exploration, development and production of CBM in China. In addition, the Chinese government has provided incentives to stimulate the development of CBM, including exempting CBM development from import duties and import-related duties (Encouraged and Restricted B of the Guidance Catalog of Industries for Foreign Investments, specific measures executed in accordance with No. 1602 Document issued by the State Administration of Customs in 1997) and reducing value-added tax ("VAT"), for CBM projects with foreign companies to 5% compared to 13% to 17% VAT for conventional gas companies ("The Notice of the Interim Regulations Concerning the Value-Added Tax, Consumption Tax and Sales Tax Applied to Foreign Investment Enterprise and Foreign Enterprise" (February 22, 1994, Item 3)).  For more information on the laws, regulations and regulatory bodies that affect our business, see "Regulations Impacting Our Business" below.

 

 

  The term of each of the Shanxi Agreements consists of an exploration period, a development period and a production period.  The exploration period is divided into three phases called Phase I, Phase II and Phase III. We have completed our Phase I and Phase II obligations under the Shanxi Agreements, and elected to enter into Phase III. Phase III of the exploration periods under each of the two Shanxi PSCs will expire on June 30, 2009, unless extended or otherwise amended.  After the exploration period, the development period as to any CBM field in the Shanxi Province project will begin after the approval of one or more overall development programs, jointly by us and CUCBM, and then by Chinese governmental authorities. The production period as to any CBM field in the Shanxi Province project will begin after the date of commencement of commercial production of that CBM field. Provided the Company remains in compliance with the requirements under the PSCs, the Shanxi Agreements will expire on July 1, 2032, unless extended or otherwise amended.

Currently, we hold a minimum 70% participating interest, and CUCBM has a maximum 30% participating interest in each of the Shouyang Block and the Quinnan Block of the Shanxi Province, although we bear costs attributable to 100% of the participating interest during the exploration period.  Pursuant to the farmout agreements with Phillips, we acquired a 70% participating interest from Phillips (to be reduced by CUCBM’s participation up to 30%, if any, after the exploration periods), subject to a Phillips election at the transition from Phase II to Phase III of the exploration periods either to retain its remaining 30% participating interest or to receive an overriding royalty interest.  Upon our election to enter Phase III of the exploration periods, Phillips elected to convey its remaining 30% participating interest to us and to receive an overriding royalty interest up to 3.5% of the total participating interest. Additionally, prior to the beginning of the development period of any CBM field in the Shanxi project, CUCBM may elect to participate in the development of that CBM field at a participating interest between zero and 30%. Therefore, depending upon whether and to what extent CUCBM elects to participate in the project, our interest will range from 66.5% (assuming full participation by CUCBM) to 96.5% (assuming CUCBM chooses not to participate). During the exploration period, we bear costs equal to 100% participating interest in the properties, and this includes all exploration costs for discovering and evaluating CBM-bearing areas. If any CBM field is discovered, the development costs for that CBM field will be borne by us and CUCBM in proportion to the respective participating interests.

Our Phase I, Phase II, and Phase III obligations and results during the exploration period of the Shanxi PSCs are described below.  The two agreements are interdependent in certain respects. In particular, the Phase II and III obligation to complete 12,000 meters of horizontal drilling in coal seam may be achieved by combining Phase II and Phase III drilling in the two separate blocks.

Phase I. We have completed our Phase I obligations of both PSCs under the Shanxi Agreements. Phase I obligated us, at our expense, to perform a hydraulic fracture of one of three exploration wells previously drilled by Phillips by January 31, 2005. In September 2004, the hydraulic fracture and testing was completed on the QN-002 well drilled previously by Phillips on its acreage in the Qinnan Block located in the Shanxi Province. The testing was performed on the coal seam at a depth of approximately 550 meters (1,880 feet), with an objective of gaining information on the permeability of that coal seam and completing our obligations for Phase I under the Shanxi Agreements.

