specifying the causes of its impediment, the estimated period of suspension of the activities and the way in which it affects fulfillment of the corresponding affected obligation. The other Party shall respond in writing, either accepting the cause or not for force majeure or acts of God. 33.3 The Party affected by the cause for force majeure or acts of God shall recommence fulfillment of the affected obligations within a reasonable term once such cause has disappeared, for which it shall advise the other Party within ten (10) working days after the cause has disappeared. In the event of partial or delayed execution of the obligation affected by force majeure or acts of God, the Party that is obligated to its fulfillment shall exert its best efforts to execute it within the terms and conditions agreed- to between the Parties in this Contract, having to continue with the fulfillment of the remaining contractual obligations. 33.4 If the force majeure cause were to affect the execution of any of the Exploration Work agreed to as part of the exploratory activities that Clause 5 of this Contract refers to, the guarantee that supports the fulfillment of the affected Exploration Work shall be extended for the same period of time that the impediment may last, which were not executed during this period of time. For such purpose, THE ASSOCIATE shall extend or substitute such guarantee, as the case may be. 75 CLAUSE 34 - REVISION OF THE OPERATIONS AGREEMENT This Operations Agreement may be revised when the Parties consider it convenient to do so, at the request of any of the Parties. For its revision or modifications the Executive Committee is fully empowered to do so. This Operations Agreement shall be valid until one of the following events occurs: 34.1 Termination of The Contract 34.2 Agreement in writing between the Parties 34.3 The signing of a new Agreement. In faith of the previously mentioned, the Parties sign the present Operations Agreement, in contract paper of ECOPETROL on the twentieth (20) day of the month of December of the year two thousand two (2002). EMPRESA COLOMBIANA DE PETROLEOS ECOPETROL (Signed) illegible ALBERTO CALDERON ZULETA President HARKEN DE COLOMBIA LIMITED (Signed) illegible GABRIEL GUSTAVO CANO VELASQUEZ Principal Legal Representative WITNESSES (Signed) Illegible (Signed) Illegible VICTOR EDUARDO PEREZ ALBERTO TOVAR 76 ANNEX C - LINEAMENTS FOR THE PREPARATION OF THE DEVELOPMENT PLAN ANNEX C - LINEAMENTS FOR THE PREPARATION OF THE DEVELOPMENT PLAN The present Annex establishes the main aspects that must be considered for the preparation of the initial Development Plan and of the programs, projects and annual Budget for each of the Fields discovered in the development of The Contract, which shall be subject to the consideration of ECOPETROL. In this document the general conditions of the Development Plan are described without including a detailed explanation of the format or of the level of detail to be presented, further than the coverage of the main issues identified herein. Additional information may be presented in each Development Plan as it is considered appropriate. A. INITIAL DEVELOPMENT PLAN 1. Outline of the Development Strategy Summary of the background of the Field, of the development strategy and of the most relevant aspects of the economic and commercial conclusions. 2. Description of the Field Includes the geological synthesis of the Reservoirs discovered and the determination of the geometry of the field. In this section the area capable of producing Hydrocarbons of the different Reservoirs is determined and the commercial area is delimited, using the plain Gauss coordinates, by the projection in surface of the lowest level of Hydrocarbons commercially exploitable. 3. Reservoir Engineering This implies the evaluation of the properties of the rocks and of the fluids contained in the Field Reservoirs and other analysis that conduce to: a) Determine the original volumes of Hydrocarbons in each Reservoir, the tested, probable and possible Reservoirs of the Field (in each case, based on its useful life, independently from the duration of the Exploitation Period established in The Contract) and discriminated by Liquid Hydrocarbons and Gas Hydrocarbons. b) Establish the forecast for production of Hydrocarbons that THE ASSOCIATE expects to produce during each year of exploitation of the Field, both for the tested Reservoirs and for the tested Reservoirs plus those probable. c) Define the strategy for exploitation so that the production profile, in the case of tested Reservoirs, achieves the Maximum Degree of Productive Efficiency (MER) or the top of the production, in that case in which THE ASSOCIATE identifies restrictions to achieve he MER, and expose the preliminary strategy of exploitation of the probable Reservoirs. 77 d) Specify the program of obtainment of information to be executed for the adequate administration of the Reservoirs. 4. Criteria of the Design of the Development Plan Description of the logics and coherence of the Development plan and synopsis of the criteria, bases and presumptives taken into consideration for the design of the plan. 5. Development Drilling and Completion Back ground of the main aspects that refer to the drilling and completion of Development Wells. 6. Surface Installations Presentation of the options of development that were taken into account, the justification of the option chosen, its general specifications, key aspects and diagram of each of the Production Systems; Treatment and Storage; Transportation and Transfer, and of Support to the production of Hydrocarbons that come from the Field. 7. Construction and Assembly Explanation of the strategy for the Development drilling and the construction and assembly of the surface facilities and the assurance of the quality. 8. Operation and Maintenance General Description of the scheme and logistics of the operation with its corresponding proposal of the Organizational Letter for the handling of the field with a background of the contingency plans for the control of the critical factors. 9. Abandonment of the Field and Restoration of the Area Synthesis of the program, methods and practices foreseen for the abandonment of the wells and the withdrawals of the surface facilities and alternatives considered for the provision of funds for the abandonment of the field and the recuperation of the area 10. Economic and Commercial Aspects. They include the evaluation of the commercialization options of the Hydrocarbons discovered, the economic viability of the Field and the reasons why such alternative was chosen. It must also include: a) Estimate of the Direct Exploration Costs incurred in before the presentation of the initial Development Plan. 78 b) Annual budget and chronogram for disbursements on account of capital expenses (investments) and operational (Direct and Indirect Expenses) in current dollars during the exploitation of the Field, with relation to the Reservoirs tested and the Reservoirs tested plus those probable. c) Main economic indicators obtained in the economic evaluation and optimization carried out for the determination of the commerciality of the Field. d) When it is necessary to unify the field or when the design of the Development Plan suggests the need to share the production facilities of the Field with other Fields discovered in the development of the same Contract, or of another Association Contract, the proposal of a unified exploitation plan that THE ASSOCIATE proposes to submit for the consideration of others interested and/or the proposal of the agreement to share facilities or other assets, including cost assignments and other distributions necessary, must be attached. B. PROGRAMS, PROJECTS AND ANNUAL BUDGET The Operator, or THE ASSOCIATE if concerning a field exploited under the modality of only risk, pursuant to that established in The Contract and in the Operating Agreement (Annex B), shall prepare and present to the Parties the proposal of the programs, projects and Budget for the following calendar year, pursuant to the initial Development Plan accepted for the field. For all effects of the presentation of the annual programs and projects, by program it is understood the group of projects to be developed, or that by their technical, operational and administrative characteristics deserve to be controlled in a joint manner (for example: Building of Battery X). Each program includes the presentation of the projects to be carried out, their sequence of execution and the general conditions to which they must abide by to obtain a determined result. By project it is understood the group of activities proper of a work or an specific necessary work for the development and production of the field. (example: Civil work, Access roads, Facilities, Separation and Treatment System, etc.). Each project shall be duly supported with the explanatory documents and the technical and economic specifications. The annual Budget shall be divided into Expense Budget and Investment Budget. For all effects of the presentation, the Expense Budget shall be divided into programs, groups and concepts of expenses and that of Investments in programs and projects, in numerical order and continuous within each section of the Budget. With respect to the Expense Budget, the programs and projects shall be divided into expense groups and these into concept of expenses. By expense groups it is understood the purpose or object of the expense (for example Personnel Expenses) and by concept of expenses the specific assignment granted (for example: Salaries, Social Benefits). EXAMPLE OF THE INDEX OF THE INITIAL DEVELOPMENT PLAN 1. Development Scheme of the field . History and Location of the Field . Development Strategy 79 . Production Curve and Investment and Expense Program . Commercial and Economic Conclusions 2. Description of the Field . Geology . Regional Frame . Local Frame . Structural . Geology of Reservoirs (Stratigraphy, Sedimentology and factors that control the quality of the reservoir) . Geophysics - Seismic Information . Seismic Data Base . Seismic Data Processing . Analysis and Interpretation of Seismic Data . Petrophysics . Subsurface Logging Information . Data on recovered Nucleus . Calibration of the information on Logs and Nucleus . Analysis and Interpretation of Petrophysical data . Maps and Geological Patterns . Isopachous . Structural . Isoporosity . Others 80 3. Reservoir Engineering . Basic Reservoir Information . Rock Properties . Fluid Properties . Analysis of Nucleus and PVT . Gas-Oil and Oil-Water Contacts . Productivity of the wells . Simulation of Reservoirs . Models of Reservoirs . Predictions . Original Hydrocarbons "in-situ". OOIP and OGIP . Uncertainties . Calculation of Reservoirs (scenarios for Tested, Probable and Possible Reserves) . Production Forecasts (of Tested Reservoirs and of Tested plus Probable) . Exploitation Strategy . Development Wells Spacing (Productive and Injectors) . Pressure Maintenance Projects . Conservation and/or Use of Gas . Administration of Reservoirs and Obtainment of Data . Well Testing . Pressure Measurement and Fluid Sampling . Coring and Logging . Production Behavior 81 . Production Optimization . Projects of Improved Recovery . Opportunities for Future Developments . Well Testing 4. Criteria of the Design of the Development Plan . Logics of the Design . Regulations and Standards Observed . Environmental Criteria . Environmental Diagnostic and Impacts . Operational Limits . Functional Criteria . Production Mechanisms of the Reservoirs . Flow Rates and Production Capacities . Useful Life . Specifications of the fluids produced . Geotechnical Criteria 5. Development Drilling and Completion . Development wells . Location . Design of the Wells (pursuant to the purpose of the well, type and trajectory of the hole. . Drilling Strategy and Chronogram . Critical success factors (technical and operational) 82 . Completion of Wells under Development . Design of the completion of Producer and Injector Wells . Artificial Lifting . Subsequent Operations . Overhauling . Stimulation 6. Surface Installations (Diagram, Specifications and Key Aspects) . Production System . Systems considered . Justification of the system(s) proposed . Sub-system of Pressure Maintenance . Improved Recovery . Treatment and Storing System . Gathering . Separation and Treatment . Measurement and Sampling . Water, gas and impurities disposition . Storing . Pumping . Support Systems . Safety and Control of the Production . Telecommunications . Power Generation . Camping, Warehouses, workshops, Offices and Transportation Terminals 83 . Transportation System and Transference of Hydrocarbons. 7. Construction and Assembly . Strategy . Coordination of Activities . Permissions and Licenses required . Construction and Assembly Chronogram . Required Services . Quality Assurance and Control 8. Operation and Maintenance . Proposal of an Organizational Letter of the Field . Operational Limits of the surface and subsurface systems. . General Vision of the Logistics of the Operation . Production . Health, Safety and Environmental Monitoring . Relations with the Community and the Government . Personnel lodging . Warehouses . Materials and Supplies . Displacement and Transportation . Communications . Others 84 . Contingency Plans . Evaluation of Operational Risks . Organization and Training for Emergencies Response 9. Abandonment of the field and Restoration of the Area . Methods and Practices of Abandonment and withdrawal of installations . Development Wells (Producers and Injectors) . Surface Installations . Restoration and recuperation of the area 10. Economic and Commercial Aspects . Commercialization . Market Opportunities and Options considered . Justification of the Option(s) proposed . Estimation of Incomes . Critical success factors . Direct Exploration Costs caused before the design of the Plan . Acquisition of Seismic Information . Exploratory Wells . Estimation of Capital Costs and Operation Expenses . Investments (Distributed between the main operations or goods) . Direct Expenses (Distributed between the main activities) . Indirect Expenses 85 . Disbursement Chronograms . Investments . Expenses . Total . Economic Analysis and Evaluation of the project . Economic Indicators . Sensibility Analysis . Exploratory Wells EX-10.15 5 dex1015.txt REPUBLIC CONTRACT Exhibit 10.15 ------------- PURCHASE AND SALE AGREEMENT dated January 31, 2002 between REPUBLIC RESOURCES, INC. as Seller and HARKEN ENERGY CORPORATION as Buyer TABLE OF CONTENTS 1. PURCHASE AND SALE........................................................ 1 1.1. PURCHASE AND SALE............................................. 1 1.2. INTERESTS..................................................... 1 1.3. RESERVED INTERESTS............................................ 2 1.4. EFFECTIVE TIME................................................ 2 2. PURCHASE PRICE........................................................... 3 2.1. PURCHASE PRICE................................................ 3 2.2. ADJUSTMENTS TO PURCHASE PRICE................................. 3 3. REPRESENTATIONS AND WARRANTIES........................................... 4 3.1. REPRESENTATIONS AND WARRANTIES OF SELLER...................... 4 3.2. REPRESENTATIONS AND WARRANTIES OF BUYER....................... 5 4. COVENANTS AND AGREEMENTS................................................. 6 4.1. COVENANTS AND AGREEMENTS OF SELLER............................ 6 4.2. COVENANTS AND AGREEMENTS OF BUYER............................. 7 5. TITLE MATTERS............................................................ 8 5.1. DEFENSIBLE TITLE.............................................. 8 5.2. TITLE DEFECT ADJUSTMENTS...................................... 9 5.3. CASUALTY LOSS................................................. 9 5.4. CONSENTS..................................................... 10 6. ENVIRONMENTAL MATTERS................................................... 10 7. TAX MATTERS............................................................. 11 8. CONDITIONS TO CLOSING................................................... 11 8.1. SELLER'S CONDITIONS.......................................... 11 8.2. BUYER'S CONDITIONS........................................... 11 9. CLOSING................................................................. 12 9.1. DATE OF CLOSING.............................................. 12 9.2. PLACE OF CLOSING............................................. 12 9.3. CLOSING OBLIGATIONS.......................................... 12 10. OBLIGATIONS AFTER CLOSING............................................... 13 10.1. POST-CLOSING ADJUSTMENT PROCEDURE............................ 13 10.2. FILES AND RECORDS............................................ 14 10.3. FURTHER ASSURANCES........................................... 14 10.4. ASSUMPTION OF OBLIGATIONS.................................... 14 10.5. INDEMNIFICATION.............................................. 15 11. TERMINATION OF AGREEMENT................................................ 15 11.1. TERMINATION................................................. 15 11.2. LIABILITIES UPON TERMINATION OR BREACH...................... 15 12. MISCELLANEOUS........................................................... 16 12.1. EXHIBITS.................................................... 16 12.2. EXPENSES.................................................... 16 12.3. NOTICES..................................................... 16 12.4. WIRE TRANSFER INSTRUCTIONS.................................. 17 12.5. AMENDMENTS.................................................. 17 12.6. ASSIGNMENT.................................................. 17 12.7. CONDITIONS.................................................. 17 12.8. COUNTERPARTS................................................ 17 12.9. GOVERNING LAW............................................... 17 12.10. ENTIRE AGREEMENT............................................ 18 12.11. PARTIES IN INTEREST......................................... 18 12.12. SURVIVAL.................................................... 18 12.13. ARBITRATION................................................. 18 EXHIBIT NO. DESCRIPTION ----------- ----------- EXHIBIT A Description of Seller's oil and gas wells EXHIBIT B Seller's oil and gas leases EXHIBIT C Contracts and agreements EXHIBIT D Contingent Payment Agreement EXHIBIT E Form of assignment, conveyance and bill of sale EXHIBIT F Debenture Exchange Subscription Agreement EXHIBIT G Registration Rights Agreement (ii) PURCHASE AND SALE AGREEMENT This Purchase and Sale Agreement (the "Agreement"), dated January 31, 2002, is between Republic Resources, Inc. ("Seller"), a Nevada corporation and Harken Energy Corporation ("Buyer"), a Delaware corporation, and is made with reference to the following agreed facts: A. Seller holds an undivided interest in various oil and natural gas properties in the states of Texas and Louisiana in which there were, as of January 1, 2002, estimated proved reserves of oil and natural gas totaling approximately 3.1 Bcfe. B. As of the date of this Agreement, there are outstanding $2,645,500 of Seller's 11% Convertible Debentures ("Debentures") and approximately $5.1 million in Seller's Series C Redeemable Preferred Stock, including accrued but unpaid dividends ("Series C Preferred"). C. Seller intends to sell and transfer to Buyer or Buyer's Subsidiary all of Seller's interests in certain oil and natural gas reserves in accordance with the terms and conditions set forth below and to have the purchase price paid to the holders of its outstanding Debentures and Series C Preferred. IN CONSIDERATION OF the mutual promises contained herein, the benefits to be derived by each party hereunder and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, Buyer and Seller agree as follows: 1. PURCHASE AND SALE. 1.1. PURCHASE AND SALE. Seller agrees to sell and convey and Buyer agrees to purchase and pay for the all of Seller's right, title and interest in and to those certain oil and natural gas properties (the "Interests" as defined in Section 1.2), subject to the terms and conditions of this Agreement. 