##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-K (Mark One)þ
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended December 31, 2004ORo
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from to Commission File Number 0-32455 Far East Energy Corporation  Nevada
    
    88-0459590(State or other jurisdiction of
incorporation or organization)
    
    (I.R.S. Employer Identification No.)400 N. Sam Houston Parkway East, Suite 205, Houston, Texas
    
    77060(Address of principal executive offices)
    
    (Zip Code)
 Registrants telephone number, including area code: (832) 598-0470 Securities registered pursuant to Section 12(b) of the Exchange Act: None Securities registered under 12(g) of the Exchange Act:Common Stock (par value $0.001 per share) Indicate by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or15(d)of the Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days. YesþNoo Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation
S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form 10-K
or any amendment to thisForm 10-K.   o Indicate by check mark whether the registrant is an accelerated filer (as defined in
Exchange Act Rule 12b-2). Yesþ  Noo. The aggregate market value of the voting Common Stock, par value $0.001 per share, held by
non-affiliates of the registrant was approximately $76,653,000 as of June 30, 2004 (based on $1.45
per share, the last price of the Common Stock as reported on the OTC Bulletin Board on such date).
For purposes of the foregoing calculation only, all directors, executive officers and 5% beneficial
owners have been deemed affiliates. The number of shares of Common Stock, par value $0.001 per share, outstanding as of March 4,
2005 was 77,439,910. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrants proxy statement for the annual meeting of stockholders to be held May
24, 2005 are incorporated by reference into Part III of this Form 10-K.




---



FAR EAST ENERGY CORPORATION
TABLE OF CONTENTS PagePART IItem 1. Business
    
    
    1Item 2. Properties
    
    
    9Item 3. Legal Proceedings
    
    
    10Item 4. Submission of Matters to a Vote of Security Holders
    
    
    10PART IIItem 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
    
    
    10Item 6. Selected Financial Data
    
    
    12Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    13Item 7A. Quantitative and Qualitative Disclosures About Market Risk
    
    
    31Item 8. Financial Statements and Supplementary Data
    
    
    32Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
    
    
    63Item 9A. Controls and Procedures
    
    
    63Item 9B. Other Information
    
    
    63PART IIIItem 10. Directors and Executive Officers of the Registrant
    
    
    63Item 11. Executive Compensation
    
    
    64Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
    
    
    64Item 13. Certain Relationships and Related Transactions
    
    
    64Item 14. Principal Accounting Fees and Services
    
    
    64PART IVItem 15. Exhibits and Financial Statement Schedules
    
    
    64Signatures
    
    
    65Articles of IncorporationSpecimen stock certificateEmployment Agreement - Garry R. WardEmployment Agreement - Zhendong "Alex" YangStock Option Agreement - Thomas CavanaghStock Option Agreement - Donald JuckettStock Option Agreement - Randall D. KeysStock Option Agreement - John C. MihmStock Option Agreement - Thomas WilliamsStock Option Agreement - Garry WardStock Option Agreement - Tun Aye SaiStock Option Agreement - Zhendong "Alex" YangProduction Sharing ContractFirst Amendment to Farmount Agreement - Qinnan PSCFirst Amendment to Farmount Agreement - Shouyang PSCStock Subscription AgreementRegistration Rights AgreementRegistration Rights AgreementRegistration Rights AgreementProduction Sharing ContractCertification of CEO Pursuant to Section 302Certification of CFO Pursuant to Section 302Certification of CEO Pursuant to 18 U.S.C. Section 1350Certification of CFO Pursuant to 18 U.S.C. Section 1350




