Zephyr Energy “a self-sustaining, cash generating, oil producing group”

Zephyr Energy

Zephyr Energy plc (LON:ZPHR), the Rocky Mountain oil and gas company focused on responsible resource development from carbon-neutral operations, has announced its audited results for the year ended 31 December 2021.

Highlights

A transformational period in which Zephyr evolved from a single project exploration company into a self-sustaining, cash generating, oil producing group with a balanced portfolio of operated and non-operated assets in two established U.S. oil producing basins.

 Paradox Project, Utah, U.S. (operated asset)

· First flowing hydrocarbons from the Company’s State 16-2 LN-CC well, a historical and operational milestone after many years of investment in the project.

· Sproule completed Competent Persons Report (“CPR”) which highlighted the scale and resource potential of the project:

o  2P Reserves: First Paradox Basin Proved Reserves of 2.1 million barrels of oil equivalent (“boe”)

o  2C Resources: 27 million boe

o  Prospective resources from overlying reservoirs: 203 million net unrisked boe (68 million boe risked with a weighted-average 33% chance of success)

· Preparations are well underway for the commencement of a high impact three-well drilling programme to further delineate the scale of the project.

Williston Basin, North Dakota, U.S. (non-operated assets)

· Following the completion of several discrete acquisitions, the Company now has a cash-generative non-operated portfolio with working-interests in 219 wells in the Williston Basin, North Dakota, U.S.

· First quarter 2022 sales from the portfolio were over 1,600 barrels of oil equivalent per day (net to Zephyr) with corresponding revenues of US$11.5 million.

· Non-operated portfolio expected to have turnover of US$35-40 million in 2022, providing significant operating cash flow available for reinvestment into the Paradox project development.

Financial

· The Group reports a net profit after tax for the year ended 31 December 2021 of US$0.8 million, reflecting the initial cashflows from its non-operated asset portfolio.

· Revenues for the year from the non-operated asset portfolio were US$6 million with a gross profit of US$3.3 million.

· At 31 May 2022, the Group had cash and cash equivalents of US$11.9m (which includes cash receipts from the non-operated portfolio for the month of May 2022 which were received in early June 2022).

Corporate

· In February 2022, the Company announced that it had raised a further US$17.4 million (before expenses) through the placing of new Ordinary Shares in the Company, along with raising US$28 million through a senior debt facility. The net proceeds from these debt and equity instruments were used to complete the Group’s US$36 million acquisition of non-operated assets in the Williston Basin and to fund further drilling activity across the portfolio.

· In line with the Company’s ESG objectives, Zephyr achieved carbon-neutrality across its operational footprint (through the purchase of Verified Emission Reduction credits (or “VERs”)) prior to its published goal of 30 September 2021.

Rick Grant, Zephyr’s Non-Executive Chairman, said: 

 “The period under review was a time of substantial progress in the ongoing transformation of Zephyr. During this period the Group evolved from a single project exploration company into a self-sustaining, cash generating, oil producing group with a balanced portfolio of operated and non-operated assets located in two established oil producing basins in the U.S.

“The 2022 fiscal year promises to be an equally exciting time for our Shareholders as we aim to bring our State 16-2LN-CC well into commercial production and commence our proposed three well drill programme on the Paradox project. A successful drilling programme will see the Group further defining the Paradox project and materially increasing its reserve base in the project, and expected to deliver significant cashflows. This activity will be fully funded by cashflows from our non-operated asset portfolio in the Williston Basin, North Dakota, U.S. (the “non-operated portfolio”), which was formed during the period under review through a number of discrete acquisitions with the main purpose of funding our proposed activity on the Paradox project.

“Our forthcoming activity across all our operations will be carried out consistent with our core values of being responsible stewards of investors’ capital and responsible stewards of the environment.”

Notice of AGM

The Annual General Meeting of the Shareholders of the Company will be held at 10 a.m. on 21 July 2022 at the offices of Zephyr Energy plc, First Floor, Newmarket House, Market Street, Newbury, Berkshire, RG14 5DP.  

Further details are set out in the notice of AGM. A copy of the Company’s annual report and accounts, which includes the notice of AGM, will shortly be available on Zephyr’s website, http://www.zephyrplc.com , and posted to Zephyr’s Shareholders.

Extension of warrants

In November 2019, certain Directors were issued with warrants to subscribe for Ordinary Shares in the Company at a price of 2 pence per Ordinary Share (“Warrants”). These Warrants were issued in connection with the equity placing that was carried out by the Company and announced on 4 November 2019 (the “Placing”). In the Placing, Chris Eadie (Finance Director of Zephyr) invested £10,000, and in accordance with the terms of the Placing, he was issued 454,545 Warrants. Origin Creek Energy LLC (“OCE”) invested £480,000 and was issued with 21,818,182 Warrants. The shareholders and directors of OCE are Rick Grant, the Chairman of Zephyr, and Colin Harrington, the CEO of Zephyr. Colin Harrington is indirectly the controlling shareholder of OCE.  