1.2. INTERESTS. Subject to the reservations set forth in Section 1.3, all of Seller's, right, title and interest in and to the following shall herein be called the Interests: (a) The oil and gas wells described in EXHIBIT A hereto (the "Wells"), --------- together with all oil, gas and mineral production from the Wells; (b) The leasehold estates created by the leases, licenses, permits and other agreements described in EXHIBIT B, (the "Leases"); together with all --------- overriding royalty interests, production payments and other payments out of or measured by the value of oil and gas production; (c) All oil, gas, casinghead gas, condensate, distillate, liquid hydrocarbons, gaseous hydrocarbons and all products refined therefrom, together with all minerals produced in association with these substances (collectively called the "Hydrocarbons") in and under and which may be produced and saved from or attributable to the Leases or Wells, and all rents, issues, profits, proceeds, products, revenues and other income from or attributable thereto; (d) All of the personal property, fixtures and improvements appurtenant to the Wells, or the Leases or used or obtained in connection with the operation of the Wells, or the Leases or with the production, treatment, sale or disposal of hydrocarbons or water produced therefrom or attributable thereto, including without limitation, pipelines, disposal systems, gathering systems and compression facilities (the "Equipment") appurtenant to or located upon the Leases; and (e) All the property, rights, privileges, benefits and appurtenances in any way belonging, incidental to, or pertaining to the property, interests and rights described in Sections 1.2(a) through 1.2(d) including the Wells, the Leases and reserves of unproduced oil and natural gas in place, including, to the extent transferable, all exploration agreements, letter agreements, product purchase and sale contracts, surface leases, gas gathering contracts, processing agreements, compression agreements, equipment leases, permits, gathering lines, rights-of-way, easements, licenses, farmouts and farmins, options, orders, pooling, spacing or consolidation agreements and operating agreements and all other agreements relating thereto, including those listed on EXHIBIT C (the "Contracts"); --------- and (f) All of the files, records, data (including seismic data and related information) and other documentary information maintained in the normal course of business by Seller pertaining to the Wells, Leases, Equipment, Hydrocarbons and the Contracts (collectively, the "Data") in the format maintained by Seller. The Data shall not, however, include any information, which, if disclosed, would cause Seller to breach any contract or agreement. Seller will use reasonable efforts to obtain any required consent to disclose such information. 1.3. RESERVED INTERESTS. Seller shall reserve and except from the sale and conveyance of the Interests in favor of itself, its successors and assigns the following: (a) All accounts receivable attributable to the Interests that are, in accordance with generally accepted accounting principles, attributable to the period prior to the Effective Time; (b) All claims and rights relating to overpayments of costs and expenses attributable to periods prior to the Effective Time, including, without limitation, the right to initiate, prosecute or participate, at Seller's sole cost and expense, in all audits, audit claims and tax claims or proceedings relating to or including periods prior to the Effective Time, regardless of when commenced, arising under applicable law, operating or product sale agreements or otherwise, and to recover all costs and expenses claimed or shown by such audits or proceedings as owing to the owner of the Interests for periods prior to the Effective Time; and (c) All rights, if any, to recover additional production or proceeds or requirements to refund monies attributable to such production or proceeds therefrom attributable to the Interests for any production month prior to the Effective Time, resulting from any adjustment to the net revenue interest attributable to the Interests in the applicable division orders. 1.4. EFFECTIVE TIME. The purchase and sale of the Interests shall be deemed to be effective as of January 1, 2002 at 12:01 a.m. at the location of the Interests (the Effective Time). 2 2. PURCHASE PRICE. 2.1. PURCHASE PRICE. The purchase price ("Purchase Price") for the Interests shall consist of the following: (a) A number of shares of Buyer's $0.01 par value common stock (the "Common Stock") determined by dividing $2,645,500 by the average reported closing price for Buyer's common stock for the 20 trading days ending on the day before the Closing Date of this Agreement (the "Common Stock Value Per Share"), provided that under no circumstances shall the Common Stock Value Per Share be less than $1.00, such that no more than a maximum of 2,645,500 shares of Buyer's common stock shall be issued; (b) The cash adjustment required for any adjustments described in Section 2.2(c) below (the "Cash Adjustment"); and (c) A "Contingent Payment" payable within 45 days of December 31, 2003 which shall be made to holders of Seller's outstanding Series C Preferred . A description of the factors to be used to determine the amount of the Contingent Payment, the payees and other details concerning Buyer's obligation to pay the Contingent Payment are described in EXHIBIT D --------- attached hereto and incorporated herein by reference (the "Contingent Payment Agreement"). 2.2. ADJUSTMENTS TO PURCHASE PRICE. The Cash Adjustment portion of the Purchase Price shall be adjusted at Closing as follows: (a) The Purchase Price shall be adjusted upward by the following: (1) the value of any oil in storage above the pipeline connection as of the Effective Time and not previously sold by Seller that is attributable to the Interests, such value to be the actual amount received by Seller. (2) the amount of all expenditures; rentals and other charges; ad valorem, property, production, excise, severance and similar taxes based upon or measured by the ownership of property or the production of hydrocarbons or the receipt of proceeds therefrom; expenses billed under applicable operating agreements and, in the absence of an operating agreement, expenses of the sort customarily billed under such agreements paid by the Seller in connection with the operation of the Interests, attributable to the period after the Effective Time and paid before Closing, which shall be evidenced by billings, statements or other like written evidence; (3) an amount equal to all prepaid expenses attributable to the Interests that are paid by or on behalf of Seller that are attributable to the period after the Effective Time and paid before Closing, including without limitation cash calls for wells to be drilled in accordance with the Contracts; (4) any other amount agreed upon by Seller and Buyer; and (b) The Purchase Price shall be adjusted downward by the following: 3 (1) proceeds received by Seller before Closing attributable to the Interests that are attributable to production sold from and after the Effective Time and received by Seller before Closing; (2) an amount equal to the sum of all Title Defect adjustments; (3) any other amount agreed upon by Seller and Buyer. (c) In the event of Cash Adjustment of the purchase price required by Sections 2.2(a) or (b), the net amount of any such adjustments shall be determined and Buyer shall pay to Seller, or Seller shall pay to Buyer, as appropriate, the net amount of any Cash Adjustment, to be paid at the Closing or, as described in Sections 8.3(b) and 9.1 not later than 90 days from the Closing Date of this Agreement. 3. REPRESENTATIONS AND WARRANTIES. 3.1. REPRESENTATIONS AND WARRANTIES OF SELLER. Seller represents and warrants as of the date hereof and as of the Closing Date to Buyer as follows: (a) The consummation of the transactions contemplated by this Agreement will not violate, or be in conflict with any provision of any agreement or instrument to which Seller is a party or by which it is bound. (b) Seller is a corporation duly organized, validly existing and in good standing under the laws of the State of Nevada, and is duly qualified to carry on its business in each state where the Interests are located, or where the ownership of the Interests located in such state require Seller to be so qualified. (c) Seller has all requisite corporate power and authority to carry on its business as presently conducted, and to perform its obligations under this Agreement. The consummation of the transactions contemplated by this Agreement will not violate, or be in conflict with, (i) any provision of its articles of incorporation or bylaws; (ii) any provision of any agreement or instrument to which it is a party or by which it is bound, noncompliance with which would have a material adverse effect upon Buyer's ownership or operation of the Interests, or upon any of the transactions contemplated by this Agreement, and (iii) to its knowledge, any judgment, decree, order, statute, rule or regulation applicable to Seller. (d) This Agreement has been, subject to the receipt of approval of Seller's stockholders which will be received before Closing, duly authorized, executed and delivered on behalf of Seller and constitutes the legal, valid and binding obligation of Seller, enforceable in accordance with its terms, subject, however, to the effects of bankruptcy, insolvency, reorganization and other laws for the protection of creditors. (e) Seller has incurred no liability, contingent or otherwise, for brokers or finders fees relating to the transactions contemplated by this Agreement for which Buyer shall have any responsibility whatsoever. (f) There are no bankruptcy, reorganization or arrangement proceedings pending, being contemplated by or, to the knowledge of Seller, threatened against Seller. 4 (g) Seller has, and shall deliver to Buyer at Closing, Defensible Title to the Interests as defined in Section 5 below. (h) Seller is in compliance in all material respects with all the Contracts and with all operating agreements, productions sales agreements, and other material contractual obligations and commitments which relate to the Interests. (i) The Seller has, and to the best of the Seller's information and belief each operator of the Interests has, complied with all rules, regulations, laws, judgments, orders, or other restrictions applicable to the Interests and in the operations thereon, including any environmental laws, rules or regulations. The Seller has received no notice or other information from any operator of any of the Interests or any other person that is contrary to the preceding sentence. (j) To the best of Seller's information and belief, all holders of Debentures qualify as Accredited Investors under Rule 501 of Regulation D adopted under the Securities Act of 1933, as amended ("Securities Act"). 3.2. REPRESENTATIONS AND WARRANTIES OF BUYER. Buyer represents and warrants as of the date hereof and as of the Closing Date to Seller as follows: (a) The consummation of the transactions contemplated by this Agreement will not violate, or be in conflict with any provision of any agreement or instrument to which Buyer is a party or by which it is bound. (b) Buyer is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware, and is duly qualified to the extent legally necessary to carry on its business in each state where the Interests are located, or where the ownership of the Interests located in such state require Buyer to be so qualified. (c) Buyer has all requisite corporate power and authority to carry on its business as presently conducted, and to perform its obligations under this Agreement. The consummation of the transactions contemplated by this Agreement will not violate, or be in conflict with, (i) any provision of its articles of incorporation or bylaws; (ii) any provision of any agreement or instrument to which it is a party or by which it is bound, noncompliance with which would have a material adverse effect upon its ownership or operation of the Interests, or upon any of the transactions contemplated by this Agreement, and (iii) to its knowledge, any judgment, decree, order, statute, rule or regulation applicable to Buyer. (d) This Agreement constitutes the legal, valid and binding obligation of Buyer, enforceable in accordance with its terms, subject, however, to the effects of bankruptcy, insolvency, reorganization and other laws for the protection of creditors. (e) Buyer has incurred no liability, contingent or otherwise, for brokers or finders fees relating to the transactions contemplated by this Agreement for which Seller shall have any responsibility whatsoever. (f) The Interests to be acquired by Buyer pursuant to this Agreement are being acquired by it for its own account for investment purposes and not for distribution within the meaning of any securities law. In acquiring the Interests, it is acting in the conduct of its own business and not under 5 any specific contractual commitment to any third party, or any specific nominee agreement with any third party, to transfer to, or to hold title on behalf of, such third party, with respect to all or any part of the Interests. (g) There are no bankruptcy, reorganization or arrangement proceedings pending, being contemplated by or, to the knowledge of Buyer, threatened against Buyer. (h) The Common Stock of Buyer to be issued as part of the Purchase Price, shall, at the time of Closing, be duly authorized by all necessary corporate action and such securities shall be validly issued such that the holders to whom the securities shall be issued shall have the rights set forth on the certificates delivered by Buyer at the Closing. 4. COVENANTS AND AGREEMENTS. 4.1. COVENANTS AND AGREEMENTS OF SELLER. Seller covenants and agrees with Buyer as follows: (a) Upon execution of this Agreement, Seller will make available to Buyer for examination at Seller's Grand Junction, Colorado office during normal business hours, all of Seller's title information, production information and other information relating to the Interests, including without limitation, accounting files, production files, land files, lease files, well files, division order files, contract files and marketing files, and, subject to the consent and cooperation of operators and other third parties, will cooperate with Buyer in Buyer's efforts to obtain, at Buyer's expense, such additional information relating to the Interests as Buyer may reasonably desire, to the extent in each case that Seller may do so without violating legal constraints or any obligation of confidence or other contractual commitment of Seller to a third party. (b) Seller shall use reasonable efforts to cause the operators of the Interests to permit Buyer's authorized representative to conduct, at Buyer's sole risk and expense, on-site inspections of the Interests. All such inspections shall be conducted at the sole risk, cost and expense of Buyer, and Buyer shall indemnify and defend Seller from and against any and all losses arising from such inspections. (c) During the period from the date of this Agreement to the Closing Date, Seller agrees, unless specifically waived by Buyer in writing, as follows: (1) Subject to the provisions of applicable operating and other agreements, Seller shall continue to administer the Interests in a good and workmanlike manner consistent with its past practices, and shall carry on its business with respect to the Interests in substantially the same manner as before execution of this Agreement. (2) Seller shall, except for emergency action taken in the face of risk to life, property or the environment, submit to Buyer for prior written approval, all requests for operating or capital expenditures and all proposed contracts and agreements relating to the Interests that involve individual commitments of more than $20,000.00 net to Seller's interest, or a cumulative total of $75,000 net to Seller's interest. Seller will timely notify Buyer of any and all such expenditures and commitments made which relate to the Interests. 6 (3) Buyer acknowledges that Seller owns an undivided interest in all of the Interests, and Buyer agrees that the acts or omissions of the other working interest owners who are not affiliated with Seller shall not constitute a violation of the provisions of this Agreement, nor shall any action required by a vote of working interest owners constitute such a violation so long as Seller has voted its interest in a manner that complies with the provisions of this Section. To the extent that Seller is not the operator of any of the Interests, the obligations of Seller in this Agreement shall be construed to require that Seller use reasonable efforts (without being obligated to incur any expense or institute any cause of action) to cause the operator of such Interests to take such actions or render such performance within the constraints of the applicable operating agreements and other applicable agreements. 4.2. COVENANTS AND AGREEMENTS OF BUYER. Buyer covenants and agrees with Seller that: (a) Buyer shall use its best efforts to ensure that as of the Closing Date it will not be under any material legal or contractual restriction that would prohibit or delay the timely consummation of such transaction. (b) Buyer shall, subject to the applicable terms of existing operating agreements, become the working or other interest owner of the Interests as of 12:01 a.m. local time at the wellsites on the Closing Date, effective as of the Effective Time. (c) After this Agreement is signed, Buyer shall provide reasonable assistance to Seller to solicit from Seller's Debenture holders Debenture Exchange Subscription Agreements (in the form approved by both parties and attached hereto as EXHIBIT F, hereafter the "Exchange Agreements") pursuant --------- to which the holders shall agree to exchange the Debentures for Common Stock of Buyer (as described in Section 7.1(a) (2) below), subject to Closing of the Agreement in a manner which is intended to be exempt from registration under Rule 506 of Regulation D adopted under the Securities Act. Buyer shall prepare, with reasonable assistance from Seller, a disclosure document for delivery to the holders. Buyer and Seller shall take reasonable steps to comply with Regulation D; however Buyer shall have no obligation to Seller or to any such holder with respect to the number of holders who enter into the Exchange Agreements. At the Closing of the transaction, Buyer shall issue the appropriate number of shares of Buyer's Common Stock as determined under Section 2.1(a) above. Such shares shall be issued to Seller and the holders of Seller's Debentures, as directed in writing by Seller on or before the Closing Date. (d) Buyer shall cause the Common Stock of Buyer that is issued pursuant to this Agreement to be registered on Form S-3 (or other appropriate form) for resale by the holders of such stock within 60 days following the Closing Date. Buyer shall use reasonable commercial efforts to have the registration statement covering the Common Stock declared effective by the United States Securities and Exchange Commission within a reasonable time after filing such registration statement. The terms and conditions of the Registration Rights Agreement, attached hereto as EXHIBIT ------- G, which shall run to the benefit of the former holders of the Debentures, - shall govern the obligations of the Buyer and the rights of the holders of the Common Stock. (e) If Buyer issues Common Stock to Seller under Section 11.2 of this Agreement, or in accordance with its obligations under the Contingent Payment Agreement, then in either such case, Buyer shall file a registration statement to register such shares for resale within three (3) months after 7 issuance and the obligations of Buyer under the Registration Rights Agreement shall be deemed to be obligations of Buyer to the holders in any such registration. 