Item
1. Business.
General
Discovery
Energy Corp. (the “Company”) was incorporated under the laws of the state of Nevada on May 24,
2006 under the name “Santos Resource Corp”. The current business of the Company is the exploration and development
of the 584,651 gross acres (914 sq. miles) area in South Australia (“Prospect”) held under Petroleum
Exploration License PEL 512 (“License”). The Prospect is located in the “Western Flank”
area, which is the southwest Permian edge of the Cooper and Eromanga Basins, the most prolific producing onshore region
in Australia. There are three separate acreage blocks in the Prospect: West (~400,000 acres), South (~181,000 acres) and Lycium
(~4,000 acres). In May 2012, the Company incorporated a wholly owned Australian subsidiary, Discovery Energy SA Ltd. (“Subsidiary”),
for the purpose of acquiring a 100% working interest in the License. In May 2016, the Subsidiary’s legal entity status changed
from public to private and its name changed to Discovery Energy SA Pty Ltd. The Company is in the initial exploration phase of
determining whether or not the Prospect contains economically recoverable volumes of crude oil, natural gas and/or natural gas
liquids (collectively “Hydrocarbons”). Although the Company’s current focus is primarily on the
Prospect, management from time-to-time exchanges information with other industry participants regarding additional investment
opportunities in Australia.
Recent
Developments and Events
During
fiscal 2020, the Company entered into a contractual arrangement believed significant to the Company at the time. In addition,
the Company has been dramatically affected by two recent developments beyond the Company’s control. The remainder of this
section discusses these developments and events.
Terminated
Farmout Arrangement. During fiscal 2020, the Subsidiary entered into a farmout agreement (the “Farmout
Agreement”) with WESI PEL512 Pty Ltd, a company formed under the laws of New South Wales, Australia (“WESI”).
Pursuant to the Farmout Agreement, the Subsidiary was to assign to WESI one-half of the Subsidiary’s 100% working interest
in the South and Lycium blocks of the Prospect. In consideration of this assignment, WESI was obligated (among other things) to
pay to the Subsidiary AU$2.5 million in cash (the “Cash Consideration”) within forty five (45) days
of the signing of the Farmout Agreement. WESI failed to timely pay the Cash Consideration. As a result, the Farmout Agreement
terminated automatically upon such failure. Upon the termination of the Farmout Agreement, the Company resumed efforts to complete
a major capital raising or joint venture transaction. Such efforts are ongoing.
Coronavirus
Pandemic. In December 2019, a novel strain of coronavirus, SARS-CoV-2, which causes coronavirus disease 2019 (COVID-19),
surfaced in Wuhan, China. Since then, SARS-CoV-2 and COVID-19 spread to many countries, including the U.S. The COVID-19 pandemic
led to the implementation of various responses, including government-imposed quarantines, travel restrictions and other public
health safety measures. It resulted in a significant spike in unemployment and a concomitant decline in economic activity in the
U.S., Australia and many other countries, and any future outbreak of a health epidemic or other adverse public health developments
may have similar effects. Although the effects of the COVID-19 pandemic had been lessening in the U.S. and other parts of the
world overall, these effects recently started worsening again in the U.S. and elsewhere, creating renewed uncertainty regarding
the future. The current COVID-19 pandemic could continue to, and future similar epidemics or pandemics could also, materially
and adversely impact our ability to finance and conduct our business once it becomes operational, and could materially and adversely
impact our operations, financial condition and results. See the risk factor captioned “PANDEMICS OR DISEASE OUTBREAKS (SUCH
AS THE NOVEL CORONAVIRUS, ALSO KNOWN AS THE COVID-19 VIRUS) COULD MATERIALLY AND ADVERSELY AFFECT US IN A VAREITY OF WAYS.”
Severe
Hydrocarbons Price Decline. Another recent development occurring more or less simultaneously with the COVID-19 pandemic
is a Hydrocarbons price war that began in early March 2020. At the time that this event started on March 8, 2020, the price of
Brent crude was $45.27 per barrel, which was already down from a recent high of $68.91 on January 6, 2020. Such price declined
to a low of $19.33 on April 21, 2020. On July 10, 2020, the posted price of Brent was $43.17. Prices of Hydrocarbons
are volatile and entail certain risks. See the risk factor captioned “HYDROCARBONS ARE COMMODITIES SUBJECT TO PRICE VOLATILITY
BASED ON MULTIPLE FACTORS OUTSIDE THE CONTROL OF PRODUCERS, AND LOW PRICES MAY MAKE PROPERTIES UNECONOMIC.” The Company
has no assurance that the price of Hydrocarbons will recover to adequate levels or that the Company will not be harmed by prolonged
low levels of Hydrocarbon prices.
Historical
Milestones
To
date, the Company has achieved the following milestones:
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On
October 26, 2012, the License was granted to the Subsidiary. After the License grant, the Company’s primary focus was
on completing a financing to raise sufficient funds so that the Company could undertake a required proprietary seismic acquisition
program. After exploring a number of possible financings, the precipitous decline in crude oil prices starting in the summer
of 2014 delayed the Company’s ability to successfully complete a financing of the type being sought.
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In
May 2016, the Company completed its first closing under a financing arrangement pursuant to which the Company issued to two
investors Senior Secured Convertible Debentures due May 27, 2021 (each a “Debenture” and collectively
the “Debentures”). To date, the Company has issued a total of 14 Debentures having an aggregate
original principal amount of $6,850,000. The Debentures are due and payable on or before May 27, 2021. Interest on the Debentures
to date has been accrued and added to principal, thereby increasing the outstanding balance on the Debentures to approximately
$9,139,000 as of June 30, 2020. Interest will be accrued until such time as the Debentures are repaid or converted. Among
other uses, the proceeds from the Debentures enabled the Company to undertake required seismic work. In conjunction with certain
issuances of Debentures, warrants (“Warrants”) were issued that grant the holder the right to purchase
up to a maximum of 19,125,000 common shares at an initial per-share exercise price of $0.20. For more information about the
Debentures and the Warrants, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results
of Operations - Liquidity and Capital Resources - Financing History and Immediate, Short-Term Capital Needs - Debenture Financing”
below.
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On
October 30, 2016, fieldwork was completed on the Company’s proprietary Nike 3D seismic survey (the “Nike
Survey”) covering an approximately 69 sq. mile (179 sq. km.) section of the western portion of the South Block
of the Prospect and directly on trend and in close proximity to mature producing oilfields and recent discoveries on
the blocks to the north. The Nike Survey was completed at a “turnkey price” of approximately $2.4 million.
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The
raw data from the Nike Survey was converted to analytical quality information, processed and interpreted by the Company’s
geophysical advisor. Interpretation of the processed data included advanced technical analysis by specialized consultants.
This technical work identified an inventory of more than 30 leads judged to be potential areas of crude oil accumulations.
The Company has prioritized these initial prospective locations for presentation to potential sources of significant capital.
Technical analysis is on-going.
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In
June 2017, the Company completed the archeological and environmental field surveys of seven prospective drilling locations
as required by applicable laws and regulations. It subsequently filed reports on these surveys with the South Australian government;
no material issues were identified at any of the prospective drilling sites.
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In
addition to the amounts raised pursuant to the Debentures arrangements, since the Company adopted its current business plan,
the Company has raised funds totaling approximately $4.3 million through private placements of the Company’s common
shares.
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In
several transactions to date, the Company (through the Subsidiary) purchased portions of an original 7.0% royalty interest
relating to the Prospect retained by the party that, in effect, transferred and sold the License to the Company. As a result,
the Company (through the Subsidiary) now owns an aggregate 5.0% royalty interest, while the previous holder of the original
7.0% royalty interest continues to hold a 2.0% royalty interest. The aggregate purchase price for the aggregate 5.0% royalty
interest was $540,500.
