UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
     
þ   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For The Fiscal Year Ended October 31, 2006
or
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File Number 0-8877
 
CREDO PETROLEUM CORPORATION
 
(Exact name of registrant as specified in its charter)
         
         
Colorado       84-0772991
         
(State or other jurisdiction       (I.R.S. Employer Identification Number)
of incorporation or organization)        
1801 Broadway, Suite 900, Denver, Colorado 80202-3837
(Address of principal executive offices and zip code)
Registrant’s telephone number, including area code: (303) 297-2200
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.10 Par Value
(Title of class and shares outstanding)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act: o Yes       þ No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act: o Yes       þ No
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.       þ Yes      o 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 or information statements incorporated by reference in Part III of this form 10-K or any amendment to this Form 10-K.       þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. (See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Act.)
Large accelerated filer o            Accelerated filer þ            Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act. o Yes       þ No
The aggregate market value of the voting and non-voting common equity held by non-affiliates as of April 30, 2006, the end of the registrant’s most recently completed second quarter was $171,035,000.
As of January 8, 2007, the registrant had 9,261,000 shares of common stock outstanding.
 
 

 

 

 

 

DOCUMENTS INCORPORATED BY REFERENCE
Pursuant to instruction G (3) to Form 10-K, Items 10, 11, 12, 13 and 14 are omitted because the company will file a definitive proxy statement (the “Proxy Statement”) pursuant to Regulation 14A under the Securities Exchange Act of 1934 not later than 120 days after the close of the fiscal year. The information required by such items will be included in the Proxy Statement to be so filed for the company’s annual meeting of shareholders to be held on or about March 22, 2007 and is hereby incorporated by reference.
NON-GAAP FINANCIAL MEASURES
In this Annual Report on Form 10-K, the company uses the term “EBITDA (Earning Before Interest, Taxes, Depreciation and Amortization)” which is considered a non-GAAP financial measure as defined in SEC Regulation S-K Item 10 and should not be considered in isolation or as a substitute for measures of performance prepared in accordance with GAAP. See Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations for a definition of this measure as used in this Annual Report on Form 10-K.
Estimated Future Net Revenues Discounted at 10% is not a GAAP measure of operating performance. This pre-tax, non-GAAP measure is used by the company in connection with estimating funds expected to be available in the future for drilling and other operating activities. See Item 2 PROPERTIES, Significant Properties, Estimated Proved Oil and Gas Reserves, and Future Net Revenues for a reconciliation of Estimated Future Net Revenues Discounted at 10% to the Standardized Measure of Discounted Future Net Cash Flows From Reserves as shown in Note 8 to the company’s Consolidated Financial Statements.
FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K includes certain statements that may be deemed to be “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements included in this Annual Report on Form 10-K, other than statements of historical facts, address matters that the company reasonably expects, believes or anticipates will or may occur in the future. Forward-looking statements may include, among other things, statements relating to:
  •   the company’s future financial position, including working capital and anticipated cash flow;
 
  •   amounts and nature of future capital expenditures;
 
  •   projections of operating costs and other expenses;
 
  •   wells to be drilled or reworked;
 
  •   expectations regarding oil and natural gas prices and demand;
 
  •   existing fields, wells and prospects;
 
  •   diversification of exploration;
 
  •   estimates of proved oil and natural gas reserves;
 
  •   reserve potential;
 
  •   development and drilling potential;
 
  •   expansion and other development trends in the oil and natural gas industry;
 
  •   the company’s business strategy;
 
  •   production of oil and natural gas;
 
  •   matters related to the Calliope Gas Recovery System, including projections for future use of Calliope and the success of Calliope
 
  •   effects of federal, state and local regulation;
 
  •   adequacy of insurance coverage;
 
  •   employee relations;
 
  •   effectiveness of the company’s hedging transactions;
 
  •   investment strategy and risk; and
 
  •   expansion and growth of the company’s business and operations.