Phase II.  We completed our Phase II obligations of both PSCs under the Shanxi Agreements by drilling and completing two horizontal wells (FCC-HZ01 and FCC-HZ02) in the Shouyang Block prior to March 31, 2006.  We also completed a third horizontal well (FCC-HZ03) under Phase II.  These wells are currently being dewatered.  FCC-HZ01 and FCC-HZ03 have demonstrated continuous gas production.  The volumes being produced are small and the data obtained is not yet sufficient to project peak gas production or commercial viability.

Phase III. After completion of Phase II, we elected to commit to Phase III in the Shanxi Province PSCs.  Our work commitment to complete  Phase III consists of furthering the horizontal drilling in the coal seam begun in Phase II to a total of 12,000 meters. This work obligation can be met by combining the drilling results in the Shouyang and Qinnan Blocks.  We have completed two horizontal wells (FCC-HZ04 and FCC-HZ05) in the Shouyang Block under Phase III, the second of which was completed in the first quarter of 2007.  We have also extended the horizontal reach in the coal seam of FCC-HZ03 by drilling the well laterally in the second quarter of 2007.  The extension added 1,700 meters (6,576 feet) to the well.  The wells we have drilled to date total approximately 8,805 meters of horizontal drilling in coal seam.  Therefore, we will be required to drill additional

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wells to fulfill the 12,000 meter obligation.  The Phase III exploration period will expire on June 30, 2009, unless extended.

 

The drilling depths for our horizontal wells drilled in the Shouyang Block during Phases II and III are summarized as follows:

										Horizontal Drilling
		Vertical Depth								In Coal Seam
Horizontal Wells		(Meters)				(Feet)				(Meters)				(Feet)
Phase II
FCC-HZ01							1,770				2,500				8,200
FCC-HZ02							2,100				2,700				8,856
FCC-HZ03							1,800				2,030				6,658
Phase III
FCC-HZ04							1,623								2,870
FCC-HZ05							1,551								2,296
Total			2,709				8,844				8,805				28,880

Our five horizontal wells are drilled with the objective of enhancing the potential for gas production and facilitating the dewatering process.  During the second quarter of 2007, we drilled an underbalanced vertical well (FCC-HZ06V) and cavitated the well bore in the coal to accelerate the dewatering process.  The well is located in the drilling pattern surrounding the FCC-HZ01 well.  The volumes being produced are small and the data obtained is not yet sufficient to project peak gas production or commercial viability.  However, we believe that the FCC-HZ06V produces a rate of gas production that provides further evidence of the high permeability of the area.

With the objective of determining the optimal approach to minimize costs and maximize gas recovery, we continue to closely monitor our first pattern of horizontal and vertical wells.  In the fourth quarter of 2007, we drilled two vertical wells (FCC-HZ07V and FCC-HZ08V) and began drilling two other vertical wells (FCC-HZ10V and FCC-HZ15V).  We also entered into a multi-well drilling contract with a local Chinese drilling company.  We plan to drill five additional vertical wells during 2008 in a pattern that represents an orderly progression of the field in a westerly direction using two drilling rigs simultaneously.

In the Qinnan Block of the Shanxi Province, we have acquired and processed 26 kilometers of 2D seismic data.  We also have obtained test data from a vertical well we drilled in December 2006.  We have utilized the well data and the 2D seismic data in the planning for future wells.  In June 2007, we entered into a turnkey contract with a Chinese drilling company to drill a horizontal well in the Qinnan Block for $1.2 million.  The plan for the well was to achieve a horizontal reach in the coal of approximately 3,000 meters (9,800 feet).  The drilling company encountered serious drilling difficulties and was unable to complete the well program as specified at year-end.  We are not liable for payment of the cost of this well until the drilling company meets its obligations under the contract.  As such, there is no current accrual for the expected cost of approximately $1.2 million in our financial statements.  Drilling operations are continuing, but we cannot predict when or if the drilling company will be able to successfully drill the well.