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Prospect
There
are producing wells on trend and directly north and east of the Company’s South block. A typical Namur well, a primary producing
reservoir in the Western Flank, is drilled to a depth of approximately 5,500 feet. The wellbore is vertical or near vertical and
there is no lateral drilling or hydraulic stimulation required. This high-permeability reservoir combined with a strong aquifer
system produces very high flow and recovery rates. Initial production rates typically range from approximately 450 to 940 barrels
of oil per day (“BOPD”). Production is anticipated to be sweet, high gravity (45
degrees) crude which is expected to result in premium pricing. As described in the section captioned “Markets and
Marketing” below, markets for the Company’s future production are readily accessible via existing infrastructure.
Beginning
in 2018, Beach Energy began implementing horizontal drilling techniques targeting the lower permeability McKinlay and Birkhead
reservoirs in the Western Flank. Several wells, with lateral sections of approximately 2,000 feet, were successfully drilled and
completed. Initial production rates ranged from 800 to 2,000 BOPD resulting in an average well productivity improvement of 8.2
times over vertical wells for 1.5 times the cost. Typically, the time and cost to drill a well decreases and production rates
and economics improve as additional wells are drilled and the increase in knowledge and experience is incorporated into best practices.
Exploration
Activity
Since
2012, the Company has assembled a database that now includes a substantial inventory of data, analyses and technical information
on the Cooper and Eromanga Basins, fields in the Western Flank, operators and operations, all in close proximity to the Prospect.
In 2012, an engineering consultant was engaged to prepare an NI 51-101 compliant report which resulted in the identification of
more than 110 seismic generated leads over approximately 30% of the Prospect. This was complimented by the reinterpretation of
approximately 3,200 miles (5,153 km.) of 2D seismic data and the reprocessing and reinterpretation of approximately 55 sq. miles
(141 sq. km.) of 3D seismic data from a survey conducted over the Lake Hope area in the eastern portion of the South block. The
data described in the preceding sentence was acquired in connection with the issuance of the License. In late 2016, the Company
conducted the approximately $2.4 million Nike Survey covering an area of approximately 69 sq. miles (179 sq. km.) located in the
western section of the South block and directly on trend and in close proximity to mature producing oil fields and recent discoveries
on blocks to the north. The Company has also undertaken some “work area clearance” (“WAC”)
surveys.
Terms
of the License
In
2012, the Subsidiary received a formal grant of the License from the South Australian Minister for Mineral Resources and Energy.
The License is a “Petroleum Exploration License” (a “PEL”) granting the right to explore
for all regulated resources (including petroleum and any other substance that naturally occurs in association with petroleum)
relating to the Prospect, provided, however, that the License does not permit use of the Prospect as a source of geothermal energy
or a natural reservoir for the purpose of gas storage.
The
Company now holds a 100% working interest in the License, subject to overriding royalty interests as detailed below:
Royalty Holder
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Percentage Royalty Interest
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State of South Australia
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10%
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The Subsidiary
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5%
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Others
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3%
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Total
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18%
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In
view of the overriding royalty interests detailed above, the Company’s net revenue interest in the License is 87%
The
License is subject to a five-year work commitment as described below. Failure to comply with the work program requirements could
lead to the cancellation of the License. The License also requires that insurance of the types and amounts of coverage that management
believes are reasonable, customary and the industry standard be maintained, and contains provisions regarding environmental matters
and liabilities that management also believes are reasonable, customary and the industry standard.
The
initial term of the License is five years, with two five-year renewal terms, subject to the provisions of the South Australian
Petroleum and Geothermal Energy Act 2000. As discussed herein, the initial five-year term has been suspended a number of times;
as a result, this initial term currently remains in effect. At the end of the initial five-year term of the License and assuming
that the Company has met its obligations, the License can be renewed for a first five-year renewal term, provided, however, that
the Company must relinquish one-third of its acreage or convert all or portions of it to a Petroleum Retention License (a “PRL”).
At the end of the first five-year renewal term of the License, assuming that the Company has met its commitment obligations, the
License can be renewed for a second five-year renewal term, provided, however, that the Company must relinquish one-third of its
original acreage or convert all or portions of the remaining acreage to a PRL. Relevant law requires the South Australian government
to grant a PEL with respect to any acreage to be relinquished if the related licensee submits a reasonable application for renewal
of the related license. Management believes that (as a matter of practice) the South Australian government almost invariably grants
renewals, although the Company has no assurance that this will occur in its case. Any renewal could entail additional requirements,
such as additional work commitments. Control over acreage can remain in effect indefinitely, so long as the licensee converts
its license to a Petroleum Production License” (a “PPL”) and is producing Hydrocarbons from the
related acreage. A PPL has requirements similar to but somewhat different from a PEL, and the scope of the acreage in effect “held
by production” is limited by applicable law.
Plan
of Operation
Current
Status
The
Company is in the initial phase of its Plan of Operation. To date, field operations have been limited to the successful completion
of seismic and related WAC surveys. Without drilling results, the Company does not have the necessary technical data to prepare
estimates of Hydrocarbon reserves needed to prepare various reports for submission to regulators. The Company cannot provide assurance
that it will find commercially producible volumes of Hydrocarbons.
Current
Primary Activities
The
Company’s current primary activity is to complete either a major financing or a major joint venture relationship, or both,
so that it can execute the remaining work commitment described below, and develop the Prospect.
The
License is subject to a five-year work commitment, which imposes certain financial obligations on the Company. In management’s
view, the geotechnical work completed in Years 1 and 2 of the commitment was sufficient to satisfy the License requirements for
those two years. Required reports in connection with these activities were timely filed. To date, no comments from the government
have been received, and management understands that the relevant government agency is required by law to furnish comments within
30 days after the reports are filed. Moreover, such agency has extended and modified the work commitment a number of times since
the filing of the reports, and has been very accommodating with Company requests.
Over
the last several years, a number of extensions and modifications of the work commitment have been granted. The current remaining
work commitment is as follows:
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Year
3 ending October 28, 2020 - Shoot 2D seismic data totaling at least approximately 62 miles (100 km.) and shoot 3D seismic
data totaling at a minimum approximately 77 sq. miles (200 sq. km.) and drill two wells.
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Year
4 ending October 29, 2021 - Shoot 3D seismic data totaling a minimum of approximately 77 sq. miles (200 sq. km.) and drill
two wells.
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Year
5 ending October 29, 2022 - Drill three wells.
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The Company does not
believe that it will be able to complete its Year 3 Commitment obligations by October 28, 2020 due date. Accordingly, the Company
expects to seek an extension of such obligations prior to the due date. While the Company has to date been successful in obtaining
such extensions, it has no assurance that any further extensions will be obtained. Failure to obtain extension will materially
and adversely impact the Company. See the section captioned “Liquidity and Capital Resources - Consequences of a Financing
Failure” below.
The
Company needs a significant amount of capital to fulfill its obligations under the work commitment. Moreover, the Debentures mature
in May 2021, and the Company will need to raise additional funds or generate sufficient revenues through Hydrocarbons production
to timely repay the Debentures. The Company’s capital requirements and financing activities are described in the section
captioned “Liquidity and Capital Requirements” below. The success of the initial phase of the Plan of Operation depends
upon the Company’s ability to obtain additional capital or enter into a suitable joint venture arrangement in order to acquire
additional seismic data and successfully drill commitment wells. Failure to obtain required additional capital or enter into a
suitable joint venture arrangement will materially and adversely affect the Company and its stockholders in ways that are discussed
in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and
Capital Resources - Consequences of a Financing Failure” below. The Company cannot provide assurance that it will obtain
the necessary capital and/or enter into a suitable joint venture agreement.
Once
the Company is in a position to commence drilling, it intends to engage the services of a third-party contractor. No significant
impediments to procuring the services of one or more qualified contract operators and drillers in connection with the initial
phase of the Company’s Plan of Operation are anticipated. However, a considerable increase in drilling activity in the West
Flank area could result in longer wait times and higher costs to obtain materials and services. The contract operator will be
responsible for all regulatory compliance matters; hiring the drilling contractor, geologist and petroleum engineer to make final
decisions relative to the zones to be targeted; well design; drilling and logging. Should wells comprising the Company’s
drilling operations be successful, the operator will then be responsible for completion operations, production facilities procurement,
installation, operations and maintenance, interconnecting with gathering or transmission pipelines and attending to various administrative
matters.