On 22 November 2021 the exercise period for these Warrants was extended until 30 June 2022. However, due to continued circumstances beyond their control these directors have not been able to exercise their Warrants and therefore the Independent Directors (Gordon Stein and Tom Reynolds) have agreed to an extension of the exercise period for these Warrants for a further six months until 31 December 2022.

The agreement to extend the exercise date of the Warrants held by OCE and Chris Eadie is a related party transaction pursuant to rule 13 of the AIM Rules for Companies.  Accordingly, the Independent Directors of Zephyr (Gordon Stein and Tom Reynolds) consider, having consulted with the Company’s nominated adviser, that the terms of the transaction are fair and reasonable insofar as the Company’s shareholders are concerned .

Chairman’s Statement

Overview

The period under review was a time of substantial progress in the ongoing transformation of Zephyr. During this period the Group evolved from a single project exploration company into a self-sustaining, cash generating, oil producing group with a balanced portfolio of both operated and non-operated assets located in two established oil producing basins in the U.S.

I am incredibly proud of what was achieved during the period, and we remain fully committed to our primary goal of opening up the next prolific onshore U.S. oil and gas play through the systematic development of our flagship project in the Paradox Basin, Utah, U.S. (the “Paradox project”).

The 2022 fiscal year promises to be an equally exciting time for our Shareholders as we aim to bring our State 16-2LN-CC well into commercial production and commence our proposed three well drill programme on the Paradox project. A successful drilling programme will see the Group further defining the Paradox project, will deliver significant cashflows, and will see the Group materially increasing its reserve base in the project. This activity will be fully funded by cashflows from our non-operated asset portfolio in the Williston Basin, North Dakota, U.S. (the “non-operated portfolio”), which was established during the period under review , and since, t hrough a number of discrete acquisitions with the main purpose of funding our proposed activity on the Paradox project.

Our forthcoming activity across all our operations will be carried out consistent with our core values of being responsible stewards of investors’ capital and responsible stewards of the environment.

Background

Our goals for 2021 were simple but ambitious. We were determined to transform the Group into a well-capitalised hydrocarbon producer, with healthy cashflows and significant growth potential. I am delighted to report that 2021 saw us deliver on all these key objectives.

Our results are even more remarkable when one considers that they were achieved in spite of the backdrop of the second year of the global pandemic. I was thoroughly impressed that our management team and contractors dealt with the extraordinary circumstances in such a positive and effective way, and always with a view to ensuring the welfare of our people and the minimal disruption to our announced timeframes. That we achieved so much during a time of significant market instability, particularly for energy companies, is testament to their abilities and performance and I am extremely grateful for their efforts.

Operational activity

After many years of investment in the Paradox project, it was gratifying that the Group was able to make material progress towards unlocking the potential considerable value of the project during the period. In particular, we saw the first flowing hydrocarbons at the State 16-2LN-CC well from the Cane Creek reservoir target during our highly successful well test. This well test exceeded management’s pre-drill estimates and achieved a proven rate-constrained production high of 1,083 barrels of oil equivalent per day (“boepd”), with internal modelling indicating potential flow rates of 2,100 boepd once it is no longer rate-constrained. The well test clearly demonstrated that 16-2LN-CC is both a sizeable and potentially profitable well, and it endorsed Zephyr’s strategy of the proposed wider development of the Paradox project.

Zephyr’s position within the Paradox Basin was also given a significant boost in 2021 when the United States Bureau of Land Management (the “BLM”) approved the formation of a new 25,000-acre Federal Unit, known as the White Sands Federal Unit (the “WSU”), which incorporated all of the Group’s leases covered by its historic 3D seismic survey. This provides us with increased security of tenure and an excellent long-term framework for the development of our lease acreage, including the lease on which the State 16-2LN-CC well is situated. 

The ultimate scale and resource potential of the Paradox project was further demonstrated with the completion of an updated independent reserves and resource evaluation, conducted by Sproule International Limited (“Sproule”), the key findings of which were published in April 2022 (the “CPR”). Following the success of the State 16-2LN-CC well, the CPR saw the first proven reserves booked for the Paradox project, with a 2P figure of 2.1 million net barrels of oil equivalent (“boe”). In addition, the CPR saw the doubling of our 2C resource estimates across the Cane Creek reservoir with 27 million net boe, up from 12.3 million boe reported in the Group’s previous CPR on the Paradox project that was carried out in 2018.

The plan for the Paradox project for the remainder of the current financial year is to recommence production from the State 16-2LN-CC well, with gas volumes produced being utilised by a co-located crypto-mining facility, and to commence our proposed three well drilling campaign to further delineate the scale and production potential of the project. At the time of writing, we expect to have the State 16-2LN-CC in production by the end of September, and we are making final preparations for our fully funded three well campaign which is due to commence in the coming weeks.

