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ZN > SEC Filings for ZN > Form 10-Q on 5-Nov-2012All Recent SEC Filings

Show all filings for ZION OIL & GAS INC

Form 10-Q for ZION OIL & GAS INC


5-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH OUR UNAUDITED INTERIM FINANCIAL STATEMENTS AND THE RELATED NOTES TO THOSE STATEMENTS INCLUDED IN THIS FORM 10-Q. SOME OF OUR DISCUSSION IS FORWARD-LOOKING AND INVOLVES RISKS AND UNCERTAINTIES. FOR INFORMATION REGARDING RISK FACTORS THAT COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS, REFER TO THE DISCUSSION OF RISK FACTORS IN THE "DESCRIPTION OF BUSINESS" SECTION OF OUR ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2011 FILED WITH THE SECURITIES AND EXCHANGE COMMISSION.

Forward-Looking Statements

Certain statements made in this discussion are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These statements may materially differ from actual results.

Forward-looking statements can be identified by terminology such as "may", "should", "expects", "intends", "anticipates", "believes", "estimates", "predicts", or "continue" or the negative of these terms or other comparable terminology and include, without limitation, statements regarding:

our ability to explore for and develop natural gas and oil resources successfully and economically;

the availability of equipment, such as drilling rigs and transportation pipelines;

the impact of governmental regulations, permitting and other legal requirements in Israel relating to onshore exploratory drilling;

our estimates of the timing and number of wells we expect to drill and other exploration activities and planned expenditures and the time frame within which they will be undertaken;

changes in our drilling plans and related budgets;

the quality of our license areas with regard to, among other things, the existence of reserves in economic quantities;

anticipated trends in our business;

our future results of operations;

our liquidity and our ability to raise capital to finance our exploration and development activities;

our capital expenditure program;

future market conditions in the oil and gas industry; and

the demand for oil and natural gas, both locally in Israel and globally.

Because forward-looking statements involve risks and uncertainties, there are important factors that could cause actual results to differ materially from those expressed or implied by these forward-looking statements. Although we believe that expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, performance or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of these forward-looking statements. We undertake no duty to update any forward-looking statements after the date of this report or to conform such statements to actual results.

Overview

Zion Oil & Gas, Inc. is an initial stage oil and gas exploration company with a history of over 11 years of oil and gas exploration in Israel. As of September 30, 2012, we have no revenues or operating income and are considered to be a "development stage" company.

We are headquartered in Dallas, Texas and have a field office in Caesarea, Israel.

We hold three petroleum exploration licenses, named the "Joseph License", the "Asher-Menashe License" and the "Jordan Valley License", covering approximately 218,000 acres of land in onshore Northern Israel.

We have continuously held the Joseph License since October 2007 and the Asher-Menashe License since June 2007. We were awarded the Jordan Valley License in April 2011. The Joseph License and Asher-Menashe License areas are geographically contiguous and within a similar geologic environment.

The Joseph License is currently scheduled to expire on April 10, 2013, but is subject to extension through October 10, 2014. The Asher-Menashe License is scheduled to expire on June 9, 2013 and is subject to extension through June 9, 2014.

Current Exploration Efforts

To date, we have completed drilling three exploratory wells in the Joseph License and have partly completed drilling one exploratory well in the Asher-Menashe License area.

We are currently in the process of identifying our next drilling prospect. Towards that end, we have recently reprocessed already existing seismic data, acquired new 2-D seismic data, as well as gravity and magnetic surveys in our license areas. In our Asher-Menashe License area, in July 2012 we re-entered our existing Elijah #3 well in order to obtain additional wireline log information, a VSP (vertical seismic profile) survey and sidewall core samples. The primary purpose of this effort was to obtain additional geologic and geophysical data to better understand the hydrocarbon potential of a shallower zone through which we drilled while drilling the Elijah #3 well in 2009/2010. The results of these studies continue to be analyzed and interpreted but additional data is needed. In November 2012, we acquired additional reservoir fluid and pressure data in order to decide the future course of action to take with regard to the Elijah #3 well.