---



##### Table of Contents



PART I 
 Item 1. BUSINESS Overview We were incorporated in Nevada on February 4, 2000. In January 2002, we renamed our company
Far East Energy Corporation and changed our focus to exploring, developing, producing and selling
coalbed methane gas, or CBM. Today, our operations concentrate on CBM exploration and development
in the Yunnan Province in Southern China and in the Shanxi Province in Northern China. Our goal is
to become a recognized leader in coalbed methane gas property acquisition, exploration, development
and production. Our principal offices are located at 400 North Sam Houston Parkway, Suite 205,
Houston, Texas 77060. We also maintain offices in Beijing, China and Kunming, Yunnan Province,
China. We are a development stage company and to date our activities have been principally limited to
organizational activities, including developing a strategic operating plan, capital funding, hiring
personnel, entering into contracts, acquiring rights to explore, develop, produce and sell oil and gas or CBM and,
beginning in 2003, the drilling, testing and completion of exploratory wells. We have entered into
three production sharing contracts that enable us to explore for, develop, produce and sell CBM on
over 1.3 million acres located in the Yunnan and Shanxi Provinces of the Peoples Republic of China
(PRC), which we believe makes us the third largest holder of coalbed methane acreage in China.
To date, we have drilled three exploratory wells on acreage in the Yunnan Province. We have also
successfully completed a hydraulic fracture simulation test on a well previously drilled by our
partner, Phillips China Inc., a subsidiary of ConocoPhillips, Inc. (Phillips), on acreage in the
Quinnan Block of the Shanxi Province. We have not recognized any
revenues from our operations and do not anticipate recognizing significant revenues prior to late 2006. Until recently, we also owned undeveloped oil, gas and mineral rights and interests in
approximately 149,000 net acres located in the eastern portion of Montana. On February 2, 2005,
our wholly owned subsidiary, Newark Valley Oil & Gas, Inc., entered into a purchase and sale
agreement with Zier & Associates, Ltd. for the sale of our oil and gas leasehold interests and
other property interests in Montana. As a condition to the sale of our Montana properties, we
acquired certain overriding royalty interests in adjoining acreage for $100,000, which were also
sold under the terms of the purchase and sale agreement. The transaction closed on February 2,
2005. At the closing, we received gross proceeds of $1,135,000 from the sale of our Montana
properties (including the overriding royalty interests described above). We consider our Montana
properties to be non-core assets of our company. We sold these assets in order to focus our
efforts on the exploration and development of our coalbed methane holdings located in China. As a
result, all of our long-lived assets are presently located in the PRC. Our Website Our website can be found at www.fareastenergy.com. Our Annual Report on Form 10-K, Quarterly
Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or
furnished with the U.S. Securities and Exchange Commission (SEC) pursuant to Section 13(a) or
15(d) of the Securities Exchange Act of 1934 (the Exchange Act) can be accessed free of charge by
linking directly from our website under the Investor RelationsSEC Filings caption to the SECs
Edgar Database. These filings will be available as soon as reasonably practicable after we
electronically file such material with, or furnish it to, the SEC. Information contained on the
website is not part of this report. Coalbed Methane Gas and Testing of Coalbed Methane Resources CBM is a type of natural gas found in coal seams of various types of coal. As coal is formed,
large quantities of natural gas are generated and adsorbed on the internal surface area of the
coal.




---



##### Table of Contents



Coalbed methane exploration and production involves drilling into a known coal deposit and
extracting the gas that is contained in the coal. A coal seam is often saturated with water, with
methane being held in the coal by water pressure. To produce methane from coalbeds, water must
first be pumped from the seam in order to reduce the water pressure that holds the gas in the seam.
This process is called dewatering. When the water pressure is
reduced, the gas adsorbed on the coal is released and diffuses into the fractures, or cleats, contained in the coal seam. Gas flows to
the well bore through the cleat system as well as any of the other cracks, crevices and fractures
found in the coalbed. Dewatering volumes decrease as  peak CBM production is reached. The productivity potential of a well depends on many reservoir and geological characteristics,
including permeability, thickness and depth of the coalbed, the coal ranking of the coalbed, gas
content and other factors. We consider these factors, as well as
isotherm tests conducted on core samples,
the amount of dewatering required of a well and a number of other factors when
choosing where to develop coalbed methane present in our CBM acreage. Permeability Coalbed methane exploration requires that the coal have sufficient permeability. Permeability
is based upon how many cleats the coal has and how close they are to each other. The more cleats
coal has, the better the coals permeability and the greater
opportunity to retrieve the adsorbed
CBM. Therefore, reservoirs with high permeability have a higher propensity for strong production
than less permeable reservoirs. Thickness The
thickness of the coal seam is crucial to coalbed methane production.
A coal seam with traditionally
unacceptably low permeability could be produced with sufficient thickness. In this case, the gas
would flow out slowly, but because the coal seam is thick, more of the slow-flowing gas would be
produced since there is a thick area from which to collect the CBM. Depth The depth of the coal seam is also a significant factor in the productivity potential of a
well. Where the coal, and thus the methane, lies at shallow depths, wells are generally easier to
drill and less expensive to complete. With greater depth, increased pressure closes cleats in the
coal, which reduces permeability and the ability of the CBM to move through and out of the coal.
On the other hand, if a coal seam is not buried deeply enough, there may not be sufficient water
pressure to hold the gas in place on the coal. Coal Ranking Methane is contained in all ranks of coal. The most CBM is contained in the highest rank
coal, which is called anthracite. Unfortunately, anthracite has very low permeability.
Semi-anthracite coal typically has lower quantities of CBM than anthracite coal, but may still
contain significant cleats as well, making it more permeable. The coalbeds found in our Shanxi
Province project are semi-anthracite coal that has a favorable cleat structure, which should also
make the permeability favorable. The next lesser coal rank is bituminous coal that contains less CBM per ton but usually has a
good cleat structure allowing for better permeability. The coalbeds found in our Enhong  Laochang
blocks, which are located in the Yunnan Province, have bituminous and semi-anthracite coal. Dewatering Water must be removed from the coal seams to decrease reservoir pressure and release the gas
to produce methane from coalbeds. After the detachment of gas molecules from the coal surface, or
desorption, occurs, the gas diffuses through the coalbeds cleats and fractures toward the well
bore. Substantial dewatering of the coalbed is required initially. Water production declines as
methane gas production increases. Produced water disposal presents major economic and
environmental challenges for operators. These costs alone can determine the feasibility of coalbed
methane projects. 2