The initial wells alone cannot produce sufficient CBM to achieve commercial viability. We are drilling and completing several more wells in close proximity to the wells we have already drilled with the intent to make it feasible to begin commercial production from our current project area under the Shouyang PSC. Actual production may vary materially from preliminary test results. Actual production from the wells may also be at recovery rates and gas quality materially worse than our first indications.

On June 26, 2007, the MOC approved the extension of the exploration phase for both the Shouyang and Qinnan PSCs from June 30, 2007 to June 30, 2009.  In connection with the extension, we have committed to satisfy certain annual minimum exploration expenditure requirements for the Shouyang PSC and for the Qinnan PSC.  Thus, we must meet both our work obligations (the obligation to complete 12,000 meters of drilling in the coal) and our minimum exploration expenditure requirements under those PSCs.  The PSC’s minimum exploration expenditure

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requirements are based on minimum exploration expenditure requirements of CUCBM established by the Ministry of Land and Resources ("MLR").  The MLR sets its requirements by applying a minimum expenditure per acre to the total acreage encompassed by each PSC.  Under the PSC, the portion of the exploration expenditures which exceed the current year’s minimum exploration expenditure requirement can be carried forward toward the satisfaction of the subsequent year’s minimum requirement. The resulting minimum expenditure requirement is a significant factor that influences the Company’s exploration work program.

 

The annual minimum exploration expenditure requirements for 2007 were prorated based on the June 2007 date of the extension approval.  For 2007, we have spent in total more than the prorated minimum requirement for both PSCs.  At December 31, 2007, we incurred exploration expenditures of $3.8 million for the Shouyang PSC which exceeded its prorated 2007 minimum requirement by $2.5 million.  The 2008 minimum exploration expenditure for the Shouyang PSC is approximately $2.6 million. The excess of $2.5 million from 2007 can be applied to the 2008 minimum exploration expenditure.  In addition, based on the costs we have incurred to date at the Shouyang Block in 2008, we have already met the 2008 minimum exploration expenditure.

For the Qinnan PSC, we incurred exploration expenditures of $0.6 million as of December 31, 2007, which was $0.9 million less than the prorated 2007 exploration expenditure requirement of $1.5 million.  The deficiency in fulfilling the prorated 2007 minimum requirement for the Qinnan PSC was due to the aforementioned failure by the contracted drilling company to complete the horizontal well program as specified.  As a result, we have agreed to increase the 2008 minimum exploration expenditure for the Qinnan PSC to approximately $4.2 million.

Related Payments.  Under the PSCs, we are required to make certain payments to CUCBM, including: (1) CUCBM assistance fees totaling $100,000 per year during the exploration period and $240,000 per year during the development and production periods; (2) training fees for Chinese personnel working on the projects of $120,000 per year during the exploration phase and $300,000 per year during the development and production periods; (3) signature fees totaling $300,000, which will be due within 30 days after first approval of the overall development plan following the exploration period; (4) reimbursement to CUCBM for government-imposed fees for CBM exploration rights during the exploration period, which were $278,000 in 2007, and are estimated to be approximately $285,000 in 2008, and are in proportion to our participating interest in the development and production periods; and (5) salary and benefits paid to CUCBM professionals during the exploration period, which was $151,000 in 2007 and are estimated to be approximately $164,000 in 2008. The allocation of salary and benefits for CUCBM professionals during the development and production periods are determined by negotiation with CUCBM.

