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Beetaloo Basin, Northern Territory, Australia

Overview

Falcon Australia, Falcon’s 96.9% owned subsidiary, is the registered holder of four exploration permits, comprising approximately 7 million acres (approximately 28,000 km2) in the Beetaloo Basin, Northern Territory, Australia. The Beetaloo Basin is located 600 kilometres south of Darwin close to infrastructure including a highway, two pipelines and a railway, offering transport options to the Australian market and beyond via the existing and proposed LNG capacity in Darwin.

The Beetaloo Basin is a Proterozoic and Cambrian tight oil and gas basin. In its entirety, the Beetaloo Basin covers approximately 8.7 million acres (approximately 35,260 km2) and is a relatively underexplored onshore exploration basin with, as far as the Company is aware, 11 exploration wells drilled in the Beetaloo Basin to date. The area is remote and sparsely populated and the Board believes that it is well suited for oil and gas projects. Australia has a developed resources industry with a stable political, legal and regulatory system.

RPS Energy, in its CPR dated 1 January 2013 (filed on SEDAR in January 2013 and available on the Falcon website), estimates gross unrisked recoverable prospective resource (play level) potential of 162 trillion cubic feet (“Tcf”) of gas and 21,345 million barrels of oil (“Mmbo”) (P50) for Falcon Australia’s Beetaloo Exploration Permits.

Exploration Permits

A summary of Falcon Australia’s Beetaloo Exploration Permits is contained in the table above. The acreage interests covered by the Beetaloo Exploration Permits cover the majority of the Beetaloo Basin and are held 100% in the name of Falcon Australia. Falcon Australia is the operator of the exploration permits.

The work commitments for the Beetaloo Exploration Permits held by Falcon Australia have been met for previous years, with the exception of exploration permit EP-99, on which an original extension was granted to 31 December 2013.

In June 2013, the exploration permit for EP-99 was extended to 31 December 2014. The permits for EP-76, EP-98 and EP-117 are due to expire on 31 December 2013. Application to extend the permits will be made prior to 30 September 2013.

In accordance with local law and regulations, all Falcon Australia’s acreage interests are subject to royalties on production values of up to approximately 12% to government and native title holders/claimants and 12% to other parties. In addition, Falcon Australia is subject to Commonwealth Government corporation tax of 30%, and to the Commonwealth Government’s Petroleum Resource Rent Tax (“PRRT”) levied at the rate of 40% on the taxable profits derived from the petroleum projects. The PRRT is calculated on the individual projects and royalties are deductible for PRRT purposes. The PRRT tax system is separate from the company income tax system and is based on cash flow. Both royalties and PRRT are deductible for corporate income tax purposes.

Discoveries and Prospectivity

The Board believes that the Beetaloo Basin is relatively under-explored and has shale oil, shale gas and BCGA (“basin centered gas accumulations”) potential. As far as the Company is aware, 11 wells have been drilled in the Beetaloo Basin to date. This work was undertaken by a Rio Tinto Group subsidiary company exploring for conventional hydrocarbons and while not leading to a conventional development, the data from the cores demonstrated the presence of tight oil and gas and several horizons were shown to be prospective for unconventional oil and gas.

There are no existing fields but there are numerous mudlog and core oil and gas shows throughout the Beetaloo Basin in prospective formations. The Shenandoah-1 well was a vertical hole well drilled by Sweetpea in 2007. The well was deepened by Falcon Australia in 2009 to finish at 2,714 metres. It was re-entered in Quarter 3 2011 and five short tests were conducted including several fracking operations. Gas was recovered from three zones with some liquids.

Current activity

In April 2011, Falcon Australia entered into a joint venture with Hess Australia (Beetaloo) Pty Ltd (“Hess”) whereby Hess agreed to collect seismic data over an area made up of three of the four Beetaloo Exploration Permits, excluding exploration permit EP-99 and an area within exploration permit EP-98 (the Shenandoah-1 well and approximately 100,000 acres (approximately 405 km2) of land around the well-bore), referred to as the “Hess Area of Interest”. Falcon Australia was the operator of exploration permit EP-99 and Hess was the operator of exploration permits EP-76, EP-98 and EP-117. Falcon Australia also retained operatorship in the Shenandoah-1 well and approximately 100,000 acres (approximately 405 km2) of land around the Shenandoah-1 well-bore within exploration permit EP-98.