 

 

 

 

Although the company believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to be correct. Disclosure of important factors that could cause actual results to differ materially from the company’s expectations, or cautionary statements, are included under “Risk Factors” and elsewhere in this Annual Report on 10-K, including, without limitation, in conjunction with the forward-looking statements. The following factors, among others that could cause actual results to differ materially from the company’s expectations, include:
  •   unexpected changes in business or economic conditions;
 
  •   significant changes in natural gas and oil prices;
 
  •   timing and amount of production;
 
  •   unanticipated down-hole mechanical problems in wells or problems related to producing reservoirs or infrastructure;
 
  •   changes in overhead costs;
 
  •   material events resulting in changes in estimates; and
 
  •   competitive factors.
All forward-looking statements speak only as of the date made. All subsequent written and oral forward-looking statements attributable to the company, or persons acting on the company’s behalf, are expressly qualified in their entirety by the cautionary statements. Except as required by law, the company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which it is made or to reflect the occurrence of anticipated or unanticipated events or circumstances.

 

 

 

 

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PART I
ITEM 1. BUSINESS
General
CREDO Petroleum Corporation (“CREDO”) was incorporated in Colorado in 1978. CREDO and its wholly owned subsidiaries, SECO Energy Corporation and United Oil Corporation (“SECO”, “United” and collectively “the company”), are Denver, Colorado based independent oil and gas companies which engage primarily in oil and gas exploration, development and production activities in the Mid-Continent region of the United States. The company has operating activities in ten states and has twelve employees. CREDO is an active operator in Kansas, Wyoming, Colorado, Louisiana and Texas. United is an active operator doing business primarily in Oklahoma, and SECO primarily owns royalty interests in the Rocky Mountain region. References to years as used in this report indicate fiscal years ended October 31.
The company effected a 20% stock dividend in fiscal 2003, and a three-for-two stock split in each of fiscal 2005 and 2004. All share and per share amounts discussed and disclosed in this Annual Report on Form 10-K reflect the effect of the dividend and stock splits.
Business Activities
During 2006, the company continued implementation of new projects commenced in 2005 which are designed to sustain the company’s growth rate by expanding and diversifying its business, both technically and geographically. These projects will also diversify the capital exposure, risk and reserve potential of the company’s drilling activities. This includes approximately equal commitments to conventional drilling and to the company’s patented Calliope Gas Recovery System (“Calliope”) operations.
The company’s goal is to create steady growth by adding production and long-lived reserves at reasonable costs and risks. The strategy to achieve this goal involves conventional drilling and increasing the number of Calliope installations. Third party industry participants are involved in most of the company’s operating activities.
Historically, the company’s primary drilling focus has been in the Anadarko Basin of Oklahoma where the company owns interests in approximately 68,000 gross acres. The company will continue generating prospects and drilling on this acreage concentrating on medium depth properties generally ranging from 7,000 to 9,000 feet. Refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Oil and Gas Activities-Drilling Activities-Northern Anadarko Basin” for additional information.
Commencing in 2005, the company significantly expanded both the volume and breadth of its exploration program with new projects in South Texas and north-central Kansas. Compared to drilling in Oklahoma, the South Texas project involves higher costs and greater risks but significantly higher per well reserve potential. The South Texas project is 3-D seismic driven with well depths ranging from 10,000 to 15,500 feet. The north-central Kansas projects are geared to oil exploration and has excellent potential to add significant reserves at moderate costs and risks. This project is also 3-D seismic driven with well depths of approximately 4,000 feet. Exploration teams for both projects specialize in their respective geographic areas and have been highly successful finding new reserves using 3-D seismic. The company believes that both projects have the potential to generate significant future production and reserve growth. Refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Oil and Gas Activities—Drilling Activities-Drilling Program Expansion and Diversification, South Texas, and North-Central Kansas” for additional information.
The company has participated in developing, testing, refining, and patenting Calliope. Calliope efficiently lifts fluids from wellbores using pressure differentials, thus allowing gas previously trapped by fluid build-up in the wellbore to flow to the surface. Calliope is clearly different from all other fluid lift technologies because it does not rely on bottom-hole pressure and has only one down-hole moving part. Calliope is primarily applicable to

