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ZN > SEC Filings for ZN > Form 10-Q on 12-Nov-2013All Recent SEC Filings

Show all filings for ZION OIL & GAS INC

Form 10-Q for ZION OIL & GAS INC


12-Nov-2013

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, 2012, 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 likelihood of being granted new petroleum exploration rights by Israeli authorities;

? 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 13 years of oil and gas exploration in Israel. As of September 30, 2013, 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.

As of September 30, 2013, we held 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.

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.

Current Exploration Efforts

In April 2013, we submitted an application seeking a new petroleum exploration license in the Megiddo-Jezreel Valley area, onshore Israel, covering an area of approximately 98,000 acres. As proposed, the Megiddo-Jezreel Valley license area boundary is adjacent to and westward of our existing Jordan Valley License. If granted, the new Megiddo-Jezreel Valley License would likely be for an initial three-year term, extendable at the option of the Petroleum Commissioner for four additional one-year terms, for a total of seven years. On October 24, 2013, Zion received word that Israel's Advisory Petroleum Council met to discuss Zion's application and recommended to the Petroleum Commissioner that our application be approved. As of the date of this filing, we are still awaiting official receipt of the new Megiddo-Jezreel License.

Assuming the Company is granted the Megiddo-Jezreel License, we will still need to reprocess existing seismic data and acquire new seismic data to refine our understanding of the subsurface geology and confirm our preliminary well site location for our first exploratory well there. Toward that end, in June 2013 we entered into a contract with Geomage, an Israel-based geophysical company, to reprocess existing seismic lines in an effort to improve our subsurface imaging ability in both the Jordan Valley and proposed Megiddo-Jezreel License areas. This effort will aid us in high-grading exploration leads in both areas to develop them into drillable prospects. We continue to reprocess existing seismic lines with Geomage.

On April 10, 2013, Zion submitted to Israel's Petroleum Commissioner (the "Petroleum Commissioner") an application seeking a one-year extension for its Joseph License, which covers approximately 83,000 acres. On May 12, 2013, the Petroleum Commissioner notified the Company that our Joseph License was extended for only six months, until October 10, 2013 to allow for an orderly plugging and abandonment of the wells drilled to date in such license area as required by our license terms. (See related discussion under "License Requirements.")

On May 23, 2013, Zion submitted to the Petroleum Commissioner an application seeking a one-year extension for its Asher-Menashe License, which covers approximately 79,000 acres, to conduct additional in-well testing operations at the Elijah #3 well in hopes of finding commercially productive hydrocarbons. On June 12, 2013, the Company's Board of Directors authorized in-well testing of Zion's Elijah #3 well with operations likely to occur in November, 2013.


On July 7, 2013, the Petroleum Commissioner notified the Company that our Asher-Menashe License was extended until June 9, 2014. Under the terms of the license extension, the Company is required to perform a perforation and stimulation operation at the Elijah #3 well and conduct a production test. If the outcome of the test is negative, the well is to be plugged and abandoned ("P&A") and within 60 days thereafter, a final report should be submitted and the license is to be returned.

In mid to late November, we plan to perforate the zone of interest, fluid stimulate the carbonate rock, and perform a drill stem test. A drill stem test is a procedure for isolating and testing the pressure, permeability and productive capacity of a geological formation within a well. The test is a key method of obtaining information on the formation fluid and establishing whether a well has found a commercial hydrocarbon reservoir. If the test is positive, the Company will contact the Petroleum Commissioner's office to discuss future development plans. If the outcome of the test is negative, the Company plans to initiate P&A procedures immediately.

The Jordan Valley License is scheduled to expire on April 12, 2014, subject to additional one-year extensions at the option of the Petroleum Commissioner through April 2018.

As we reassessed our existing seismic data to prepare to submit our new Megiddo-Jezreel License application, we identified several exploration leads in our existing Jordan Valley License area. The newly reprocessed seismic data has already helped us to refine our understanding of the underlying geology of the area. The Company continues to reprocess existing seismic lines with Geomage to further refine our subsurface geologic model.

After we identify the site of our next exploratory well, we will need to begin the procedure of obtaining the needed authorizations and permits to commence drilling - this includes an extensive environmental supplement to an oil and gas exploration plan and a separate drilling permit. As we have previously disclosed in our periodic filings, we anticipate that the newly promulgated regulations relating to petroleum exploration will considerably increase the time needed to obtain all of the needed permits and authorizations from regulatory and local bodies in Israel as well as the associated expenses. We are unable to accurately estimate the time frame in which we can expect to obtain the necessary authorizations once a drilling prospect has been identified.

Finally, prior to actually spudding our next exploratory well, we will need to contract with an appropriate rig contractor for the necessary drilling rig, operating crews and other appropriate drilling equipment. Toward that objective, we have already started to evaluate potential contractors both within and outside of Israel.

