Sugarloaf Prospect Summary
1. Introduction
Eureka owns a 12.5% working interest in the large Sugarloaf Joint Venture Project which is located within the exciting new Austin Chalk ‘Sugarkane’ Field discovery in Texas. The Sugarloaf Area of Mutual Interest (“AMI”) comprises contiguous leases covering approximately 22,200 acres (2,775 acres net to Eureka). The AMI is situated in the centre of the Sugarkane Field and provides the Company with an exceptional opportunity to participate in the development of a potential multi trillion cubic feet equivalent (“TCFE”) gas and condensate resource.
Eureka has participated in the drilling of two wells within the Sugarloaf AMI (Sugarloaf #1 and Kennedy #1H). In lease areas surrounding the Sugarloaf AMI a number of wells have now been drilled, including the discovery well, Kunde #1 and two other horizontal wells that have intersected natural fracturing of the Austin Chalk and have had very productive gas & condensate tests. Eureka has no ownership interest in these wells or the leases surrounding the Sugarloaf AMI.
Together with the Operator, Texas Crude Energy Inc., Eureka is planning additional appraisal and development wells for the second half of 2008 focused on unlocking the value within the significant Sugarloaf AMI resource potential.
2. Sugarkane Field Overview
The Sugarkane Field is an exciting discovery of substantial size covering an identified area of in excess of 200,000 acres which is proving to have high potential for gas and condensate production.
Potential gross resources have been estimated for the entire Sugarkane Field at greater than 3 tcf of gas and approximately 700 million barrels of condensate in the reservoir zone tested to date.
The Sugarkane Field was discovered in 2006 with the Kunde #1 exploration well that intersected the Austin Chalk formation within the region. The Kunde #1 vertical well has been producing gas and condensate since September 2006. The Sugarkane Field is still in the early stages of appraisal with six exploration and appraisal wells having been drilled into the targeted Austin Chalk formation. Two of these wells lie within the Sugarloaf AMI and four wells have been drilled by a major exploration and production company external to but within close proximity of the Sugarloaf AMI’s lease holding. Additionally a number of wells have been permitted for drilling within the Sugarkane Field during the remainder of 2008.
The Sugarkane Field is a relatively new discovery. The reason that it has been overlooked to date is that it lies some 20 km’s south of the main Austin Chalk trend and as such has been lightly drilled. Traditional thinking has been that the Chalk is a relatively low productivity reservoir in comparison to other reservoirs targeted by previous wells drilled in this area. Whilst this play is in its early stages of appraisal it is exhibiting characteristics that appear superior to classic Austin Chalk Fields. The Sugarloaf AMI lies within the larger Sugarkane Field.
3. Traditional Austin Chalk Plays
Austin Chalk plays are well known in Texas and are exploited from a broad regional trend of wide spread Upper Cretaceous marine chalk which primarily passes just to the north of the Sugarkane Field.
There are four main Austin Chalk reservoirs in the region, Pearsall, Giddings, Brookeland and Masters Creek. All fours reservoirs produce both oil and gas but a geological quirk leads to oil in shallower formations and gas at deeper levels. The Austin Chalk is a prolific resource with some 5 TCF of gas and 600 mmbls of oil having been produced from the Giddings and Pearsall fields alone.
The Austin Chalk was originally produced from vertical wells drilled in the 1960’s and was characterized by low production rates over a long period of time. Well performance within this play has a wide statistical variation and although profitable it is normally a long term return on investment. The Austin Chalk is generally characterized by low matrix porosity and permeability. The Sugarkane Field has indicated greater matrix porosity than traditional Austin Chalk formations. Chalk, being brittle in nature, is predominantly produced through fractures within the formation therefore the most productive wells are the ones that have the most exposure to naturally occurring fractures.
With greater understanding of the production mechanism and advancements in technical capability within the E & P industry, horizontal wells were extensively drilled from the early 1990’s. Horizontal wells significantly increase the surface area exposed to low matrix porosity Chalk as well as increasing the probability of intersecting naturally occurring fractures thereby substantially improving production rates and reserves recovered per well. This has the ability to dramatically improve the financial returns achieved. Additional production is often achieved by artificially fracturing the reservoir along the length of the well bore by hydraulically pumping fluid into the well bore until fracturing occurs.