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mature natural gas wells in low pressure, natural gas expansion reservoirs at depths below 8,000 feet. The company has a 10 year unrestricted exclusive license for the Calliope technology which can be extended, at the company’s option, to cover the term of the latest patent. External sources of capital have not been required for the development, refinement or installation of Calliope. At October 31, 2006, Calliope has been installed on 24 wells ranging in depth from 6,500 feet to 18,400 feet. The company has proven Calliope’s economic viability and flexibility over a wide range of applications.
Commencing in 2005, the company significantly expanded its Calliope operations by moving into Texas and Louisiana and by entering into discussions with other companies regarding the formation of joint venture arrangements that utilize Calliope. In addition, higher gas prices have facilitated a new Calliope project to drill wells into low-pressure reservoirs continuing substantial stranded gas reserves. Calliope will then be used to recover those reserves. This is expected to enhance the company’s control over monetizing Calliope’s value while providing the opportunity to optimize Calliope’s performance and broaden the range of reservoirs for Calliope applications. Refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Oil and Gas Activities-Calliope Gas Recovery Technology” for additional information.
The company acts as “operator” of approximately 111 wells pursuant to standard industry operating agreements. The company owns interests in approximately 1,426 wells of which approximately 1,159 wells represent small overriding royalty interests.
Markets and Customers
Marketing of the company’s oil and gas production is influenced by many factors which are beyond the company’s control, and the exact effect of which cannot be accurately predicted. These factors include changes in supply and demand, market prices, regulation, and actions of major foreign producers. Oil price fluctuations can be extremely volatile as was demonstrated when, during 2003, the posted price for West Texas intermediate fell below $25.00 per barrel and then rose to over $78.00 per barrel during 2006.
Natural gas price decontrol, the advent of an active spot market for natural gas, changes in supply and demand for natural gas, and weather patterns cause natural gas prices to be subject to significant fluctuations. The company presently sells virtually all of its natural gas under one to five year contracts with major pipeline companies. The sales price is typically based on monthly index prices for the applicable pipeline. Title to the natural gas normally passes to the pipeline at meters located near the wells. The index prices are reduced by certain pipeline charges.
Most of the company’s natural gas production is located in northwestern Oklahoma. There has been significant consolidation among natural gas pipelines in this area, thereby reducing the number of available purchasers. In many instances, there may be only one viable pipeline option, which enables the pipeline to charge higher rates.
Over the past few years there has been increasing concern that a supply/demand imbalance has developed in domestic natural gas based on increasing demand and lower deliverability. This, together with rising oil prices, political unrest and uncertainty in certain major producing regions, supply vulnerability to natural disasters, such as hurricanes, and active speculation in the natural gas futures market has caused natural gas prices to become increasingly volatile. The company expects natural gas prices to remain strong but cannot reasonably predict the extent or timing of natural gas price fluctuations.
As discussed elsewhere in this Annual Report on Form 10-K, the company periodically hedges the price of a portion of its estimated natural gas production in the form of forward short positions and collars on both the NYMEX futures market and regional markets.
Oil production is sold to crude oil purchasing companies at competitive spot field prices. Crude oil and condensate production are readily marketable, and the company is generally not dependent on a single purchaser. Crude oil prices are subject to world-wide supply and demand, and are primarily dependent upon available supplies which can vary significantly depending on production and pricing policies of OPEC and other major producing countries and