The
Company initially plans to focus on oil-bearing formations, and thus crude oil is most likely to be the Company’s principal
product for the foreseeable future, if the Company is successful in its exploration and production activities. Natural gas is
not expected to be a significant opportunity for the foreseeable future. The Company expects that most of its oil production will
be transported through trucking operations owned by others.
Any
natural gas produced may (depending on the amount produced) be flared or transported through gathering systems and gas pipelines
that are owned by others. Transportation capacity on gas gathering systems and pipelines is occasionally limited and at times
unavailable due to repairs or improvements being made to the facilities or due to use by other gas shippers with priority transportation
agreements or who own or control the relevant pipeline. The Company cannot accurately predict the costs of transporting its natural
gas production until it drills, completes and tests its initial successful wells. The cost of installing infrastructure to deliver
the Company’s natural gas production to Moomba, which, as described below, is the principal transportation center for the
area, or elsewhere will vary depending upon distance traversed, negotiated handling/treating fees, pipeline tariffs and other
associated costs. Although issues pertaining to the Company’s natural gas transportation could adversely affect the Company,
the Company does not believe that this will be the case due to the minor role that any natural gas production is expected to play
in the Company’s business.
Markets
and Marketing
The
petroleum industry has been characterized historically by Hydrocarbon prices that fluctuate (sometimes dramatically),
and supplier costs can rise significantly during industry booms. The most recent price decline cycle started in early March 2020
when an oil price war began. On March 8, 2020, the price of Brent crude was $45.27 per barrel, which was already down from a recent
high of $68.91 on January 6, 2020. Such price declined to a low of $19.33 on April 21, 2020. On June 30, 2020, the posted price
of Brent was $41.88. The Company has no assurance that the price of Hydrocarbons will recover to adequate levels or that the Company
will not be harmed by prolonged low levels of Hydrocarbon prices. Hydrocarbon prices and markets are likely to remain volatile.
Sales prices for these commodities are subject to wide fluctuations in response to relatively minor changes in supply and demand,
market uncertainty, and a variety of additional factors beyond the Company’s control. These factors include:
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international
political conditions (including embargoes, wars and civil unrest, such as the recent unrest in the Middle East);
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the
domestic and foreign supply of Hydrocarbons;
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consumer
demand;
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weather
conditions;
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domestic
and foreign governmental regulations and other actions;
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actions
taken by the Organization of the Petroleum Exporting Countries (“OPEC”);
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technological
advances affecting energy consumption;
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technology
and knowledge advances’ impact seismic, drilling, development and production;
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the
price and availability of alternative fuels;
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epidemics,
pandemics and government action that impedes the ability of companies to undertake their businesses; and
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general economic conditions.
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Decreases
in Hydrocarbon prices might not only decrease the Company’s future revenues on a per unit basis, but could also reduce the
volumes that the Company could produce economically. A sustained decline in sales prices could materially and adversely
affect the Company’s future business, financial condition, results of operations, liquidity and borrowing capacity, and
may require a reduction in the carrying value of the Company’s assets. While the Company’s future revenues may increase
if prevailing prices increase significantly, exploration and production costs and acquisition costs for additional properties
and reserves could also increase. The Company might enter into hedging arrangements or use derivative financial instruments to
hedge in whole or in part the risk associated with fluctuations in Hydrocarbon prices.
The
Company does not expect to refine any of its production, although it may need to treat or process some of its production to meet
the quality standards of purchasing or transportation companies. Therefore, the Company expects that all or nearly all of its
production will be sold to a relatively small number of customers. Production from the Company’s properties will be marketed
in a manner consistent with industry practices. The Company does not currently have any long-term sales contracts for its future
production, but it expects that it will generally sell any production that it develops pursuant to these types of contracts. The
Company does not believe that it will have any difficulty in entering into long-term sales contracts for its production, although
there can be no assurance in this regard.
The principal Hydrocarbons
transportation hub for the Western Flank is located in the vicinity of Moomba. This processing and transportation center is
approximately 37 miles due east of the Prospect’s easternmost boundary and about 40 miles from the Company’s expected
initial drill sites. These sites are located about 20 miles from a privately-owned terminal for trucking oil in Lycium. The Lycium
Hub is also the terminal point for a main Trunk Line with a capacity of 20,000 barrels per day, which delivers oil to the Moomba
Processing Facility. If the Company is unable to enter into a suitable contractual relationship with the owner of the truck terminal
in Lycium, the Company would sell its crude oil production to a regional carrier that is legally required to purchase the Company’s
produced crude oil and transport it by truck to Moomba. Large diameter pipelines deliver oil and gas liquids from Moomba south
to Port Bonython (Whyalla). Natural gas is also moved south to Adelaide or east to Sydney. A gas transmission pipeline connects
Moomba to Ballera, which is located northeastward in the State of Queensland. From Ballera, natural gas can be moved to Brisbane
and Gladstone, where a liquefied natural gas (“LNG”) project is under development. The Moomba treating and transportation
facilities and the southward pipelines were developed and are operated by a producer consortium led by Santos Limited.
The
availability of a ready market for the Company’s production will depend upon a number of factors beyond the Company’s
control, including the availability of other production in the Prospect’s vicinity, the proximity and capacity of Hydrocarbon
pipelines, and fluctuations in supply and demand. Although the effect of these factors cannot be accurately predicted or anticipated,
the Company does not anticipate any unusual difficulty in contracting to sell its production of Hydrocarbons to purchasers at
prevailing market prices and under arrangements that are usual and customary in the industry. However, there can be no assurance
that market, economic and regulatory factors will not in the future materially and adversely affect the Company’s ability
to sell its production.
Sales
prices for Hydrocarbon production are negotiated based on factors normally considered in the industry, such as the reported trading
prices for Hydrocarbons on local or international commodity exchanges, distance from wells to pipelines, well pressure, estimated
reserves, commodity quality and prevailing supply conditions. Historically, Hydrocarbon sales prices have experienced high volatility
resulting from changing perceptions throughout the industry centered on supply and demand. The Company cannot predict the occurrence
of events that may affect sales prices or the degree to which such prices will be affected. However, sales prices realized by
the Company should be equivalent to the then current market prices in the geographic region of the Prospect. Typically, crude
oil prices in Australia reflect or are “benchmarked” against European commodity market trading settlement prices,
mainly Brent Crude.
The
Company will strive to obtain the best sales prices in the area of its production. The Company’s revenues, profitability
and future growth will depend substantially on prevailing prices. Decreases in the sales prices would likely adversely affect
the carrying value of any proved reserves the Company is successful in establishing and its prospects, revenues, profitability
and cash flow.
Competition
The Company expects to
operate in the highly competitive areas of Hydrocarbon exploration, development and production. The Company believes that the
level of competition in these areas will continue and may even intensify. In the areas of Hydrocarbon exploration, development
and production, competitive advantage is gained through superior capital investment decisions, technological innovation and cost
management. The Company’s competitors include major firms and a large number of independent companies. Because the Company
expects to have control over acreage sufficient for its exploration and production efforts for the foreseeable future, the Company
does not expect to compete for the acquisitions of properties for the exploration for Hydrocarbons. However, the Company will
compete for the equipment, services and labor required to explore for, develop and produce its properties and to transport its
production. Many of the Company’s competitors have substantially larger operating staffs and greater financial and other
resources. In addition, larger competitors may be able to absorb the burden of any changes in laws and regulations more easily
than the Company can, which would adversely affect its competitive position. Moreover, most of the Company’s competitors
have been operating in the Western Flank for longer periods than the Company has and they have demonstrated the ability to operate
through a number of industry cycles. The impact of this intense competition cannot currently be determined.
Regulation
The Company’s operations in South Australia and within the
Western Flank are subject to the laws and regulations of the State of South Australia and the Commonwealth of Australia. The License
was granted under the Petroleum and Geothermal Energy Act 2000 (SA) and the Company’s operations within and with respect
to the License are governed by this Act and by the Petroleum and Geothermal Energy Regulations 2013 (SA). This legislation covers
all phases of the Company’s operations including exploration, appraisal, development and production of Hydrocarbons from
the License area. Other legislation which the Company will be required to comply with at various stages of its operations include:
Environment Protection Act 1993 (SA); Aboriginal Heritage Act 1988 (SA); Native Title Act 1994 (SA) and Native Title Act 1993 (Cth).