Our Holdings in the Yunnan Province of the People’s Republic of China

Overview.  On January 25, 2002, we entered into one PSC with CUCBM to develop two areas in the Yunnan Province: (1) the Enhong area, which covers approximately 145,198 acres and (2) the Laochang area, which covers approximately 119,772 acres. We are the operator under the PSC. The term of the PSC consists of an exploration period, a development period and a production period. The exploration period is divided into two phases, Phase I and Phase II.  We have completed Phase I and have elected to enter into Phase II.  The Phase II portion of the exploration period expires on June 30, 2009.  Following completion of Phase II of the exploration period, we may elect to continue the PSC and conduct development and production operations on any CBM discoveries. After the exploration period, the development period as to any CBM field in the Enhong-Laochang project will begin after the approval of one or more overall development programs, jointly by us and CUCBM, and then by Chinese governmental authorities. The production period as to any CBM field in the Enhong-Laochang project will begin after the date of commencement of commercial production of that CBM field.  Provided the Company remains in compliance with the requirements under the agreement, the agreement with CUCBM will expire on January 1, 2033, unless extended or otherwise amended.

During the exploration period, we hold a 100% participating interest in the properties, and we must bear all exploration costs for discovering and evaluating CBM-bearing areas. Prior to the beginning of the development period of any CBM field in the Enhong-Laochang project, CUCBM may elect to participate in the development of that CBM field at a level of between zero and 40%. Therefore, depending upon CUCBM’s participation, should we elect to develop a CBM field, our working interest in that CBM field will range from 60% to 100%. If any CBM field is discovered, the development costs for that CBM field will also be borne by CUCBM and us in proportion to

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the respective participating interests. Our Phase I and Phase II obligations and results during the exploration period of our PSC with CUCBM are described below.

 

Phase I.  We have completed our Phase I obligations. We drilled and completed three wells on the project, performed a hydraulic fracture and tested one of these three wells and drilled two slim hole vertical wells.

We believe the three wells we have drilled under our Phase I requirement have yielded favorable gas content results.   We drilled our first well(FCY-LC01) to a total depth of approximately 825 meters (2,722 feet). A total of 15 mineable coal seams were penetrated during the drilling of the well, with a total thickness of approximately 29.4 meters (97 feet). The coring of the coal samples showed a recovery rate of 94.8%. In addition, the drilling revealed four targeted major coal seams with a total thickness of approximately 16.3 meters (54 feet), all within an interval of about 110 meters (363 feet), which we believe are favorable for production of CBM. Testing of 18 desorption samples from the well resulted in gas content averaging 18 to 20 cubic meters per ton of coal or about 650 to 700 cubic feet per ton of coal.  The second well(FCY-EH02) was drilled to a total depth of approximately 420 meters (1,344 feet). The well penetrated 15 coal seams with a thickness of 16.7 meters (53 feet). The total thickness of the coal seams targeted for potential production was 6.6 meters (22 feet) with a recovery rate of 70%. The gas content, based on desorption results, is averaging 8.5 cubic meters per ton of coal, or about 300 cubic feet per ton of coal.  The third well(FCY-EH01) was drilled to a total depth 435 meters (1,436 feet). The well penetrated 42 coal seams with a thickness of 42.8 meters (141 feet). The total thickness of the four coal seams targeted for potential production was 17.2 meters (57 feet). The gas content, based on desorption results, is approximately 8 to 10 cubic meters per ton of coal, or approximately 280 to 350 cubic feet per ton of coal.  We fractured the FCY-EH01 well with two coal seams (#9 and #16 coal seams), and conducted dewatering and production testing for six months.  The production rate on this well during the production test was 25 thousand cubic feet (Mcf) of CBM per day.

During Phase I, we also conducted geological data gathering, shot 2D seismic data for 10 kilometers in the Enhong area, drilled one slim hole vertical well in the Enhong area and one slim hole vertical well in the Laochang area with desorption and standard CBM lab analysis.