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on significant events in major producing regions. Political unrest and market uncertainty in the Middle East, Africa, South America and former Soviet Union, OPEC’s renewed cooperation in managing the price of its produced oil, and increased demand from countries with developing economies, such as China and India, have resulted in higher world-wide oil prices during the past several years.
Information concerning the company’s major customers is included in Note (8) to the Consolidated Financial Statements.
Competition and Regulation
The oil and gas industry is highly competitive. As a small independent, the company must compete against companies with substantially larger financial, human and other resources in all aspects of its business.
Oil and gas drilling and production operations are regulated by various federal, state and local agencies. These agencies issue binding rules and regulations which carry penalties, often substantial, for failure to comply. The company anticipates its aggregate burden of federal, state and local regulation will continue to increase particularly in the area of rapidly changing environmental laws and regulations. The company also believes that its present operations substantially comply with applicable regulations. To date, such regulations have not had a material effect on the company’s operations, or the costs thereof. There are no known environmental or other regulatory matters related to the company’s operations which are reasonably expected to result in material liability to the company. The company believes that capital expenditures related to environmental control facilities or other regulatory matters will not be material in 2007. The company cannot predict what subsequent legislation or regulations may be enacted or what effect they might have on the company’s business.
ITEM 1A. RISK FACTORS
In evaluating the company, careful consideration should be given to the following risk factors, in addition to the other information included or incorporated by reference in this Annual Report on Form 10-K. Each of these risk factors could adversely affect the company’s business, operating results and financial condition, as well as adversely affect the value of an investment in the company’s common stock.
Volatility of oil and natural gas prices could adversely affect the company’s profitability and financial condition.
The company’s performance in terms of revenues, operating results, profitability, future rate of growth and the carrying value of its oil and natural gas properties is significantly impacted by prevailing market prices for oil and natural gas. Any substantial or extended decline in the price of oil or natural gas could have a material adverse effect on the company. It could reduce the company’s operating cash flow as well as the value and, to a lesser degree, the quantity of its oil and natural gas reserves. See the table of oil and gas sales volumes and prices on page 19 for further information.
The company is currently experiencing delays in securing drilling rigs and delivery of production equipment, primarily compressors and coil tubing. These delays are extending the time it takes the company to conduct its field operations. As a result, the company could be at risk for price increases related to these types of services and equipment.

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Historically, the markets for oil and natural gas have been volatile, and they are likely to continue to be volatile. Relatively minor changes in supply or demand can have a significant effect on oil and natural gas prices. Some of the factors affecting oil and natural gas prices which are beyond the company’s control include:
  •   worldwide and domestic supplies of oil and natural gas;
 
  •   worldwide and domestic demand for oil and natural gas;
 
  •   the ability of the members of OPEC to agree to and maintain oil price and production controls;
 
  •   political instability or armed conflict in oil or natural gas producing regions;
 
  •   worldwide and domestic economic conditions;
 
  •   the availability of transportation facilities;
 
  •   weather patterns; and
 
  •   actions of governmental authorities.
Competition for opportunities to replace and increase production and reserves is intense and could adversely affect the company.
Properties produce at a declining rate over time. In order to maintain current production rates the company must add new oil and natural gas reserves to replace those being depleted by production. Competition within the oil and natural gas industry is intense and many of the company’s competitors have financial and other resources substantially greater than those available to the company. This could place the company at a disadvantage with respect to accessing opportunities to maintain, or increase, its oil and natural gas reserve base.
In the event that the company does not have adequate cash flow to fund operations, it may be required to use debt or equity financing.
The company makes, and will continue to make, significant expenditures to find, acquire, develop and produce oil and natural gas reserves. If oil and natural gas prices decrease, or if operating difficulties are encountered that result in cash flow from operations being less than expected, the company may have to reduce capital expenditures unless additional funds are raised through debt or equity financing. Debt or equity financing or cash generated by operations may not be available to the company in sufficient amounts or on acceptable terms to meet these requirements.
Future cash flows and the availability of financing will be subject to a number of variables, such as:
  •   the company’s success in locating and producing new reserves;
 