 A key accomplished objective for 2021 was to grow production and positive cash flow for the Group via a combination of our existing portfolio and acquisitions. The rapid growth of our portfolio of non-operated production assets in the Williston Basin, through a number of discrete acquisitions, was a major development in helping us achieve this objective. Our ability to self-fund the upcoming Paradox drilling campaign is the result of successfully executing this strategy of building out our cash generative non-operated portfolio to ensure the organic development of the Paradox project.

Our non-operated portfolio, which currently consists of working-interests in 219 wells (the vast majority of which are currently in production), is expected to provide US$35-40 million of revenue, net to Zephyr, in 2022. In Q1 2022, Zephyr’s revenues from the non-operated portfolio were US$11.5 million, resulting in operating cashflows to the Group of US$9.8 million, demonstrating our ability to self-finance the operational activity across our portfolio.

Environmental, Social and Governance (“ESG”)

In a year that saw COP26 hosted in Glasgow bringing The Paris Agreement on climate change into ever sharper focus, Zephyr demonstrated its commitment to play its part in this essential global effort. We will always aspire to have ESG credentials that are amongst best in class. This was no more evident than when we achieved, ahead of schedule, our stated target of “net-zero” operational carbon impact. This was done primarily through our programme of purchasing Verified Emission Reduction credits (“VERs”), designed to mitigate all Scope 1 carbon emissions and was an initiative that was unanimously supported by the Company’s Board of Directors (“Board”).

Followers of Zephyr will be familiar with our commitment to stewardship of both the natural environment and Shareholder capital at the core of all our activity. Prudent and careful cash management and ESG focus were clearly in evidence during the period under review and remain the central tenet of our philosophy. The Board firmly believes this is not only the right way to run the Group but the approach that will ensure our ongoing success on behalf of all stakeholders. Good environmental and operational performance, supported by the appropriate levels of governance is the optimal way to drive superior investor returns. The progress made in 2021 was a clear sign of our firm intent to operate within these key principals and we intend to ensure that they remain embedded at the heart of the Group.

Conclusion

On behalf of the Board, I would like to thank everyone within Zephyr for their unswerving hard work and commitment during this transformational period. I would also like to extend my heartfelt gratitude to our Shareholders and advisers for their continued support. Due to the achievements of 2021, we can look to the future with a high degree of confidence and excitement as we continue in our pursuit of building a Group of which all our stakeholders can be proud.

RL Grant

22 June 2022

Strategic report

PRINCIPAL OBJECTIVES AND STRATEGIES

Zephyr Energy plc is an Oil & Gas (“O&G”) exploration and production group operating in the Rocky Mountain region of the U.S.

The Group’s stated mission is to open up the next prolific onshore U.S. oil and gas play through the development of its flagship Paradox project. The two core values of the Group are to be responsible stewards of investors’ capital and responsible stewards of the environment.

To achieve this mission, the Group has prioritised:

· constructing a team with significant experience in the U.S./Rocky Mountain O&G sector, with a particular focus on operations, development, governance, finance, merger and acquisition and turnaround experience;

· a sharpening of focus – we are wholly focused on responsible Exploration and Production (“E&P”) investment in the Rocky Mountain region and have exited all other legacy sectors and geographies;

· the development of a non-operated asset portfolio that provides cashflow to be reinvested in the Paradox project;

· the redoubling of ESG efforts, including corporate governance compliance, ensuring carbon-neutrality across our operations, and proactive engagement with the communities in which we operate;

· the leveraging of partnerships (such as the U.S. Department of Energy, experienced operators in the Basins in which we operate, and private equity investors);

· the design and build of a technology-led acquisition process which can rapidly assess opportunities of further interests through acquisition, farm-in agreements or joint venture arrangements; and

· tight financial control and cash conservation.

REVIEW OF OPERATIONS AND FUTURE DEVELOPMENTS

Background

As outlined in the Chairman’s Statement, the period under review has been one of extraordinary progress and transformation for Zephyr.

During this period the Group has achieved multiple operational milestones, most notably with the first flowing hydrocarbons from our flagship Paradox project and with the construction of our cash generating non-operated portfolio.

The Group’s operated asset is in the Paradox Basin where it holds a 37,613-acre leasehold and, following the initial drilling success during the year, the Group is expecting its first commercial production from its State 16-2LN-CC well by the end of the third quarter of this year, with gas volumes produced being utilised by a co-located crypto-mining facility which is currently under development. The Group is also well underway with the planning of a three-well drill programme which will commence in the coming weeks to further delineate the scale and production potential of the project.