License Requirements

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

Under the terms of the Asher-Menashe License extension, the Company is required to perform a perforation and stimulation operation at the Elijah #3 well and conduct a production test. If the outcome of the test is negative, the well is to be plugged and abandoned ("P&A") and within 60 days thereafter, a final report should be submitted and the license is to be returned. The Company is planning to undertake these operations starting in mid to late November, 2013.

Under the Joseph License extension, the Company is required to complete the plugging and abandonment of its two wells within the license area by October 1, 2013 to be followed by submission of a report. As of the date of this filing, the Company has completed the plugging obligations of the two wells within the Joseph License area. The Company acknowledges its obligation to complete the abandonment of the two wells in accordance with guidance from the Environmental Ministry even though the Joseph License period has technically expired.


Under the terms of the Jordan Valley License, we were to identify a drilling prospect in the license area and contract for the drilling of such prospect by October 13, 2012 and to drill a well to a target depth of approximately 5,000 meters by April 13, 2013. We identified several exploration leads in the license area as we reassessed our existing seismic data in preparation for submitting our new Megiddo-Jezreel Valley License application. We will need additional pre-drilling exploratory work such as seismic data reprocessing as well as acquisition, to identify, if possible, a drillable prospect. Accordingly, we will need extensions of the requirements that we enter into a drilling contract to drill an exploratory well in the license area, and we plan to submit a work plan to extend the Jordan Valley License for at least one year beyond the current expiration date of April 12, 2014.

At this point, we are unable to assess the implications, if any, of our non-compliance with the express terms of our licenses.

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 newly revised permitting process regime will result in further delays in meeting the express terms of the licenses.

We routinely update the Commissioner's office with all relevant developments, including delays in the time frames specified in our licenses and previous requests for extensions. However, we cannot provide any such assurance that we will be granted such extensions in the future.

New Onshore Licensing and Oil and Gas Exploration Guidelines

The procedure for Israeli onshore exploratory licensing and exploration drilling has undergone considerable modification. Under recently adopted guidelines first proposed in June 2012 by the Energy Ministry, applicants for new exploration licenses now need to comply with much more demanding requirements relating to the applicant's financial capability, experience and access to experienced personnel.

More recently, in July 2013, the Environmental Ministry published:
"Environmental Guidelines for the preparations of an environmental document supplementary to a license for searching - experimental drilling and land extraction tests." This document details the extensive requirements for a supplemental environmental document to an oil and gas exploration plan. For additional detail, refer to Note 5, Subsection C, Environmental and Onshore Licensing Regulatory Matters.

We believe that these new regulations will significantly increase the expenditures associated with obtaining new exploration rights and considerably increase the time needed to obtain all of the necessary authorizations and approvals prior to drilling new wells.

Capital Resources Highlights

We will need to raise significant funds to drill our next exploratory well to the desired depth. No assurance can be provided that we will be successful in raising the needed capital on terms favorable to us (or at all).

Toward that end, on March 27, 2013, we launched a Dividend Reinvestment and Direct Stock Purchase Plan (the "Plan") which offers investors the ability to purchase shares of our common stock directly from us. Additionally, through November 29, 2013, investors can also purchase under the Plan units of the Company's securities with each unit comprised of (i) one share of common stock and (ii) a warrant to purchase an additional share of the Company's common stock. The warrant will become first exercisable on December 30, 2013 and continue to be exercisable through December 30, 2018 at a per share exercise price of $2.00. The Plan is being administered by Registrar and Transfer Company of Cranford, New Jersey, which also serves as our stock transfer agent.


Under the Plan, investors can make an initial investment in our common stock or units, or a combination of both, with an initial payment of $250 or more and up to $10,000. Once a registered shareholder, an investor can increase its holdings of our common stock or units (while the units continue to be offered) through optional monthly cash payments of $50 or more. Investors interested in investing over $10,000 can also participate in the waiver program administered by our stock transfer agent. As of October 31, 2013, the Company raised approximately $1,984,000 by issuing shares and units to shareholders under the Plan.

Principal Components of our Cost Structure

Our operating and other expenses primarily consist of the following:

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

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

o 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.

Critical Accounting Policies

We have identified the accounting principles which we believe are most critical to the reported financial status. 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. 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.

Impairment of Oil and Gas Properties

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.

Our 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.

During the nine months ended September 30, 2013, we recorded a non-cash impairment charge of approximately $1,851,000 of our unproved oil and gas properties representing the remaining capitalized cost of the Joseph License. Following the impairment charges noted above, the total net book value of our unproved oil and gas properties under the full cost method is $3,428,000 at September 30, 2013.

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
                                                    2013                 2012              2013                 2012
                                                       (US $ in thousands)                    (US $ in thousands)
General and administrative expenses
Legal and professional fees                              262                  296               848                  912
Salaries                                                 527                  869             1,730                3,073
Other                                                    477                  429             1,701                2,536
Impairment of unproved oil and gas properties              -                    -             1,851                    -
Subtotal G&A                                           1,266                1,594             6,130                6,521

Other expense (income), net                              (25 )                 (7 )             (38 )                (32 )

Net loss                                               1,241                1,587             6,092                6,489

Revenue. We have no revenue generating operations, as we are still a development stage oil and gas company.