  •   the level of production from existing wells; and
 
  •   prices of oil and natural gas;
Issuing equity securities to satisfy the company’s financing requirements could cause substantial dilution to existing stockholders. Debt financing could make the company more vulnerable to competitive pressures and economic downturns.
Reserve quantities and values are subject to many variables and estimates and actual results may vary.
This Annual Report on Form 10-K contains estimates of the company’s proved oil and natural gas reserves and the estimated future net revenues from those reserves. Any significant negative variance in these estimates could have a material adverse effect on the company’s future performance.
Reserve estimates are based on various assumptions, including assumptions required by the SEC relating to oil and natural gas prices, drilling and operating expenses, capital expenditures, taxes and availability of funds. The process of estimating reserves is complex. This process requires significant decisions and assumptions in the evaluation of available geological, geophysical, engineering and economic data.

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Reserve estimates are dependent on many variables, and therefore, as more information becomes available, it is reasonable to expect that there will be changes to the estimates. Actual future production, oil and natural gas prices, revenues, taxes, development expenditures, operating expenses and quantities of recoverable oil and natural gas reserves will most likely vary from those estimated. Any significant variance could materially affect the estimated quantities and present value of reserves disclosed by the company. In addition, estimates of proved reserves will be adjusted in the future to reflect production history, results of exploration and development, prevailing oil and natural gas prices and other factors, many of which are beyond the company’s control.
As of October 31, 2006, approximately 13% of the company’s estimated proved reserves are classified as proved undeveloped. Estimation of proved undeveloped reserves and proved developed non-producing reserves is generally based on volumetric calculations rather than the performance data used to estimate reserves for producing properties. Recovery of proved undeveloped reserves generally requires significant capital expenditures and successful drilling operations. Revenues from proved developed non-producing and proved undeveloped reserves will not be realized until some time in the future. The reserve estimate includes an estimate of the capital expenditures required to develop these reserves as well as the timing of such expenditures. Although the company has prepared estimates of its proved undeveloped reserves and the associated development costs in accordance with industry standards, they are based on estimates, and actual results may vary.
You should not interpret the present value of estimated reserves, or PV-10, as the current market value of reserves attributable to the company’s properties. The 10% discount factor, which we are required to use to calculate PV-10 for reporting purposes, is not necessarily the most appropriate discount factor given actual interest rates and risks to which the company’s business or the oil and natural gas industry in general are subject. The company has based the PV-10 on prices and costs as of the date of the reserve estimate, in accordance with applicable regulations. Actual future prices and costs may be materially higher or lower. In addition to the price volatility factors discussed above, factors that will affect actual future net cash flows, include:
  •   the amount and timing of actual production;
 
  •   curtailments or increases in consumption by oil and natural gas purchasers; and
 
  •   changes in governmental regulations or taxation.
As a result, the company’s actual future net cash flows could be materially different from the estimates included in this Annual Report on Form 10-K.
The company’s reserve quantities and values are concentrated in a relative few properties and fields.
The company’s reserves, and reserve values, are concentrated in 53 properties which represent 24% of the company’s total properties but a disproportionate 76% of the discounted value (at 10%) of the company’s reserves. Individual wells on which Calliope is installed comprise 23% of these significant properties and 28% of the discounted reserve value of such properties. New wells comprise 9% of these significant properties and 20% of the discounted reserve value of such properties.
Estimates of reserve quantities and values for these properties must be viewed as being subject to significant change as more data about the properties becomes available. Such properties include wells with limited production histories and properties with proved undeveloped or proved non-producing reserves. In addition, Calliope is generally installed on mature wells. As such, they contain older down-hole equipment that is more subject to failure than new equipment. The failure of such equipment, particularly casing, can result in complete loss of a well.

