with characteristics of both liabilities and equity. The statement requires that we classify as liabilities the fair value of all mandatorily redeemable financial instruments that had previously been recorded as equity or elsewhere in our consolidated financial statements. This statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise effective for all existing financial instruments, except for minority interests in limited-life entities, beginning in the third quarter of 2003. This statement did not affect our financial statements.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The following summarizes several of our critical accounting policies. See a complete list of significant accounting policies in Note 2 to our consolidated financial statements.

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from these estimates. The use of these estimates significantly affects natural gas and oil properties through depletion and the full cost ceiling test, as discussed in more detail below.

Oil and Natural Gas Properties

We account for investments in natural gas and oil properties using the full-cost method of accounting. All costs directly associated with the acquisition, exploration and development of natural gas and oil properties are capitalized. These costs include lease acquisitions, seismic surveys, and drilling and completion equipment. We proportionally consolidate our interests in natural gas and oil properties. We capitalized compensation costs for employees working directly on exploration activities of $1.0 million, $1.0 million and $1.4 million in 2001, 2002 and 2003, respectively. We expense maintenance and repairs as they are incurred.

We amortize natural gas and oil properties based on the unit-of-production method using estimates of proved reserve quantities. We do not amortize investments in unproved properties until proved reserves associated with the projects can be determined or until these investments are impaired. We periodically evaluate, on a property-by-property basis, unevaluated properties for impairment. If the results of an assessment indicate that the properties are impaired, we add the amount of impairment to the proved natural gas and oil property costs to be amortized. The amortizable base includes estimated future development costs and, where significant, dismantlement, restoration and abandonment costs, net of estimated salvage values. The depletion rate per Mcfe for 2001, 2002 and 2003 was $1.15, $1.41 and $1.55, respectively.

We account for dispositions of natural gas and oil properties as adjustments to capitalized costs with no gain or loss recognized, unless such adjustments would significantly alter the relationship between capitalized costs and proved reserves. We have not had any transactions that significantly alter that relationship.

The net capitalized costs of proved oil and natural gas properties are subject to a "ceiling test" which limits such costs to the estimated present value, discounted at a 10% interest rate, of future net revenues from proved reserves, based on current economic and operating conditions. If net capitalized costs exceed this limit, the excess is charged to operations through depreciation, depletion and amortization.

In mid-March 2004, during the year-end close of our 2003 financial statements, it was determined that there was a computational error in the ceiling test calculation which overstated the tax basis used in the computation to derive our after-tax present value (discounted at 10%) of future net revenues from proved reserves. We further determined that this tax basis error was also present in each of our previous ceiling test computations dating back to 1997. This error only affected our after-tax computation, used in the ceiling test calculation and the unaudited supplemental oil and gas disclosure, and did not impact our: (1) pre-tax valuation of the present value (discounted at 10%) of future net revenues from proved reserves, (2) our proved reserve volumes, (3) our EBITDA or our future cash flows from operations, (4) our net deferred tax liability, (5) our estimated tax basis in oil and gas properties, or (6) our estimated tax net operating losses.

After discovering this computational error, the ceiling tests for all quarters since 1997 were recomputed and it was determined that no write-down of our oil and gas assets was necessary in any of the years from 1997 to 2003. However, based upon the oil and natural gas prices in effect on December 31, 2001, March 31, 2003 and September 30, 2003, the unamortized cost of oil and natural gas properties exceeded the cost center ceiling. As permitted by full cost accounting rules, improvements in pricing and/or the addition of

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