Since signing the agreement with Hess, Hess has acquired 3,490 kilometres of 2D seismic data at an estimated cost in excess of $55 million. The 2D seismic data is currently being processed and interpreted.

Hess had the option, valid until 30 June 2013, to acquire a 62.5% working interest in the Hess Area of Interest by committing to drill and evaluate five exploration wells at Hess’ sole cost, one of which must have been a horizontal well. All costs to plug and abandon the five exploration wells would have been borne solely by Hess. The Board estimated that the gross costs associated with the five-well programme would have been approximately $75 million. Hess had also agreed, subject to proceeding to the development phase, to carry Falcon Australia, on a first development well, up to a gross cost of $10 million, which the Board believed would have been the total gross cost of this well. Costs to drill wells after the five exploration wells and the first development well (and after the initial $10 million) would have been borne 62.5% by Hess and 37.5% by Falcon Australia.

However, Hess did not elect to commit to drilling the five wells required to earn their interest in the Beetaloo permits by the agreed deadline. Therefore, in accordance with the Participation Agreement (as amended), which granted Hess the first extension; failure to elect on time meant that Hess forfeited their right to earn 62.5% in three of the Beetaloo permits. Hess had requested a one month extension to allow them sufficient time to conclude a farm-out deal with a third party, which they described as one of the largest oil and gas companies in the world. However, the late request by Hess to defer the election date again was unanimously rejected by Falcon’s Board for reasons outlined below:

 Falcon retains a 100% working interest in the four Beetaloo exploration permits which puts Falcon in a stronger position going forward.

 Hess has transferred a perpetual, royalty-free and irrevocable licence to Falcon over the 3,490 km of seismic acquired by them.

 The initial interpretation of 3,490 km of new seismic data, acquired at no cost to Falcon, is extremely encouraging.

 Identification of a shale oil play in the northern part of the permits in addition to the shale gas and conventional plays throughout the acreage.

 Unsolicited interest from major oil and gas companies.

 Falcon had already granted Hess an extension from August 2012 to June 2013.

Under the minimum work commitments for exploration permit EP-99, Falcon Australia must spend a minimum of $1.5 million by 31 December 2014 in collecting 2D seismic data on the underlying acreage within exploration permit EP-99. Falcon Australia is currently finalising a 2D seismic acquisition programme for exploration permit EP-99 in order to meet permit requirements. This 2D seismic data is expected to provide the necessary information to plan a potential well programme in the coming years. Falcon Australia intends to meet this commitment either through a farm-out arrangement or through its own resources. Falcon Australia has received expressions of interest from a number of third parties regarding a possible farm-out arrangement.

Karoo Basin, South Africa

Overview

The Company holds a Technical Co-operation permit (“TCP”) covering an area of approximately 7.5 million acres (approximately 30,327 km2), in the southwest Karoo Basin, South Africa, which grants the Company exclusive rights to apply for an exploration right over the underlying acreage. In August 2010, the Company submitted an application to the Petroleum Agency of South Africa for an exploration right over the acreage covered by the TCP and, as part of the application process, the Company submitted an environmental management plan in January 2011.

On 1 February 2011, the Minister of Mineral Resources (the “Minister”) published a notice in the Government Gazette declaring a moratorium on the processing of all new applications relating to the exploration and production of shale gas in the Karoo Basin. This moratorium did not extend to existing applications, such as Falcon’s, that were submitted prior to 1 February 2011. In April 2011, the Minister announced a further moratorium, which was not officially declared in terms of a notice in the Government Gazette, prohibiting all new applications and suspending the processing of all pending application whilst the South African Department of Mineral Resources conducted an environmental feasibility study on the effects of hydraulic stimulation and developed a system to regulate onshore exploration activities (the “Undeclared Moratorium”). The undeclared moratorium has no legal effect since it is a requirement of the South African petroleum legislation that all such moratoriums be published in the Government Gazette. In September 2012, the South African Government announced a decision to lift the undeclared moratorium on shale gas exploration. The Minister has indicated that although the Undeclared Moratorium has been “lifted”, pending exploration right applications will not be processed and awarded until the regulations regarding hydraulic fracturing are published. These regulations have not yet been published. Consequently, the Board expects that the exploration right over the acreage will be awarded in 2014.