The Group’s non-operated production comes from working-interests in wells across the Bakken and Three Forks formations in the Williston Basin, North Dakota. Zephyr currently has working-interests in 219 wells and Q1 2022 sales from the non-operated portfolio was circa 1,600 boepd (net to Zephyr) resulting in corresponding revenues for Zephyr from the portfolio of circa US$11.5 million for the quarter.

The Board’s strategy is to recycle the considerable cashflows expected to be generated from the non-operated Williston Basin portfolio into the proposed Paradox development programme, and this organic growth strategy is expected to enable the Group to fully fund the three-well drilling programme on the Paradox project planned for later this year.

In the Board’s opinion the Group’s asset portfolio is ideally positioned, with the cash generating, non-operating portfolio providing Shareholders with an engine that can drive the development of the Paradox project and help unlock its potential considerable upside. Set out below is a detailed summary of the progress made across both our operated and non-operated portfolios during the period under review.

Paradox project – operated asset

Background

Having completed the comprehensive restructuring of the Paradox project in 2020, which primarily involved overhauling the existing joint venture partnership and securing additional tenure for the most attractive project acreage, the key task for the 2021 financial year was to commence operations on the ground and to finally begin the process of delivering value from the project after many years of significant investment.  

The securing of a US$2 million U.S. Government grant in late 2020 enabled us to proceed with the drilling of the State 16-2 well and this was the catalyst for the considerable progress on the project in the period under review.

The State 16-2 well was completed in January 2021 having been successfully drilled to a measured depth of 9,745 feet total depth (“TD”). Drilling operations were safe and effective, conducted in accordance with Covid-19 related guidance and restrictions, and were completed well within the Group’s forecast timeframe.

The objective was to drill and set casing at 6,450 feet measured depth (“MD”) in order to provide a host wellbore for a future horizontal side track. This goal was achieved within thirteen days from spud which represented a marked improvement over historical drilling efforts in this part of the Paradox Basin. This reduction in drilling time represented a major operational success and demonstrated that the cost of future development wells could be materially reduced from our earlier estimates, thereby improving the overall potential value of the Paradox project for Shareholders.

Our secondary objective was to acquire a significant amount of new data to improve our understanding of our Paradox acreage. We were pleased to report that Zephyr’s data acquisition programme secured the following:

· approximately 113 feet of continuous whole core across the historically productive Cane Creek reservoir interval – the first whole Cane Creek core ever to be retrieved in the northern part of the Paradox Basin;

· rotary side wall cores in eleven shallower exploration targets; and

· gamma ray, neutron density, resistivity, formation litho scanner and sonic wireline log data across the bulk of the Paradox Formation, which secured significant additional petrophysical data.

Following the completion of drilling and data acquisition operations, the State 16-2 well was temporarily plugged at 6,450 feet TD, and left stable and for future re-use as a lateral wellbore host. 

Decision to proceed with State 16-2LN-CC lateral well

The core and log data acquired from the State 16-2 Cane Creek reservoir both corroborated and supported the Board’s long-held view that the Paradox project has the potential to be a project of considerable scale.

On 15 March 2021, Zephyr announced a detailed update on the Paradox project, which included confirmation of evidence of hydrocarbon saturation across the entirety of the continuous core acquired from the Cane Creek reservoir. When integrated with the recently acquired log data, existing 3D seismic data, and geologic and regional analogue analysis, the resulting analysis gave the Board strong justification for advancement to the next phase of the project. The Board therefore elected to proceed with detailed planning for the near-term drilling of the lateral well, and following the successful completion of a US$13.9 million fundraise in April 2021, the Group was fully funded to commence the drilling of the lateral portion of the well.

Drilling of the State 16-2LN-CC lateral well

Drilling operations commenced in July 2021, ahead of Zephyr’s forecast timeline and, in August 2021 the Group announced that the well was successfully drilled to a TD of 14,370 feet at which point a full suite of wireline logs was run and production casing was set.

Drilling operations achieved their main objective of hitting the Cane Creek reservoir target and staying within that reservoir across the entire lateral portion of the well. In addition, there was evidence of hydrocarbon charge across the entirety of the Cane Creek lateral, as well as in multiple overlying reservoirs.

With the setting of production casing, we were confident of having secured an excellent well bore platform from which to complete the well and test production from the Cane Creek reservoir.

Results from the State 16-2LN-CC data evaluation and diagnostic fracture injection test (“DFIT”)

Following the completion of the lateral well, the Group reported its results from the interpretation of the data acquired during drilling operations and the Board was particularly pleased that wireline data suggested that 85 per cent of the lateral had the potential to be completed for well testing and production, with additional positive data suggesting porosity and permeability estimates equivalent to other producing basins with prolific hydraulic stimulated resource potential (“HSRP”) development, as well as mud gas mass spectrometry evidence suggesting the presence of oil, gas and condensate with corresponding apparent low water saturations.