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Competition for materials and services is intense and could adversely affect the company.
Major oil companies, independent producers, and institutional and individual investors are actively seeking oil and gas properties throughout the world, along with the equipment, labor and materials required to develop and operate properties. Shortages of equipment, labor or materials may result in increased costs or the inability to obtain such resources as needed. Many of the company’s competitors have financial and technological resources which exceed those available to the company.
The company’s hedging arrangements involve credit risk and may limit future revenues from price increases.
To manage the company’s exposure to price risks associated with the sale of natural gas, the company periodically enters into hedging transactions for a portion of its estimated natural gas production. These transactions may limit the company’s potential gains if natural gas prices were to rise substantially over the price established by the hedge. In addition, such transactions may expose the company to the risk of financial loss in certain circumstances, including instances in which:
  •   the company’s production is less than the amount hedged;
 
  •   the contractual counterparties fail to perform under the contracts; or
 
  •   a sudden, unexpected event, materially impacts natural gas prices.
The terms of the company’s hedging agreements may also require that it furnish cash collateral, letters of credit or other forms of performance assurance in the event that mark-to-market calculations result in settlement obligations by the company to the counterparties, which would encumber the company’s liquidity and capital resources.
In addition, hedging transactions using derivative instruments involve basis risk. Basis risk in a hedging contract occurs when the index upon which the contract is based is more or less variable than the index upon which the hedged asset is based, thereby making the hedge less effective.
The marketability of the company’s natural gas production is dependent upon infrastructure, such as gathering systems, pipelines and processing facilities, that the company does not own or control.
The marketability of the company’s natural gas production depends in part upon the availability, proximity and capacity of natural gas gathering systems, pipelines and processing facilities necessary to move the company’s natural gas production to market. The company does not own this infrastructure and is dependent on other companies to provide it.
Oil and natural gas operations are inherently risky.
The oil and natural gas business involves a variety of risks, including the risks of operating hazards such as fires, explosions, cratering, blow-outs, and encountering formations with abnormal pressures. The occurrence of any of these risks could result in losses. The company maintains insurance against some, but not all, of these risks. Management believes that the level of insurance against these risks is reasonable and is consistent with general industry practices. The occurrence of a significant event that is not fully insured could have a material adverse effect on the company’s financial position and results of operations.
All of the company’s oil and natural gas properties are located on-shore in the continental United States. The company’s future drilling activities may not be successful, and its overall drilling success rate may change. Unsuccessful drilling activities could have a material adverse effect on the company’s results of operations and financial condition. Also, the company may not be able to obtain the right to drill in areas where it believes there is significant potential for the company.

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The company’s operations are subject to a variety of regulatory constraints.
The production and sale of oil and natural gas are subject to a variety of federal, state and local government regulations. These include:
  •   the prevention of waste;
 
  •   the discharge of materials into the environment;
 
  •   the conservation of oil and natural gas;
 
  •   pollution;
 
  •   permits for drilling operations;
 
  •   drilling bonds;
 
  •   reports concerning operations;
 
