Elko Energy

Elko Energy Inc (Dutch and Danish North Sea)

Elko is a Canadian registered oil & gas exploration company which has interests in exploration and production licences in the Danish and Dutch North Sea. Its major asset is in the Danish North Sea; an 80% interest on 26 offshore blocks in a 5,400 sq km exploration and production licence close to the prolific Central Graben oil field. Technical work indicates the potential for significant reserves. Elko also holds a 60% operating interest in gas-bearing license blocks P1 and P2 in the Dutch North Sea. Xtract owns approximately 36.8% of Elko’s issued share capital.

Elko operates the largest offshore exploration licence in Denmark with an area of 1.3 million acres. The licence area offers P50 un-risked net prospective resources of 1.8 billion barrels oil or 8.4 Tcf of gas (evaluated by Tracs International, an independent reservoir engineer, in May 2008). Elko owns 80% of the licence with 20% held by a Danish government entity.

In the Netherlands sector of the North Sea, Elko operates two gas-bearing exploration blocks. Block P1 is located on the southern margin of Southern Permian Gas basin and covers 51,623 acres. Eight wells have been drilled by previous operators. Of these, five encountered gas on three separate structures. Block P2 is directly adjacent and east of Block P1. Elko holds both licences which represent a 60% working interest. Dutch Government partner Energie Beheer Nederland BV (EBN) owns the remaining 40% working interest.

A National Instrument 51-101 independent engineering report was prepared by TRACS International during 2008 on the hydrocarbon resources contained within the P1 and P2 Blocks. The report estimated hydrocarbon gas in place at over 250 bcf within the Slochteren sandstone with additional prospects identified which could contain a further 500 bcf.

Progress on the Dutch assets was hampered during 2008 by the lack of a joint operating agreement and the inability of former licence partner Oyster BV to attract interest in the intended disposal of its holding. This situation became more acute with the decline in oil and gas prices and the significant deterioration in investment conditions in the later part of the year.

Unfortunately, Elko did not meet its objective of making an Initial Public Offering and a listing on a recognised stock exchange within one year of the December 2007 pre-IPO fund-raising. Although much of the preparatory work was completed, Elko’s financial advisors suggested the IPO be delayed due to market volatility. As equity and debt markets became largely inaccessible to small-cap companies, attention has turned to finding funding partners amongst strategic and industry participants.

The disappointing performance of Elko in the first part of the year led Xtract to review its approach to the investment. Whilst recognising the achievements of Mr Rudi Kleiber, founder and former CEO, in establishing Elko as a promising independent operator, Xtract determined that a new board at Elko would leave it better positioned to advance its attractive asset portfolio and bring it to market when conditions permitted.

The board changes were brought about by a process initiated in December 2008 by Xtract and DM Bray Capital LLC (“DM Bray”), at that time the two largest shareholders of Elko who together held approximately 48% of the voting interests in Elko. Xtract and DM Bray called for the replacement of the Board with a new slate of directors.

As a result of the changes, Andy Morrison remained a director of Elko and was joined on the Elko Board by fellow Xtract Director, Mr John Conlon and DM Bray nominee Mr Jack Bray. Former Elko Chairman, Jeremy Kane agreed to remain as an independent non-executive director for a temporary period to continue to represent the interests of the minority shareholders. The board changes were aimed at increasing alignment of Elko’s strategy with the interests of all shareholders.

In January 2009, Elko confirmed the appointment of a new President and Chief Executive Officer, Mr Peter Moir with effect from 26 January 2009.

The new board got to work quickly. Elko completed the acquisition of Oyster Energy BV on 19 February 2009, increasing Elko’s combined working interest in Netherlands Blocks P1 and P2 from 33% to 60%. The acquisition of Oyster resolved the previous lack of a joint operating agreement and enabled Elko to proactively progress the development and marketing of the Dutch assets.

During the first quarter of 2009, an integrated block development concept for the discoveries and prospects on Blocks P1 and P2 was prepared. The concept provided for the offshore removal and underground storage of CO2 contained in gas within the P1/P2 discoveries. The geology, geophysical and reservoir engineering definitions were further developed to create an outline field development plan and to pin-point an appraisal well location.

Discussions with offshore facilities and pipeline infrastructure owners identified a number of options for the offshore removal and storage of CO2 and the onward transportation of sales gas to European markets. A number of potential new financing partners have been identified to replace Oyster via a farm out of a percentage of Elko’s working interest in Blocks P1 and P2. Partnering discussions continue in parallel with discussion with infrastructure owners.

After the reporting period on 26 August 2009, Elko and its subsidiary Dragon Energy Inc (“Dragon”) signed an overriding royalty agreement whereby Elko will benefit from a 2.5% overriding royalty from future revenues from the Kotaneelee field, over a maximum term of five years capped at an aggregate value of CDN$750,000. In exchange Elko returned to Dragon 15,600,000 common shares representing its 51% ownership and Jack Bray, Peter Moir and Andy Morrison resigned from the board of Dragon.

Dragon holds a 30.667% working interest in the Kotaneelee field in the Yukon Territory, Canada operated by Devon Energy Corp. Gas production at Kotaneelee is in decline and gas prices in North America are depressed resulting in a significantly weakened revenue stream from current production levels. The disposal of Dragon eliminated a potential liability from Elko’s balance sheet.

In Denmark, enhanced seismic processing of the Chalk prospects was undertaken. The results are part of a marketing initiative aimed at securing an additional financing partner or partners. Elko has designed a low cost exploration drilling initiative that will further de-risk its future work on the Danish asset. These plans have been favourably received by its Danish state partner and the Danish Energy Agency because of the lower risk scenario they offer as Elko aims to exploit the asset’s exceptionally high potential.

Whilst much has been achieved by the new Elko board, the company remains in a challenging situation. Its projects are attractive, but capital-intensive. Financing discussions are advanced, but there can be no assurance that these will ultimately lead to definitive arrangements. It is hoped to unlock the assets and enable them to be taken forward through the exploration and appraisal phases thereby adding significant intrinsic value to the portfolio. In managing its investment in Elko, Xtract drives for its success whilst at the same time preparing for alternative scenarios.