Based on the positive data received, the Board therefore elected to initiate a DFIT to provide additional insight into the potential for successful hydraulic stimulation on our acreage position. As the State 16-2LN-CC is the first horizontal well in this part of the Paradox Basin, the ability to develop a strong understanding of reservoir mechanical properties was crucially important to help assess the series of options for wider potential development.

In early September 2021, the Group announced the results from the DFIT, during which a 3 feet interval at the toe of the lateral was perforated and hydraulically stimulated.

The results from the DFIT were highly encouraging and suggested high formation pressure (a strong positive indicator of reservoir drive), permeability consistent with other prolific resource plays, and demonstrable evidence of hydrocarbons flowing into the well after stimulation. In addition, the DFIT provided rock mechanical data (including lithostatic gradient, effective stress and fracture propagation data) which was subsequently interpreted and provided valuable insight to assist with completion design.

In all, the results of the DFIT, combined with the significant amount of data previously gathered from the well, indicate that the State 16-2LN-CC had the potential to be an excellent “proof of concept” location for an HSRP test. 

On that basis, the Board unanimously approved proceeding with a HSRP completion at the State 16-2LN-CC.

First hydrocarbons produced from Paradox project

The HSRP completion commenced on 18 October 2021 and the Group subsequently announced that the operation was successfully completed. The well was stimulated in fourteen separate stages across 4,020 feet of horizontal lateral wellbore. The stimulation utilised a total of 40,000 barrels of water, 2.4 million pounds of sand and a cross linked gel fluid, all in line with pre-completion forecasts.

On 11 November 2021, the Board was delighted to announce the first flowing hydrocarbons from the State 16-2 LN-CC well which represented a significant historical and operational milestone for the Group, particularly as this was the first horizontal well in the wider Paradox Basin to flow hydrocarbons using a modern hydraulically stimulated completion.

The Group carried out 23 days of safe and successful production testing on the well and it demonstrated the potential to drain a larger hydrocarbon resource and with stronger economics than initially forecast by the Group.

Key conclusions from State 16-2 LN CC completion

· During the test, the well averaged rate-constrained daily rates of 716 boepd, with rate-constrained highs of 1,083 boepd achieved with limited pressure drawdown which was incredibly encouraging.

· Initial simulation modelling suggests possible plateau rates of 2,100 boepd are possible when the well is fully equipped and no longer rate-constrained. The test was rate-constrained to minimise flow assurance issues from salt deposition in the well bore. Future flow assurance issues are expected to be mitigated when the well’s final completion equipment is installed.

· Gas rates are substantially higher than expected, with modelling suggesting the well is capable of production plateau rates of 10 million square cubic feet of gas per day and 500 boepd of liquids.

· Initial data from the production test suggests the State 16-2LN-CC has a single well potential Estimated Ultimate Recovery (“EUR”) of 2.65 million barrels of oil equivalent (“mmboe”), significantly higher than the Group’s pre-drill estimates of up to 0.85 mmboe.

· Not only does this successful production test indicate the potential for a highly profitable single well, but the Board also believes the test will lead to a substantial reduction in development risk across our acreage while allowing for a future systematic development of the project – one with relatively predictable well distribution within both the Cane Creek reservoir as well as across the multiple overlying reservoirs.

Following the completion of the production testing, Zephyr commissioned the independent reserve consulting firm Sproule to complete a Competent Persons Report (“CPR”) to assess the Group’s reserves across both the Cane Creek reservoir and the eight overlying reservoirs.

Competent Persons Report 

The previous CPR on the Paradox project was completed in 2018 by Gaffney Cline & Associates (“2018 CPR”). In April 2022, the Group announced the results from Sproule’s CPR.

Sproule audited the crude oil, natural gas, and field condensate reserves and contingent resources and the associated future net revenue attributable to the WSU and Cane Creek DSU (“CC DSU”) with an effective date of March 31, 2022. Sproule also conducted an audit of the Prospective Resources attributable to the WSU on the same date.

The Board was delighted with the conclusions drawn by Sproule, which both demonstrate the impact of our recent drilling success and which further highlight the substantial potential scale and profitability of the Paradox project.

The key findings were as follows:

· 2P Reserves: First Paradox Basin Proved Reserves of 2.1 million boe, based on the State 16-2 LN-CC

· 2C Resources: 27 million boe – more than double the 2C Resources in the 2018 CPR

· Prospective resources from overlying reservoirs: 203 million net unrisked boe (68 million boe risked with a weighted-average 33% chance of success (“CoS”))

Combined with Zephyr’s Williston Basin non-operated portfolio, Zephyr’s total 2P Proved Reserves now have an estimated net present value at a ten per cent discount rate (“NPV-10”) of over US$111 million (up from zero value ascribed in 2018) with substantial multiples of additional upside potential from success cases related to its contingent and prospective resources. 