5. TITLE MATTERS. 5.1. DEFENSIBLE TITLE. (a) The term Defensible Title shall mean, as to the Interests, such title, whether held by Seller or for the benefit of Seller, that, except for and subject to the Permitted Encumbrances (as defined in Section 5.1(b)): (i) entitles Seller to receive as to each Well set forth in EXHIBIT A not less than the Net Revenue Interest set forth in EXHIBIT A as --------- --------- to the oil, gas and associated liquid and gaseous hydrocarbons produced, saved and marketed therefrom as to its presently producing formations; (ii) obligates Seller to bear costs and expenses relating to the maintenance, development and operation of each Well or Lease in an amount not greater than the Working Interest set forth in EXHIBIT A without a proportionate --------- increase in the Net Revenue Interest, and (iii) is free and clear of liens and material encumbrances and defects. (b) The term Permitted Encumbrances, as used herein, shall mean, as follows: (1) lessors' royalties, overriding royalties, unitization and pooling designations and agreements, reversionary interests and similar burdens; (2) required third party consents to assignments, preferential rights to purchase, and similar agreements with respect to which prior to Closing (i) waivers or consents have been or will be obtained from the appropriate parties prior to the closing date, or (ii) the appropriate time period for asserting such rights has expired without an exercise of such rights; (3) all rights to consent by, required notices to, filings with, or other actions by governmental entities in connection with the sale or conveyance of oil and gas leases or interests therein if the same are customarily obtained subsequent to such sale or conveyance; (4) easements, rights-of-way, servitudes, permits, surface leases and other rights with respect to surface operations, pipelines, grazing, logging, canals, ditches, reservoirs or the like; conditions, covenants or other restrictions; and easements for streets, alleys, highways, pipelines, telephone lines, power lines, railways and other easements and rights-of-way, on, over or in respect of any of the Interests; (5) materialmen's, mechanics', repairmen's, employees', contractors', operators', tax and other similar liens or charges arising in the ordinary course of business incidental to construction, maintenance or operation of any of the Interests: (i) if they have not been filed pursuant to law, (ii) if filed, they have not yet become due and payable or payment is being withheld as provided by law, or (iii) if their validity is being contested in good faith in the ordinary course of business by appropriate action; (6) any other liens, charges, encumbrances, contracts, agreements, instruments, obligations, defects or irregularities of any kind whatsoever affecting the Interests that individually or in the aggregate are not such as to have a materially adverse effect, do not prevent Seller and after Closing will not prevent Buyer from receiving the proceeds of production and that do not and after Closing will not operate to (i) reduce the net revenue interest of Seller below that set forth on EXHIBIT A, or --------- (ii) increase the working interest above that set forth on EXHIBIT A --------- without a proportionate increase in the Net Revenue Interest; and 8 (7) the limitations included in the contracts, agreements and other matters, if any, described on EXHIBIT C. --------- (c) The term Title Defect as used herein shall mean any material encumbrance or defect in Seller's title to the Interests (expressly excluding Permitted Encumbrances), that renders Seller's title to the Interests less than Defensible Title. The term Allocated Value as used herein means the value allocated to the Well as set forth in the Netherland, Sewell Reserve Report on the Interests as of the Effective Time, to be prepared after the date of this Agreement. 5.2. TITLE DEFECT ADJUSTMENTS. (a) No adjustment to the Purchase Price for Title Defects shall be made unless and until, and only to the extent that the individual value of each Title Defect exceeds $25,000 net to Seller's Working Interest in the Well or Lease affected by the Title Defect or exceeds $75,000 in the aggregate for all such Title Defects in all Wells or Leases. (b) Buyer shall give Seller written notice of Title Defects ten (10) days prior to the Closing Date. Such notice shall be in writing and shall include (i) a description of the Title Defect, and (ii) the amount by which Buyer believes the Value of such Well or Lease has been reduced because of such Title Defect. Buyer shall be deemed to have waived all Title Defects of which Seller has not been given timely notice by Buyer and all Title Defects that do not meet the thresholds for an adjustment set forth in Section 5.2(a). (c) Subject to the limitation contained in Section 5.2(a), a Title Defect of a Well and the Leases comprising the production unit or proration unit for the Well shall be cured to the reasonable satisfaction of Buyer before the Closing, provided that Seller may cure the Title Defect to Buyer's reasonable satisfaction within 30 days following Closing. If the Title Defect cannot be cured before the Closing or within the 30 day period following Closing to the reasonable satisfaction of Buyer, then the parties shall negociate a reduction of the Purchase Price to reflect the diminution of value due to the Title Defect in accordance with Section 2.2 unless prior to closing, (i) Buyer agrees to waive the relevant Title Defect and purchase the affected Interests notwithstanding the defect, or (ii) Seller agrees to indemnify Buyer against all losses, costs, expenses and liabilities with respect to such Title Defect. 5.3. CASUALTY LOSS. If subsequent to the date of this Agreement and, prior to the Closing, all or any material portion of the Interests to be conveyed to Buyer at the Closing is destroyed by fire or other casualty, is taken in condemnation or under the right of eminent domain or proceedings for such purposes are pending or threatened, subject to the limitations set forth in Section 5.2, Buyer shall purchase such Interests notwithstanding any such destruction, taking or pending or threatened taking and the Purchase Price shall be adjusted in accordance with the diminution in value. Seller shall, at the Closing, pay to Buyer all sums paid to Seller by third parties by reason of the destruction or taking of such Interests to be assigned to Buyer, and shall assign, transfer and set over unto Buyer all of the right, title and interest of Seller in and to any unpaid awards or other payments from third parties arising out of the destruction, taking or pending or threatened taking as to such Interests to be conveyed to Buyer. Seller shall not voluntarily compromise, settle or adjust any material amounts payable by reason of any material destruction, taking or pending or threatened taking as to the Interests to be conveyed to Buyer without first obtaining the written consent of Buyer. 9 5.4. CONSENTS. Some of the Leases are subject to consent of assignment by the Lessor. Seller will use its best efforts to obtain consents prior to Closing and will assist Buyer in obtaining any required consents after Closing. Any such consent not obtained prior to Closing will be deemed to be a Title Defect under Section 5.2 above, without need of further notice from Buyer. Seller shall have the right to cure Title Defects arising under this Section within the time limits described in Section 5.2(c) above. 6. ENVIRONMENTAL MATTERS. Buyer acknowledges that Seller is a non-operator of the Interests and has no direct control over any matter or circumstance relating to environmental laws, environmental conditions or environmental claims, the release of materials into the environment or protection of the environment or health. Buyer hereby agrees to assume the risk that the Interests may contain waste materials, including naturally occurring radioactive materials, or hazardous substances, that adverse physical conditions, including the presence of unknown abandoned oil and gas wells, water wells, sumps and pipelines may not have been revealed by Buyer's investigation, and that liabilities under environmental claims or environmental conditions or environmental laws could in the future be asserted against persons who hold working interests in any of the Interests. Seller shall protect, release, defend and indemnify and hold Buyer free and harmless from and against any and all costs, expenses, claims, demands, litigation costs, attorneys' fees and causes of action of every kind and character which result, or may be claimed to result from, environmental claims, or environmental conditions or claimed breach of environmental laws or regulations which occurred or existed on or in connection with any of the Interests as of the Closing Date of this Agreement, provided, however, that this obligation of Seller to indemnify Buyer shall apply only to claims, demands, expenses or costs which are asserted by third parties on or before December 31, 2002. Except for Seller's obligation to indemnify and hold harmless the Buyer for liabilities associated with claims made on or before December 31, 2002 for claims which arose or would be deemed to have arisen prior to the Closing Date, Buyer hereby releases and discharges, and shall be deemed to release Seller at Closing from and against, any and all other claims at law or in equity, including but not limited to environmental claims and environmental conditions, known or unknown, whether now existing or arising in the future, contingent or otherwise, against Seller with respect to any matter or circumstance relating to environmental laws, the release of materials into the environment or protection of the environment or health. Assuming the occurrence of Closing, Buyer hereby expressly agrees to protect, release, defend, indemnify and hold Seller, its officers, directors, representatives, agents and its employees free and harmless from and against any and all costs, expenses, claims, demands, litigation costs, attorneys fees, and causes of action of every kind and character, including but not limited to injuries or death to persons, damages to or loss of property, environmental claims or environmental conditions, arising out of or in connection with the use, operation, occupancy, occupation, resale or abandonment of the Interests to be assigned to Buyer hereunder regardless of whether the claim is a result of an act or omission occurring or condition existing prior to or after the Closing Date, and from any violation of environmental laws, provided that Buyer has no obligation to Seller with respect to any liabilities for environmental claims, environmental conditions or alleged violation of environmental laws or regulations related to any of the Interests which are asserted against Buyer or Seller by any third party and which may have occurred prior to the Closing Date and are asserted on or before December 31, 2002. The parties acknowledge and agree that the indemnity provided for in this section complies with the express negligence rule. 10 Buyer represents that it has had an adequate opportunity to review the indemnity and waiver provisions contained in this Section including the opportunity to submit the same to legal counsel for review and comment, and understands the indemnity obligations contained herein. Buyer acknowledges that, except for Seller's representations and warranties expressly set forth in this Agreement, it accepts the Interests "AS IS, WHERE IS" with all faults and existing conditions. 7. TAX MATTERS All ad valorem, severance, personal property taxes or any other taxes assessed against the Interests prior to the Effective Time shall be the obligation of Seller no matter when invoiced by the operator of any of the Interests. All ad valorem, severance, personal property taxes or any other taxes assessed against the Interests after the Effective Time shall be the obligation of Buyer. 8. CONDITIONS TO CLOSING. 8.1. SELLER'S CONDITIONS. The obligations of Seller at the Closing are subject to the satisfaction, at or prior to the Closing, of the following conditions: (a) Each of the following shall have occurred: (1) Holders of a majority of the outstanding voting common stock of the Seller shall have voted, at a special meeting of stockholders called for that purpose, to approve this Agreement and the transfer of the Interests by the Buyer to the Seller; (2) Holders of at least 90% of the outstanding principal amount of Seller's Debentures shall have conditionally agreed to exchange the Seller's Debentures held by them in exchange for the following: for each $10,000 in principal amount of the Debentures, the holder will receive at Closing of this Agreement, out of the Purchase Price, a number of shares of Buyer's Common Stock determined by dividing $10,000 by the Common Stock Value Per Share, and rounded to the nearest whole share; and (3) Holders of 100% of the outstanding Series C Preferred shall have voted or consented in writing to approve this transaction. (b) No order shall have been entered by any court or governmental agency having jurisdiction over the parties or the subject matter of this Agreement that restrains or prohibits the purchase and sale contemplated by this Agreement and which remains in effect at the time of such Closing; and (c) The aggregate sum of Title Defect adjustments, if any, shall not exceed $100,000. 8.2. BUYER'S CONDITIONS. The obligations of Buyer at the Closing are subject to the satisfaction at or prior to the Closing of the following conditions: 11 (a) All representations of Seller contained in this Agreement shall be true in all material respects at and as of the Closing as if such representations were made at and as of the Closing, and Seller shall have performed and satisfied all material agreements in all material respects required by this Agreement to be performed and satisfied by Seller at or prior to the Closing; (b) No order shall have been entered by any court or governmental agency having jurisdiction over the parties or the subject matter of this Agreement that restrains or prohibits the purchase and sale contemplated by this Agreement and which remains in effect at the time of such Closing; and (c) The aggregate sum of Title Defect adjustments, if any, shall not exceed $100,000; and (d) Each of the following shall have occurred: (1) Holders of at least 90% of the outstanding principal amount of Seller's Debentures shall have conditionally agreed to exchange the Seller,s Debentures held by them in exchange for the following: for each $10,000 in principal amount of the Debentures, the holder will receive at Closing of this Agreement, out of the Purchase Price, a number of shares of Buyer's Common Stock determined by dividing $10,000 by the Common Stock Value Per Share, and rounded to the nearest whole share; and (2) Holders of 100% of the outstanding Series C Preferred shall have voted or consented in writing to approve this transaction. 9. CLOSING. 9.1. DATE OF CLOSING. Subject to the conditions stated in this Agreement, the consummation of the transactions described herein (the "Closing") shall be held on the first business day following the Seller's Stockholders meeting at which this agreement is approved or at such later date as may be agreed upon by the parties. The date the Closing actually occurs is called the Closing Date. 9.2. PLACE OF CLOSING. The Closing shall be held at the offices of Buyer in Houston, Texas. 9.3. CLOSING OBLIGATIONS. At the Closing the following events shall occur, each being a condition precedent to the others and each being deemed to have occurred simultaneously with the others: (a) Seller and Buyer shall execute, acknowledge and deliver an assignment, bill of sale and conveyance (in sufficient counterparts to facilitate recording) in substantially the form of EXHIBIT E hereto --------- conveying to Buyer or Buyer's Subsidiary the Interests; and 12 (b) Seller and Buyer shall execute and deliver a settlement statement, prepared in accordance with this Agreement (the "Settlement Statement") prepared by Seller that shall set forth any Cash Adjustments required under Section 2.2 then known to the parties and the means used to determine such amount. Seller shall provide Buyer with the preliminary Settlement Statement three business days prior to Closing for Buyer's review and approval, using for such adjustments the best information then available. (c) Buyer shall deliver to Seller, or if appropriate, Seller shall deliver to Buyer, the Cash Adjustments to Purchase Price, subject to any further amounts which may be later determined under Section 10.1 below. (d) Buyer shall issue the appropriate number of shares of Buyer's Common Stock determined in accordance with Section 2.1(a) above. The Common Stock shall be issued as designated by Seller to Buyer in writing at or prior to the Closing Date. At the written request of Seller, Buyer shall transmit certificates for the Common Stock to the appropriate holders of Seller's Debentures conditional upon Buyer having received a fully executed Debenture Exchange Subscription Agreement as set forth in EXHIBIT F. --------- (e) Buyer shall enter into the Contingent Payment Agreement EXHIBIT D --------- with each holder of Seller's Series C Preferred Stock, pursuant to written instructions from Seller to be delivered at or before the Closing Date. (f) Buyer shall deliver to Seller the balance of the Purchase Price not paid to holders of Seller's Debentures. (g) Seller and Buyer shall execute, acknowledge and deliver letters in lieu of transfer orders directing all purchasers of production to make payment to Buyer of proceeds attributable to production from the Interests assigned to Buyer after the Effective Time. (h) Seller shall prepare such notices to third-party operators of the change in ownership of the Interests from Seller to Buyer. 10. OBLIGATIONS AFTER CLOSING. 10.1. POST-CLOSING ADJUSTMENT PROCEDURE. As soon as practicable after the Closing Date, but no later than 90 days after the Closing Date, Seller shall prepare and deliver to Buyer, in accordance with this Agreement, a statement (the Final Settlement Statement) setting forth each adjustment or payment under Section 2.2 that was not finally determined as of the Closing Date and showing the calculation of such adjustments. Within fifteen days after receipt of the Final Settlement Statement, or if Seller fails to deliver a Final Settlement Statement, Buyer shall deliver to Seller a written report containing any changes that Buyer proposes be made to the Final Settlement Statement. The parties shall undertake to agree with respect to the amounts due pursuant to such post-closing adjustment no later than fifteen days after Seller has received Buyer's proposed changes. The date upon which such agreement is reached or upon which the Final Purchase Price is established, shall be called the Final Settlement Date. In accordance with Section 2.1(d), if (i)Buyer owes a net amount to Seller, Buyer shall pay in immediately available federal funds the amount of such difference to Seller or to Seller's account (as designated by Seller), or (ii) Seller owes a net amount to Buyer, Seller shall pay in immediately available federal funds the amount of such difference to Buyer or to Buyer's account (as designated by Buyer). Payment by Buyer or Seller of this portion, if any, of the Cash Adjustment shall be made within five days after the Final Settlement Date. 13 10.2. FILES AND RECORDS. Within thirty days after the Closing Date, Seller shall deliver to Buyer originals of all of Seller's files and records relating to the Interests in the format maintained by Seller, but excluding any records or data that cannot be transferred because of prior contractual restrictions. Seller shall have the right to retain copies of any or all files and records delivered to Buyer. Buyer shall make available to Seller, in Buyer's office during normal hours, Buyer's files and records relating to the Interests so long as Buyer retains such files and records. 