---



##### Table of Contents



Coalbed Methane in the Peoples Republic of China China is the worlds largest coal producing country, and has substantial coalbed methane
resources located within its abundant coalfields. Because most of Chinas CBM is found at shallow
depths, it is easier to drill and complete coalbed methane wells than traditional natural gas
wells. Additionally, the vast amounts of undeveloped coalbed methane in China result in the
country releasing six billion cubic meters of methane into the environment each year from Chinas
many coal mines. This results in serious pollution and wastes a
precious resource, which could be recovered prior to mining, such as
CBM. Our business strategy is to explore, develop and produce the coalbed methane currently
untapped in China. China is currently the worlds second largest user of petroleum and one of the
largest importers of oil and gas in the world. Chinas energy needs are also increasing rapidly,
fueled in part by a recent economic upswing in the country. Demand in China is projected to outpace
the rest of the world over the next decade. As a result of Chinas increasing energy needs, the
Chinese government has, in recent years, focused its attention on the development of energy
sources, including CBM. As reported in the China Daily,
China has mandated that natural gas replace coal as a major source
of electricity by the 2008 Summer Olympics being held in Beijing. As part of its plan to increase
coalbed methane production, the State Council of the PRC, the chief administrative body of the PRC,
created the China United Coalbed Methane Co. Ltd. (CUCBM). The State Council has granted CUCBM
the exclusive right to contract with foreign corporations for the exploration, development and
production of coalbed methane in China. In addition, the Chinese government has provided
incentives to stimulate the development of CBM, including exempting CBM development from import
duties and import-related duties (Encouraged and Restricted B of the Guidance Catalog of Industries
for Foreign Investments,specific measures executed in accordance with No. 1602 Document issued by
the State Administration of Customs in 1997) and reducing value-added tax, or VAT, for CBM projects
with foreign companies at 5% compared to 13% to 17% VAT for conventional gas companies (The Notice
of the Interim Regulations Concerning the Value-Added Tax, Consumption Tax and Sales Tax Applied to
Foreign Investment Enterprise and Foreign Enterprise (February 22, 1994) Item 3). Horizontal Drilling Horizontal drilling technology has yielded successful results in coalbed methane applications
in the United States. We plan to leverage this technology in our coalbed methane production in
China. A horizontal well allows a well bore to be in contact with hundreds of feet of coal because
the drill stem, when it hits the coal seam, is redirected from a downward angle to a horizontal
plane and follows the coalbed for hundreds of feet in various directions. This access should
change the dynamics of the CBM recovery. In a normal CBM well, we would have to drill an 8-inch
hole contacting and hollowing out a coal seam 10 feet thick. With horizontal drilling, we can go
directly along the coal seam for hundreds of feet or more in many directions, increasing
the coalface exposure. This greater exposure of the coalface to flow associated with horizontal drilling allows
more CBM production on a daily basis than can be achieved with conventional vertical
stimulation techniques. Although horizontal wells are more costly than traditional wells, they
offer more potential in reduced surface facilities and increased production rate. Our Holdings in the Peoples Republic of China We
are parties to production-sharing contracts and farmout agreements covering over 1.3
million acres in two Provinces in China  the Yunnan Province in the southern region of China and
the Shanxi Province in the northern region of China. Yunnan Province, China On January 25, 2002, we entered into one production sharing contract with CUCBM to develop two
areas in the 3