In our Joseph License area, we continue to evaluate our existing older seismic dataset and re-process some of that data in an effort to enhance the data quality. In October 2012, we acquired an additional 11 kilometer seismic survey and the results of such survey are currently being processed and analyzed. The Geophysical Institute of Israel, our seismic acquisition and processing entity, has informed us that a second 9 kilometer seismic survey is to be acquired in November 2012. Once this seismic work is completed and the results are integrated, we believe that our exploration staff will have a better understanding of the geology of the southern Joseph License area.

In our Jordan Valley License area, we have recently processed, interpreted and integrated into our geologic model the seismic and gravity data that we acquired in May 2012. Following the analysis of such data, we have determined that additional pre-drilling exploratory work is needed before a drillable prospect, if any, can be matured and recommended in this license area. These additional studies could include acquiring additional seismic data and conducting basin history and petroleum system modeling, among other possibilities.

After a drill site and coordinates have been defined, we will need to complete the permitting process and also finalize arrangements for a suitable drilling rig and experienced drilling crew in order to drill such prospect to the desired depth.

Towards that end, on June 4, 2012, we signed a Memorandum of Understanding (MoU) with Lapidoth Israel Oil Prospectors Corp. Ltd. ("Lapidoth"), a forerunner of onshore oil prospecting in Israel. The MoU, outlines plans to establish a company, tentatively named "Zion-Lapidoth Drilling", which is to locate and purchase a drilling rig suitable for drilling wells to a depth of up to 25,000 feet, to be 50% owned by Zion Oil and 50% by Lapidoth. The anticipated cost of the drilling rig is up to $15 million and each of Zion and Lapidoth are to share equally in the financing of Zion-Lapidoth Drilling. The MoU provides that we are to retain Zion-Lapidoth Drilling for our drilling program and when not required by Zion Oil, Zion-Lapidoth Drilling may lease the drilling rig to third party oil and gas drilling entities. The MoU is subject to certain standard conditions, including the execution of definitive purchase and shareholder agreements, obtaining required governmental approvals and the completion of acceptable due diligence by the parties. Additionally, the implementation of the MoU is subject to our raising at least $10 million by June 4, 2013 (of which approximately $3.2 million has been raised as of the date of this report). The MoU provides that Lapidoth will have a right of first refusal to drill wells, as needed, in accordance with Zion Oil's work program, until June 4, 2013.

As of the filing of this quarterly report on Form 10-Q, we have not yet entered into any legally binding documents as to the drilling of our next deep drill exploratory well, other than the Lapidoth right of first refusal described above.

Outlook for the Permitting Process

The permitting process in Israel with respect to petroleum exploration is undergoing significant modification. In our annual report on Form 10-K for the year ended December 31, 2011, we disclosed that, in January 2012, the Ministry of Energy and Water Resources of the State of Israel submitted draft regulations relating to petroleum exploratory drilling. The result of the draft regulations would be to considerably increase the time period needed to obtain the necessary permits to undertake exploratory drilling once a drilling prospect was identified.

On April 24, 2012, the draft regulations were adopted in large measure. The new regulations are entitled "Petroleum Regulations (Permission to deviate from the provisions of the Planning and Building Law) 2012" and detail a new permitting process. Among other things, the new regulations require the submission, to the local regulatory and permitting authorities, of a detailed environmental report relating to the proposed drilling site and surroundings. The report is to address, in detail, the environmental implications of the drilling, including hydrological analysis, surface water management, risk assessment, environmental impact, and abandonment and remediation of the drill site, among others.

The drilling application must be published and there are specified time frames (approximately 100 days) for any person (including environmental and other interested bodies) to comment on the drilling application. As a result, we believe that the time periods to obtain the necessary permits (prior to spudding a well) have been considerably increased. Currently, we are unable to accurately assess the time period that we would require to obtain the necessary permits to allow us to spud our next exploratory well.

License Requirements

Our licenses require us to take certain specified exploratory and drilling related actions within specified time frames.