As its Hydrocarbon exploration and production operations in South Australia proceed, the Company will provide more detailed information
regarding the material features and effects of these laws and regulations and such other legislation with which the Company will
be required to comply.
Employees
As
of the date of this Report, the Company had two employees. An additional employee has been added since the end of fiscal 2020.
Fiscal 2020 was the first time that the Company had employees since it adopted its current business plan. However, the Company
has used a number of consultants and part-time service providers in the past, including members of the Company’s management
team. During fiscal 2020 and through the filing of this Report, the Company entered into employment agreements with three of its
officers (one of whom is a director and an executive officer) and two consulting agreements with persons who are Company directors
and executive officers. The agreements involving executive officers are described in “ITEM 11. EXECUTIVE COMPENSATION -
Compensation Agreements with Key Personnel.” The Company’s needs for additional personnel in the future are uncertain.
Item
1A. Risk Factors.
An
investment in our common shares is highly speculative and involves a high degree of risk. You should carefully consider all of
the risks discussed below, as well as the other information contained in this Annual Report. If any of the following risks develop
into actual events, our business, financial condition or results of operations could be materially and adversely affected and
the trading price of our common shares could decline.
RISKS
RELATING TO OUR COMPANY
WE
ARE AN EARLY-STAGE COMPANY WITH NO PROVED RESERVES, AND WE HAVE A NUMBER OF IMPORTANT MILESTONES THAT WE MUST ACHIEVE.
Our
business plan is to explore, develop and produce crude oil, natural gas and/or natural gas liquid (collectively “Hydrocarbons”)
from a tract of land (the “Prospect”) covered by Petroleum Exploration License (“PEL”) 512
(the “License”) in the State of South Australia. The Prospect is considered “undeveloped acreage,”
which the U.S. Securities and Exchange Commission (the “Commission”) defines as “lease acreage
on which wells have not been drilled or completed to a point that would permit the production of commercial quantities of Hydrocarbons
regardless of whether such acreage contains proved reserves.” We have no proved reserves. In view of our extremely limited
history in the Hydrocarbon exploration business, an investor may have difficulty in evaluating us and our business, both current
and future activities. An investor must consider our business and prospects in light of the risks, expenses and difficulties frequently
encountered by companies in their early stage of development. For our business plan to succeed, we must successfully undertake
most of the following activities:
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Complete
a financing or similar transaction that will provide us with sufficient funds;
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Drill
successful exploratory test wells on the Prospect to determine the presence of Hydrocarbons in commercially viable quantities;
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Develop
the Prospect to a stage at which Hydrocarbons are being produced in commercially viable quantities;
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Contract
with purchasers of our commercial production of Hydrocarbons upon such commencement; and
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Identify
and enter into binding agreements with suitable third parties (such as joint venture partners and contractors) for the Prospect.
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There
can be no assurance that we will be successful in undertaking such activities. Our failure to undertake successfully most of the
activities described above could materially and adversely affect our business, financial condition and results of operations.
WE
HAVE A HISTORY OF LOSSES, AND WE MAY NOT BECOME PROFITABLE.
We
have incurred losses since our inception. For our fiscal year ended February 29, 2020, we incurred net losses of $5,903,133, of
which interest expense, both non-cash and accrued, in the amount of $2,243,062 was a primary driver. As of February 29,
2020, we had an accumulated deficit of $25,578,025. We expect our losses to continue as we incur significant capital expenditures
and operating expenses to explore for Hydrocarbons on the Prospect. These continuing losses will most likely be greater than current
levels. If our revenues do not increase substantially or if our expenses exceed our expectations, we may never become profitable.
There can be no assurance that our exploration and production activities will produce Hydrocarbons in commercially viable quantities,
if any at all. Moreover, even if we succeed in producing Hydrocarbons, we expect to incur operating losses until such time (if
ever) as we produce and sell a sufficient volume of our commercial production to cover direct production costs as well as corporate
overhead. There can be no assurance that sales of our Hydrocarbon production will ever generate significant revenues, that we
will ever generate positive cash flow from our operations or that (if ever attained) we will be able to sustain profitability
in any future period.
WE
ARE SIGNIFICANTLY LEVERAGED.
During
a two-year period beginning in May 2016, we took on a significant amount of debt through the sale of Senior Secured Convertible
Debentures due May 27, 2021 (each a “Debenture” and collectively the “Debentures”).
The amount of this indebtedness (including principal and accrued interest) was approximately $9,139,000 compounded through June
30, 2020. Our Debentures are secured by all of our assets owned directly or indirectly but for the License. The use of secured
indebtedness to finance our business is referred to as leveraging. Leveraging increases the risk of loss to us if and to the extent
we have insufficient revenue to pay our debt obligations. In such event, cash from other sources will be required. Our Debentures
must be repaid or converted by the holders thereof on or before May 27, 2021. Unless we generate such cash, we may not have sufficient
funds to pay our Debentures and other indebtedness when due. In such event, we might be required to sell our assets and properties
to meet our obligations, or to seek an extension to our Debentures, or alternative debt or equity financing. If sale, extension
or refinancing is not obtained or consummated, we could default in our obligations.
THE
EXERCISE OF SECURED CREDITOR RIGHTS COULD RESULT IN A SIGNIFICANT OR COMPLETE LOSS.
If
we default on our Debentures, the remedy of our Debentures holders would be (among other things) to institute proceedings against
our assets and properties to sell them to satisfy the amounts owed pursuant to our Debentures. This could result in the partial
or total loss of our assets and properties. We have no assurance that, upon the exercise of our Debentures holders’ secured
creditor rights, we would receive a return of anything on our assets and properties. The loss of our assets and properties by
the exercise of our Debentures holders’ secured creditor rights would most likely materially and adversely affect our business,
financial condition or assets, and could result in a total loss to our stockholders.
OUR
DEBENTURES FEATURE CERTAIN OPERATING COVENANTS THAT COULD ADVERSELY AFFECT THE COMPANY.
Our
Debentures contain operating covenants that prohibit us from certain actions (negative operating covenants) and that require us
to continually undertake other actions (affirmative operating covenants). The negative operating covenants could preclude us from
taking actions that we believe to be in the best interests of our stockholders. The affirmative operating covenants will require
us to incur continuing costs and expense and could require us to take actions that we believe are not in our best interests. Moreover,
our failure to comply with either negative operating covenants or affirmative operating covenants would most likely be a default
under our Debentures, giving to our Debentures holders the rights described above.
Pandemics
or disease outbreaks (such as the novel coronavirus, also known as the COVID-19 virus) could materially AND adversely affect us
in a vareity of ways.
Pandemics
or disease outbreaks such as the novel coronavirus (the COVID-19 virus) could materially and adversely affect us in a number
of ways. First, the current pandemic resulted, and future pandemics and epidemics could result, in economic downturns that could
affect the market for our proposed products. Transport restrictions related to quarantines or travel bans, or simply declines
in customers desire and willingness to travel, due to pandemics and epidemics have caused, and can be expected to cause when they
occur in the future, significant declines in demand for products derived from crude oil, such as gasoline and jet fuel. Such declines
greatly reduce not only the amount of products that can be sold on an aggregate basis, but also the price received for such products.
Such results can be expected to have the following effects:
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harm
our financial results (especially revenues and profits) if and when we enter into commercial production
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harm
our ability to raise funds (if needed) due to a diminished interest in investing in Hydrocarbon exploration and production
companies in general
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depress
our stock price, further harming our ability to raise funds
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Workforce
limitations and travel restrictions resulting from pandemics or disease outbreaks and related government actions may impact many
aspects of our business. We could experience interruptions or delays in receiving supplies of products and services from third
parties due to staffing shortages, production slowdowns or stoppages, disruptions in delivery systems, travel limitations, mass
transit disruptions, and the like. If a significant percentage of persons provided employment and other contractual services to
us were unable to work, including because of illness or travel or government restrictions in connection with pandemics or disease
outbreaks, our operations could be materially and adversely impacted.