The South African Government is entitled to a royalty on the sale of mineral resources of up to 7% of gross sales (in the case of unrefined resources) and 5% of gross sales (in the case of refined resources, such as oil and gas). The Liquid Fuels Charter provides that an oil and gas company must reserve not less than 9% for Historically Disadvantaged South Africans (“HDSA”) to buy-in to any offshore production right granted. On the advice of South African counsel, the Board believes that the HDSA buy-in will also apply to onshore production rights in South Africa, including any right granted pursuant to the TCP. Similarly, the State has an option to acquire an interest of up to 10% in any production right granted. However, it is not required to pay any consideration for its 10% interest or contribute to past costs, but must contribute pro rata in accordance with its interest towards production costs going forward.

Corporation tax in South Africa is imposed at a rate of 28% of taxable income. Dividends tax is imposed on the shareholder at a rate of 15%.

Discoveries and Prospectivity

In its entirety, the Karoo Basin is approximately 173 million acres (approximately 700,000 km2) in size located in central and southern South Africa and contains thick, organic rich shales such as the Permian Whitehill Formation. The Karoo describes a geological period lasting some 120 million years and the rocks laid down during that period of time, covering the late Paleozoic to early Mesozoic interval periods. These rocks were deposited in a large regional basin and resulted in the build-up of extensive deposits. Until recently, the Karoo Basin was not considered prospective for commercial hydrocarbons resulting in very limited modern hydrocarbon exploration onshore in South Africa. In an independent report dated April 2011, the U.S. Energy Information Administration (“EIA”) estimated that there are 485 Tcf technically recoverable resources in the Karoo Basin which would rank it fifth in the world after China, USA, Argentina and Mexico for shale gas potential. In particular the Permian Ecca group contains three potential shales identified as having potential for shale gas. The shale in the Whitehall Formation, in particular, is ubiquitous, has a high organic content and is thermally mature for gas.

Current activity

In December 2012, Falcon entered into an exclusive cooperation agreement with Chevron to jointly seek unconventional exploration opportunities in the Karoo Basin. The Chevron Agreement provides for Falcon to work exclusively with Chevron for a period of five years to jointly seek to obtain exploration rights in the Karoo Basin subject to the parties mutually agreeing participation terms applicable to each right. As part of the Chevron Agreement, Chevron made a cash payment to Falcon of $1 million in February 2013 as a contribution to past costs.

Makó Trough, Hungary

Overview

Falcon has been active in the Makó Trough since 2005 when it acquired two exploration licences, the Makó and the Tisza exploration licences. Between 2005 and 2007, Falcon pursued a work programme consisting of the acquisition of 1,100 km2 of 3D seismic data and a six-well drilling programme. Each of the six wells encountered thick sequences of hydrocarbon bearing rocks, and tests flowed hydrocarbons from each tested horizon. In 2007, Falcon’s subsidiary, TXM, was awarded the 35-year Makó Production Licence which covers some of the acreage originally covered by the Makó and the Tisza exploration licences.

Hungary is an established oil and gas producing country. The Makó Production Licence is in the vicinity of the largest producing field in Hungary, the MOL Group owned and operated Algyö field, which has produced approximately 2.5 Tcf and 220 Mmbo to date. The Makó Production Licence is located approximately ten kilometres to the east of the MOL Group owned and operated Algyö field and is transected by existing gas pipelines and infrastructure, including a 12 kilometre gas pipeline built by Falcon in 2007, together offering transport and potential access to local markets and larger distribution centres for international markets.

Makó Production Licence

The Makó Production Licence was granted by the Hungarian Mining Authority over a gas exploration project in the Makó Trough, located in south-eastern Hungary. The lands within the Makó Production Licence were formerly part of the Group’s two hydrocarbon exploration licences – the Tisza exploration licence and the Makó exploration licence.

The Makó Production License covers approximately 245,775 acres (approximately 1,000 km2) and is held 100% by TXM, a wholly owned subsidiary of the Group. Under the terms of the Makó Production Licence, the Group is obliged to pay a 12% royalty to the Hungarian Government on any unconventional production and has a further 5% royalty payable under an agreement with Prospect Resources Inc., the previous owners of the acreage covered by the Makó Production Licence. Corporate profits are taxed at 19%. In 2009, an additional profit based energy industry tax, levied on energy supplying companies, was introduced. The rate was originally set at 8% but, as part of Hungary’s third package of austerity measures, the rate has increased to 31% from 2013, with deductions allowable for certain capital expenditures. TXM is the operator and there are no outstanding work commitments on the Makó Production Licence.