10.3. FURTHER ASSURANCES. After Closing, Seller and Buyer shall execute, acknowledge and deliver or cause to be executed, acknowledged and delivered such instruments, and shall take such other action as may be necessary or advisable to carry out their obligations under this Agreement and under any document, certificate or other instrument delivered pursuant hereto. 10.4. ASSUMPTION OF OBLIGATIONS. (a) Transfer and assignment of the Interests to Buyer or Buyer's Subsidiary shall constitute an express assumption by Buyer of, and Buyer expressly agrees to pay, perform, fulfill and discharge all claims, costs, expenses, liabilities and obligations (including but not limited to environmental claims and environmental conditions) accruing or relating to the owning, developing, exploring, operating and maintaining of the Interests conveyed to Buyer at the Closing, including without limitation, all violations of environmental law and all obligations arising under operating agreements, product sales agreements and the other agreements covering or relating to the Interests, except as specifically stated to the contrary in Section 6 above. (b) Buyer acknowledges that Seller has not made, and Seller hereby expressly disclaims and negates, any representation or warranty, express or implied, relating to the condition of any real or immovable property, personal or movable property, equipment, inventory, machinery and fixtures constituting part of the interests including, without limitation, (i) any implied or express warranty of merchantability, (ii) any implied or express warranty of fitness for a particular purpose, (iii) any implied or express warranty of conformity to models or samples of materials, (iv) any rights of Buyer under appropriate statutes to claim diminution of consideration or return of the Purchase Price, and (v) any implied or express warranty regarding environmental laws, the release of materials into the environment including naturally occurring radioactive material, or protection of the environment or health, it being the express intention of Buyer and Seller that the real or immovable property, personal or movable property, equipment, inventory, machinery and fixtures shall be conveyed to Buyer as is and in their present condition and state of repair. Buyer represents to Seller that Buyer has made or caused to be made such inspections with respect to the real or immovable property, personal or movable property, equipment, inventory, machinery and fixtures as Buyer deems appropriate and Buyer will accept the real or immovable property, personal or movable property, equipment, inventory, machinery and fixtures as is, in their present condition and state of repair. (c) Seller hereby expressly negates and disclaims, and Buyer hereby waives and acknowledges that Seller has not made, any representation or warranty, express or implied, relating to (i) the accuracy, completeness or materiality of any information, data or other materials (written or oral) furnished to Buyer by or on behalf of Seller or (ii) production rates, recompletion opportunities, decline rates, geological or geophysical data or interpretations, the quality, quantity, cost of recovery of any hydrocarbon reserves, any product pricing assumptions, or the ability to sell or market any hydrocarbons after Closing. 14 (d) Buyer shall also indemnify Seller for all liabilities which are assessed against Seller for federal, state, or local taxes, (not including income taxes) together with penalties or interest thereon (provided the penalties and interest do not result from the negligence, late filing, fraud or other acts of malfeasance of Seller), which relate to all operations of the property transferred hereunder and which arise on or after the Effective Time. 10.5. INDEMNIFICATION. From and after the Closing date, Buyer and Seller shall indemnify each other as follows: (a) Seller shall defend, indemnify and save and hold harmless Buyer, its officers, directors, employees and agents, against all losses, damages, claims, demands, suits, costs, expenses, liabilities and sanctions of every kind and character, including without limitation reasonable attorneys' fees, court costs and costs of investigation, which arise from or in connection with any breach by Seller of this Agreement. (b) Buyer shall defend, indemnify and save and hold harmless Seller, its officers, directors, employees and agents against all losses, damages, claims, demands, suits, costs, expenses, liabilities and sanctions of every kind and character, including without limitation reasonable attorneys' fees, court costs and costs of investigation, which arise from or in connection with (i) any of the claims, costs, expenses, liabilities and obligations assumed by Buyer pursuant to Section 6 or (ii) any breach by Buyer of this Agreement. 11. TERMINATION OF AGREEMENT. 11.1. TERMINATION. This Agreement and the transactions contemplated hereby may be terminated in the following instances: (a) By Seller if any of the conditions set forth in Section 8.1 are not satisfied in all material respects or waived as of the Closing Date. (b) By Buyer if any of the conditions set forth in Section 8.2 are not satisfied in all material respects or waived as of the Closing Date. (c) At any time by the mutual written agreement of Buyer and Seller. (d) By either party at its written election if the Closing Date has not occurred by April 15, 2002. 11.2. LIABILITIES UPON TERMINATION OR BREACH. In the event of the termination of this Agreement by Seller in accordance with Section 11.1(a), Seller shall pay Buyer $25,000 cash as liquidated damages for termination. If Buyer terminates this Agreement for any reason other than those described in Section 11.1(b) above, it shall pay Seller $200,000 as liquidated damages for termination. Any obligation under this Section 11.2 shall be payable immediately upon termination of this Agreement. In the event Buyer shall owe Seller liquidated damages under this Section, Buyer may at its sole election pay up to one-half of such liquidated damages in shares of Buyer's Common Stock 15 12. MISCELLANEOUS. 12.1. EXHIBITS. The Exhibits referred to in this Agreement are hereby incorporated in this Agreement by reference and constitute a part of this Agreement. 12.2. EXPENSES. Except as otherwise specifically provided, all fees, costs and expenses incurred by Buyer or Seller in negotiating this Agreement or in consummating the transactions contemplated by this Agreement shall be paid by the party incurring the same, including, without limitation, legal and accounting fees, costs and expenses. 12.3. NOTICES. All notices and communications required or permitted under this Agreement shall be in writing and any communication or delivery hereunder shall be deemed to have been duly made when personally delivered to the individual indicated below, or if mailed, when received by the party charged with such notice and addressed as follows: IF TO SELLER: REPUBLIC RESOURCES, INC. 743 Horizon Court, Suite 333 Grand Junction, Colorado 81506 Attention: Patrick J. Duncan, President With a copy to: ALAN W. PERYAM, ESQ. 1120 Lincoln Street, Suite 1000 Denver, Colorado 80203 IF TO BUYER: HARKEN ENERGY CORPORATION 580 WestLake Park Boulevard, Suite 600 Houston, Texas 77079 Attention: Bruce N. Huff, President and Chief Operating Officer 16 With a copy to: HARKEN ENERGY CORPORATION 580 WestLake Park Boulevard, Suite 600 Houston, Texas 77079 Attention: Larry E. Cummings, Vice President, General Counsel Any party may, by written notice so delivered to the other parties, change the address or individual to which delivery shall thereafter be made. 12.4. WIRE TRANSFER INSTRUCTIONS. In the event a party is required to pay cash to the other party, payments shall be by wire transfer unless otherwise agreed by the parties at the time. When a wire transfer payment is required, the party to whom payment is to made shall furnish written wire transfer instructions to the other party. 12.5. AMENDMENTS. This Agreement may not be amended nor any rights hereunder waived except by an instrument in writing signed by the party to be charged with such amendment or waiver and delivered by such party to the party claiming the benefit of such amendment or waiver. 12.6. ASSIGNMENT. Neither party may assign all or any portion of its rights or delegate all or any portion of its duties hereunder unless it continues to remain liable for the performance of its obligations hereunder and obtains the prior written consent of the other party, which consent shall not be unreasonably withheld. 12.7. CONDITIONS. The inclusion in this Agreement of conditions to Seller's and Buyer's obligations at the Closing shall not, in and of itself, constitute a covenant of either Seller or Buyer to satisfy the conditions to the other party's obligations at the Closing. 12.8. COUNTERPARTS. This Agreement may be executed by Buyer and Seller in any number of counterparts, each of which shall be deemed an original instrument, but all of which together shall constitute but one and the same instrument. 12.9. GOVERNING LAW. This Agreement and the transactions contemplated hereby shall be construed and enforced in accordance with the laws of the state of Colorado, but without regard to laws or principles of conflicts of laws that would cause application of the laws of another jurisdiction. The parties hereby consent to the exclusive venue of the proper state or federal court located in the Denver, Colorado, and hereby waive all other venues. 17 12.10. ENTIRE AGREEMENT. This Agreement (including the Exhibits hereto) constitutes the entire understanding among the parties with respect to the subject matter hereof, superseding all negotiations, prior discussions and prior agreements and understandings relating to such subject matter. 12.11. PARTIES IN INTEREST. This Agreement shall be binding upon, and shall inure to the benefit of, the parties hereto, and their respective successors and assigns, and nothing contained in this Agreement, express or implied, is intended to confer upon any other person or entity any benefits, rights or remedies. 12.12. SURVIVAL. The representations, warranties, covenants, agreements and indemnities provided for in this Agreement shall survive the Closing and shall not be extinguished by the doctrine of merger by deed or any similar doctrine and no waiver, release, or forbearance of the application of the provisions of those paragraphs in any given circumstance shall operate as a waiver, release, or forbearance of the provisions of the paragraphs as to any other circumstance. 12.13. ARBITRATION. All disputes arising out of or in connection with this agreement, or any determination required to be made by the parties as to which the parties are unable to agree (including, without limitation, the determination of Defects), shall be settled by arbitration in Denver, Colorado. Any matter to be submitted to arbitration hereunder may be submitted to arbitration by either party. Any matter submitted to arbitration shall be conducted in accordance with the rules of the American Arbitration Association. Any award by the arbitrator(s) shall be final, binding and not appealable, and judgment may be entered thereon in any court of competent jurisdiction. Notwithstanding the above, neither Seller or Buyer shall be required to resolve any disputes relating to this Agreement through arbitration if an unrelated third party files suit against both Buyer and Seller relating to the interests conveyed pursuant to this Agreement, in such event, it being understood and agreed that Buyer and Seller may assert any claims and/or defenses arising out of this Agreement against each other in the lawsuit. 18 Executed as of the date stated on the first page of this Agreement. SELLER: REPUBLIC RESOURCES, INC. By: /s/ Patrick J. Duncan ------------------------ Patrick J. Duncan, President BUYER: HARKEN ENERGY CORPORATION By: /s/ Bruce N. Huff ----------------------- Bruce N.Huff, President and Chief Operating Officer 19 EXHIBIT A [Ommited] EXHIBIT B [Ommited] EXHIBIT C [Ommited] EXHIBIT D EXHIBIT D CONTINGENT PAYMENT AGREEMENT This Contingent Payment Agreement (this "Agreement") is made and entered into as of the day of , 2002, by and between Republic ----------- ----------- Resources, Inc. ("Republic"), a Nevada corporation, and Harken Energy Corporation ("Harken"), a Delaware corporation. RECITALS A. Republic and Harken have entered into that certain Purchase and Sale Agreement (the "Purchase Agreement") dated January 31, 2002, pursuant to which Republic is selling to Harken all of Republic's interest in and to certain oil and natural gas properties in the states of Texas and Louisiana, as further described therein; B. Pursuant to Section 2.1 (c) of such Purchase Agreement, Harken is entering into this Agreement (which is attached as Exhibit D to the Purchase Agreement) to pay, subject to the terms and conditions herein, to Republic a "Contingent Payment" (as defined herein). AGREEMENT NOW, THEREFORE, for and in consideration of the foregoing Recitals and the mutual agreements contained herein, the sufficiency of which is hereby acknowledged and confirmed, the parties hereto, intending to be legally bound, hereby agree as follows: Section 1. Contingent Payment. ------------------ (a) Subject to the terms and conditions of this Agreement, Harken hereby covenants and agrees to pay, within forty five (45) days after December 31, 2003, to Republic or its permitted assigns (as provided in Section 3 of this Agreement), the Contingent Payment (as hereinafter defined). The Contingent Payment may be payable in either cash, shares of Harken Common Stock, $.01 par value (the valuation of such shares as determined below), or any combination thereof, as Harken in its sole and absolute discretion determines. In the event some or all of the Contingent Payment is made in the form of shares of Harken Common Stock, the value per share of such shares shall be equal to the average reported closing price for Harken's Common Stock for the 20 trading days immediately prior to the Valuation Date. (b) The Contingent Payment shall be determined as follows (all the amounts below will be determined or calculated either: a) as of December 31, 2003; or b) through December 31, 2003, as appropriate); Revenues XXX Less Costs (XXX) ---- Equals the (Excess Cost) or the Excess Revenue (XXX) or XXX Less 15% of Excess Cost, if any (XXX) Plus: PV15 of the PDP Reserves XXX PV30 of the PDNP Reserves XXX PV50 of the PUD Reserves XXX ---- Subtotal XXX Times the Contingent Payment % 50% ---- Equals the Contingent Payment XXX ==== Should the above calculation result in a negative number for the Contingent Payment, there will be no liability by either Republic or Harken. In no event shall the Contingent Payment exceed $3,968,250. (c) In the event Harken elects to make any portion of the payment which may become due hereunder in the form of its shares of Common Stock, Harken shall execute and deliver to Republic (or its permitted assigns) a Registration Rights Agreement in a form substantially similar to the Registration Rights Agreement entered into in connection with the Purchase Agreement, provided that Harken shall not be obligated to execute and deliver such Registration Rights Agreement unless and until the recipient of such Registration Rights Agreement agrees to execute and be bound by the terms and provisions of such Registration Rights Agreement. (d) Notwithstanding anything in this Agreement, in no event shall Harken have any duty, commitment or obligation to develop or participate in the Properties, and Harken may develop or participate in the Properties as it determines in its sole and absolute discretion (using such reasonable business judgment as Harken uses in connection with its other properties). In the event Harken determines in its sole and absolute discretion not to participate in development of the Properties, then the Proved Reserves Value will be calculated on the non-consenting, reversionary or other retained interest (if any) held by Harken in such Properties. If the Proved Reserves Value after application of the Adjusted Costs is zero, then Harken shall not be obligated to make any Contingent Payment hereunder. Section 2. Definitions and References.When used in this Agreement, the following -------------------------- terms shall have the respective meanings assigned hereto: "Lookback Properties" shall mean Harken's right, title and interest in ------------------- and to acquired pursuant to the Purchase Agreement: (i) the Wilcox Prospects located in Jackson County, Texas, currently known as the Matterhorn Prospect, the W1 and W2 prospects, the WR (Wilcox River) prospect, the W3 prospect, the W4 prospect, and the W5 prospect, and (ii) the Yegua Prospects located in Jackson County, Texas, currently known as the Yegua 17-C prospect, and the River prospect, all of these prospects and corresponding leases being more particularly described on Exhibit A attached hereto. "Revenues" shall mean any proceeds received or receivable by Harken -------- from any production or sale of the Lookback Properties between January 1, 2002 and December 31, 2003. "Costs" shall mean any and all costs (including without limitation ----- geophysical, geological and land costs), expenses, obligations, liabilities, and all other associated costs incurred by Harken relating to or incurred in connection with the development and production of the Lookback Properties between January 1, 2002 and December 31, 2003. "Proved Reserves" shall mean the estimated quantities of oil and/or --------------- natural gas from of any interests held by Harken in the Lookback Properties that, with reasonable certainty, appear to be recoverable in the future under the economic and operating conditions as of December 31, 2003. The Parties agree that this estimate of proved reserves will be determined by either Netherland, Sewell and Associates or some other mutually agreeable petroleum engineering firm. "Proved Reserves Value" shall mean the undiscounted pre-tax value of --------------------- any interests held by Harken in the Proved Reserves as of the December 31, 2003. In determining the Proved Reserves Value, the oil and gas shall be priced by using the average of (x) the average strip price for the 12 months immediately preceding the Valuation Date (as published in Inside ------ FERC (or other publications acceptable to Harken and Republic) on the ---- Valuation Date) and (y) the projected average strip price for the 12 months immediately following the Valuation Date (as published in The Wall Street --------------- Journal (or other publications acceptable to Harken and Republic) on the ------- December 31, 2003). In addition, the Proved Reserve Values will be categorized between Proved Developed Producing ("PDP"), Proved Developed Non-producing ("PDNP"), and Proved Underdeveloped ("PUD") in accordance with generally accepted petroleum-engineering methods. The Parties agree that the estimate of Proved Reserves Value will be determined by the same petroleum-engineering firm that determines the Proved Reserves. "PV15 of the PDP Reserves" shall mean the value of the Proved ------------------------ Developed Producing Reserve Value discounted on an annual basis at 15%. "PV30 of the PDNP Reserves" shall mean the value of the Proved ------------------------- Developed Non-producing Reserve Value discounted on an annual basis at 30%. "PV50 of the PUD Reserves" shall mean the value of the Proved ------------------------ Undeveloped Reserve Value discounted on an annual basis at 50%. "Contingent Payment" shall be the amount payable by Harken, as ------------------ computed and described in Section 1 of this Agreement. In no event shall the Contingent Payment exceed $3,968,250. "Valuation Date" shall mean December 31, 