Moreover,
the spread of pandemics or disease outbreaks such as the COVID-19 virus may also disrupt logistics necessary to import, export,
and deliver products to us or our customers. Ports and other channels of entry may be closed or operate at only a portion of capacity,
as workers may be prohibited or otherwise unable to report to work, and means of transporting products within regions or countries
may be limited for the same reason.
Currently,
uncertainty exists relating to the potential effect of COVID-19 on our business. Infections may become more widespread, exacerbating
an already challenging environment. The extent to which any pandemic or epidemic impacts our business will depend on future developments,
which are highly uncertain and cannot be predicted with confidence, such as the ultimate geographic spread of the disease, the
duration of the outbreak, travel restrictions and actions to contain the outbreak or treat its impact, such as social distancing
and quarantines or lock-downs in the United States and other countries, business closures or business disruptions and the effectiveness
of actions taken in the United States and other countries to contain and treat the disease.
Also,
the current pandemic, and future pandemics and epidemics could hamper our efforts to provide our investors with timely information
and comply with our filing obligations with the Commission. Of major concern is loss of key staff and/or service providers
due to life threatening health issues.
OUR
OUTSTANDING OBLIGATIONS AND ABILITY TO ISSUE ADDITIONAL COMMON SHARES COULD RESULT IN SIGNIFICANT DILUTION TO STOCKHOLDERS.
Our Debentures
outstanding as of the date of the filing of this Report are convertible into 55,793,894 common shares, and
the number of shares into which these Debentures may be converted is expected to increase in the future. An aggregate of
19,125,000 common shares can be acquired upon the exercise of the outstanding Warrants. The conversion price of our
Debentures and the exercise price of the Warrants may be less than the then current market price of the common shares at the
time of conversion and exercise. Moreover, we have registered an aggregate of 6,000,000 common shares for issuance pursuant
to an equity incentive plan to employees, officers, directors, and outside consultants to compensate them for services
provided or to provide incentives to them. Of these common shares, 1,747,300 are still available for issuance in the future.
Future issuance of additional shares pursuant to the Debentures, Warrants or the equity incentive plan or otherwise could
cause immediate and substantial dilution to the net tangible book value of common shares issued and outstanding immediately
before such transactions. Any future decrease in the net tangible book value of such issued and outstanding shares could
materially and adversely affect the market value of the common shares. Moreover, any common shares issued as described above
would further dilute the percentage ownership of existing stockholders. The terms on which we could obtain additional capital
while our Debentures or the Warrants are outstanding may be adversely affected because of the potential dilution described in
this risk factor.
WE
NEED ADDITIONAL CAPITAL TO SATISFY OUR WORK COMMITMENT, TO PROVIDE WORKING CAPITAL AND TO DEVELOP THE PROSPECT, WHICH CAPITAL
WE MAY NOT BE ABLE TO RAISE OR WHICH MAY BE AVAILABLE ONLY ON TERMS UNFAVORABLE TO US.
We
have a work commitment with respect to the Prospect requiring us to expend significant stipulated amounts. We will need additional
funds to satisfy the remainder of the work commitment, which includes the actual drilling of wells. Moreover, we will need working
capital and further funds to explore and develop the Prospect in the manner that we prefer.
We
are actively engaged in efforts to complete a capital raising transaction sufficient for us to complete the third year of the
work commitment and provide additional funds to cover general and administrative costs. In the past, we have used the services
of firms that specialize in capital procurement, but we are currently pursuing our own capital raising initiatives. If funds are
not procured pursuant to this arrangement, we will be constrained to seek alternative financing. We have no assurance that we
will be successful in completing a transaction that will provide us with required funds. Our failure to honor our work commitment
could result in our loss of the Prospect. Moreover, our failure to procure funds needed to develop operations sufficient to generate
enough cash to retire our Debentures as they become due could result in Debentures holders’ eventual exercise of the rights
of a secured creditor and the possible loss of all or a large part of our assets. If either of the preceding events were to occur,
we could be forced to cease our current business plan, which could result in a complete loss to our stockholders. Our future liquidity
will depend upon numerous factors, including the success of our business efforts and our capital raising activities. If we obtain
funds through the issuance of equity securities, the following results will or may occur:
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the
percentage ownership of our existing stockholders will be reduced.
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the
new equity securities could have rights, preferences or privileges senior to those of the holders of our common shares.
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We
have no assurance of our ability to raise funds for any purpose.
THERE IS SUBSTANTIAL
DOUBT AS TO WHETHER WE WILL CONTINUE OPERATIONS WITHOUT ADDITIONAL FINANCING.
Based
on our assessment of the related risk factors (described further below), we believe there is substantial doubt about our ability
to continue to operate as a going concern for the 12 months following the issuance of our February 29, 2020 financial statements.
Our independent registered public accountant has added an emphasis
paragraph to its report on our financial statements for the year ended February 29, 2020 regarding our ability to continue as
a going concern. Key to this determination is our lack of any historical revenues and our accumulated deficit of $25,578,025 since
inception through February 29, 2020. Since May 2016, we have placed Debentures having an aggregate original principal amount of
$6,850,000. Proceeds from these placements largely financed our business for our fiscal years 2017 and 2018, and the first half
of our fiscal year 2019. Since that time, we have financed our business through private common shares financings. Notwithstanding
the preceding, we still need additional funds. There can be no assurance that we will be successful in securing funding, becoming
profitable, or continuing our business without either a temporary interruption or a permanent cessation.
IF
WE GROW OUR BUSINESS AS PLANNED, WE MAY NOT BE ABLE TO MANAGE PROPERLY OUR GROWTH, AND WE EXPECT OPERATING EXPENSES TO INCREASE,
WHICH MAY IMPEDE OUR ABILITY TO ACHIEVE PROFITABILITY.
If
we are successful in growing our business as we plan, our operations may expand rapidly and significantly. Any rapid growth could
place a significant strain on our management, operational and financial resources. In order to manage the growth of our operations,
we will be required to improve and expand existing operations; to implement new operational, financial and inventory systems,
procedures and controls, including improvement of our financial and other internal management systems; and to train, manage and
expand our staffing. If we are unable to manage growth effectively, our business, results of operations and financial condition
will be materially and adversely affected. In addition, if we are successful in growing our business as we plan, we expect operating
expenses to increase, and as a result, we will need to generate increased revenue to achieve and maintain profitability. These
additional costs and expenses could delay our ability to achieve continuing profitability.
CONDUCTING
BUSINESS INTERNATIONALLY MAY RESULT IN INCREASED COSTS AND OTHER RISKS.
We
plan on operating our business in Australia. Operating internationally exposes us to a number of risks. Examples include a possible
downturn in local economic conditions due to local policy decisions, increases in duties and taxes, and other adverse changes
in laws, regulations and policies affecting our business, or governing the operations of foreign based companies. Additional risks
include currency fluctuations, interest rate movements, imposition of trade barriers, and restrictions on repatriation of earnings.
If we are unable to address these risks adequately, our financial position and results of operations could be adversely affected.
RISKS
RELATING TO OUR INDUSTRY
OIL
AND NATURAL GAS EXPLORATION AND PRODUCTION PRESENT MANY RISKS THAT ARE DIFFICULT TO MANAGE.
Our
Hydrocarbon exploration, development and production activities are subject to many risks that may be unpredictable and are difficult
to manage. In addition, the cost and timing of drilling, completing and operating wells is often uncertain. In conducting exploration
and development activities, the presence of unanticipated pressure or irregularities in formations, miscalculations or accidents
may cause exploration, development and production activities to be delayed or unsuccessful. This could result in a total loss
of our investment in a particular drilling program. If exploration efforts are unsuccessful in establishing proved reserves in
a timely manner and exploration activities cease, the amounts accumulated as unproved costs will be charged against earnings as
impairments.
OUR
FOCUS ON EXPLORATION ACTIVITIES EXPOSES US TO GREATER RISKS THAN ARE GENERALLY ENCOUNTERED IN LATER-STAGE HYDROCARBON PROPERTY
DEVELOPMENT BUSINESSES.