In determining the NPV-10 for the reserves and resources, Sproule utilised its March 31, 2022 price forecast for both oil and gas which includes a West Texas Intermediate (“WTI”) oil price forecast of US$93/barrel (“bbl”) in 2022, US$83/bbl in 2023, and US$73/bbl in 2024, with a further US$5.00 per barrel deduction for price differential. For the gas price forecast, Sproule used a Henry Hub gas price of US$5.00/per million British thermal units (“mmbtu”) in 2022, US$4.25/mmbtu in 2023, and US$3.25/mmbtu, with a further gas price differential of US$1.25 per million standard cubic feet (“mscf”) reduction from Henry Hub, a heating value of 1000 btu per mscf and a shrinkage of 5% for losses due to surface facilities. Prices and costs are escalated at 2.0% per annum until the price doubles, and are then held flat. 

The CPR marked a key milestone for the Group, further outlining the potential value in the Paradox project and due to the success of the State 16-2 LN-CC well, and our acquisition of proved reserves around the Cane Creek field, the Group was able to book Proved Reserves on the Paradox project for the first time.

Due to the early-stage nature of the Paradox Basin resource play, the range of outcomes for Zephyr’s Utah assets remains large. Both Zephyr and Sproule identified uncertainties due to limited data across the areas planned for development by the Group. These include fluid composition and compressibility, water production, continuity of geomechanical properties across the reservoir and their impact on hydraulic fracture characteristics, and stimulated area around a well (well drainage area). The Group plans to utilise its upcoming three well drilling campaign to further quantify both the risks and upside presented by these uncertainties.

Formation of the WSU Federal Unit

Following the successful State 16-2 LN-CC drilling programme, the Group was also thrilled to report that the BLM had approved the formation of a new 25,000-acre Federal Unit to be operated by Zephyr. The new unit, the WSU, incorporates the Group’s existing leases covered by its historic 3D seismic survey, including the lease on which the State 16-2LN-CC well is situated. 

The WSU approval, effective October 2021, was another key milestone in the Group’s ongoing development of the Paradox project. By consolidating over twenty separate leases into one overarching land agreement, Zephyr can focus on an optimal long-term development plan for the project as a whole, rather than maintaining its lease position in an ad-hoc fashion.

If the State 16-2 LN CC well is determined to be capable of delivering paying quantities of hydrocarbons, or if a second well is drilled on the WSU acreage within the next twelve months, the WSU will be extended beyond the initial 36-month extension currently approved by the BLM.

Next steps

Following the successful completion of State 16-2LN-CC well test and after taking into account the conclusions of the CPR, the Group intends to commence a high impact three-well drilling programme later this year to further delineate the scale of the project. This will include:

· one delineation/development well targeting the Cane Creek reservoir in Zephyr’s 25,000-acre WSU (the “State 36-2 LNW-CC” well);

· one exploration well targeting Clastic 9 to see the zones potential to host a resource play (the “State 36-3 LN-C9 well); and

· one delineation/development well in the historically prolific Cane Creek Field (new acreage south of the WSU)

Drilling permits for the drilling programme have been submitted, all necessary on-site surveys have been completed and negotiations continue with rig vendors.

Zephyr has also commenced work to equip the State 16-2LN-CC well for commercial production, and on 7 June 2022, the Group announced its plans to recommence production by the end of September 2022. Liquid volumes produced from the well will be trucked and sold to refineries in Utah, and produced gas volumes will be sold to fuel onsite power generators which in turn will provide electricity for the co-located crypto-mining facility.

The Group plans to fund the initial investment required to launch the initial 1 megawatt (“MW”) crypto-mining facility (capital expenditure forecast to be less than US$2 million) from existing cash resources or via third party investment, with facility capital payback expected in under two years at current crypto-currency prices.  CryptoKnight Energy, an experienced operator of oil industry co-located crypto mining operations, will serve as the general contractor for the construction and operation of the mining facility.

Following the testing of the 1MW facility, Zephyr may elect to build up to 4MW of power generation and crypto-mine facilities on the pad. Zephyr is evaluating a range of third-party investment options in the event it elects to expand the crypto-mining infrastructure.

Over the longer-term, the Group expects to tie its gas production from the Paradox project into the nearby gas export infrastructure recently purchased by Dominion Energy Inc. (“Dominion”) a Fortune 500 Company which currently services over seven million customers in the U.S. Dominion has made public its plans to refurbish and expand the natural gas infrastructure running across Zephyr’s acreage, and is expected to be available to accept gas volumes from Zephyr’s wells in 2023.

Williston Project – Non-operated asset

In January 2021, Zephyr stated that one of its key goals for the year was to establish production and positive cashflow either through its existing portfolio (the Paradox project), via acquisition, or through a combination of both. In the period under review, and since, the Group has delivered on this goal and the Board is incredibly proud that, following a series of acquisitions, the Group now has a non-operated portfolio that delivered sales of over 1,600 boepd, net to Zephyr, in Q1 2022, with corresponding revenues of US$11.5 million for the quarter.