General and administrative expenses. General and administrative expenses were $1,266,000 and $6,130,000 for the three and nine months ended September 30, 2013 compared to $1,594,000 and $6,521,000, respectively, for the three and nine months ended September 30, 2012. The decrease in general and administrative expenses during the three and nine months ended September 30, 2013 as compared to the corresponding periods in 2012 is primarily attributable to a deliberate effort to run the Company more efficiently, resulting in reduced costs in salaries and other expenses, offset by the impairment charge of $1,851,000 recorded during the nine months ended September 30, 2013 representing the remaining capitalized cost of the Joseph License. Legal and professional fees were $262,000 and $848,000 for the three and nine months ended September 30, 2013 compared to $296,000 and $912,000, respectively, for the three and nine months ended September 30, 2012. The decrease in legal and professional fees during the three and nine months ended September 30, 2013 as compared to the corresponding periods in 2012 is primarily attributable to the decreased utilization of legal services. Salary expenses were $527,000 and $1,730,000 for the three and nine months ended September 30, 2013 compared to $869,000 and $3,073,000, respectively, for the three and nine months ended September 30, 2012. The decrease in salary expenses during the three and nine months ended September 30, 2013 as compared to the corresponding periods in 2012 is primarily attributable to a lesser salary cost due to a reduction in workforce and cost coupled with a lesser non-cash expense recorded in connection with stock option grants that were awarded in December 2011 and 2012. Other general and administrative expenses were $477,000 and $1,701,000 for the three and nine months ended September 30, 2013 as compared to $429,000 and $2,536,000, respectively, for the three and nine months ended September 30, 2012. Other general and administrative expenses are comprised of non-compensation and non-professional expenses incurred. The decrease in other general and administrative expenses during the nine months ended September 30, 2013 as compared to the corresponding periods in 2012 is primarily attributable to decreased marketing and investor relations related expenses and operational expenses. The Increase in other general and administrative expenses during the three months ended September 30, 2013 as compared to the corresponding periods in 2012 is immaterial.


Other expense (income), net. Other expense (income), net, was ($25,000) and ($38,000) for the three and nine months ended September 30, 2013 as compared to ($7,000) and ($32,000), respectively, for the three and nine months ended September 30, 2012. The increase in other income during the three and nine months ended September 30, 2013 as compared to the corresponding periods in 2012 is primarily attributable mainly to currency exchange gains generated by exchange rate fluctuations of the U.S. dollar against the New Israeli Shekel.

Net Loss. Net loss was $1,241,000 and $6,092,000 for the three and nine months ended September 30, 2013 compared to $1,587,000 and $6,489,000, respectively, for the three and nine months ended September 30, 2012.The decrease in net loss for the three and nine months ended September 30, 2013 as compared to the corresponding periods in 2012 is primarily attributable to the strategic effort to enhance Company efficiency, resulting in reduced costs in salaries and other expenses, as mentioned above.

Liquidity and Capital Resources

Liquidity is a measure of a company's ability to meet potential cash requirements. We have historically met our capital requirements through the issuance of common stock (or securities convertible into common stock) as well as proceeds from the exercise of warrants and options to purchase common equity.

At September 30, 2013, we had approximately $12,632,000 in cash and cash equivalents compared to $14,983,000 at December 31, 2012.

During the nine months ended September 30, 2013, cash used in operating activities totaled $3,135,000. Cash provided by financing activities during the nine months ended September 30, 2013 was $1,924,000 and is attributable to proceeds received from the Dividend Reinvestment and Direct Stock Purchase Plan (the "Plan") which offers investors the ability to purchase units and shares of our common stock directly from us. Net cash used in investing activities such as unproved oil and gas properties and other assets was $1,140,000 during the nine months ended September 30, 2013.

In advancing our exploration programs, we expect to incur substantial expenditures. We estimate that, when we are not actively drilling a well, our expenditures are approximately $460,000 per month excluding exploratory operational activities. However, when we become engaged in active drilling operations, we estimate an additional minimum expenditure of approximately $2,500,000 per month. The drilling cost estimates are subject to change. Management believes that our existing cash balance will be sufficient to finance our plan of operations through December 30, 2014. However, there are factors that can adversely impact our ability to fund our operating needs through such date, including (without limitation), unexpected or unforeseen cost overruns in planned non-drilling exploratory work (e.g., seismic acquisition, drilling and environmental permit acquisition costs, etc.) in existing and newly sought license areas and the costs associated with extended delays in undertaking the required exploratory work, which is typical of what we have experienced in the past, or plugging and abandonment activities. We are considering various alternatives with respect to raising additional capital but to date have made no specific plans or arrangements, except for the launch in March 2013 of the Plan discussed above. We expect that when we seek to raise additional capital it will be through the sale of equity securities, debt or other financing arrangements. Due in part to our lack of any oil and natural gas reserves, there can be no assurance this capital will be available and if it is not, we may be . . .

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