If
we are funded, most of our initial activity will involve drilling exploratory test wells on acreage with no proved Hydrocarbon
reserves. While all drilling (whether developmental or exploratory) involves risks, exploratory drilling involves greater risks
of dry holes or failure to find commercial quantities of Hydrocarbons. The economic success of any drilling program will depend
on numerous factors, including the ability to estimate the volumes of recoverable reserves relating to the drilling program, rates
of future production, future commodity prices, investment and operating costs and possible environmental liabilities. All of these
factors may impact whether a drilling program will generate cash flows sufficient to provide a suitable return on investment.
If we experience a series of failed drilling projects, our business, results of operations and financial condition could be materially
and adversely affected.
WE
WILL RELY ON INDEPENDENT EXPERTS AND TECHNICAL OR OPERATIONAL SERVICE PROVIDERS OVER WHOM WE MAY HAVE LIMITED CONTROL.
We
are, and will continue to be, engaging independent contractors to provide us with technical assistance and services. These include
the services of geologists, geophysicists, chemists, landmen, engineers and scientists. We also are and will be relying upon them
to analyze the Prospect and any other future prospects to determine methods in which the Prospect may be developed in a cost-effective
manner and to select drill sites. In addition, we intend to rely on the owners and operators of oil rigs and drilling equipment,
and on providers of oilfield services, to drill and develop our prospects to production. Moreover, if our properties hold commercial
quantities of Hydrocarbons, we would need to rely on third-party gathering, trucking and/or pipeline facilities to transport and
purchase our production. Our limited control over the activities and business practices of these providers, any inability on our
part to maintain satisfactory commercial relationships with them or their failure to provide quality services could materially
and adversely affect our business, results of operations and financial condition.
SHORTAGES
OF RIGS, EQUIPMENT, SUPPLIES AND PERSONNEL COULD DELAY OR OTHERWISE ADVERSELY AFFECT OUR COST OF OPERATIONS OR OUR ABILITY TO
OPERATE ACCORDING TO OUR BUSINESS PLAN.
If
drilling activity increases in the Western Flank, a general shortage of drilling and completion rigs, field equipment and qualified
personnel could develop. As a result, the costs and delivery times of rigs, equipment and personnel could be substantially greater
than in previous years. From time to time, these costs have sharply increased and could do so again. The demand for and wage rates
of qualified drilling rig crews generally rise in response to the increasing number of active rigs in service and could increase
sharply in the event of a shortage. Shortages of drilling and completion rigs, field equipment or qualified personnel could delay,
restrict or curtail our exploration and development operations, which could in turn adversely affect our results of operations.
OUR
REVIEW OF PROPERTIES CANNOT ASSURE THAT ALL DEFICIENCIES OR ENVIRONMENTAL RISKS MAY BE IDENTIFIED OR AVOIDED.
We
plan on undertaking reviews that we believe are consistent with industry practice for our drilling programs. However, these reviews
will often be limited in scope, and may not reveal all existing or potential problems, or permit us to become sufficiently familiar
with the related properties to assess all potential problems. Moreover, we may not perform an inspection on every platform or
well, and our inspections may not reveal all structural or environmental problems. Our license rights with respect to the Prospect
contain no indemnification for environmental liabilities. Accordingly, we will pursue our drilling programs on an “as is”
basis, which could require us to make substantial expenditures to remediate environmental contamination. If a property deficiency
or environmental problem cannot be satisfactorily remedied to warrant commencing drilling operations on a property, we could lose
our entire investment in the asset.
WE
MAY NOT BE ABLE TO FULLY INSURE AGAINST ALL RISKS RELATED TO OUR PROPOSED OPERATIONS, WHICH COULD RESULT IN SUBSTANTIAL CLAIMS
FOR WHICH WE ARE UNDERINSURED OR UNINSURED.
We
currently do not have any insurance with regard to our proposed Hydrocarbon exploration and production activities. Prior to commencing
these activities, we do intend to obtain insurance that we believe will be consistent with prevailing industry practices. We have
no assurance that we will be able to obtain such insurance, or if obtained, we will be able to maintain it if costs become prohibitively
expensive. Moreover, we have no assurance that such insurance will cover all risks. Losses and liabilities arising from uninsured
and underinsured events, which could arise from even one catastrophic event, could materially and adversely affect our business,
results of operations and financial condition. Our exploration, drilling and other activities are subject to risks such as:
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fires
and explosions;
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environmental
hazards, such as uncontrollable flows of natural gas, oil, brine, well fluids, toxic gas or other pollution into the environment,
including groundwater contamination;
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abnormally
pressured formations;
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mechanical
failures of drilling equipment;
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personal
injuries and death, including insufficient worker compensation coverage for third-party contractors who provide drilling services;
and
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natural
disasters, such as adverse weather conditions.
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Our
business could be negatively affected by security threats, including cybersecurity threats, and other disruptions.
We
will depend to a meaningful extent on digital technologies to conduct our business. These technologies will relate to seismic,
financial, operating and other data. Cyber incidents have recently increased, and have involved malicious software and attempts
to gain unauthorized access to data and systems. Our technologies, systems, networks, and those of our business partners, may
become the target of cyberattacks or information security breaches that could result in the unauthorized release, misuse, loss
or destruction of proprietary and other information, or other disruption of our business operations. Our implementation of various
procedures and controls to monitor and mitigate security threats and to increase security for our information, facilities and
infrastructure may result in increased capital and operating costs. Moreover, there can be no assurance that such procedures and
controls will be sufficient to prevent security breaches from occurring. Any security breach could likely materially and adversely
affect our business, financial condition or results of operation.
OPERATIONAL
IMPEDIMENTS MAY HINDER OUR ACCESS TO HYDROCARBON MARKETS OR DELAY OUR PRODUCTION.
We
expect to deliver Hydrocarbons through trucking systems, gathering systems and pipelines that we do not own. Existing facilities
may not be available to us now or in the future. The marketability of our future production depends in part upon the availability,
proximity and capacity of truck terminals, pipelines, natural gas gathering systems and processing facilities owned by others.
Our failure to establish suitable contractual relationships with respect to our production would materially and adversely affect
our business, results of operations and financial condition. In addition, any significant change in our arrangements with trucking
firms, gathering system or pipeline owners and operators or other market factors affecting the overall infrastructure facilities
servicing our properties could adversely impact our ability to deliver the Hydrocarbons we produce to markets in a satisfactory
manner. In some cases, we may be required to shut in wells, at least temporarily, for lack of a market because of the inadequacy
or unavailability of transportation facilities. If that were to occur, we would be unable to timely realize revenue from those
wells until arrangements were made to deliver our production to market. Moreover, our ability to produce and market Hydrocarbons
could be negatively impacted by:
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government
regulations; and
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government
transportation, tax and energy policies.
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HYDROCARBON
RESERVES DECLINE ONCE A PROPERTY BECOMES PRODUCTIVE, AND WE EXPECT TO NEED TO FIND ADDITIONAL RESERVES TO SUSTAIN REVENUE GROWTH.
Even
if we add Hydrocarbon reserves through our exploration activities, our reserves will decline as they are produced. We will be
constantly challenged to add additional reserves through further exploration or further development of our existing properties.
There can be no assurance that our exploration and development activities will be successful in adding new reserves. If we fail
to replace reserves, our level of production and cash flows will be adversely impacted.
WE
EXPECT TO HAVE LIMITED CONTROL OVER ACTIVITIES ON PROPERTIES WE DO NOT OPERATE, WHICH COULD REDUCE OUR PRODUCTION AND REVENUES.
We
expect that we will operate all of our initial wells. However, some of our business activities could be conducted through joint
operating agreements under which we own partial interests in Hydrocarbon properties. In such situation, we may not operate the
related properties and in some cases we may not have the ability to remove the operator in the event of poor performance. As a
result, we may have a limited ability to exercise influence over normal operating procedures, expenditures or future development
of underlying properties and their associated costs. The failure of an operator of our wells to adequately perform operations,
or an operator’s breach of the applicable agreements, could reduce our production and revenues. The success and timing of
our drilling and development activities on properties operated by others therefore depend upon a number of factors outside of
our and the operator’s control, including:
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timing
and amount of capital expenditures;
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expertise
and financial resources; and
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inclusion
of other participants.