Phase II.  On February 23, 2005, we elected to enter into Phase II, which required us to drill at least one horizontal well with a minimum of two laterals.   To continue our preparation for the drilling of the horizontal well and future development of this field, we continued our geological and geophysical activities and drilling of slim hole vertical wells in 2007 to gain more data and to enhance our understanding of structure complexity, coal lateral continuity, coal properties and reservoir characteristics.  To date, we have drilled six vertical wells in Phase II under this PSC with the most recent one completed in December 2007. We are reviewing the data collected from these wells and other wells drilled by the Chinese coal industry.  Based on the data gathered, we plan to drill a  cluster of four deviated wells to stimulate and test-produce the major coal seams in 2008.  As described below, the Phase II exploration period under the Enhong-Laochang PSC will expire on June 30, 2009, unless extended or otherwise amended.  Following the completion of Phase II of the exploration period, we may elect to conduct development and production operations on any CBM discoveries.

These initial wells alone cannot produce sufficient CBM to achieve commercial viability. We must complete several more wells in close proximity to the wells we have already drilled in order to make it feasible to begin production from any of our current Enhong-Laochang project wells. Actual production may vary materially from preliminary test results. Actual production from the wells may also be at recovery rates and gas quality materially worse than our first indications.

On June 26, 2007, the MOC approved the extension of the exploration phase from June 30, 2007 to June 30, 2009.  In connection with the extension, we have committed to satisfy certain annual minimum exploration expenditure requirements for the Enhong-Laochang PSC.  Thus, we must meet both our work obligations (drilling at least one horizontal well with a minimum of two laterals) and our minimum exploration expenditure requirement under the PSC.  The PSC’s minimum exploration expenditure requirement is based on minimum exploration expenditure requirements of CUCBM established by the MLR.  The MLR sets its requirements by applying a minimum expenditure per acre to the total acreage encompassed by the PSC.  Under the PSC, the portion of the exploration expenditures which exceed the current year’s minimum exploration expenditure requirement can be carried forward toward the satisfaction of the subsequent year’s minimum requirement. The resulting minimum expenditure requirement is a significant factor that influences our exploration work program.

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The annual minimum exploration expenditure requirement for 2007 was prorated based on the June 2007 date of the extension approval.  In 2007, we incurred exploration expenditures for the Enhong-Laochang PSC of $0.6 million which was $0.1 million less than the prorated 2007 exploration expenditure requirement of $0.7 million.  We did not incur the $0.1 million in 2007 due to a delay in the completion of drilling of our next vertical well which we started in December 2007.  We plan to complete the vertical well in early 2008.   As a result, we have agreed to increase the  2008 minimum exploration expenditure for the Yunnan PSC by $0.1 million to $1.5 million.

Related Payments.  Pursuant to the terms of our Enhong-Laochang PSC with CUCBM, we have paid CUCBM signature fees totaling $375,000.  Under the PSC, we are required to make certain payments to CUCBM, including: (1) CUCBM assistance fees for Chinese personnel totaling $45,000 per year during the exploration phase and $80,000 per year during the development and production periods; (2) training fees for Chinese personnel working on the projects of $45,000 per year during the exploration period and $80,000 per year during the development and production periods; (3) reimbursement to CUCBM for government-imposed fees for CBM exploration rights during the exploration period, which were $45,000 in 2007 and are estimated to be approximately $61,000 in 2008, and in proportion to our participating interest in the development and production periods; and (4) salary and benefits paid to CUCBM professionals during the exploration period, which was approximately $190,000 in 2007 and are estimated to be approximately the same in 2008.  The allocation of salary and benefits for CUCBM professionals during the development and production periods are determined by negotiation with CUCBM.

 

Marketing and Transportation of Our CBM in China

The marketability of any gas production will depend, in part, upon the availability, proximity and capacity of pipelines, gas gathering systems and processing facilities. We may transport our CBM through pipelines or by compressing or liquefying the CBM for transportation. CBM projects traditionally require multiple wells to properly dewater the coal and generate predictable volumes of gas. It is not yet possible to predict volumes so firm decisions about marketing the CBM cannot yet be made.