2003. -------------- 2 Section 3. Miscellaneous. (a) Except as otherwise specifically provided, all fees, costs and expenses incurred by Republic or Harken in negotiating this Agreement or in consummating the transactions contemplated by this Agreement shall be paid by the party incurring the same, including, without limitation, legal and accounting fees, costs and expenses. (b) All notices and communications required or permitted under this Agreement shall be in writing and any communication or delivery hereunder shall be deemed to have been duly made when personally delivered to the individual indicated below, or if mailed, when received by the party charged with such notice and addressed as follows: IF TO REPUBLIC: REPUBLIC RESOUCES, INC. 743 Horizon Court, Suite 333 Grand Junction, Colorado 81506 Attention: Patrick J. Duncan, President With a copy to: ALAN W. PERYAM, ESQ. 1120 Lincoln Street, Suite 1000 Denver, Colorado 80203 IF TO HARKEN: HARKEN ENERGY CORPORATION 580 WestLake Park Boulevard, Suite 600 Houston, Texas 77079 Attention: Bruce N. Huff, President and Chief Operating Officer With a copy to: HARKEN ENERGY CORPORATION 580 WestLake Park Boulevard, Suite 600 Houston, Texas 77079 Attention: Larry E. Cummings, Vice President, General Counsel Any party may, by written notice so delivered to the other parties, change the address or individual to which delivery shall thereafter be made. (c) This Agreement may not be amended nor any rights hereunder waived except by an instrument in writing signed by the party to be charged with such amendment or waiver and delivered by such party to the party claiming the benefit of such amendment or waiver. (d) Neither party may assign all or any portion of its rights or delegate all or any portion of its duties hereunder unless it continues to remain liable for the performance of its obligations hereunder and obtains the prior written consent of the other party, which consent shall not be unreasonably withheld. Notwithstanding the foregoing, Republic may assign this Agreement to the holders of its Series C Redeemable Preferred Stock (the "Series C Preferred"), provided that Republic provides prior notice of such assignment and provided further that Harken receives prior to such assignment evidence to Harken's reasonable satisfaction that the holders of such Series C Preferred are "accredited investors" as that term is defined in Regulation D promulgated under the Securities Act of 1933 and such other evidence as Harken may reasonably require that such assignment does not violate federal and state securities laws. Further, notwithstanding the foregoing, Harken may assign this Agreement to any of its subsidiaries if Harken shall also assign the Properties under this Agreement to such subsidiairy. Harken shall provide notice of such assignment to Republic following making of the same. (e) This Agreement may be executed by Republic and Harken in any number of counterparts, each of which shall be deemed an original instrument, but all of which together shall constitute but one and the same instrument. 3 (f) This Agreement and the transactions contemplated hereby shall be construed and enforced in accordance with the laws of the state of Colorado, but without regard to laws or principles of conflicts of laws that would cause application of the laws of another jurisdiction. The parties hereby consent to the exclusive venue of the proper state or federal court located in Denver, Colorado, and hereby waive all other venues. (g) All disputes arising out of or in connection with this Agreement, or any determination required to be made by the parties as to which the parties are unable to agree, shall be settled by arbitration in Denver, Colorado. Any matter to be submitted to arbitration hereunder may be submitted to arbitration by either party. Any matter submitted to arbitration shall be conducted in accordance with the rules of the American Arbitration Association. Any award by the arbitrator(s) shall be final, binding and not appealable, and judgment may be entered thereon in any court of competent jurisdiction. In the event Republic initiates such arbitration and it is determined in such arbitration that Harken has failed to pay any amounts required to be paid under this Agreement to Republic by an amount of 5% or more, then Harken shall be required to pay the costs of the arbitrators. (h) Notwithstanding anything in this Agreement to the contrary, in no event shall Harken have any duty, commitment or obligation to develop or participate in the Properties, and Harken may develop or participate in the Properties as it determines in its sole and absolute discretion (using such reasonable business judgment as Harken uses in connection with its other properties). (i) All references in this Agreement to sections, subsections and other subdivisions refer to corresponding sections, subsections and other subdivisions of this Agreement unless expressly provided otherwise. Titles appearing at the beginning of any such subdivisions are for convenience only and shall not constitute part of such subdivisions and shall be disregarded in construing the language contained herein. Words in the singular form shall be construed to include the plural and vice versa, unless the context otherwise requires. ---------- (j) Harken shall provide to Republic (or its permitted assigns) semi-annually, on a calendar year basis, a status report on the current value of the proved oil and natural gas reserves in the Properties (as of the date of such report), using the calculations as described herein to determine the Proved Reserves Value and determining the value of such proved reserves as of the date of the report instead of the Valuation Date. Harken shall also include with such report the assumptions used in calculating the Proved Reserves Value. Harken may base such report upon its own internal reserve valuations if such report is provided for any time other than as of a calendar year end. Any such report provided as of a calendar year end will be based upon a third party outside engineering report. Executed as of the date stated on the first page of this Agreement. END OF EXHIBIT D 4 EXHIBIT E --------- Form of Assignment, Conveyance and Bill of Sale ----------------------------------------------- KNOW ALL MEN BY THESE PRESENTS: Republic Resources, Inc., 743 Horizon Court, Suite 333 Grand Junction, CO 81506-8715 (hereinafter referred to as "Assignor") for and in consideration of the sum of Ten Dollars ($10.00) and other valuable consideration, the receipt and sufficiency of which are hereby acknowledged, does hereby sell, assign, convey, transfer, and set over, subject to the reservations herein set forth, unto Xplor Energy SPV-I, Inc. an Oklahoma corporation, 580 WestLake Park Boulevard, Suite 600 Houston, TX 77079 (hereinafter referred to as "Assignee") and subject to the following terms and provisions, all of its right, title and interest in and to the "Subject Property" described as follows: (a) The oil and gas wells described in EXHIBIT A hereto (the "Wells"), --------- together with all oil, gas and mineral production from the Wells; (b) The leasehold estates created by the leases, licenses, permits and other agreements described in EXHIBIT B, (the "Leases"); together with all --------- overriding royalty interests, production payments and other payments out of or measured by the value of oil and gas production; (c) All oil, gas, casinghead gas, condensate, distillate, liquid hydrocarbons, gaseous hydrocarbons and all products refined therefrom, together with all minerals produced in association with these substances (collectively called the "Hydrocarbons") in and under and which may be produced and saved from or attributable to the Leases or Wells, and all rents, issues, profits, proceeds, products, revenues and other income from or attributable thereto; (d) All of the personal property, fixtures and improvements appurtenant to the Wells, or the Leases or used or obtained in connection with the operation of the Wells, or the Leases or with the production, treatment, sale or disposal of hydrocarbons or water produced therefrom or attributable thereto, including without limitation, pipelines, disposal systems, gathering systems and compression facilities (the "Equipment") appurtenant to or located upon the Leases; and (e) All the property, rights, privileges, benefits and appurtenances in any way belonging, incidental to, or pertaining to the property, interests and rights described in(a) through (d) including the Wells, the Leases and reserves of unproduced oil and natural gas in place, including, to the extent transferable, all exploration agreements, letter agreements, product purchase and sale contracts, surface leases, gas gathering contracts, processing agreements, compression agreements, equipment leases, permits, gathering lines, rights-of-way, easements, licenses, farmouts and farmins, options, orders, pooling, spacing or consolidation agreements and operating agreements and all other agreements relating thereto, including those listed on EXHIBIT C (the --------- "Contracts"); (f) All of the files, records, data (including seismic data and related information) and other documentary information maintained in the normal course of business by Seller pertaining to the Wells, Leases, Equipment, Hydrocarbons and the Contracts (collectively, the "Data") in the format maintained by Assignor. The Data shall not, however, include any information, which, if disclosed, would cause Seller to breach any contract or agreement. Assignor will use reasonable efforts to obtain any required consent to disclose such information; and (g) All other rights and interests in, to or under or derived from the Subject Property, even though improperly described in the Exhibits. It is the expressed intent of the parties that all of Assignor's right, title and interest in any and all of the Subject Property, whether or not the same may be correctly described on the Exhibits hereto be assigned to Assignee hereunder. This Assignment, Conveyance and Bill of Sale is made subject to the following terms and provisions: (a) NOTWITHSTANDING ANY PROVISION IN THIS ASSIGNMENT, CONVEYANCE AND BILL OF SALE OR ANY DOCUMENT DELIVERED IN CONNECTION HEREWITH TO THE CONTRARY, THE SUBJECT PROPERTY AND ANY OTHER PROPERTY OR RIGHTS CONVEYED HEREUNDER ARE CONVEYED "AS IS, WHERE IS," "WITH ALL FAULTS," AND IN THEIR PRESENT CONDITION AND STATE OF REPAIR, AND WITHOUT WARRANTY, EITHER EXPRESS OR IMPLIED (EXCEPT WARRANTY OF TITLE BY, THROUGH OR UNDER ASSIGNOR, BUT NOT OTHERWISE) INCLUDING WARRANTY OF MERCHANTABILITY, OR FITNESS FOR A PARTICULAR PURPOSE OR ANY OTHER SORT OF WARRANTY. ASSIGNEE HAS INSPECTED, OR HAS HAD THE OPPORTUNITY TO INSPECT, THE ASSIGNED PREMISES FOR ALL PURPOSES. (b) Assignor reserves from this Assignment, Conveyance and Bill of Sale in favor of itself the following: (i) All accounts receivable attributable to the Subject Property that are attributable to the period prior the Effective Time; (ii) All claims and rights relating to overpayments of costs and expenses attributable to period prior to the Effective Time, including, without limitation, the right to initiate, prosecute or participate, at Assignor's sole cost and expense, in all audits, audit claims and tax claims or proceedings relating to or including periods prior to the Effective Time, regardless of when commenced, arising under applicable law, operating or product sale agreements or otherwise, and to recover all costs and expenses claimed or shown by such audits or proceedings as owing to the owner of the Subject Property for periods prior to the Effective Time; and (iii)All rights, if any, to recover additional production or proceeds or requirements to refund monies attributable to such production or proceeds therefrom attributable to the Subject Property for any production month prior to the Effective Time, resulting from any adjustment to the net revenue interest attributable to the Subject Property in the applicable division orders. Assignee, its successors and assignees, shall observe, perform and comply with the terms, provisions, covenants and conditions, express or implied, of the oil and gas leases described on EXHIBIT B, together with any related contracts, --------- and all laws, rules, regulations and orders, both state and federal, applicable to the ownership and enjoyment of the rights herein assigned. Effective from and after the Effective Time of this instrument, Assignee hereby agrees to assume and shall assume, pay and perform all liabilities and obligations arising in connection with the ownership or operations of the Subject Property. Commencing from and after the Effective Time of this instrument, Assignee shall indemnify and hold harmless Assignor against and from any and all loss, cost, expense, liability or damage (including fees and expenses of attorneys, technical experts and expert witnesses) incurred or suffered by Assignor arising out of or relating to Assignee's failure to discharge any such liabilities and obligations. All saleable gas, oil and/or condensate at the Effective Time of this instrument is owned by the Assignor and is not to be considered a part of this sale. This Assignment, Conveyance and Bill of Sale is to be treated as an occasional sale, and no sales tax is being collected from Assignee. If however, this transaction is later deemed to be subject to sales or use tax, Assignee agrees to be solely responsible for any and all sales or use taxes due on equipment, material and property hereby assigned and sold, and Assignee shall remit such taxes to the proper taxing authority. 2 This Assignment, Conveyance and Bill of Sale is subject to the terms and provisions of that certain Purchase and Sale Agreement dated January 31, 2002 by and between Assignor and Assignee. This instrument shall be binding upon and inure to the benefit of Assignor and Assignee, their personal representatives, executors, successors and assigns. The provisions hereof shall be covenants running with the lands and leases assigned. EXECUTED this day of , 2002, but effective --------- --------------------- for all purposes as of January 1, 2002, at 12:01 A.M. at the location of the Subject Property ("Effective Time"). ASSIGNOR: Attest: REPUBLIC RESOURCES, INC. By: By: ----------------------------- ---------------------------- Marilyn L. Adams, Secretary Patrick J. Duncan, President ASSIGNEE: Attest: Xplor Energy SPV-I, Inc. an Oklahoma corporation, By: By: ----------------------------- ------------------------ ACKNOWLEDGMENTS STATE OF COLORADO) )ss COUNTY OF MESA) This instrument was acknowledged before me, a Notary Public, by Patrick J. Duncan, President of Republic Resources, Inc., a Nevada corporation, on behalf of said corporation. Witness my hand and official seal this day of , 2002. -------- ------- My Commission Expires: - --------------------------------------------------------------------- - ------------------------------ Notary Public in and for the State of - -------------- STATE OF TEXAS) )ss COUNTY OF) This instrument was acknowledged before me, a Notary Public, by - ----------------- , President of Xplor Energy SPV-I, Inc., an Oklahoma corporation, on behalf of said corporation. Witness my hand and official seal this day of , 2002. --------- -------- My Commission Expires: - --------------------------------------------------------------------- - ------------------------------ Notary Public in and for the State of - -------------- END OF EXHIBIT E 3 EXHIBIT F --------- Debenture Exchange Subscription Agreement ------------------------------ Name of Debenture Holder ------------------------------ Principal Amount DEBENTURE EXCHANGE SUBSCRIPTION AGREEMENT This Debenture Exchange Subscription Agreement (the "Agreement") is between the debenture holder identified on the signature page of this Agreement ("Subscriber"), Republic Resources, Inc. ("Republic") and Harken Energy Corporation ("Harken") and is made with reference to the following agreed facts: A. The undersigned Subscriber is the holder of a 11% Convertible Debenture, due April 15, 2003 (the "Debenture") of Republic (formerly Pease Oil and Gas Company) in the principal amount set forth on the signature page of this Agreement. B. There are outstanding $2,645,500 of the Debentures held by Subscriber and other holders of the Debentures. C. Republic has agreed to sell to Harken, pursuant to a Purchase and Sale Agreement dated January 31, 2002 (the "Asset Sale Agreement"), all of Republic's interests in its oil and natural gas properties located in the states of Louisiana and Texas that have "proved reserves" as of January 1, 2002. The properties to be sold include all of Republic's income-producing assets as of January 1, 2002. In exchange for these assets, Harken will deliver at closing up to 2,645,500 shares of Harken common stock that will be distributed to the Subscriber and other holders of the Debentures on a pro-rata basis in full satisfaction of Republic's principal obligation under the outstanding Debentures. D. The number of shares of Harken Common Stock to be issued at the closing of the Asset Sale Agreement will be determined by dividing the total principal amount of Republic's outstanding Debentures by the average reported closing price for Harken's Common Stock for the 20 trading days ending on the day before the Closing of the Asset Sale Agreement (hereafter the "Common Stock Value Per Share"). However, under no circumstances shall the Common Stock Value Per Share be less than $1.00. E. The completion of the sale of the Republic assets to Harken is contingent upon: (i) the approval of the Asset Sale Agreement by stockholders of Republic at a special meeting of stockholders to be called for that purpose, and (ii) acceptance of the exchange offer described in this Agreement by the holders of substantially all of the outstanding Debentures. F. The parties intend that this Agreement shall be irrevocable by Subscriber unless the Asset Sale Agreement is not closed by at least June 1, 2002. G. In addition to the proved oil and gas properties, Republic will also convey to Harken the Company's interest in certain exploratory prospects in Jackson County, Texas that have not been given any initial value in the contemplated transaction. These exploratory prospects will be evaluated for additional value at the end of 2003 using a "Lookback" formula as defined in the P&S Agreement, and a future "Lookback Payment" may be made in early 2004. The amount of any "Lookback Payment" will be contingent on, among other things, future exploratory successes in the Jackson County prospects, of which there can be no assurance. In addition, there can be no assurance that the operators of those prospects will actually drill any wells on the prospects by the end of the Lookback period (which is at the end of 2003) and if so whether Harken will agree to participate in exploration of the prospects since it will be under no obligation to do so. Accordingly, the amount of any "Lookback Payment", if any, cannot be reasonablely determined at this time. In any case, Republic anticipates that the contingent Lookback Payment ultimately will be assigned to the holders of its Series C Redeemable Preferred Stock in connection with a restructuring of that security. It is expressly understood that neither the Subscriber nor any other holder of the Debentures will haveany right, title or interest in the contingent Lookback Payment regardless of its ultimate value, if any, and regardless of whether it is ultimately assigned to the Series C Preferred stockholders or retained by Republic. IN CONSIDERATION, of the covenants and agreements of the parties and other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties agree as follows: 1. Agreement to Exchange. Subscriber hereby agrees to exchange and surrender the Debenture held by Subscriber effective on the day of Closing of the Asset Sale Agreement. In exchange for surrender and cancellation of Subscriber's Debenture, Subscriber shall receive the following: (a) Payment of all unpaid interest on Subscriber's Debenture through the date of the Closing, to be paid by Republic at such time as Subscriber's Debenture certificate is delivered to Republic for cancellation; and (b) An amount of common stock of Harken determined by dividing the principal amount of Subscriber's Debenture by the "Common Stock Value Per Share" determined as described above. The shares of Harken Common Stock shall be issued effective as of the closing of the Asset Sale Agreement and shall be delivered to Subscriber at such time as Subscriber's Debenture certificate is delivered to Republic for cancellation. Republic shall pay the interest to Subscriber through the date of the Closing of the Asset Sale Agreement and Subscriber's Debenture shall be deemed surrendered and canceled as of such date, subject only to delivery to Subscriber of the Harken Common Stock in exchange for surrender of Subscriber's Debenture certificate. 