Under the terms of the Asher-Menashe License, we were required, among other things, to contract with a drilling contractor to re-enter our existing Elijah #3 well in order to obtain a VSP (vertical seismic profile) by May 15, 2012. Due to unexpected delays relating to the availability of an appropriate workover rig and the negotiations with Lapidoth, the Israeli drilling contractor, we were unable to agree to the terms of the contract until June 28, 2012. As noted above, the well re-entry was completed in August 2012 and we have obtained additional wireline log information, a VSP (vertical seismic profile) survey and sidewall core samples. Under the terms of the license, we were required to file a final report with the Isreal Petroleum Commissioner on all exploratory activities in the license area and recommendations for future plans by November 1, 2012, sign a drilling contract by November 1, 2012 and commence actual drilling in the license area by January 1, 2013. However, we have recently re-entered the well in October 2012 in order to acquire additional reservoir pressure and fluid data. Accordingly, we have submitted a request to the Petroleum Commissioner seeking an extension of the November 1, 2012 report deadline until December 1, 2012 so that we may include the results of the re-entry and a recommendation of future activity at the well and in the license area. On October 23, 2012, we received a written response from the Petroleum Commissioner authorizing extension of the November 1, 2012 Asher-Menashe report due date to December 1, 2012.

Under the terms of the Joseph License, Israel's Petroleum Commissioner approved our request for an extension of the term of the Joseph License to April 10, 2013 to accommodate delays that the Geophysical Institute of Israel (GII), our seismic survey services provider, in completing a 20 kilometer seismic line in the Southern Joseph License area. We completed the acquisition of an 11 kilometer seismic line in the southern Joseph License area only in October 2012, and we expect that GII will acquire the remaining 9 kilometer long seismic line by November 2012. Under the terms of the Joseph License, as extended in August 2012, we were required, among other things, to (i) obtain a seismic survey, process and integrate the data and submit the process report and ancillary material to the National Geophysical Archive maintained at GII by October 15, 2012, (ii) interpret, process and integrate the results of the new seismic survey with existing seismic lines, update the geophysical maps and submit a geophysical summary and file a report with the Israeli Petroleum Commissioner by December 15, 2012, (iii) identify and prepare a drilling prospectus that includes a geological description of the geological background, the desired drilling depths, a geological forecast and engineering plan for the proposed drilling by January 15, 2013, and (iv) execute a drilling contract to drill a new well or drill the existing well by February 15, 2013. As a result of further delays in seismic data acquisition by GII, in September 2012 we submitted a follow-up request letter to Israel's Petroleum Commissioner seeking a further extension of the scheduled work program time frames beyond April 2013. As of the filing of this quarterly report on Form 10-Q, we await a response from the Petroleum Commissioner.

While we endeavor to comply with the terms of our licenses, the limited availability (and at times complete unavailability) in Israel of suitable equipment and the experienced crews to operate that equipment and our lack of control over these factors sometimes prevents us from undertaking required exploratory activities within the time frames prescribed in our licenses. Additionally, we expect that the modified permitting process regime discussed above that will need to comply with once the drill coordinates of our next exploratory well are determined is expected to result in further delays in meeting the express terms of the licenses.

Accordingly, we do not believe that we will be able to comply with the express terms of our licenses specified above. With respect to the Asher-Menashe License area, pending the completion of planned additional reservoir fluid and pressure data, we anticipate that we will need to request extensions to the requirements to enter into drilling contract by November 1, 2012 and to begin drilling by January 1, 2013. With respect to the Jordan Valley License area, as noted above we will require additional pre-drilling exploratory work in order to mature, if ever, a drillable prospect. Accordingly, we will need extensions to the time frames in the Jordan Valley License, where we are currently required to enter into a drilling contract to drill an exploratory well in the license area by the middle of October 2012 and to actually drill such well to approximately 5,000 meters by the middle of April 2013. We routinely update the Petroleum Commissioner's office of all relevant developments, including delays in the time frames specified in our license areas, and our previous requests for extensions to the express time frames specified in the licenses have been granted. However, we cannot provide any such assurance that we will be granted these extensions in the future and, accordingly, we are unable to assess the implications, if any, of our non-compliance with the express terms of our licenses.

New Onshore Licensing Guidelines

The procedure for Israeli onshore exploratory licensing is undergoing considerable modification. Applications for new exploration licenses will need to comply with more demanding requirements relating to a license applicant's financial capability, experience and access to experienced personnel.