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HYDROCARBONS
ARE COMMODITIES SUBJECT TO PRICE VOLATILITY BASED ON MULTIPLE FACTORS OUTSIDE THE CONTROL OF PRODUCERS, AND LOW PRICES MAY MAKE
PROPERTIES UNECONOMIC.
Hydrocarbons
are commodities, and, therefore, their prices are subject to wide fluctuations in response to relatively minor changes in supply
and demand. Historically, the markets for Hydrocarbons have been volatile. These markets will likely continue to be volatile in
the future. The prices a producer may expect and its level of production depend on numerous factors beyond its control, such as
those described in “Item 1. Business - Markets and Marketing.” Lower Hydrocarbons prices may not only decrease revenues
on a per unit basis, but also may reduce the volume of Hydrocarbons that can be economically produced. Lower prices will also
negatively impact the value of proved reserves.
COMMODITY
PRICE RISK MANAGEMENT DECISIONS MAY CAUSE US TO FOREGO ADDITIONAL FUTURE PROFITS OR RESULT IN MAKING ADDITIONAL CASH PAYMENTS.
To
reduce our exposure to changes in the prices of Hydrocarbons, we may enter into commodity price risk management agreements for
a portion of our Hydrocarbon production. The agreements that we could enter into generally would have the effect of providing
us with a fixed price for a portion of the expected future Hydrocarbon production over a fixed period of time. Commodity price
risk management agreements expose us to the risk of financial loss, including the following:
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production
is less than expected;
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the
counter-party to the commodity price risk management agreement may default on its contractual obligations to us;
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we
could be required to post additional cash to cover margin requirements, which could materially and adversely affect liquidity;
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we
could be unable to meet additional margin requirements, which could result in the closing of positions thereby leading to
a financial loss as well as the possible loss of the anticipated benefits of the related hedging transactions;
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there
may be a change in the expected differential between the underlying price in the commodity price risk management agreement
and actual prices received; and
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market
prices may exceed the prices for which we are contracted to receive, resulting in the need to make significant cash payments.
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Furthermore,
commodity price risk management arrangements may limit the benefit we would receive from increases in the prices for Hydrocarbons.
OUR
PROPERTIES MAY BE SUBJECT TO SUBSTANTIAL IMPAIRMENT OF THEIR RECORDED VALUE.
The
accounting rules for our properties, for which we establish proved reserves, will require us to review periodically their carrying
value for possible impairment. If Hydrocarbon prices decrease or if the recoverable reserves on a property are revised downward,
we may be required to record impairment write-downs, which would result in a negative impact to our financial position. We also
may be required to record impairment write-downs for properties lacking economic access to markets and must record impairment
write-downs for our Prospect as the license for it expires or when we expect such license to expire without an extension, both
of which could also negatively impact our financial position.
OUR
COMPETITORS INCLUDE LARGER, BETTER-FINANCED AND MORE EXPERIENCED COMPANIES.
The
Hydrocarbon industry is intensely competitive. As an early-stage company, we must compete against larger companies that may have
greater financial and technical resources than we have and substantially more experience in our industry. These competitive advantages
may better enable our competitors to sustain the impact of higher exploration and production costs, Hydrocarbon price volatility,
productivity variances among properties, overall industry cycles and other factors related to our industry. The advantages of
our competitors may also negatively impact our ability to acquire prospective properties, develop reserves, attract and retain
quality personnel and raise capital.
CONDUCTING
OPERATIONS IN THE HYDROCARBON INDUSTRY SUBJECTS US TO COMPLEX LAWS AND REGULATIONS, INCLUDING ENVIRONMENTAL REGULATIONS THAT CAN
HAVE A MATERIAL ADVERSE EFFECT ON THE COST, MANNER OR FEASIBILITY OF DOING BUSINESS.
Companies
that explore for and develop, produce and sell Hydrocarbons in Australia are subject to extensive government laws and regulations,
including complex tax laws and environmental laws and regulations, and are required to obtain various permits and approvals from
government agencies. If these permits are not issued or unfavorable restrictions or conditions are imposed on our drilling activities,
we may not be able to conduct our operations as planned. Alternatively, failure to comply with these laws and regulations, including
the requirements to obtain any permits, may result in the suspension or termination of our operations and subject us to administrative,
civil and criminal penalties. Compliance costs can be significant. Further, these laws and regulations could change in ways that
substantially increase our costs and associated liabilities. We cannot be certain that existing laws or regulations, as currently
interpreted or reinterpreted in the future, or future laws or regulations will not harm our business, results of operations and
financial condition. For example, matters subject to regulation and the types of permits required include:
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water
discharge and disposal permits for drilling operations;
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drilling
permits;
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reclamation;
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spacing
of wells;
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occupational
safety and health;
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air
quality, noise levels and related permits;
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rights-of-way
and easements;
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calculation
and payment of royalties;
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gathering,
transportation and marketing of Hydrocarbons;
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taxation;
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waste
disposal; and
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flaring
on-site of unsold natural gas.
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Under
these laws and regulations, we could be liable for:
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personal
injuries;
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property
damage;
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oil
spills;
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discharge
of hazardous materials;
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remediation
and clean-up costs;
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fines
and penalties; and
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natural
resource damages.
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RISKS
RELATING TO OUR MANAGEMENT
WE
DEPEND ON CERTAIN KEY PERSONNEL.
We
rely upon the efforts and skills of our current and expected future management. We currently have no employees. The loss of the
services of any member of management, including the lack of sufficient time to devote to our operations, could materially and
adversely affect our operations. Currently, no member of management has entered into a written employment agreement or any covenant
not to compete with us, although we have entered into consulting agreements with two members of our management team, neither of
which contains a covenant not to compete. As a result, any member of management may discontinue providing his services to us at
any time and for any reason, and even thereafter commence competition with us. Moreover, we do not currently maintain key man
life insurance on any member of management.
OUR
CURRENT MANAGEMENT RESOURCES MAY NOT BE SUFFICIENT FOR THE FUTURE, AND WE HAVE NO ASSURANCE THAT WE CAN ATTRACT ADDITIONAL QUALIFIED
PERSONNEL.
There
can be no assurance that the current level of management is sufficient to perform all responsibilities necessary or beneficial
for management to perform. Our future success also depends on our continuing ability to attract, assimilate and retain highly
qualified sales, technical and managerial personnel. Competition for these individuals is intense, and there can be no assurance
that we can attract, assimilate or retain necessary personnel in the future.
OUR
MANAGEMENT OWNS A LARGE PERCENTAGE OF OUR OUTSTANDING SHARES, AND CUMULATIVE VOTING IS NOT AVAILABLE TO STOCKHOLDERS.
Our
current senior management owns approximately 63.16% of our outstanding common shares as of the date of the filing of this Report.
Cumulative voting in the election of directors is not authorized in our First Amended and Restated Articles of Incorporation.
Accordingly, it is not permitted as a matter of law. As a result, the holder or holders of a majority of our outstanding common
shares may elect all of our directors. Management’s large percentage ownership of our outstanding common shares will enable
them to maintain their positions as such and thus their control of our business and affairs.
OUR
OBLIGATION TO INDEMNIFY MEMBERS OF MANAGEMENT COULD REQUIRE US TO PAY THEM FOR LOSSES CAUSED BY THEM, AND LIMITATIONS ON CLAIMS
AGAINST SUCH STOCKHOLDERS COULD PREVENT OUR RECOVERY OF SUCH LOSSES FROM THEM.
The
corporation law of Nevada allows a Nevada corporation to indemnify its directors and each of its officers, agents, contractors
and/or employees to the extent that certain standards are met, and our First Amended and Restated Articles of Incorporation permit
indemnification of our directors, and our Bylaws require indemnification of our directors and officers to the maximum extent permitted
by law. If the required standards are met, we could be required to indemnify management for losses caused by them. Further, we
may purchase and maintain insurance on behalf of any such persons whether or not we have the power to indemnify such person against
the liability insured against. Moreover, the corporation law of Nevada allows a Nevada corporation to limit the liability of its
directors to the corporation and its stockholders to a certain extent, and our First Amended and Restated Articles of Incorporation
and Bylaws have eliminated the director’s liability to the maximum extent permitted by law. Consequently, because of the
actions or omissions of our management, we could incur substantial losses and be prevented from recovering such losses from such
persons. Further, the U.S. Securities and Exchange Commission maintains that indemnification for liabilities arising under the
Securities Act is against the public policy expressed in the Securities Act, and is therefore unenforceable.