2. Irrevocable Subscription; Acceptance. Subscriber understands and acknowledges that this subscription to exchange Subscriber's Debenture in the manner described in this Agreement is irrevocable by Subscriber unless Republic and Harken have not closed the Asset Sale Agreement by June 1, 2002. Acceptance of this subscription by Republic and Harken is subject to: (i) approval of the Asset Sale Agreement by Republic stockholders, (ii) receipt of Debenture Exchange Subscriptions from holders of at least 90% of the outstanding principal amount of Republic's Debentures (provided that Harken and Republic may, in their discretion, waive this condition), and (iii) Closing of the Asset Sale Agreement. Until and unless the foregoing conditions are satisfied, Subscriber's Debenture shall continue to earn interest and to represent an obligation of Republic to Subscriber as described in the Debenture. 3. Acknowledgment of Disclosure. Subscriber acknowledges the receipt of Harken's Disclosure Memorandum, dated January 31, 2002, including Harken's Annual Report on Form 10-KSB for the fiscal year ended December 31, 2001, and Quarterly Report on Form 10-QSB for the quarter ended September 30, 2001, which are the last publicly-filed reports of Harken. Subscriber acknowledges receipt from Republic of Republic's letter dated January 11, 2002, together with copies of Republic's Quarterly Report on Form 10-QSB for the quarter ended September 30, 2001 and Form 8-K dated February , 2002, the most recent public reports -- filed by Republic. Subscriber has also been given access to full and complete information regarding Republic and Harken and has utilized such access to the Subscriber's satisfaction for the purpose of obtaining such information regarding Republic and Harken as the Subscriber has reasonably requested; and, particularly, Subscriber has been given reasonable opportunity to ask questions of, and receive answers from, representatives of Republic and Harken concerning the terms and conditions of the exchange offer described in this Agreement, the business and affairs of Republic and of Harken and all additional information requested by Subscriber to the extent it would be reasonably available. 4. Investment Intent. Subscriber represents and warrants that the common stock of Harken which will be issued upon completion fo the exchange described in this Agreement will be held for the Subscriber's own account and for investment purposes only, and without the intention of reselling or redistributing the same except as may be effected in compliance with the registration requirements of the Securities Act of 1933, as amended ("Securities Act"); Subscriber has made no agreement with others regarding any of the securities to be obtained in the exchange and Subscriber's financial condition is such that it is not likely that it will be necessary for Subscriber to dispose of any of such securities in the foreseeable future. Subscriber further represents and agrees that if, contrary to the foregoing intentions, Subscriber should later desire to dispose of or transfer any of the Harken Common Stock received by Subscriber in the exchange in any manner, Subscriber shall not do so unless and until (i) such securities have been registered under the Securities Act and all applicable securities laws; or (ii) Subscriber shall first deliver to Harken a written notice declaring such holders's intention to effect such transfer and describe in sufficient detail the manner and circumstances of the proposed transfer, which notice shall be accompanied either by: (A) written opinion of legal counsel who shall be reasonably satisfactory to Harken, which opinion shall be addressed to Harken and reasonably satisfactory in form and substance to Harken's counsel, to the effect that the proposed sale or transfer is exempt from the registration provisions of the Securities Act and all applicable state securities laws, or (B) a "no-action letter" from the Securities and Exchange Commission to the effect that the transfer of the Harken Common Stock without registration would not result in a recommendation by the staff of the Commission that action be taken with respect thereto. 5. Residence of Subscriber. Subscriber represents and warrants that Subscriber is a bona fide resident of, is domiciled in, and received the exchange offer and made the decision to exchange securities in the state of residence set out on the signature page of this Agreement. 6. Subscriber is Accredited Investor. Subscriber acknowledges that at the time the Debenture was initially acquired, and at the time that Republic and Subscriber agreed to extend the maturity and otherwise modify the terms of the Debentures in March 2001, Subscriber qualified as a Accredited Investor as described in Rule 501 of Regulation D adopted by the United States Securities and Exchange Commission under the Securities Act. Subscriber represents to Republic and Harken that as of the date of this Agreement set forth on the signature page below, Subscriber continues to qualify as an Accredited Investor. 2 7. Acknowledgment of Certain Risks. Subscriber acknowledges that upon Closing of the Asset Sale Agreement, Subscriber shall have exchanged the Republic Debenture now held, a debt security of Republic, for Harken Common Stock, an equity security in a different entity. Following the exchange Republic shall have no obligation to Subscriber and Subscriber will, instead, hold an equity investment in Harken with no assurance that he will be able to liquidate the investment and no right to receive the existing principal amount of the Debenture. Subscriber acknowledges that holding the Harken Common Stock involves certain risks, some of which are summarized or referred to in the Harken Disclosure Memorandum. Likewise, Subscriber acknowledges that continuing to hold the Republic Debenture would involve risk to Subscriber and other holders of the Debentures, some of which are summarized in the information furnished to Subscriber as summarized or described above. Subscriber is accepting the exchange offer described in this Agreement notwithstanding such risks. 8. No Tax Advice. Subscriber acknowledges that an exchange of Subscriber's Debenture for Harken Common Stock as described in this Agreement is likely to be deemed to be a taxable transaction to Subscriber. Subscriber is likely to have taxable gain or loss equal to the difference between Subscriber's tax basis in the Debenture and the fair market value of the Harken Common Stock to be received in the exchange. While it is expected that the fair market value of the Harken Common Stock is likely to be approximately equal to the principal balance of the Debenture, Republic and Harken have made no representations to Subscriber as to the tax implications to Subscriber from the exchange described in this Agreement and Subscriber has been advised to seek his own tax counsel regarding the exchange. Subscriber has received, from Subscriber's own tax or other advisors, all information Subscriber requires concerning the tax consequences of the exchange described in this Agreement and has not, and does not, rely upon Republic or Harken with respect to tax implications of the exchange. 9. No Transfer or Assignment. Neither this Agreement nor any of the rights of Subscriber, Republic or Harken may be transferred or assigned by any party. This Agreement shall survive the death or disability of Subscriber and shall be binding upon Subscriber's heirs, executors, administrators, successors and attempted assigns. 10. Arbitration of Disputes. In the event that a dispute arises between Subscriber and Republic or Harken arising out of or in connection with exchange by Subscriber of the Debenture for Harken Common Stock, Subscriber, Republic and Harken hereby expressly agree that such dispute shall be resolved through arbitration rather than litigation. The undersigned hereby agrees to submit the dispute to binding arbitration through the American Arbitration Association ("AAA") in Denver, Colorado, to be conducted in accordance with the rules of commercial arbitration adopted by AAA. Such a dispute shall be submitted to arbitration by any party by filing a written request for arbitration with AAA. Subscriber, Republic and Harken agree that the Federal Arbitration Act shall govern the disposition of all issues raised in the arbitration proceeding. A decision in the arbitration proceeding shall be final and binding on the parties. 11. Notices. All notices or other communications required under this Agreement shall be in writing and shall be deemed to have been duly given if delivered personally or mailed by certified or registered mail, return receipt requested, postage prepaid as follows: if to Subscriber, to the address set forth on the signature page to this Agreement; and if to Republic or Harken to their address as set forth in the Harken Disclosure Memorandum. [The balance of this page is blank] 3 SIGNATURE PAGE TO DEBENTURE EXCHANGE SUBSCRIPTION AGREEMENT ----------------------------------------- By signing this Agreement in the place indicated below, Subscriber represents to Republic and Harken that Subscriber has read this entire Agreement, that the information set forth below is accurate, and that Subscriber agrees to exchange his or her Debenture for Harken Common Stock as described in this Agreement. INDIVIDUAL ---------- - ----------------------------------------- Address to Which Correspondence Name of Registered Owner of Should be Directed Debenture ("Subscriber") ------------------------------------------- ------------------------------------------- - ----------------------------------------- ------------------------------------------- Signature (Individual) City, State, and Zip Code - ----------------------------------------- -------------------------------------------- Signature (Second Signature if Joint Owner) Tax Identification or Social Security Number - ----------------------------------------- -------------------------------------------- Name Typed or Printed Second Name Type or Printed ( ) ( ) - ----------------------------------------- -------------------------------------------- Fax Number Telephone Number $ - ----------------------------------------- ------------------------------------------- Date Principal Amount of Debenture
ACCEPTANCE ---------- This Debenture Exchange Subscription Agreement is accepted as of ----------- , 2002 (the date of Closing of the Purchase and Sale Agreement dated January 31, 2002). REPUBLIC RESOURCES, INC. HARKEN ENERGY CORPORATION By By ------------------------------ --------------------------------- Patrick J. Duncan, President Bruce N. Huff, President 4 SIGNATURES ---------- By signing this Agreement in the place indicated below, Subscriber represents to Republic and Harken that Subscriber has read this entire Agreement, that the information set forth below is accurate, and that Subscriber agrees to exchange his or her Debenture for Harken Common Stock as described in this Agreement. CORPORATION, PARTNERSHIP, TRUST OR OTHER ENTITY ----------------------------------------------- Address to Which Correspondence - ----------------------------------------- Should be Directed Name of Registered Owner of Debenture ("Subscriber") ------------------------------------------- ------------------------------------------- - ----------------------------------------- ------------------------------------------- Signature (Individual) City, State, and Zip Code - ----------------------------------------- -------------------------------------------- Signature (Second Signature if Joint Owner) Tax Identification or Social Security Number - ----------------------------------------- -------------------------------------------- Name Typed or Printed Second Name Type or Printed ( ) ( ) - ----------------------------------------- -------------------------------------------- Fax Number Telephone Number $ - ----------------------------------------- ------------------------------------------- Date Principal Amount of Debenture
*The Certificate of Signatory must also be completed. CERTIFICATE OF SIGNATORY ------------------------ To be completed if the Debentures are owned by an entity -------------------------------------------------------- I, , am the of -------------------------------------- ------------------ [Name printed] (the "Entity") - ------------------------------------------------------------------ I certify that I am empowered and duly authorized by the Entity to execute anc carry out the terms of this Agreement and to exchange the Debentures as described in this Agreement, and certify that this Agreement has been duly and validly executed on behalf of the Entity and constitutes a legal and binding obligation of the Entity. IN WITNESS WHEREOF, I have hereto set my hand this day of ----- , 200 . - -------- -- -------------------------------------------- Signature ACCEPTANCE ---------- This Debenture Exchange Subscription Agreement is accepted as of , 2002 (the date of Closing of the Purchase and Sale Agreement dated - ----------- January 31, 2002). REPUBLIC RESOURCES, INC. HARKEN ENERGY CORPORATION By By ------------------------------------ -------------------------------- Patrick J. Duncan, President Bruce N. Huff, President 5 EXHIBIT G --------- REGISTRATION RIGHTS AGREEMENT THIS REGISTRATION RIGHTS AGREEMENT ("Agreement") is made and entered into as of the day of , 2002, by and among Harken Energy Corporation, a ---- -------------- Delaware corporation ("Harken"), and Republic Resources, Inc., a Nevada corporation ("Republic"). RECITALS: --------- A. Reference is hereby made to that certain Purchase and Sale Agreement dated as of the date hereof (the "Purchase Agreement") by and among Harken and Republic pursuant to which Republic will upon Closing, receive a certain number of Shares of Harken Common Stock, which Shares are the subject of this Agreement. B. Pursuant to the terms of the Agreement, Harken has agree to provide Republic and the holders of the Registrable Securities (as defined herein) with the registration rights set forth herein. AGREEMENT: ---------- NOW, THEREFORE, for and in consideration of the foregoing Recitals and the mutual agreements contained herein, the sufficiency of which is hereby acknowledged and confirmed, the parties hereto, intending to be legally bound, agree as follows: Section 1. Definitions and References. -------------------------- (1) When used in this Agreement, the following terms shall have the respective meanings assigned to them in this Section 1 or in the Sections referred to below: "Agreement" shall mean this Registration Rights Agreement, as hereafter amended or modified in accordance with the terms hereof. "Commission" shall mean the Securities and Exchange Commission (or any successor body thereto). "Common Stock" shall mean the common stock, par value $0.01 per share, of Harken. "Purchase Agreement" shall mean the Purchase and Sale Agreement dated as of the date hereof between Harken and Republic. "Exchange Act" shall mean the Securities Exchange Act of 1934, as amended, and all rules and regulations promulgated under such Act. "Harken" shall have the meaning assigned to it in the preamble to this Agreement. "Harken Indemnified Parties" shall have the meaning assigned to it in Section 5(b). "Holder" shall mean any Person that holds Registrable Securities. "Holder Indemnified Parties" shall have the meaning assigned to it in Section 5(a). "Republic" shall have the meaning assigned to it in the preamble to this Agreement. "Person" shall mean any individual, corporation, partnership, joint venture, limited partnership, limited liability company, trust, unincorporated organization, government or any agency or political subdivision thereof or other entity. "Prospectus" shall mean the prospectus included in any Registration Statement (including, without limitation, a prospectus that discloses information previously omitted from a prospectus filed as part of an effective registration statement in reliance upon Rule 430A promulgated pursuant to the Securities Act), as amended or supplemented by any prospectus supplement, with respect to the terms of the offering of any portion of the Registrable Securities covered by such Registration Statement, and all other amendments and supplements to any such prospectus, including post-effective amendments, and all material incorporated by reference or deemed to be incorporated by reference, if any, in such prospectus. "Registrable Securities" shall mean the Shares issued to Republic under the Purchase Agreement or pursuant to that certain Contingent Payment Agreement attached as EXHIBIT D to the Purchase Agreement. --------- "Registration Expenses" shall mean all fees and expenses incident to Harken's performance of or compliance with the registration rights granted hereunder, including (without limitation) all registration and filing fees, fees and expenses of compliance with securities and blue sky laws, printing and engraving expenses, messenger, telephone and delivery expenses, fees and disbursements of counsel for Harken, and fees and disbursements of all independent certified public accountants and underwriters (excluding discounts and commissions); provided, however, that Registration Expenses shall not include any Selling Expenses. "Registration Statement" shall mean any registration statement of Harken that covers any of the Registrable Securities pursuant to this Agreement, including the Prospectus, amendments and supplements to such registration statement or Prospectus, including pre- and post-effective amendments, all exhibits thereto, and all material incorporated by reference or deemed to be incorporated by reference, if any, in such registration statement. "Securities Act" shall mean the Securities Act of 1933, as amended, and all rules and regulations promulgated under such Act. "Selling Expenses" shall mean underwriting discounts or commissions, any selling commissions and stock transfer taxes attributable to sales of Registrable Securities and the fees and expenses of counsel for any Holder. (2) All references in this Agreement to sections, subsection and other subdivisions refer to corresponding sections, subsections and other subdivisions of this Agreement unless expressly provided otherwise. Titles appearing at the beginning of any such subdivisions are for convenience only and shall not constitute part of such subdivisions and shall be disregarded in construing the language contained herein. The words "this Agreement", "this instrument", "herein", "hereof", "hereby", "hereunder" and words of similar import refer to this Agreement as a whole and not to any particular subdivision unless expressly so limited. Words in the singular form shall be construed to include the plural and vice versa, ---------- unless the context otherwise requires. Section 2. Registration Shares. ------------------- Harken shall prepare and file with the Commission as soon as reasonably practicable and in any event no later than sixty (60) days after Closing the Purchase Agreement and the issuance contemplated