In June 2012, the Ministry of Energy and Water Resources issued guidelines relating to onshore exploratory licensing. Under the guidelines, which remain subject to continuing review, an applicant for an exploration license will have to meet certain specified conditions and provide detailed information with respect to the requested license area. The applicant must engage, at a minimum, an exploration manager, geologist, geophysicist and engineer with minimum years of experience in oil and gas exploration and at least one of these persons must be a resident of Israel. Additionally, if the license application relates to an area that has produced reserves in the past and the submitted work plans include production of oil and gas from this area, then the applicant must also engage a production engineer. The applicant must also demonstrate the financial resources to support the estimated costs of non-drilling exploratory activities and at least 50% of the estimated drilling costs, but in any event of not less than $5 million. An Applicant will be deemed to have the requisite financial resources if it has liquid assets or equity equal to the required amount, less undertakings pursuant to other licenses or permits. The application for the exploration license will be published in a daily newspaper and on the Ministry's web site and other prospective license applicants will then have an opportunity to submit an application for the requested license area within three months from such publication. In the event of more than one application for a license area, the winner will be determined by a grading system utilizing certain deemed pertinent factors (inter alia, experience of the applicant, experience of the staff, financial resources, etc.). A condition to the issuance of any license will be the submission by the license of a performance bank guarantee. In October 2012, the Ministry published proposed guidelines (which are subject to comment until November 15, 2012) relating to the submission of performance bank guarantees for new and existing exploration license. Under the guidelines, an applicant for a new exploration license must submit a performance bank guarantee for 10% of the cost of the proposed work program upon the award by the Petroleum Commissioner of the applied-for license. An existing exploration license owner will be required to submit a performance bank guarantee equal to 10% of the cost of the balance of the planned work program, by the earlier of (a) the application for a license extension, (b) the application for transfer of license rights, or (c) the application for changes to the work program, but in no event later than February 28, 2013. The face amount of the performance bank guarantee for existing licenses will be based on an estimated budget for the balance of the planned work program that an existing license owner is to submit to the Petroleum Commissioner by no later than November 30, 2012, which budget is subject to approval by the Petroleum Commissioner. If the licensee violates (whether intentionally or not) any of the license terms, then the Commissioner is entitled to impose a forfeiture of the bank guarantee, following the giving of notice to the licensee and an opportunity to cure.

In 2011, we submitted to the Israeli Petroleum Commissioner three exploration rights applications comprised of an exploration license and two preliminary exploration permits. The application for the exploration license relates to an area covering approximately 74,925 acres of land within the vicinity of the Dead Sea, in central Israel. The applications for the preliminary exploration permits relate to an area covering approximately 157,480 acres of land to the east of our Asher-Menashe License area and approximately 80,000 acres of land, adjacent to our Joseph License area.

We are currently in the process of examining the re-submission of these three exploration rights applications to comply with the new guidelines discussed above. We anticipate that our previous applications for the preliminary exploration permits and one license will need to be re-submitted as license applications or otherwise be cancelled. Accordingly, we are currently in the process of examining whether to apply for a new license. We are unable to determine at this time the impact, if any, of the new guidelines on our applications for new exploration rights.

Capital Resources Highlights

We anticipate that we will need to raise significant funds in order to spud and drill our next exploratory well to the desired depth and to implement the plans contemplated by the MoU that we signed with Lapidoth, to establish a jointly owned drilling subsidiary and purchase a deep drilling rig.

To date, we have funded our operations through the issuance of our securities. We anticipate that we will need to raise additional funds through the issuance of equity securities (or securities convertible into or exchangeable for equity securities). No assurance can be provided that we will be successful in raising the needed equity on terms favorable to us (or at all).

We currently have two different sets of publicly traded outstanding warrants (with original exercise prices), as follows: (a) ZNWAZ ($4.00) warrants, that expire on December 31, 2012 and (b) ZNWAW ($7.00) warrants, that expire on December 31, 2012.

On June 6, 2012, we implemented a temporary reduction in the exercise price of all of our publicly traded warrants under which these warrants can be exercised, through August 15, 2012, at the reduced warrant exercise price of $1.75. A third series of publicly traded warrants under the symbol ZNWAL expired on August 15, 2012.

Between January 1, 2012 and October 25, 2012, we raised approximately $3,222,000 from the exercise of our publicly traded warrants.

