the
capital expenditures associated with building a cogeneration plant are not likely
to be warranted for a period of several years. As a result, we determined that,
rather than awaiting the construction of a cogeneration plant, we would instead
further develop our Camp Hill properties with the existing steam generators. In
August 2005, management proposed the acceleration of the Camp Hill development
to our board of directors. Accordingly, a development plan was formally approved
by the board for increased drilling activity in the Camp Hill field, beginning
with an initial 60-well drilling program. In February 2006, our board of directors
formally approved a multi-year plan to fully develop the entire Camp Hill field.
In furtherance of this plan, we expect to drill between 35 and 40 gross wells
(35 to 40 net) in this area at an estimated cost of $3.2 million during 2006.
To fully develop the field, we expect to drill approximately 326 wells from 2006
through 2017, at a total cost of approximately $22 million and total operating
costs including steam of approximately $175.0 million. The precise timing and
amount of our expenditures on additional well drilling and increased steam injection
to develop the proved undeveloped reserves in this project will depend on several
factors including the relative prices of oil and natural gas. We
have recently taken other steps to accelerate Camp Hill development. To implement
our development plan, we have entered into a new fuel gas supply contact; we are
upgrading the steam generator burners and burner controls; and we have obtained
a 30-well drilling rig contract. This rig was placed in the field in late March
2006. We recommenced steam injection in the Camp Hill field in April 2006. Other
Project Areas in the East Texas Region We have
leased nine additional exploratory prospects in our East Texas region and an additional
seven prospects that are currently being pursued. We expect to invest $1.9 million
to drill one (0.5 net) well in these areas other than Camp Hill in 2006. Wyoming/Montana
Coalbed Methane Project Area Rocky Mountain Region
In June 2003, we contributed our Powder River Basin
interests, including all leasehold, wells and reserves, in the Arvada, Bobcat,
Clearmont and Kirby prospects into the formation of Pinnacle. Our interests in
Castle Rock, Montana and Oyster Ridge, Wyoming were retained. While no proved
reserves have yet been booked in either area, drilling operations were conducted
at both during 2005, with two and four wells respectively drilled in each area.
As the end of 2005, we owned direct interests in approximately 159,090 gross acres
(including 21,864 acres which have now been optioned via drill-to-earn provisions
of a farmout at Oyster Ridge). At year-end 2005, Pinnacle
had completed the acquisition and/or drilling of 624 gross wells, or approximately
336 net. Of those wells, 621 encountered coal accumulations. Coalbed methane wells
typically first produce water in a process called dewatering and then, as the
water production declines, begin producing methane gas at an increasing rate.
As the wells mature, the production peaks and begins declining. As
of December 31, 2005, Pinnacle had drilled 383 wells; of these wells, (1) 283
are producing gas; (2) 47 remain in the completion/hook-up phase; (3) 33 are in
the dewatering phase with no early indication as to gas production; (4) 17 are
waiting on or being evaluated for workovers or redrill or plugging and abandonment;
and (5) three of these wells did encounter coal accumulations. As
of December 31, 2005, of the 241 wells that Pinnacle had acquired, (1) 81 are
producing gas, (2) 108 remain in the completion/hook-up phase; (3) 17 are in the
dewatering phase with no early indication as to gas production; (4) 12 are waiting
on or being evaluated for workovers or redrill or plugging and abandonment; (5)
18 that are producing gas at uneconomic rates are currently shut in; and (6) five
have been plugged and abandoned. The dewatering process
may require significant time and resources, and there can be no assurance that
a well that encounters coal accumulations will in fact produce gas in commercial
quantities. The ultimate commercial success of the well will depend upon several
factors, including the establishment of gas and/or water inflow, the presence
of pipelines and infrastructure, the satisfaction of engineering or production
issues and other risks and uncertainties associated with drilling activities.
See “Regulation - Coalbed Methane Proceedings in Montana”
for a description of certain regulatory proceedings affecting coalbed methane
drilling in Montana. | 