Discoveries and Prospectivity

The Makó Trough contains two plays:

 a play targeting gas prospects in the shallower Algyö Play at depths between 2,300 metres and 3,500 metres; and

 a deeper unconventional play targeting significant contingent resources in the Deep Makó Trough.

The Algyö Play

The Algyö Play is a relatively shallow play of between 2,300 and 3,500 metres. A number of Falcon wells have been drilled through the Algyö Play in recent years, some of which encountered gas shows, but to date none of these wells tested the shallow play concept at an optimal location, as these wells targeted the Deep Makó Trough, at intervals of up to 6,000 metres. Multiple Algyö prospects have subsequently been identified by the Group through extensive AVO analysis, and 3D seismic data has shown the presence of possible gas zones above the Szolnok formation (part of the Deep Makó Trough). In total, ten prospects have been identified within the Algyö Play from which RPS Energy, in its independent CPR, estimates eight prospects contain gross unrisked recoverable prospective gas resources of 568 billion cubic feet (“Bcf”) (P50).

In January 2013, Falcon agreed a three-well drilling exploration programme with Naftna industrija Srbije jsc (“NIS”), owned 56% by Gazprom Group, to target the Algyö Play, whereby NIS made a cash payment of $1.5 million to Falcon in February 2013, and agreed to drill three exploration wells by July 2014. NIS will earn, after undertaking the three-well drilling obligation, 50% of the net production revenues from the three wells drilled. The Board estimates that the gross costs of the three-well drilling programme will be approximately $21 million. In addition, NIS will have an option to acquire a right of first negotiation for future drilling operations in the Algyö Play, sharing any potential future costs and revenue with the Group, on terms to be negotiated, after paying Falcon $2.75 million. Falcon will be fully carried on the drilling and testing of three exploration wells and will retain 100% interest in the Deep Makó Trough.

The Deep Makó Trough

This is a deeper unconventional play targeting gas, and to a lesser extent oil, in the low permeability and low porosity rocks in the deeper horizons of the basin. RPS Energy in its independent CPR estimates gross recoverable contingent resources for the Deep Makó Trough of 35.3 Tcf of gas and 76.7 Mmbo of oil (P50).

Between 2005 and 2007, Falcon acquired 1,100 km2 of 3D seismic data and executed a six-well drilling programme on the Deep Makó Trough. Early exploration efforts focused on proving hydrocarbon potential and delineation of the basin in order to secure the Makó Production Licence. Each of the six wells encountered thick sequences of hydrocarbon bearing rocks, and tests flowed hydrocarbons from each tested horizon. Several wells flowed gas on test and one well, the Magyarcsanád-1, tested light oil. The deepest well was the Makó-7 which, along with the Makó-4, was not tested. The Makó-7 results demonstrated the presence of a very large column of hydrocarbons in the well-bore. In 2007, Falcon constructed a 12 kilometre gas pipeline which connected the Makó-6 and Makó-7 wells with a MOL operated pipeline, offering potential access to local and international markets. The Company intends to re-enter the untested Makó-7 and Makó-4 wells and will seek a technically and financially capable partner to test and produce the shale gas and tight gas formations in the Deep Makó Trough.

Current Activity

Initial drilling operations on the first joint well between NIS and Falcon, Kútvölgy-1 well have now ceased, the well having reached total depth (“TD”) of 3,305 metres. As prognosed, the top of the Algyö formation was encountered at 2,985 metres; the well then penetrating an alternating sequence of sandstones, siltstones and shales over a gross interval of 320 metres to TD, with gas shows throughout. Two conventional cores have been taken and extensive wireline logs were run. As planned the well has been cased to TD and is now suspended while further technical evaluation is undertaken prior to carrying out an appropriate testing programme later this year. No operational problems or accidents occurred during drilling. The location of the second of the three well programme will be decided after a full evaluation of the Kútvölgy-1 well results. Operations on the second well are expected to commence in Quarter 4 this year.