Pipelines in the Shanxi Province.  Currently, two pipelines traverse China in proximity to our Shanxi Province projects.  A pipeline company is currently constructing an intra-provincial pipeline network in the Shanxi Province.  One branch of that network is currently planned to be constructed across or directly adjacent to our current area of drilling in the northern portion of the Shouyang Block.  The pipeline company has expressed interest in transporting our gas if we achieve commercial levels of production; however, the economics of any such arrangement have not been negotiated.  No condensed natural gas ("CNG") facility, liquefied natural gas ("LNG") plant or other off-take candidate currently exists near our Shanxi Province projects, and pipelines may need to be built on those projects to connect to larger pipelines to transport any CBM that may be produced from those projects.   We estimate the initial cost for these pipelines and compression facilities would be approximately $14 million.  If CUCBM elects a 30% working interest in our Shanxi Province project, our net costs would be approximately $10 million.  Should we elect to construct the connecting pipelines, there is no assurance that any of the existing pipelines we might connect to in the future will have sufficient capacity available to meet our requirements.

Pipelines in the Yunnan Province.  There are no pipelines in the vicinity of our Yunnan Province projects, and we estimate the initial cost to construct a pipeline and compression facilities from our project to the nearest large city, Kunming, would be approximately $38 million.  If CUCBM elects a 40% working interest in our Yunnan Province project our costs would be approximately $23 million.  Because there is no gas pipeline, CNG facility, LNG plant or other off-take candidate in near proximity to these wells, our ability to sell CBM produced on these projects to communities outside the general area will be contingent upon a pipeline or LNG plant being built near the Enhong-Laochang project.

Compressed Natural Gas.  If we have initial commercial production of CBM from our Shanxi or Yunnan Province projects, then prior to the point at which production reaches pipeline quantities, we could begin to market the CBM produced to local markets as CNG.  CNG is an alternative to the construction of a pipeline or LNG facility, especially appropriate for early stage gas production where gas volumes are lower.  Thus we may determine to pursue CNG facilities in order to earn revenues from any early production of CBM. Production of CNG would require the installation of a CNG facility.  We estimate that this alternative would cost approximately $500,000 for a

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compressor facility which would be capable of processing approximately 3.5 million cubic feet ("MMcf") of natural gas per day.

 

LNG Facility.  To generate revenue in China prior to the point at which production reaches pipeline quantities, we may elect to construct LNG facilities on our properties. This would allow CBM to be produced and sold in the period before we achieve production in sufficient quantities to justify constructing short connecting pipelines to the Shanjing II and West-East pipelines in the Shanxi Province, or before a pipeline or other offtake facility is operational in the Yunnan Province. We estimate that a 100-ton per day LNG facility, which would liquefy approximately five MMcf of natural gas per day, would cost $15 million to construct. We estimate that a 1,000-ton per day facility capable of liquefying 50 MMcf of natural gas per day would cost approximately $76 million.  Construction of a LNG facility is expected to take at least two years.

We do not currently have the funds to build these facilities. We will be required to raise additional funds through financings or other means or to find a strategic partner to complete these facilities. It is not likely that any such facilities will be built until favorable results are obtained from several wells. We are delaying any decision regarding the construction of LNG facilities or pipelines until such time as significant CBM production volumes are achieved. We believe this delay may allow us to avoid construction costs to the extent other strategic partners attracted by our prospects, have constructed, are constructing or are planning to construct, such facilities.

 

CBM Natural Gas Pricing.  Unlike traditional natural gas produced in China, the market price of CBM natural gas is not regulated by the Chinese government.  Based on our research on the prevailing gas market conditions in China, we expect to receive market-driven, competitive pricing for our future gas production, regardless of whether we deliver our gas through a pipeline, or in the form of CNG or LNG.

 

Our Competition

The energy industry is highly competitive in all its phases. Competition is particularly intense with respect to the acquisition of desirable producing properties, the acquisition of CBM prospects suitable for enhanced production efforts, and the hiring of experienced personnel. Our competitors in CBM acquisition, development, and production include major integrated oil and gas companies and substantial independent energy companies, many of which possess greater financial and other resources.