  •   the spacing of wells; and
 
  •   the unitization and pooling of properties.
Because current regulations covering the company’s operations are subject to change at any time, and despite its belief that it is in substantial compliance with applicable environmental and other government laws and regulations, the company could incur significant costs for future compliance.
Increases in taxes on energy sources may adversely affect the company’s operations.
Federal, state and local governments which have jurisdiction in areas where the company operates impose taxes on the oil and natural gas products sold. Historically, there has been on-going consideration by federal, state and local officials concerning a variety of energy tax proposals. Such matters are beyond the company’s ability to accurately predict or control.
The company is highly dependent on the services of one of its officers.
The company is highly dependent on the services of James T. Huffman, its President and Chief Executive Officer. The loss of Mr. Huffman could have a material adverse effect on the company.
ITEM 1B. UNRESOLVED STAFF COMMENTS
The company does not have any unresolved comments from the Commission.
ITEM 2. PROPERTIES
General
The company’s drilling activities are primarily located along the Northern Anadarko Basin of Oklahoma including the Oklahoma Panhandle where the company owns interests in 68,000 gross developed and undeveloped acres. Specifically, drilling expenditures have been focused on prospects located in Harper, Ellis and Beaver Counties, Oklahoma. Wells target the Morrow and Chester formations between 7,000 and 10,000 feet. Since 2001, the company has participated in drilling approximately 75 wells on such prospects with interests ranging up to 83%. Of those wells, 55 were completed as producers and 20 were dry holes. Several of the wells are exceptional for the area, and 16 of the wells are included in the company’s Significant Properties (see definition below). The company believes that it will drill more good wells in the area.
The company owns the exclusive right to the Calliope Gas Recovery System. The company believes it has proven that Calliope will add 0.5 to 2.0 Bcf of proved gas reserves to many dead and uneconomic wells. The company also believes there are presently many (more than 1,000) wells that meet its general criteria for Calliope candidate wells and thousands more that will meet its general Calliope criteria in the future.
Calliope operations were historically focused in Oklahoma where the company has a significant field operations infrastructure. Most Calliope wells are located in the Northern Anadarko

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Basin of Oklahoma. To date, Calliope has been installed on 24 wells located in Oklahoma, Texas and Louisiana, which range in depth from 6,500 to 18,400 feet. All of the wells were either dead or uneconomic at the time Calliope was installed. Twelve Calliope wells are included in the company’s Significant Properties. The company recently expanded its Calliope operations into Texas and Louisiana.
For additional information regarding current year activities, including oil and gas production, refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations”.
Significant Properties, Estimated Proved Oil and Gas Reserves, and Future Net Revenues
The company’s reserves, and reserve values, are concentrated in 53 properties (“Significant Properties”). Some of the Significant Properties are individual wells and others are multi-well properties. At year-end, Significant Properties represent 24% of the company’s total properties but a disproportionate 76% of the discounted value (at 10%) of the company’s reserves. Individual Calliope wells comprise 23% of the Significant Properties and represent 28% of the discounted reserve value of such properties. New wells comprise 9% of the Significant Properties and represent 20% of the discounted value of such properties.
Estimates of reserve quantities and values for certain Significant Properties must be viewed as being subject to significant change as more data about the properties becomes available. Such properties include wells with limited production histories (including post Calliope installation wells) and properties with proved undeveloped or proved non-producing reserves. In addition, Calliope wells are generally mature wells. As such, they contain older down-hole equipment that is more subject to failure than new equipment. The failure of such equipment, particularly casing, can result in complete loss of a well.
McCartney Engineering, Inc., an independent petroleum engineering firm, estimated proved reserves for the company’s properties which represented 63% in 2006, 63% in 2005 and 61% in 2004 of the total estimated future value of estimated reserves. Remaining reserves were estimated by the company in all years. At October 31, 2006, natural gas represented 86% and crude oil represented 14% of total reserves denominated in equivalent Mcf’s using a six Mcf of gas to one barrel of oil conversion ratio.
The following table sets forth, as of October 31 of the indicated year, information regarding the company’s proved reserves which is based on the assumptions set forth in Note (8) to the Consolidated Financial Statements where additional reserve information is provided. The average price used to calculate estimated future net revenues was $53.69, $55.59 and $50.43 per barrel of oil and $6.32, $10.26 and $5.84 per Mcf of gas as of October 31, 2006, 2005 and 2004, respectively. Amounts do not include estimates of future Federal and state income taxes.
                                 