The establishment of our non-operated portfolio began in March 2021, during a period of lower commodity prices, and with the integration of our recent US$36 million acquisition (completed in February 2022), our non-operated portfolio is expected to have a turnover of US$35-40 million in 2022, providing the Group with free cash flow to support of Paradox project development plans.

In order to lock in cashflow to develop our Paradox asset and meet our funding commitments, in April 2022, the Group hedged just under half of its forecast 2022 production at more than US$98 per barrel of oil.

Zephyr currently has working-interests in 219 wells, the vast majority of which are currently in production with multiple additional wells expected to be put in production over the next six months. The working-interests are in prime locations, and the majority of the wells are operated by Whiting Petroleum Corporation (“Whiting”), a leading Williston Basin producer.

Acquisitions

The non-operated portfolio has been carefully crafted and has been achieved through five discrete acquisitions, culminating in the completion of a transformative US$36 million acquisition (the “acquisition”) in February 2022. This acquisition nearly tripled the Group’s existing non-operated production from its four previous acquisitions.

The US$36 million acquisition was a game-changer for the Group, providing a stable foundation of low-decline production and cash flows from 163 gross producing wells. In addition, 18 drilled but uncompleted wells (“DUCs”) are expected to be brought online in the near term and 47 additional gross undeveloped locations are expected to provide meaningful upside for many years to come. The acreage is also highly complementary to the Group’s other interests in the Williston Basin.

The key benefits of the Acquisition are as follows:

· A diversified, low-decline production base with established history and stable cash flows

· Near term growth from DUC wells currently being brought online

· Potential to hedge a significant portion of the existing production at attractive prices to lock in returns and provide downside protection

· Excellent complement to (and funding source for) the less mature, higher upside Paradox Basin development

In order to fund the Acquisition, in January 2022, the Group undertook an equity fundraise of £12.8 million and secured a US$28 million senior debt facility from a long-established North Dakota-based commercial bank.

The Group’s non-operated portfolio continues to perform well ahead of the Board’s forecasts and expectations, in part due to the current high commodity price environment.

Production update

Q1 2022 sales from the Group’s non-operated portfolio averaged circa 1,600 boepd net to Zephyr, up from 548 boepd in Q4 2021. 

During Q1 2022, Zephyr sold 144,540 boe and net sales to Zephyr were as follows:

Oil: 109,940 barrels (“bbls”) at an average sales price of US$90.11 /bbl

Natural Gas: 114,096 million cubic feet (“mmcf”) at an average sales price of US$5.40 /mcf

Natural Gas Liquids: 15,584 bbls at an average sales price of US$64.19 per bbl

Q1 2022 revenues totalled US$11.5 million net to Zephyr, and Q1 2022 average operating expenditure was US$11.87 boe demonstrating the high profit margin realised from the hydrocarbons sold during the period.

16 new producing wells from Zephyr’s existing portfolio are expected to be brought online over the next six months.

Hedging

In April 2022, the Group hedged just under half of its forecast non-operated production over the next two years. Using an average hedged production price of US$98 for the remainder of the year and US$90 flat for the remainder of its anticipated production, the Group forecasts a range of US$35-40 million in revenue from production for FY 2022 from its non-operated portfolio based on forecast production range of 500,000 – 550,000 boe during the year. 

ENVIRONMENTAL, SOCIAL AND GOVERNANCE (“ESG”)

The Board is unanimously committed to ensuring that every action and investment decision the Group’s makes is in line with our core values of being responsible stewards of investors’ capital and responsible stewards on the environment. This includes the following points of focus:

· we will continue to protect the Group, safeguard its existing asset base and position it for attractive growth opportunities;

· we will continue to seek creative and beneficial funding opportunities in an effort to unlock value from our existing asset portfolio, as evidenced by the U.S. Government funding we received for our recent drilling programme on the Paradox project;

· we will continue to adopt a disciplined focus on growth via the acquisition of producing or near-term development opportunities in the Rocky Mountain region. Even in this unusual economic environment, we believe that attractive, value-additive acquisitions are available and may be acquired using non-traditional funding structures;

· we will continue with our programme of tight financial controls and cash preservation which will enable the Group to continue trading effectively; and

· we will continue to ensure management and the Board are aligned with our Shareholders through significant ownership of shares.

The Board is proud of how Zephyr conducted its operations in the period under review and we will always strive to adhere to our core values

A major milestone was achieved when the Zephyr announced carbon-neutrality across its operational footprint prior to its published goal of 30 September 2021.As an integral part of this undertaking, Zephyr is collaborating with the Prax Group (“Prax”), a British multinational independent oil refining, trading, storage, distribution and retail conglomerate dealing in crude oil, petroleum products and bio-fuels, headquartered in London, United Kingdom. Prax, which has trading offices in London, Singapore and the U.S., worked with Zephyr to measure, reduce and mitigate greenhouse gas (“GHG”) emissions across Zephyr’s businesses, with mitigation efforts primarily focused on the purchase of VERs from reputable pre-vetted developers of sustainable projects. This exercise includes Zephyr’s current corporate activity, its non-operated production assets in the Williston Basin, North Dakota, U.S., and Paradox project activity.