We
may not have adequate internal controls over financial reporting.
While
we are constantly striving to improve our internal controls over financial reporting, our management has determined that
our disclosure controls, procedures and controls over financial reporting are not sufficiently effective to ensure
that information required to be disclosed by us in the reports filed or submitted under the Securities Exchange Act of 1934, as
amended (the “Exchange Act”), is recorded, processed, summarized, and reported within the time periods
specified in the rules and forms of the Commission. Our Board of Directors has not designated an Audit Committee and we do not
have any outside directors. We have implemented a number of disbursing, accounting and financial statement preparation and review
processes, and as a result the financial controls of the Company have been improved. If we do not have adequate internal accounting
controls, we may also be unable to prepare accurate accounts on a timely basis to meet our continuing financial reporting obligations
and we may not be able to satisfy our obligations under applicable securities laws.
There
may be limitations on the effectiveness of our internal controls, and a failure of our control systems to prevent error or fraud
may materially harm us.
We
do not expect that internal control over financing reporting, even if timely and well established, will prevent all errors
and fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that
the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are
resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations
in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud,
if any, have been detected. Failure of our control systems to prevent error or fraud could materially and adversely affect our
business.
WE
HAVE NOT VOLUNTARILY IMPLEMENTED VARIOUS CORPORATE GOVERNANCE MEASURES, IN THE ABSENCE OF WHICH, STOCKHOLDERS MAY HAVE MORE LIMITED
PROTECTIONS AGAINST INTERESTED DIRECTOR TRANSACTIONS, CONFLICTS OF INTEREST AND SIMILAR MATTERS.
Certain
Federal legislation, including the Sarbanes Oxley Act of 2002, has resulted in the adoption of various corporate governance measures
designed to promote the integrity of corporate management and securities markets. Some of these measures have been adopted in
response to legal requirements. Others have been adopted by companies in response to the requirements of national securities exchanges,
such as the NYSE or the NASDAQ Stock Market, on which their securities are listed. Among the corporate governance measures that
are required under the rules of national securities exchanges are those that address board of directors’ independence, audit
committee oversight, and the adoption of a code of ethics. Although we have adopted a Code of Ethics, we have not yet adopted
any of these other corporate governance measures and, since our securities are not yet listed on a national securities exchange,
we are not required to do so. We have not adopted certain corporate governance measures such as an audit or other independent
committees of our Board of Directors because we do not have sufficient funds available to do so. Possibly if we were to adopt
some or all of these corporate governance measures, stockholders would benefit from somewhat greater assurances that internal
corporate decisions were being made by disinterested directors and that policies had been implemented to define responsible conduct.
For example, in the absence of audit, nominating and compensation committees comprised of at least a majority of independent directors,
decisions concerning matters such as compensation packages to our senior officers and recommendations for director nominees may
be made by a majority of directors who have an interest in the outcome of the matters being decided. Although we intend to bolster
our corporate governance capabilities as funds become available for this purpose, prospective investors should bear in mind our
current lack of corporate governance measures in formulating their investment decisions.
RISKS
RELATING TO OUR COMMON SHARES
OUR
COMMON SHARES HAVE EXPERIENCED LIMITED TRADING.
Our
common shares are quoted on the over-the-counter markets under the name “Discovery Energy Corp.” and the symbol “DENR”.
The volume of trading of our common shares has been extremely limited. There can be no assurance as to the prices at which our
common shares will trade in the future. Until our common shares become more broadly held and orderly markets develop and even
thereafter, the prices of our common shares may fluctuate significantly. Prices for our common shares will be determined in the
marketplace and may be influenced by many factors, including the following:
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The
depth and liquidity of the markets for our common shares;
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Investor
perception of us and the industry in which we participate;
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General
economic and market conditions;
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Responses
to quarter to quarter variations in operating results;
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Failure
to meet securities analysts’ estimates;
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Changes
in financial estimates by securities analysts;
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Changes
in laws, regulations and policies;
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Conditions,
trends or announcements in the Hydrocarbon industry;
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Announcements
of significant acquisitions, strategic alliances, joint ventures or capital commitments by us or our competitors;
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Additions
or departures of key personnel;
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Sales
of our common shares;
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Accounting
pronouncements or changes in accounting rules that affect our financial statements; and
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Other
factors and events beyond our control.
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The
market price of our common shares could experience significant fluctuations unrelated to our operating performance. As a result,
a stockholder (due to personal circumstances) may be required to sell such stockholder’s common shares at a time when our
stock price is depressed due to random fluctuations, which are possibly based on factors beyond our control.
INCREASES
IN THE SALES VOLUME OF OUR SHARES COULD ADVERSELY AFFECT US.
We
have a very thinly traded market for our shares. Future sales of a large number of our shares may have a depressive effect on
the price of our common shares, and might also adversely affect our ability to raise additional capital.
THE
TRADING PRICE OF OUR COMMON SHARES MAY ENTAIL ADDITIONAL REGULATORY REQUIREMENTS, WHICH COULD NEGATIVELY AFFECT SUCH TRADING PRICE.
The
trading price of our common shares historically has been below $5.00 per share. As a result of this price level, trading in our
common shares is subject to the requirements of certain rules promulgated under the Exchange Act. These rules require additional
disclosure by broker dealers in connection with any trades generally involving any non-NASDAQ equity security that has a market
price of less than $5.00 per share, subject to certain exceptions. Such rules require the delivery, before any penny stock transaction,
of a disclosure schedule explaining the penny stock market and the risks associated therewith and impose various sales practice
requirements on broker dealers who sell penny stocks to persons other than established customers and accredited investors (generally
institutions). For these types of transactions, the broker dealer must determine the suitability of the penny stock for the purchaser
and receive the purchaser’s written consent to the transaction before sale. The additional burdens imposed upon broker dealers
by such requirements may discourage broker dealers from effecting transactions in our common shares. As a consequence, the market
liquidity of our common shares could be severely affected or limited by these regulatory requirements.
PROVISIONS
OF OUR ARTICLES OF INCORPORATION AND BYLAWS MAY DELAY OR PREVENT A TAKEOVER, WHICH MAY NOT BE IN THE BEST INTERESTS OF OUR STOCKHOLDERS.
Provisions
of our First Amended and Restated Articles of Incorporation and Bylaws may be deemed to have anti-takeover effects, which include
when and by whom special meetings of our stockholders may be called, and may delay, defer or prevent a takeover attempt. In addition,
our First Amended and Restated Articles of Incorporation authorizes the issuance of up to 10,000,000 shares of preferred stock
with such rights and preferences, as may be determined by our Board of Directors. Of this authorized preferred stock, no shares
are currently issued and outstanding. Our Board of Directors may, without stockholder approval, issue up to 10,000,000 preferred
stock with dividends, liquidation, conversion or voting rights that could adversely affect the voting power or other rights of
our common stockholders.
STOCKHOLDERS
HAVE NO GUARANTEE OF DIVIDENDS AND MAY BE CONSTRAINED TO SELL THEIR SHARES TO REALIZE A RETURN ON THEIR INVESTMENT.
The
holders of our common shares are entitled to receive dividends when, as and if declared by the Board of Directors out of funds
legally available therefore. To date, we have paid no cash dividends. Currently, our outstanding Debentures prohibit us from paying
dividends without the consent of our Debentures holders. Even if such a prohibition did not exist, the Board of Directors will
most likely not declare any dividends in the foreseeable future, but will instead retain all earnings, if any, for use in our
business operations. As a result, an investor will probably need to sell some or all of their shares to realize a return on an
investment in them, and investors may not be able to sell such shares at or above the price they paid for them.