thereunder to Republic of the Shares, a registration statement on Form S-3 or other appropriate form pursuant to Rule 415 under the Securities Act covering the sale by Republic of such Registrable Securities. Harken shall use its reasonable best efforts to cause each such Registration Statement to be declared effective as soon as reasonably practicable after the filing thereof and to keep each such Registration Statement effective for no less than the later of 365 days or the expiration of the Selling Period (as defined in the Exchange Agreement) applicable to the Registrable Securities covered thereby. Section 3. Registration Procedures. ----------------------- (a) In connection with Harken's registration obligations hereunder, Harken will use its reasonable best efforts to effect the registration of the Registrable Securities in accordance with the intended methods of disposition thereof as quickly as practicable, and pursuant thereto Harken will a expeditiously as possible: (1) prepare and file with the Commission not later than the time specified in this Agreement, a Registration Statement on the appropriate form with respect to the Registrable Securities and use its reasonable best efforts to cause such Registration Statement to become effective as soon as reasonably practicabl after the filing thereof (provided, that before filing a Registration Statement or Prospectus or any amendments or supplements thereto, Harke will furnish copies of all such documents proposed to be file to all Holders of Registrable Securities covered by such Registration Statement); 2 (2) prepare and file with the Commission such amendments an supplements to such Registration Statement and the Prospectus used in connection therewith as may be necessary to keep such Registration Statement effective for a period of not less than the period set fort in this Agreement or such shorter period which will terminate when all Registrable Securities covered by such Registration Statement have been sold (but not before the expiration of the applicable Prospectus deliver period) and comply with the provisions of the Securities Act with respect to the disposition of all Registrabl Securities covered by such Registration Statement during such period in accordance with the intended methods of disposition by the Holders thereof set forth in such Registration Statement: (3) furnish to each Holder of Registrable Securities such number of copies of such Registration Statement, each amendment and supplement thereto, the Prospectus included in such Registration Statement (including, without limitation, each preliminary prospectus) and such other documents as such Holde may reasonably request in order to facilitate the disposition of the Registrable Securities owned by such Holder. (4) use its reasonable best efforts to register or qualif such Registrable Securities under such other securities or blue sky laws of such jurisdictions within the United States as any Holder reasonably requests and do an and all other acts and things which may be reasonably necessary or advisable to enable such Holder to consummate the disposition in such jurisdictions of the Registrable Securities owned by such Holder (provided that Harken will not be required to qualify generally to do business or subject itself to any general service of process in any jurisdiction where it is otherwise not the so subject); (5) notify each Holder of such Registrable Securities, at an time when a Prospectus relating thereto is required to be delivered under the Securitie Act, of the happening of any event which requires the making of any change in the Prospectus included in such Registration Statement so that such document will not contain an untrue statement of a materia fact or omit to state any material fact required to be stated therein or necessary to make the statements therein not misleading, and, at the request of any such Holder, Harken will prepare a supplement or amendment to such Prospectus so that such Prospectus will not contain a untrue statement of a materia fact or omit to state any material fact required to be stated therein or necessary to make the statements therein not misleading; (6) use its reasonable best efforts to cause all such Registrable Securities to be listed on each securities exchange or exchanges, automated quotatio system or over-the-counter market upon which securities of Harken of the same class are then listed; (7) enter into such customary agreements (including, withou limitation, underwriting agreements in customary form, substance and scope) and take all such other actions as the Holders of a majority of the Registrable Securities being sold or the underwriters, if any, reasonably request in order to expedite or facilitate the disposition of such Registrable Securities; (8) otherwise use its reasonable best efforts to comply with all applicable rules and regulations of the Commission, and make generally available to its security holders an earnings statement no later than ninety (90) day after the end of the 12-month period beginning with the first day of Harken's first full calendar quarter after the effective date of the Registration Statement, which earnings statement shall satisfy the provisions of Section 11(a) o the Securities Act and Rule 158 thereunder; (9) in the event of the issuance or threatened issuance of any stop order suspending the effectiveness of a Registration Statement, or an order suspending or preventin the use of any related Prospectus or suspending the qualification of any Registrable Securities included in such Registration Statemen for sale in any jurisdiction, promptly notify each Holder o Registrable Securities of the issuance or threatened issuance of such order and us its reasonable best efforts promptly to prevent the entry of such order or obtain the withdrawal of such order if issued; (10) use its reasonable best efforts to cause such Registrable Securities covere by such Registration Statement to be registered with or approved by such other governmental agencies or authorities as may be necessary to enable the Holders thereof to consummate the disposition of such Registrable Securities; 3 (11) make available at all reasonable times and in a reasonable manner for inspection by any Holder of Registrable Securities, any underwriter participating in any disposition pursuant to such Registration Statement, and any attorney, accountant or other agent retained by an such Holder or underwriter (collectively, the "Inspecto", all fi records, corporate documents and properties of Harken (collectively, the "Records") and cause the officers, directors and employees of Harken to supply all information reasonably requested by any such Inspector in connection with such Registration Statement prior to its effectiveness, in each case to the extent that such Records and information are pertinent to the information disclosed in the Registration Statement; provided, that eac such Inspector shall execute and deliver to Harken a Confidentiality Agreement in the form attached hereto as EXHIBIT A. Records which Harken --------- determines, in good faith, to be confidential and which Harken notifies the Inspectors are confidential shall not be disclosed by the Inspectors unless (i) the disclosure of such Records is necessary to avoid or correct a misstatement or omission in the Registration Statement or (ii the release of such Records i ordered pursuant to a subpoen or other order from a court of competent jurisdiction; each Holder of Registrable Securities agrees that it will, upon learning that disclosure of such Records is sought in a court of competent jurisdiction, give notice to Harken and allow Harken, at Harken's expense, to undertake appropriate action to prevent disclosure of the Records deemed confidential; and (12) use its reasonable best efforts to obtain, if require by said underwriters in connection with an underwritten offering, a comfort letter from Harken's independent public accountant in customary form and covering such matters of the type customarily covered by comfor letters with respect to offerings of the type being made pursuant to the Registration Statement as the Holders of the Registrable Securities reasonably request (b) In connection with each Registration Statement, Republic agrees and each Holder of Registrable Securities (including Registrable Securities in any Registration Statement filed pursuant to this Agreement) will be deemed to have agreed, as follows: (1) upon receipt of any notice from Harken of the happening of any event of the kind described in Section 3(a)(5) or the issuance of any order of the kind described in Section 3(a 9), the Holders of Registrable Securities covered by such Registration Statement will forthwith discontinue disposition of such Registrable Securities until the Holders of Registrable Securities receive copies of the supplemented or amended Prospectus contemplated by Section 3(a)(5), or until the are advised in writing by Harken that the use of the applicable Prospectus may be resumed, an they have received copies of any additional or supplementa filings that are incorporated or deemed to be incorporated by reference in such Prospectus (it being the agreement of the parties hereto, however, that the obligation of Harken with respect to maintaining the subject Registration Statement curren and effective, and the Sellin Period (as defined in the Exchange Agreement) with respect to such Registrable Securities, shall be extended by a number of trading days equal to the period the Holders of Registrable Securities are required by this Section 3(b)(1) to discontinue disposition of such Registrable Securities; and (2) furnish to Harken such information regarding each Holder, the Registrable Securities held by such Holder and the intended method of disposition thereof as Harken shall reasonably request and as shall be reasonably required in connection with the preparation of the applicable Registration Statement and other actions taken by Harken under this Agreement, and it shall be a condition precedent to the obligation of Harken to take any action pursuant to this Agreement in respect of the Registrable Securities that such information has been furnished to Harken by the Holders of Registrable Securities. Section 4. Expenses. Harken shall pay all Registration Expenses whether or not -------- any Registration Statement is filed or becomes effective and whether or not any securities are sold pursuant to any Registration Statement and, in any event, shall pay its internal expenses (including, without limitation, all salaries and expenses of its officers and employees performing legal and accounting duties), the expense of any annual audit and the fees and expenses incurred in connection with the listing of the securities to be registered on each securities exchange on which similar securities of Harken are then listed. All Selling Expenses incurred in connection with a registration effected pursuant to the terms hereof shall be borne by the seller or sellers of Registrable Securities pro rata based upon the number of Registrable Securities included in such registration. 4 Section 5. Indemnification. --------------- (a) Harken shall indemnify and hold harmless, with respect to any and all Registration Statements, each Holder of Registrable Securities covered by such Registration Statement, and each other Person, if any, who controls such Holder within the meaning of Section 15 of the Securities Act (collectively, "Holder Indemnified Parties"), against all losses, claims, damages, liabilities and expenses, joint or several, to which any such Holder Indemnified Party may become subject under the Securities Act, the Exchange Act, at common law or otherwise, insofar as such losses, claims, damages, liabilities or expenses (or actions or proceedings, whether commenced or threatened, in respect thereof) arise out of or are based upon (i) any untrue statement or alleged untrue statement of a material fact contained in any Registration Statement in which such Registrable Securities were included or any omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, (ii) any untrue statement or alleged untrue statement of a material fact contained in any preliminary, final or summary Prospectus, together with the documents incorporated by reference therein (as amended or supplemented if Harken shall have filed with the Commission any amendment thereof or supplement thereto), or any omission or alleged omission to state therein a material fact required to be stated therein or necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading, or (iii) any violation by Harken of any federal, state or common law rule or regulation applicable to Harken and relating to action of or inaction by Harken in connection with any such registration; and in each such case, Harken shall reimburse each such Holder Indemnified Party for any reasonable legal or other expenses incurred by any of them in connection with investigating or defending any such loss, claim, damage, liability, expense, action or proceeding; provided, however, that Harken shall not be liable to any such Holder Indemnified Party in any such case to the extent that any such loss, claim, damage, liability or expense (or action or proceeding, whether commenced or threatened, in respect thereof) arises out of or is based upon any untrue statement or alleged untrue statement or omission or alleged omission made in such Registration Statement or amendment thereof or supplement thereto or in any such preliminary, final or summary Prospectus in reliance upon and in conformity with written information furnished to Harken by or on behalf of any such Holder Indemnified Party for use in the preparation thereof. Such indemnity and reimbursement of expenses and other obligations shall remain in full force and effect regardless of any investigation made by or on behalf of the Holder Indemnified Parties and shall survive the transfer of such securities by such Holder Indemnified Parties. (b) Each Holder of Registrable Securities participating in any registration hereunder shall severally (and not jointly or jointly and severally) indemnify and hold harmless Harken, its directors, officers, employees and agents, and each Person who controls Harken (within the meaning of Section 15 of the Securities Act) (collectively, "Harken Indemnified Parties") against all losses, claims, damages, liabilities and expenses to which any Harken Indemnified Party may become subject under the Securities Act, the Exchange Act, at common law or otherwise, insofar as such losses, claims, damages, liabilities or expenses (or actions or proceedings, whether commenced or threatened, in respect thereof) arise out of or are based upon (i) any untrue statement or alleged untrue statement of a material fact contained in any Registration Statement in which such Holder's Registrable Securities were included or the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, (ii) any untrue statement or alleged untrue statement of a material fact contained in any preliminary, final or summary Prospectus, together with the documents incorporated by reference therein ( as amended or supplemented if Harken shall have filed with the Commission any amendment thereof or supplement thereto), or the omission or alleged omission to state therein a material fact required to be stated therein or necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading, to the extent, in the cases described in clauses (i) and (ii), that such untrue statement or omission was furnished in writing by such Holder for use in the preparation thereof, or (iii) any violation by such Holder of any federal, state or common law rule or regulation applicable to such Holder and relating to action of or inaction by such Holder in connection with any such registration. Such indemnity obligation shall remain in full force and effect regardless of any investigation made by or on behalf of the Harken Indemnified Parties (except as provided above) and shall survive the transfer of such securities by such Holder. (c) Promptly after receipt by an indemnified party under subsection 5(a) or (b) of written notice of the commencement of any action, suit, proceeding, investigation or threat thereof made in writing with respect to which a claim for indemnification may be made pursuant to this Section 5, such indemnified party shall, if a claim in respect thereof is to be made against an indemnifying party, give written notice to the indemnifying party of the threat or commencement thereof; provided, however, that the failure to so notify the indemnifying party shall not relieve it from any liability which it may have to any indemnified party except to the extent that the indemnifying party is actually prejudiced by such failure to give notice. If any such claim or action referred to under subsection (a) or (b) is brought against any indemnified party and it then notifies the indemnifying party of the threat or commencement thereof, the indemnifying party shall be entitled to participate therein and, to the extent that it wishes, jointly with any other indemnifying party similarly notified, to assume the defense thereof with counsel reasonably satisfactory to such indemnified party. After notice from the indemnifying party to such indemnified party of its election so to assume the defense of any such claim or action, the indemnifying party shall not be liable to such indemnified party under this Section 5 for any legal expenses of counsel or any other expenses subsequently incurred by such indemnified party in connection with the defense thereof other than reasonable costs of investigation unless the indemnifying party has failed to assume the defense of such claim or action or to employ counsel reasonably satisfactory to such indemnified party. Under no circumstances will the indemnifying party be obligated to pay the fees and expenses of more than one law firm for all indemnified parties. The indemnifying party shall not be required to indemnify the indemnified party with respect to any amounts paid in settlement of any action, proceeding or investigation entered into without the written consent of the indemnifying party, which consent shall not be unreasonably withheld. No indemnifying party shall consent to the entry of any judgment or enter into any settlement without the consent of the indemnified party unless (i) such judgment or settlement does not impose any obligation or liability upon the indemnified party other than the execution, delivery or approval thereof, and (ii) such judgment or settlement includes as an unconditional term thereof the giving by the claimant or plaintiff to such indemnified party of a full release and discharge from all liability in respect of such claim for all persons that may be entitled to or obligated to provide indemnification or contribution under this Section 5. 