 

Safety and Health Matters

We employ numerous safety precautions to ensure the safety of our employees and independent contractors.  We also conduct our operations in accordance with various laws and regulations concerning occupational safety and health.  As protection against operating hazards, we maintain insurance coverage against some, but not all, potential injuries and losses.  In addition, we require service providers we engage to maintain similar insurance coverage.

 

 

Regulations Impacting Our Business

Our operations will be subject to numerous laws and regulations governing the discharge of materials into the environment or otherwise relating to environmental protection. These laws and regulations require the acquisition of a permit before drilling commences, restrict the types, quantities and concentration of various substances that can be released into the environment in connection with drilling and production activities, limit or prohibit drilling activities on certain lands lying within wilderness, wetlands and other protected areas, impose substantial liabilities for any pollution resulting from our operations and limit our discretion in marketing any production.

The exploration and production of CBM in China is regulated by and affected by the policies of multiple administrative bodies including the National Development and Reform Commission (the "NDRC"), the MOC, the MLR and CUCBM.  The Mineral Resources Law and the related regulations are the primary source of law governing the exploration and production of coalbed methane in China.

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The NDRC is responsible for the development and strategic upgrade of key industries in China, including the coalbed methane industry.  Policy making decisions of the NDRC could, therefore, affect our company.  Additionally, the MOC has many policy setting functions and, through its Foreign Investment Administration (the "FIA"), the MOC is directly responsible for foreign investment in China.  Our PSCs and the subsequent amendments to those contracts were, and presently continue to be, subject to approval of the MOC.   Within the FIA, the Service Trade Division also regulates the public utilities in urban areas, various pipeline networks, transportation and coalbed methane exploration and production and, therefore, the division's policies, rules and regulations could effect our future strategy and operations for transportation and distribution of any CBM production.

The rules and regulations of the MLR and, in particular, CUCBM more directly affect the coalbed methane industry in China and our operations.  The MLR is the principal authority regulating the coalbed methane industry in China.  It has authority over the designation of land for exploration, the approval of geological reserve reports, the review and granting of licenses for exploration and production and the administration of the registration and assignment of exploration and production licenses.  Presently, CUCBM has the right to partner with foreign investors in CBM activities.  Because only a Chinese party can hold an exploration license for CBM, CUCBM applies to MLR for the exploration licenses on behalf of foreign investors.  In operating under the PSCs, our primary interaction with Chinese administration is with CUCBM and the Joint Management Committee that administers our PSC.  The Joint Management Committee consists of members of our management team and representatives of CUCBM and it meets on a periodic basis to, among other things, discuss and make decisions concerning our exploration and development progress and plans, including budgets and capital expenditure commitments.

 

Our Employees

As of February 18, 2008,  we had 20 employees in China and 10 employees in the United States for a total of 30 employees, all of whom were employed by us on a full-time basis.

 

Item 1A. RISK FACTORS

Forward-Looking Statements

This report includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21B of the Exchange Act. All statements other than statements of historical facts contained in this report, including statements regarding our future financial position, business strategy and plans and objectives of management for future operations, are forward-looking statements. The words "believe," "may," "will," "estimate," "continue," "anticipate," "intend," "project," "expect," "consider" and similar expressions, as they relate to us, are intended to identify forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. These forward-looking statements are subject to a number of known and unknown risks, uncertainties and assumptions described in this report.

Although we believe that the expectations reflected in these forward-looking statements are reasonable, there can be no assurance that the actual results or developments we anticipate will be realized or, even if substantially realized, that they will have the expected effects on our business or operations. Actual results could differ materially from those projected in such forward-looking statements. Factors that could cause actual results to differ materially from those projected in such forward-looking statements include: our lack of operating history; limited and potentially inadequate management of our cash resources; risk and uncertainties associated with exploration, development and production of CBM; expropriation and other risks associated with foreign operations; matters affecting the energy industry generally; lack of availability of oil and gas field goods and services; environmental risks; drilling and production risks; changes in laws or regulations affecting our operations, as well as other risks described in this report and subsequent filings with the Securities and Exchange Commission.