Very recently wells have been drilled in East Texas targeting Austin Chalk with similar characteristics to that identified at Sugarkane. These recent wells have achieved high initial production rates, often in excess of 15 mmcfe/d, and have total estimated reserves of up to 28 bcfe.
4. Sugarkane Austin Chalk Play
Eureka has participated in two wells that have been drilled in the Sugarkane Field within the Sugarloaf AMI.
The Sugarloaf #1 well was drilled vertically through the Austin Chalk heading through to the much deeper Hosston formation. The well has produced hydrocarbons to surface from the Austin Chalk with attempts to increase production by fracturing the deepest untested chalk zones failing due to a poor cement bond in the annulus. Wire line log results in the Austin Chalk indicated 92 feet of possible gas pay comprised of three separate zones of enhanced porosity. The uppermost zone of possible gas pay is believed to correlate with the producing zone of the discovery well, Kunde #1, in the adjoining Sugarkane Field some 6.6 km’s west of the Sugarloaf 1 well.
The Kennedy #1H was horizontally drilled some 4,200 feet into the chalk targeting the uppermost zone believed to correlate with the producing section in the Sugarkane Field discovery well and two subsequent horizontal wells in the adjoining land that have been recently successfully flow tested. The Kennedy #1H well did not encounter any natural fractures during drilling but did encounter hydrocarbon charged matrix chalk along its horizontal length. Subsequent analysis has indicated the horizontal section of the well has drilled a deeper chalk zone than targeted.
The Kennedy #1H well was completed with a 4 ½ inch cemented liner with the deepest quarter of the hole having been fracture stimulated. A hydraulic fracture stimulation of an approximate 600 foot long zone at the end of the horizontal section of the well was undertaken via four sets of perforations. Whilst the well is still unloading frac fluid small quantities of condensate and gas have been produced which is encouraging as this is the first conclusive test of this lower zone within the Sugarkane Austin Chalk.
In the past 2 years, four wells have been drilled in the Sugarkane Field adjacent to the Sugarloaf AMI acreage by a major international E & P company comprising - two vertical wells (Kunde #1 & 2), and two horizontal wells (Kunde #3 & Baker Trust #1).
The Kunde #1 vertical well tested at a calculated absolute open hole flow rate of 1.78 mmcf of gas and 574 bbl of condensate per day. Extrapolating published data since production commenced suggests total anticipated production for the vertical well of approximately 1 bcf of gas and 260 mmbbl of condensate. This is similar to the average cumulative reserves recovered per horizontal well in the Giddings Field. Implied production rates and recoverable reserves from a horizontal well would be expected to be significantly above this.
Information to date from the exploration and appraisal activities confirms that the Sugarkane Field is not a classic Austin Chalk play. Notably the field is over pressured and has a higher porosity which should mean there is more gas and condensate present in the field, that it may be more mobile and that it should produce at higher rates than traditional chalk. Production from the Sugarkane Field also indicates a high condensate to gas ratio which if maintained across the field will significantly enhance the field’s economics and valuation.
| Giddings Field | Sugarkane Field | |
| Depth (ft) | 5,500–15,000 | 12,000 |
| Porosity (%) | 2 – 5% | 6%+ |
| Pressure (psi/ft) | 0.47 | 0.76 |
| Condensate Ratio (bbl/mmcf) | Various | 235 |
Even though there are many analogues for the classic Austin Chalk, only one other Austin Chalk field has been identified with similar characteristics to the Sugarkane Field. This analogue field is slightly south of the main Austin Chalk trend in Eastern Texas (“East Texas Chalk”) and has initial production rates from many wells in excess of 15 mmcfe/d and some wells as high as 50 mmcfe/d with recoverable volumes of up to 28 bcfe per well.
Source: Texas Railroad Commission Web Data Base
These production results are considerably higher than the performance of the average classic Austin Chalk horizontal wells and are very encouraging for the Sugarloaf AMI.