                            Estimated Future
    Oil   Gas   Estimated Future   Net Revenues
Year   (bbls)*   (Mcf)*   Net Revenues   Discounted at 10%
 
2006
    422,000       16,005,000     $ 84,861,000     $ 52,328,000  
2005
    386,000       15,516,000     $ 136,878,000     $ 81,209,000  
2004
    407,000       15,273,000     $ 77,612,000     $ 44,551,000  
 
*   The percentage of total reserves classified as proved developed was approximately 87% in 2006, 89% in 2005, and 93% in 2004.
Estimated Future Net Revenues Discounted at 10% is not a GAAP measure of operating performance. Because the company drills new wells on an ongoing basis, and plans to continue to do so in the future, it expects to continue to generate deferred income taxes which are not reasonably expected to be paid in the near term. This pre-tax, non-GAAP measure is used by the company in connection with estimating funds expected to be available in the future for drilling and other operating activities. The company believes that this performance measure may also be useful to investors for the same purpose. The difference between this measure and the Standardized Measure of Discounted Future Net Cash Flows From Reserves is that this measure excludes future income tax

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expense and the effect of the 10% discount factor on future income tax expense. The following table provides a reconciliation of Estimated Future Net Revenues Discounted at 10% to the Standardized Measure of Discounted Future Net Cash Flows From Reserves as shown in Note 8 to the company’s Consolidated Financial Statements.
                         
    Year Ended October 31,  
    2006     2005     2004  
Estimated future net revenues discounted at 10%
  $ 52,328,000     $ 81,209,000     $ 44,551,000  
 
                       
Future income tax expense
    (20,747,000 )     (36,054,000 )     (19,965,000 )
 
                       
Effect of the 10% discount factor on future income tax expense
    8,170,000       14,332,000       8,273,000  
 
                 
 
                       
Standardized measure of discounted future net cash flows from reserves
  $ 39,751,000     $ 59,487,000     $ 32,859,000  
 
                 
Production, Average Sales Prices and Average Production Costs
The company’s net production quantities and average price realizations per unit for the indicated years are set forth below. Price realizations are net of any hedging gains or losses.
                                                 
    2006   2005   2004
Product   Volume   Price   Volume   Price   Volume   Price
Gas (Mcf)
    2,176,000     $ 6.11 (1)     1,830,000     $ 6.16 (2)     1,710,000     $ 4.60 (3)
Oil (bbls)
    41,000     $ 61.14       37,000     $ 50.90       41,000     $ 36.57  
 
(1)   Includes $0.12 Mcf hedging loss.
 
(2)   Includes $0.39 Mcf hedging loss.
 
(3)   Includes $0.42 Mcf hedging loss.
Average production costs, including production taxes, per equivalent Mcf of production (using a six Mcf of gas to one barrel of oil conversion ratio) were $1.40, $1.35 and $1.06 per Mcfe in 2006, 2005 and 2004, respectively.
Productive Wells and Developed Acreage
Developed acreage at October 31, 2006 totaled 28,000 net and 118,000 gross acres. At October 31, 2006, the company owned working interests in 77.42 net (266 gross) wells consisting of 16.03 net (43 gross) oil wells and 61.39 net (223 gross) natural gas wells. In addition, the company owned royalty and production payment interests in approximately 1,159 wells, primarily coal bed methane located in Wyoming. In 2006, the company sold 2.21 net (3 gross) wells. In the same period, the company drilled and acquired interests in 4.47 net (12 gross) productive wells in which it did not previously own an interest.
Undeveloped Acreage
The following table sets forth the number of undeveloped acres leased by the company (primarily located in the Mid-Continent and Rocky Mountain Regions) which will expire during the next five years (and thereafter) unless production is established in the interim. Undeveloped acres “held-by-production” represent the undeveloped portions of producing leases which will not expire until commercial production ceases.

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Expiration   Royalty     Working  
Year Ending   Interest Acreage     Interest Acreage  
October 31,   Gross     Net     Gross     Net  
2007
    1,900       —       21,200       7,600  
2008
    —       —       23,100       6,800  
2009
    —       —       6,000       2,800  
2010
    3,300       100       5,000       1,000  
2011
    —       —       100       —  
Thereafter
    1,800       500