 

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When you consider these forward-looking statements, you should keep in mind these risk factors and the other cautionary statements in this report. Our forward-looking statements speak only as of the date made. All subsequent oral and written forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by these factors. We assume no obligation to update any of these statements.

Additional risks include among others, the following:

Risks Relating to Our Business

We must obtain additional financing in order to continue our operations.

We are not able to accurately predict when we will recognize meaningful revenues.  We expect to experience operating losses and negative cash flow for the foreseeable future. Based on funds currently available to us, and our current obligations under the PSCs management believes that we have adequate cash resources to fund our operating and minimum committed exploration and development activities in China through 2008. However, as we do not have a source of revenue, we will require additional financing by the end of the fourth quarter of 2008 in order to continue our planned exploration and development in China and sustain our operating losses. We may choose to raise additional funds in 2008.  To develop our projects over the long term, we need to obtain funding to satisfy very significant expenditures for exploration and development of those projects. Furthermore, pipelines must be built on our Shanxi Province projects to connect to larger pipelines to transport our CBM, and no facilities exist to transport or process CBM near our Yunnan Province projects. Significant expenditures would be required to build out these facilities to the extent a strategic partner does not do so. We intend to finance our operations by various methods, which might include issuing equity securities, the continued exercise of warrants issued to investors in conjunction with the previously completed private offerings, and entering into farmout agreements and other arrangement with strategic partners, among other alternatives. Therefore, we intend to continue to seek to raise equity financing. No assurance can be given that we will be able to obtain any additional financing on favorable terms, if at all. If our operating requirements or drilling obligations materially change from those currently planned, we may require more financing than currently anticipated and we may need to obtain financing earlier.  For example, it is possible that CUCBM could seek to renegotiate our PSCs to, among other things, increase our capital expenditures or accelerate our drilling program. Raising additional funds by issuing common stock or other types of equity securities would further dilute our existing stockholders. If we fail to raise the necessary funds to complete our exploration activities under our production sharing contracts and we cannot obtain extensions to the requirements under our production sharing contracts, we would not be able to successfully complete our exploration activities and we may lose rights under our production sharing contracts.

The development of coalbed methane properties involves substantial risks and we cannot assure you that our exploration and drilling efforts will be successful.

The business of exploring for and, to a lesser extent, developing and operating coalbed properties involves a high degree of business and financial risk that even a combination of experience, knowledge and careful evaluation may not be able to overcome. The selection of prospects for coalbed methane gas drilling, the drilling, ownership and operation of CBM wells and the ownership of interests in CBM properties are highly speculative. Our well data, including information relating to permeability and coal thickness, is preliminary in nature.  We cannot predict whether any prospect will produce CBM or whether, even if producing, such prospect will produce commercial quantities of CBM.

Drilling for coalbed methane gas may involve unprofitable efforts, not only from dry wells, but also from wells that are productive but do not produce coalbed methane in sufficient quantities or quality to realize enough net revenues to return a profit after drilling, operating and other costs. The cost of drilling, completing and operating wells is often uncertain and cost overruns are common. Our drilling operations may be curtailed, delayed or canceled as a result of numerous factors, many of which are beyond our control, including title problems, weather conditions, compliance with governmental requirements and shortages or delays in the delivery of equipment and services. In addition, other factors such as permeability may hinder, restrict or even make production impractical or impossible.

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Drilling and completion decisions generally are based on subjective judgments and assumptions that are speculative. We may drill wells that, although productive, do not produce CBM in economic quantities. It is impossible to predict with certainty the production potential of a particular property or well. Furthermore, a successful completion of a well does not ensure a profitable return on the investment. A variety of geological, operational, or market-related factors, including, but not limited to, unusual or unexpected geological formations, pressures, equipment fa