5 (d) Indemnification similar to that specified in the preceding subsections of this Section 5 (with appropriate modifications) is hereby given by Harken and each Holder of Registrable Securities with respect to any required registration or qualification of securities under any state securities or blue sky laws. (e) If the indemnification provided for in this Section 5 is unavailable to or insufficient to hold harmless an indemnified party under subsection (a) or (b), then each indemnifying party shall contribute to the amount paid or payable by such indemnified party as a result of the losses, claims, damages, liabilities or expenses (or actions or proceedings in respect thereof) referred to in subsection (a) or (b) in such proportion as is appropriate to reflect the relative fault of the indemnifying party on the one hand and the indemnified party on the other in connection with the statements, omissions, actions or inactions which resulted in such losses, claims, damages, liabilities or expenses as well as any other relevant equitable considerations. The relative fault of the indemnifying party and the indemnified party shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact relates to information supplied by the indemnifying party or the indemnified party, any action or inaction by any such party, and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement, omission, action or inaction. The amount paid or payable by an indemnified party as a result of the losses, claims, damages, liabilities or expenses (or actions or proceedings in respect thereof) pursuant to this subsection (e) shall be deemed to include, without limitation, any reasonable legal or other expenses incurred by such indemnified party in connection with investigating or defending any such action or claim (which shall be limited as provided in subsection (c) if the indemnifying party has assumed the defense of any such action in accordance with the provisions thereof) which is the subject of this subsection (e). No person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Securities Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. Promptly after receipt by an indemnified party under this subsection (e) of written notice of the commencement of any action, suit, proceeding, investigation or threat thereof made in writing with respect to which a claim for contribution may be made against an indemnifying party under this subsection (e), such indemnified party shall, if a claim for contribution in respect thereof is to be made against an indemnifying party, give written notice to the indemnifying party in writing of the commencement thereof (if the notice specified in subsection (c) has not been given with respect to such action); provided, however, that the failure to so notify the indemnifying party shall not relieve it from any obligation to provide contribution which it may have to any indemnified party under this subsection (e) except to the extent that the indemnifying party is actually prejudiced by the failure to give notice. The parties hereto agree that it would not be just and equitable if contribution pursuant to this paragraph were determined by pro rata allocation or by any other method of allocation which does not take account the equitable considerations referred to in the immediately preceding paragraph. 6 If indemnification is available under Section 5, the indemnifying parties shall indemnify each indemnified party to the fullest extent provided in subsections (a) or (b), without regard to the relative fault of said indemnifying party or any other equitable consideration provided for in this paragraph. The provisions of this paragraph shall be in addition to any other rights to indemnification or contribution which any indemnified party may have pursuant to law or contract, shall remain in full force and effect regardless of any investigation made by or on behalf of any indemnified party, and shall survive the transfer of securities by any such party. (f) In connection with any underwritten offering contemplated by this Agreement which includes Registrable Securities, Harken and all Holders of Registrable Securities included in any Registration Statement shall agree to customary provisions for indemnification and contribution (consistent with the other provisions of this Section 5) in respect of losses, claims, damages, liabilities and expenses of the underwriters of such offering. (g) The indemnification obligations hereunder with respect to any Registration Statement shall terminate three (3) years after the termination of the offering of Registrable Securities covered by such Registration Statement. Section 6. Selection of Underwriters. The Holders of Registrable Securities ------------------------- shall have the right to elect that the offering of Registrable Securities pursuant to a Registration Statement filed under this Agreement be in the form of an underwritten offering or a best efforts offering. If any registration hereunder is an underwritten offering or a best efforts offering, the investment banker or investment bankers and manager or managers that will administer the offering shall be selected by Harken; provided, that such investment bankers and managers must be reasonably satisfactory to the Holders of a majority of the Registrable Securities to be registered in such registration. Section 7. Rule 144. Harken covenants to each Holder that, to the extent that -------- Harken shall be required to do so under the Exchange Act, Harken shall (a) timely file the reports required to be filed by it under the Exchange Act or the Securities Act (including, but not limited to, the reports under Sections 13 and 15(d) of the Exchange Act referred to in subparagraph (c)(1) of Rule 144 adopted by the Commission under the Securities Act) and the rules and regulations adopted by the Commission thereunder, and (b) take such further action as any Holder may reasonably request, all to the extent required from time to time to enable such Holder to sell Registrable Securities without registration under the Securities Act within the limitations of the exemption provided by Rule 144 under the Securities Act, as such Rule may be amended from time to time, or any similar rule or regulation hereafter adopted by the Commission. Upon the request of any Holder, Harken shall deliver to such Holder a written statement as to whether it has complied with such requirements. Section 8. Transferability. Republic may transfer any or all of the Registrable --------------- Securities issued under the Purchase Agreement to other parties who are Holders of Republic's outstanding Debentures ("Debenture Holder"), and Republic may transfer any or all of the Registrable Securities issued under the Contingent Payment Agreement (attached as EXHIBIT D to the Purchase Agreement) to the --------- holders of Republic's Series C Redeemable Preferred Stock (the "Preferred Holders"), provided such Debenture Holder or Preferred Holder, as the case may be, first provides to Harken written representation that such party constitutes an Accredited Investor as such term is defined in the Securities Act. To the extent Republic does transfer any or all of the Registrable Securities to one or more Debenture Holders or Preferred Holders in accordance with this Section 8, then such Debenture Holders or Preferred Holders shall accrue the rights, benefits and obligations of this Agreement to the same extent as if they had originally been signature parties hereto. Republic agrees and warrants to Harken that any and all transfers of Registrable Securities to Debenture Holders and Preferred Holders will be expressly made subject to the terms of this Agreement. Transfers of any or all of the Registrable Securities except to Debenture Holders or Preferred Holders as provided in this Section 8, or under an effective registration as provided under this Agreement, may only be made with Harken's prior written consent, for which consent Harken my require representations, indemnifications and warranties regarding the proposed party to whom such transfer is requested. Section 9. Miscellaneous. ------------- (1) >From and after the date of this Agreement, Harken will not, without the prior written consent of the Holders of a majority of the Registrable Securities then outstanding, enter into any agreement with respect to its securities which is inconsistent with or violates the rights granted to the Holders of Registrable Securities in this Agreement. 7 (2) Investors agree, and each other Holder of Registrable Securities (including Registrable Securities in any Registration Statement filed pursuant to this Agreement) will be deemed to have agreed, as follows: (1) if any Registrable Securities are being registered in any registration pursuant to this Agreement, the Holder thereof will comply with all anti-stabilization, manipulation and similar provisions of Section 10 of the Exchange Act, and any rules promulgated thereunder by the Commission, and, at the request of Harken, will execute and deliver to Harken and to any underwriter participating in such offering, an appropriate agreement to such effect; and (2) at the end of any period during which Harken is obligated to keep a Registration Statement current and effective as described herein, the Holders of Registrable Securities included in this Registration Statement shall discontinue sales thereof pursuant to such Registration Statement. (3) All questions concerning the construction, validity and interpretation of this Agreement and all actions, proceedings and matters arising out of this Agreement shall be governed by the internal law, and not the law of conflicts, of the State of Texas. (4) All covenants and agreements in this Agreement by or on behalf of any of the parties hereto will bind and inure to the benefit of the respective successors and assigns of the parties hereto whether expressed or not. (5) This Agreement is intended by the parties as a final expression of their agreement and intended to be a complete and exclusive statement of the agreement and understanding of the parties hereto in respect of the subject matter herein contained. There are no restrictions, promises, warranties or undertakings, other than those set forth or referred to herein, with respect to the registration rights granted by Harken to the Holders of the Registrable Securities. This Agreement supersedes all prior agreements and understandings between the parties with respect to such subject matter. (6) All notices, demands or other communications to be given or delivered under or by reason of the provisions of this Agreement shall be in writing and shall be deemed to have been given when delivered personally or sent by reputable express courier service (charges prepaid), or mailed to the recipient by certified or registered mail, return receipt requested and potage prepaid, or sent by telefax, to the parties at the following address (or to such other address or to the attention of such other person as the recipient party has specified by prior like notice to the sending party): If to Harken: - ------------ Harken Energy Corporation 580 WestLake Park Blvd., Suite 600 Houston, Texas 77079 Telecopier No.: (281) 504-4110 Attention: Bruce N. Huff President and Larry E. Cummings, General Counsel If to Republic: - -------------- Republic Resources, Inc. 743 Horizon Ct., Suite 333 Grand Junction, Colorado 81506-8715 Tel: (970) 245-5917 Telecopier No.: (970) 243-8840 Attention: Patrick J. Duncan, President 8 With a copy to: - -------------- Alan W. Peryam, Esq. 1120 Lincoln Street, Suite 1000 Denver, Colorado 80203 Tel: (303) 866-0900 Telecopier No.: (303) 866-0999 (7) If any provision of this Agreement is held to be unenforceable, this Agreement shall be considered divisible and such provision shall be deemed inoperative to the extent it is deemed unenforceable, and in all other respects of this Agreement shall remain in full force and effect; provided, however, that if any such provision may be made enforceable by limitation thereof, then such provision shall be deemed to be so limited and shall be enforceable to the maximum extent permitted by applicable law. (9) This Agreement may be executed by the parties hereto in any number of counterparts, each of which shall be deemed an original, but all of which shall constitute one and the same agreement. Each counterpart may consist of a number of copies hereof each signed by less than all, but together signed by all, the parties hereto. (9) Each Holder of Registrable Securities, in addition to being entitled to exercise all rights granted by law, including recovery of damages, will be entitled to specific performance of its rights under this Agreement. Harken agrees that monetary damages would not be adequate compensation for any loss incurred by reason of breach by it of the provisions of this Agreement and hereby agree to waive (to the extent permitted by law) the defense in any action for specific performance that a remedy of law would be adequate. (10) In any action or proceeding brought to enforce any provision of this Agreement, or where any provision hereof is validly asserted as a defense, the successful party shall be entitled to recover reasonable attorney's fees in addition to any other available remedy. (11) Harken agrees to remove any legends on certificates representing Registrable Securities describing transfer restrictions applicable to such securities upon the sale of such securities (i) pursuant to an effective Registration Statement under the Securities Act or (ii) in accordance with the provisions of Rule 144 under the Securities Act. IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first written above. HARKEN ENERGY CORPORATION By: -------------------------- Name: Bruce N. Huff Title: President REPUBLIC RESOURCES, INC. By: -------------------------- Name: Patrick. J. Duncan Title: President 9 EX-21 6 dex21.txt SUBSIDIARIES OF HARKEN Exhibit 21 EXHIBIT 21 SUBSIDIARIES 1. AEX, Inc. 2. Burns Drilling Company 3. Chuska Resources Corporation 4. D-FW Resources Management Inc. 5. Faulkinberry Oil & Gas Company, Inc. 6. Fisher-Webb, Inc. 7. Global Energy Development Ltd. 8. Global Energy Development PLC 9. Harken Bahrain Oil Company 10. Harken Canada, Ltd. 11. Harken Capital Corporation 12. Harken Costa Rica Holdings L.L.C. (40% owned) 13. Harken de Colombia, Ltd. 14. Harken de Colombia II, Limitada 15. Harken de Colombia III, Limitada 16. Harken de Colombia Holdings 17. Harken de Mexico, Ltd. 18. Harken de Panama Holdings Ltd. 19. Harken de Panama Ltd. 20. Harken de Peru Holdings 21. Harken de Venezuela 22. Harken del Peru Limitada 23. Harken Energy West Texas Inc. 24. Harken Exploration Company 25. Harken Focus Production Company 26. Harken Gulf Exploration Company 27. Harken International Ltd. (*to be merged into Global Energy Development Ltd.) 28. Harken Operating Company 29. Harken South America, Ltd. 30. Harken TX Acquisition Corporation (f/k/a Search Acquisition Corp.) 31. Kendrick & Mulligan Oil & Gas Incorporated 32. Kennedy & Mitchell, Inc. 33. KMI Acquisition Corporation 34. KMI Capital Corporation 35. McCulloch Energy, Inc. 36. Patriot Exploration & Production Company 37. South Coast Exploration Company 38. Sunfield Energy Company 39. Supreme Well Service Company 40. XPLOR Energy Holding Company 41. XPLOR Energy, Inc. 42. XPLOR Energy Operating Company 43. XPLOR Energy SPV-I, Inc. EX-23.1 7 dex231.txt CONSENT OF RYDER SCOTT COMPANY Exhibit 23.1 EXHIBIT 23 CONSENT OF INDEPENDENT RESERVE ENGINEERS As Harken Energy Corporation's independent reserve engineers, Ryder Scott Company consents to the reference in Form 10-K to Ryder Scott Company reserve report dated December 31, 2001. RYDER SCOTT COMPANY Houston, Texas March 22, 2002 EX-23.2 8 dex232.txt CONSENT OF NETHERLAND SEWELL & ASSOCIATES, INC. Exhibit 23.2 EXHIBIT 23 CONSENT OF NETHERLAND, SEWELL & ASSOCIATES, INC. We hereby consent to the incorporation by reference in the Annual Report on Form 10-K of Harken Energy Corporation (the "Company") and to the references to this firm for the Company's estimated domestic proved reserves contained in the Annual Report on Form 10-K for the year ended December 31, 2001. NETHERLAND, SEWELL & ASSOCIATES, INC. Houston, Texas March 22, 2002 EX-23.3 9 dex233.txt CONSENT OF ARTHUR ANDERSEN LLP Exhibit 23.3 EXHIBIT 23 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation by reference of our report included in this Form 10-K into Harken Energy Corporation's previously filed Registration Statements on Form S-3 (Nos. 333-74410, 333-67156, 333-59092, 333-30490, 333-34534, 333-34650, 333-34720, 333-34830, 333-38050, 333-44564, 333-48760, 333-79617, 333-85057, 333-71751, 333-78859, 333-79281, 333-80031). ARTHUR ANDERSEN LLP Houston, Texas March 27, 2002 EX-23.4 10 dex234.txt CONSENT OF INDEPENDENT AUDITORS EXHIBIT 23.4 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in the following Registration Statements of Harken Energy Corporation and in the related Prospectuses of our report dated March 25, 2002, with respect to the consolidated financial statements and schedule of Harken Energy Corporation included in this Annual Report on Form 10-K for the year ended December 31, 2001. Form Description - ---- ----------- S-3 Registration of 135,000 shares of common stock issued to Parkcrest (No. 333-71751) S-3 Registration of 190,863 shares of common stock issued to Sidro, S.A (No. 333-78859) S-3 Registration of 131,682 shares of common stock issued to Crescent International Ltd. (No. 333-79281) S-3 Registration of 648,151 shares of common stock (No. 333-79617) S-3 Registration of 112,173 shares of common stock issued to Lambertine (No. 333-80031) S-3 Registration of 260,000 shares of common stock issued to International Rochester Energy Corporation (No. 333-85057) S-3 Registration of 300,000 shares of common stock (No. 333-30490) S-3 Registration of 200,000 shares of common stock (No. 333-34534) S-3 Registration of 239,840 shares of common stock (No. 333-34650) S-3 Registration of 173,973 shares of common stock (No. 333-34720) S-3 Registration of 274,013 shares of common stock (No. 333-34830) S-3 Registration of 246,153 shares of common stock (No. 333-38050) S-3 Registration of 133,333 shares of common stock (No. 333-44564) S-3 Registration of 777,142 shares of common stock (No. 333-48760) S-3 Registration of 3,968,920 shares of common stock (No. 333-67156) S-3 Registration of 3,193,334 shares of common stock (No. 333-74410) S-3 Registration of 521,232 shares of common stock (No. 333-59092) /s/ ERNST & YOUNG Houston, Texas March 25, 2002 EX-24 11 dex24.txt POWER OF ATTORNEY Exhibit 24 HARKEN ENERGY CORPORATION Form 10-K Power of Attorney KNOW ALL MEN BY THESE PRESENTS, that the undersigned, an Officer and/or Director of HARKEN ENERGY CORPORATION, a Delaware corporation (the "Corporation"), hereby constitutes and appoints Mikel D. Faulkner, Bruce N. Huff, Anna M. Williams, Larry E. Cummings and A. Wayne Hennecke and each of them (with full power to each of them to act alone), his true and lawful attorney-in-fact and agent with full power of substitution for him and on his behalf in his name, place and stead in any and all capacities (whether on behalf of the corporation or as an Officer or Director or both thereof or by attesting the seal of the Corporation or otherwise), to sign, execute and file an Annual Report on Form 10-K for the fiscal year ended December 31, 2001, under the Securities Exchange Act of 1934, as amended with all exhibits and any and all documents required to be filed with respect thereto with the Securities and Exchange Commission or any state or other regulatory authority, and granting unto said attorneys-in-fact and agents and each of them 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 in order to effectuate the same as fully to all intents and purposes as he himself might or could do if personally present, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them or their substitute or substitutes, may lawfully do or cause to be done. IN WITNESS WHEREOF, the undersigned have executed this Power of Attorney effective as of March 26, 2002. Name Capacities ---- ---------- /s/ Mikel D. Faulkner ___________________________________ Chairman of the Board of Directors Mikel D. Faulkner and Chief Executive Officer (Principal Executive Officer) /s/ Bruce N. Huff ___________________________________ President, and Chief Operating Bruce N. Huff Officer and Director /s/ Stephen C. Voss ___________________________________ Director Stephen C. Voss Harken Energy Corporation Form 10-K Power of Attorney March 26, 2002 /s/ Michael M. Ameen, Jr. ___________________________________ Director Michael M. Ameen, Jr. /s/ Larry G. Akers ___________________________________ Director Larry G. Akers /s/ James H. Frizell ___________________________________ Director James H. Frizell /s/ J. William Petty ___________________________________ Director J. William Petty /s/ Hobart A. Smith ___________________________________ Director Hobart A. Smith /s/ Anna M. Williams Executive Vice President - ___________________________________ Finance and Chief Financial Anna M. Williams Officer -----END PRIVACY-ENHANCED MESSAGE-----