---



##### Table of Contents



Yunnan Province: (1) the Enhong project, which covers approximately 145,198 acres and
(2) the Laochang project, which covers approximately 119,772 acres. We act as operator under the
production sharing contract. The term of the production sharing contract with CUCBM consists of an
exploration period, a development period and a production period. The exploration period is
divided into two phases called Phase I and Phase II. Following completion of Phase II of the
exploration period, we may elect to continue the production sharing contract and conduct
development and production operations on any CBM discoveries. The development period as to any CBM
field in the Enhong-Laochang project will begin after the approval of a development plan submitted
by us with respect to that field by the State Council
of the PRC and confirmed by CUCBM. The production period as to any CBM field in the
Enhong-Laochang project will begin after the date of commencement of commercial production of that
CBM field. Our agreement with CUCBM expires 20 years from the start date of the production period
of the Enhong-Laochang project. During the exploration period, we hold a 100% participating interest in the properties, and we
must bear all exploration costs for discovering and evaluating CBM bearing areas. Prior to the
beginning of the development period of any CBM field in the Enhong-Laochang project, CUCBM may
elect to participate in the development of that CBM field at a level of between zero to 40%.
Therefore, depending upon CUCBMs participation, should we elect to develop a CBM field, our
working interest in that CBM field will range from 60% to 100%. If any CBM field is discovered,
the development costs for that CBM field will also be borne by CUCBM and us in proportion to the
respective participating interests. Our Phase I and Phase II obligations during the exploration
period of our production sharing contract with CUCBM are as follows: Phase I We have completed our Phase I obligations. These obligations required us to drill and
complete three wells on the project, perform a hydraulic fracture and test of one of these three
wells and drill two slim hole vertical wells. We believe the three wells we have drilled under our Phase I requirement have yielded
favorable gas content results. Below is a description of the initial testing results we have
obtained from these three wells drilled in the Enhong-Laochang project:  
    FCY-LC01  total depth 825 meters (2,722 feet).A total of 15 mineable coal seams were
penetrated during the drilling of the well, with a total thickness of 29.4 meters (97
feet), which we consider to be excellent. The coring of the coal samples showed a recovery
rate of 94.8%. In addition, the drilling revealed four targeted major coal seams with a
total thickness of 16.3 meters (54 feet), all within an interval of about 110 meters (363
feet), which we believe are favorable for production of CBM. Testing of 18
desorption samples from the well resulted in gas content estimates of approximately 18
cubic meters per ton of coal or about 650 cubic feet per ton of coal.
    FCY-EH02  total depth 420 meters (1,344 feet). The well penetrated 15 coal seams with
a thickness of 16.7 meters (53 feet). The total thickness of the coal seams targeted for
potential production was 6.6 meters with a recovery rate of 70%. Estimated gas content,
based on preliminary desorption results is approximately 10 cubic meters per ton of coal,
or about 350 cubic feet per ton of coal.
    FCY-EH01  total depth 435 meters (1,436 feet). The well penetrated 42 coal seams with
a thickness of 42.8 meters (141 feet). The total thickness of the four coal seams targeted
for potential production was 17.2 meters (57 feet). Estimated gas content, based on
preliminary desorption results, is approximately 8 to 10 cubic meters per ton of coal, or
approximately 280 to 350 cubic feet per ton of coal. Phase II On February 23, 2005, we elected to enter into Phase II, which will require us to drill at
least one additional horizontal well with a minimum of two laterals. Our Phase II obligations are
required to be completed by December 31, 2005. Following completion of Phase II of the exploration
period, we may elect to conduct development and production operations on any CBM discoveries. 4