Additionally, in October 2012, we implemented a subsequent reduction in the exercise price of outstanding warrants under which these warrants can be exercised, through their scheduled expiration date of December 31, 2012, at the reduced warrant exercise price of $1.75. Except for the reduction in the warrant exercise prices, all of the terms and conditions contained in the applicable warrant instruments continue in full force and effect.

Principal Components of our Cost Structure

Our operating and other expenses primarily consist of the following:

Impairment of Unproved Oil and Gas Properties: Impairment expense is recognized if a determination is made that a well will not be able to be commercially productive. The amounts include amounts paid in respect of the drilling operations as well as geological and geophysical costs and various amounts that were paid to Israeli regulatory authorities.

General and Administrative Expenses: Overhead, including payroll and benefits for our corporate staff, costs of managing our exploratory operations, audit and other professional fees, and legal compliance are included in general and administrative expense. General and administrative expenses also include non-cash stock-based compensation expense, investor relations related expenses, lease and insurance and related expenses.

Depreciation, Depletion, Amortization and Accretion. We utilize the full-cost method of accounting and capitalize all costs associated with our exploration. We apportion these costs to different areas, as appropriate. As we have yet to achieve production, the costs of abandoned wells have been written off, as opposed to including them in an amortization pool.

Going Concern Basis

Our financial statements have been prepared on a going concern basis, which contemplates realization of assets and liquidation of liabilities in the ordinary course of business. Since we are in the development stage, we have limited capital resources, no revenue to date and a loss from operations. The appropriateness of using the going concern basis is dependent upon our ability to obtain additional financing or equity capital and, ultimately, to achieve profitable operations. The uncertainty of these conditions raises doubt about our ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

Critical Accounting Policies

Management's discussion and analysis of financial condition and results of operations is based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expense during the reporting period.

We have identified the accounting principles which we believe are most critical to the reported financial status by considering accounting policies that involve the most complex of subjective decisions or assessment.

We follow the full-cost method of accounting for oil and gas properties. Accordingly, all costs associated with acquisition, exploration and development of oil and gas reserves, including directly related overhead costs, are capitalized.

All capitalized costs of oil and gas properties, including the estimated future costs to develop proved reserves, are amortized on the unit-of-production method using estimates of proved reserves. Investments in unproved properties and major development projects are not amortized until proved reserves associated with the projects can be determined or until impairment occurs. If the results of an assessment indicate that the properties are impaired, the amount of the impairment is included in income from continuing operations before income taxes and the adjusted carrying amount of the unproved properties is amortized on the unit-of-production method.

The oil and gas property represents an investment in unproved properties. Oil and gas property in general is excluded from the amortized cost pool until proved reserves are found or until it is determined that the costs are impaired. All costs excluded are reviewed at least quarterly to determine if impairment has occurred. The amount of any impairment is charged to expense since a reserve base has not yet been established. Impairment requiring a charge to expense may be indicated through evaluation of drilling results, relinquishing drilling rights or other information.

Abandonment of properties is accounted for as adjustments to capitalized costs. The net capitalized costs are subject to a "ceiling test" which limits such costs to the aggregate of the estimated present value of future net revenues from proved reserves discounted at ten percent based on current economic and operating conditions, plus the lower of cost or fair market value of unproved properties. The recoverability of amounts capitalized for oil and gas properties is dependent upon the identification of economically recoverable reserves, together with obtaining the necessary financing to exploit such reserves and the achievement of profitable operations.

Asset Retirement Obligation

We record a liability for asset retirement obligation at fair value in the period in which it is incurred and a corresponding increase in the carrying amount of the related long lived assets.

RESULTS OF OPERATIONS



                                         For the Three Months Ended            For the Nine Months Ended
                                                September 30                          September 30
                                          2012                2011              2012               2011
                                             (US $ in thousands)                  (US $ in thousands)
    General and administrative
expenses
Legal and professional fees                    296                  260              912                 840
Salaries                                       869                  592            3,073               2,657
Other                                          429                1,204            2,536               2,963

Impairment of unproved oil and gas
properties                                       -               42,488                -              42,488

Other expense (income), net                     (7 )                102              (32 )                29

Net loss                                     1,587               44,646            6,489              48,977

. . .

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