In addition to the environmental benefits that will result from Zephyr’s efforts to reach carbon-neutrality, the Group anticipates that this approach will also yield economic benefits including expanded access to a wider group of potential institutional investors, as total ESG-focused assets under management are currently estimated to be over US$30 trillion globally. Moreover, the average cost of capital for companies with committed ESG and decarbonisation initiatives has been shown to be demonstrably less than that of traditional resource companies. The Board believes that incremental regulatory benefits may also materialise from Zephyr’s actions.

Partnership with Purified Resources (“Purified”)

In September 2021, the Group announced the formation of a partnership with Purified for the identification and execution of additional non-operated acquisitions. Purified’s principals have substantial experience in the Williston Basin, a basin in which they previously helped assemble and close over US$70 million of non-operated asset acquisitions and associated CAPEX for a private equity-backed vehicle. 

Purified has assisted and/or co-invested with Zephyr in all its Williston acquisitions that it has closed in the period under review, and their team will have the right to continue to co-invest in future transactions. The newly formed partnership provides Zephyr with significant land and business development expertise directly in Zephyr’s geographic region of focus.

Commencement of trading on OTCQB Venture Market

In July 2021, the Group’s announced that its Ordinary Shares had been approved to trade on the OTCQB Venture Market (“OTCQB”) in the U.S.

The Board believes that cross-trading on the OTCQB will increase liquidity and significantly enhance the ability of U.S. based investors to access and trade Zephyr shares during a period in which the Company is actively expanding its U.S. asset base.

FINANCIAL REVIEW

Income statement

The Group reports a net profit after tax of US$0.8 million or a profit of 0.08 cents per Ordinary Share for the year ended 31 December 2021 (2020: net loss after tax of US$2.3 million or 0.66 cents per Ordinary Share). The Group generated revenue of US$6 million from its non-operated asset portfolio (2020: nil), and made a gross profit of US$3.3 million (2020: nil).

Administrative expenses for the year were US$2.7 million (2020: $1.6 million) highlighting the ramp up of the Group’s operations following the pandemic, and the expansion of operations to provide the capacity and capability to develop both he operated and non-operated asset portfolios.

Balance sheet

Total investment in the Group’s exploration and evaluation assets as at 31 December 2021 was US$22.8 million (2020: US$13.9 million) reflecting continuing investment in the Paradox project.

Total investment in property, plant and equipment as at 31 December 2021 was US$11.2 million (2020: US$0.03 million) reflecting the acquisition of the Group’s non-operated assets in the Williston Basin.

Cash and cash equivalents as at 31 December 2021 were US$1.8 million (2020: US$3.9 million). During the year, the Company raised gross proceeds of US$13.9 million (2020: US$2.9 million) through the placing of new Ordinary Shares in the Company. In November 2021 the Group secured debt funding of US$4.1 million (2020: nil) to enable it to pay a US$3 million deposit in respect of a proposed acquisition which subsequently completed in February 2022. 

In February 2022, the Company announced that it had raised a further US$17.4 million (before expenses) through the placing of new Ordinary Shares in the Company, along with raising US$28 million through a senior debt facility. The proceeds from these debt and equity instruments was used to complete the Group’s US$36 million acquisition of non-operated assets in the Williston Basin and to fund further activity on the Paradox project.

At 31 May 2022, the Group had cash and cash equivalents of US$11.9m (this includes cash receipts from the non-operated portfolio for the month of May 2022 which were received in early June 2022).

Significant decisions made

During the year under review and post year end, the Directors completed four discrete acquisitions of non-operated assets. The decisions to proceed with the acquisitions and the corresponding debt and equity funding were logical decisions made to ensure the advancement of the Paradox project and were unanimously deemed by Board members to be in the best interests of the Company. Details of the acquisitions can be found in the relevant sections of this Annual Report.

In addition, and to facilitate the drilling of the State 16-2 well, the Company completed an equity fundraise through the issue of Ordinary Shares in the Company. In arriving at the decision to proceed with the fundraise the Directors considered the cash position of the Group, the dilution impact that the respective fundraises would have on the existing Shareholders of the Company and the importance of progressing the Paradox project. After due consideration, the Directors unanimously considered the fundraise to be in the best interests of the Company and its Shareholders.

We would like to thank all Shareholders for their continued support.

On behalf of the Board

JC Harrington

Chief Executive Officer, Zephyr Energy plc

22 June 2022

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