As with all Austin Chalk plays, including the East Texas Chalk, better well performance generally coincides with the intersection of natural fracture zones. The table below demonstrates that the Sugarkane Field characteristics are similar to the East Texas Chalk Field.
| Sugarkane Field | East Texas Chalk | |
| Depth (ft) | 12,000 | 13,000 |
| Porosity (%) | 6%+ | 6%+ |
| Pressure (psi/ft) | 0.76 | 0.77 |
| Condensate Ratio (bbl/mmcf) | 235 | 250 |
Much of the technical work undertaken by the Operator and the Sugarloaf AMI participants in late 2007 and early 2008 focused on identifying potential well locations within the Sugarloaf AMI that are likely to intersect the naturally occurring fractures within the Austin Chalk reservoir. The analysis and interpretation of the original 2D and recently available 3D seismic data over a portion of the Sugarloaf AMI is being used to identify locations where there is a high probability of encountering these fractures. It is not possible to see the fractures on the seismic maps however it is possible to identify areas where there are faults in the deeper Sligo formation which create areas of dip change and increase the probability of fractures occurring in the Austin Chalk formation.
The focus of future appraisal and development planning will be to target these fracture zones to establish the productive capability within the Sugarloaf AMI.
5. Eureka’s Interest in Sugarloaf AMI
Eureka has a 12.5% Working Interest (“WI”) in the Sugarloaf AMI. With total royalties payable to landowners and others of up to 29% across the various prospect leases, Eureka will have a Net Revenue Interest ("NRI") of some 9% (~71% of its 12.5% WI).
6. Current and Future Activities
Whilst the two existing wells drilled at Sugarloaf have been vitally important to date, and further work will be undertaken on them to increase productivity, Eureka believes it is important to continue with the drilling of additional wells to establish a bank of information on the reservoir and to begin to extract the rewards and value inherent at Sugarloaf for shareholders. The Operator is preparing a proposal for the drilling of new wells in the Sugarloaf Area which is anticipated to commence in Q3, 2008.
7. Economics of the US Market
7.1 Natural Gas Supply and Demand
The USA is the world's largest producer, consumer and net importer of natural gas. According to Energy Information Administration ("EIA"), as of January 2007 the USA had estimated proven natural gas reserves of 204 TCF, or 3.3% of world reserves (6th in the world). Natural gas consumption for 2007 was approximately 23.0 TCF, with gross imports of 4.6 TCF. Overall, the USA depends on natural gas for about 22% of its total primary energy requirements. Oil accounts for around 40% and coal for 23%.
From 1990 through to 2007, natural gas consumption in the USA increased by about 20%, although consumption fell about 5% during 2003 in large part as a result of high gas prices. In response to continued economic growth, natural gas demand was projected to increase by 2.2% in 2008. Natural gas is consumed in the United States mainly in the industrial (34%), electric power (30%), residential (20%), and commercial (13%) sectors.
As of 2007, the top natural-gas-producing states (in descending order) included Texas, New Mexico, Oklahoma, Wyoming, Louisiana, Colorado, Alaska, Kansas, California, and Alabama.
7.2 Natural Gas Prices
Over the past couple of years, natural gas prices have steadily increased from a base of around US$2.50 / mcf in the mid to late 1990’s to a peak in excess of US$14 / mcf and a current spot price of approximately US$12 / mcf. The reason for the increase in natural gas prices can be attributed to:
- Natural gas is no longer in surplus;
- World energy consumption continues to grow particularly in developing countries;
- Production from older fields and wells is continuing to decline;
- The cost of discovery are increasing;
- Greater levels of natural gas are being used for power generation in preference to oil, coal, water or nuclear from both an environmental and cost perspective.
7.3 US Fiscal Terms
In the USA mineral rights, including oil and gas rights, for any onshore resource belong to the landowner unless sold or assigned to a third party. As such the initial step in the oil and gas exploration process involves the acquisition of leases from the holders of the mineral rights over the prospect area. Once the leases are secured exploration activities may commence and if a discovery is made a negotiated royalty is payable to the mineral rights holder based on revenue earned from the lease. Additional overriding royalties to other third parties are also common as the leases change hands over time. Several State and local taxes are also payable based upon overall production volumes and net income.
In summary the USA is an attractive environment for international oil and gas explorers given its proven hydrocarbon potential, strong domestic market, well established infrastructure, depth of readily available technical expertise and well understood fiscal regime.