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The Company believes the following critical
accounting policies affect its more significant judgments and estimates
used in the preparation of its consolidated financial statements:
OIL AND NATURAL GAS PROPERTIES
Investments in oil and natural gas properties
are accounted for using the full-cost method of accounting. All
costs directly associated with the acquisition, exploration and
development of oil and natural gas properties are capitalized. Such
costs include lease acquisitions, seismic surveys, and drilling
and completion equipment. The Company proportionally consolidates
its interests in oil and natural gas properties. The Company capitalized
compensation costs for employees working directly on exploration
activities of $1.0 million, $1.4 million and $1.7 million in 2002,
2003 and 2004, respectively. Maintenance and repairs are expensed
as incurred.
Oil and natural gas properties are amortized
based on the unit-of-production method using estimates of proved
reserve quantities. Investments in unproved properties are not amortized
until proved reserves associated with the projects can be determined
or until they are impaired. Unevaluated properties are evaluated
periodically for impairment on a property-by-property basis. If
the results of an assessment indicate that the properties are impaired,
the amount of impairment is added to the proved oil and natural
gas property costs to be amortized. The amortizable base includes
estimated future development costs and, dismantlement, restoration
and abandonment costs, net of estimated salvage values. The depletion
rate per Mcfe for 2002, 2003 and 2004 was $1.41, $1.55 and $1.86,
respectively.
Dispositions of oil and natural gas properties
are accounted for 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.
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. During the year-end close of 2003, a
computational error was identified in the ceiling test calculation
which overstated the tax basis used in the computation to derive
the after-tax present value (discounted at 10%) of future net revenues
from proved reserves. This tax basis error was also present in each
of the previous ceiling test computations dating back to 1997. This
error only affected the after-tax computation, used in the ceiling
test calculation and the unaudited supplemental oil and natural
gas disclosure and did not impact: (1) the pre-tax valuation of
the present value (discounted at 10%) of future net revenues from
proved reserves, (2) the proved reserve volumes, (3) our EBITDA
or our future cash flows from operations, (4) the net deferred tax
liability, (5) the estimated tax basis in oil and natural gas properties,
or (6) the 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 oil and natural 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 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 proved reserves subsequent to those dates sufficiently increased
the present value of the oil and natural gas assets and removed
the necessity to record a write-down in these periods. Using the
prices in effect and estimated proved reserves on March 31, 2003
and September 30, 2003, the after-tax write-down would have been
approximately $1.0 million and $6.3 million, respectively, had we
not taken into account the subsequent improvements. These improvements
at September 30, 2003 included estimated proved reserves attributable
to our Shady Side # 1 well. Because of the volatility of oil and
natural gas prices, no assurance can be given that we will not experience
a write-down in future periods.
Depreciation of other property and equipment
is provided using the straight-line method based on estimated useful
lives ranging from five to 10 years.
OIL AND NATURAL GAS RESERVE ESTIMATES
The process of estimating quantities of proved
reserves is inherently uncertain, and the reserve data included
in this document are estimates prepared by Ryder Scott Company,
DeGolyer and MacNaughton and Fairchild & Wells, Inc., independent
petroleum engineers. Reserve engineering is a subjective process
of estimating underground accumulations of hydrocarbons that cannot
be measured in an exact manner. The process relies on interpretation
of available geologic, geophysical, engineering and production data.
The extent, quality and reliability of this data can vary. The process
also requires certain economic assumptions regarding drilling and
operating expense, capital expenditures, taxes and availability
of funds. The SEC mandates some of these assumptions such as oil
and natural gas prices and the present value discount rate.
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