---



##### Table of Contents



Although we believe we have realized strong results from the first three wells drilled and
completed, we cannot provide any assurances that we will achieve commercial viability for the
projects in the Yunnan Province. The three wells alone cannot produce sufficient CBM to achieve
commercial viability. We must complete several more wells in close proximity to the wells we have
already drilled in order to make it feasible to begin production from any of our current
Enhong-Laochang project wells. Furthermore, because there is no gas pipeline, liquefied natural
gas (LNG) plant or other off take candidate in near proximity to these wells, our ability to sell
CBM produced on these projects to communities outside the general area will be contingent upon a
pipeline or LNG plant being built near the Enhong-
Laochang project. Actual production may vary materially from preliminary test results.
Actual production from the wells may be at recovery rates and gas quality materially worse than our
first indications. Pursuant to the terms of our production sharing contract with CUCBM, we have paid CUCBM
signature fees totaling $350,000. We have also agreed to make the following payments in connection
with the production sharing contract:  
    During the exploration period, we must reimburse CUCBM for government-imposed fees for
CBM exploration rights. During 2004, we reimbursed CUCBM $8,000 for these fees. The CBM
exploration rights will be allocated to CUCBM and us in proportion to our participating
interest in the development and production periods;
    We must pay assistance fees to CUCBM totaling $45,000 per year during the exploration
period and $80,000 per year during the development and production periods;
    We have agreed to pay training fees for Chinese personnel working on the projects of
$45,000 per year during the exploration period, and $80,000 per year during the development
and production periods; and
    During the exploration period, we have agreed to pay salary and benefits for CUCBM
professionals, which are currently approximately $15,800 per month. The allocation of
salary and benefits for CUCBM professionals during the development and production period
shall be determined by CUCBM and us through consultation. In addition to our holdings in the Enhong-Laochang project, on January 25, 2002, we
entered into a production sharing contract with CUCBM with respect to CBM acreage in the Zhaotong
region. This contract has not yet received governmental approval, and we have informed CUCBM that
we do not anticipate pursuing this contract as we intend to focus our efforts on the Yunnan
Province and Shanxi Province projects. Shanxi Province, China In June 2003, we entered into two farmout agreements and assignment agreements with Phillips
pursuant to which we acquired a 40% net undivided interest
from Phillips in two production sharing contracts between Phillips and CUCBM for the Shanxi
Province (the Shanxi Agreements). The Shanxi Agreements cover a total of 1,057,650 acres. The project areas covered by
the Shanxi Agreements are located in the Shouyang Block (near Taiyuan City) and the Qinnan Block
(near Jincheng and Quinshui). The assignment agreements and related amendments to the farmout
agreements substituted us for Phillips as the principal party and
operator for the projects under the production sharing contracts. These
agreements were approved by CUCBM on March 15, 2004 and ratified by the PRCs Ministry of Commerce
on March 22, 2004. The term of each of the Shanxi Agreements consists of an exploration period, a development
period and a production period. The exploration period is divided into three phases called Phase
I, Phase II and Phase III. We have completed our Phase I obligations under the Shanxi Agreements
and have elected to enter into Phase II of the exploration period. Following completion of Phase
III of the exploration period, we may elect to continue the production sharing contracts and
conduct development and production operations on any CBM discoveries. The development period as to
any CBM field in the Shanxi Province project will begin after the approval of a development plan
submitted by us with respect to that field by the State Council of the PRC and confirmed by CUCBM.
The production period as to any CBM field in the Shanxi Province project will begin after date of
commencement of commercial production of that CBM field. Our agreement with CUCBM expires
on April 1, 2034. 5




---



##### Table of Contents



Currently, we have a 40% participating interest, Phillips has a 30% participating interest and
CUCBM has a 30% participating interest in each of the Shaouyang Block and the Qinnan Block of the
Shanxi Province. If we successfully complete Phase II, Phillips will have the option to elect to
retain a net undivided 30% participating interest or an overriding royalty interest up to 3.5% of
the total participating interest. Additionally, prior to the beginning of the development period
of any CBM field in the Shanxi project, CUCBM may elect to participate in the development of that
CBM field at a level of between zero and 30%. Therefore, depending upon whether Phillips and CUCBM
elect to
participate in the project, our interest will range from 40% (assuming full participation by
Phillips and CUCBM) to 96.5% (assuming both CUCBM and Phillips choose not to participate). We must bear all exploration costs for discovering and evaluating CBM bearing areas during
Phase II. If we successfully complete Phase II and Phillips elects to retain a 30% participating
interest, then the exploration and development costs of the project will be borne 70% by us and 30%
by Phillips. If any CBM field is discovered, the development costs for that CBM field will also be
borne by us, Phillips and CUCBM in proportion to the respective participating interests. Our Phase
I, Phase II and Phase III obligations during the exploration period of the Shanxi Agreements are as
follows: Phase I We have completed our Phase I obligations. Phase I obligated us, at our expense, to perform a
hydraulic fracture of one of three exploration wells previously drilled by Phillips by January 31,
2005. In September 2004, the hydraulic fracture and testing was completed on the QN-002 well
drilled previously by Phillips on its acreage in the Qinnan Block located in the Shanxi Province of
China. The test was performed on the #3 coal seam at a depth of 550 meters (1,880 feet),
completing our requirements for Phase I under the Shanxi Agreements. We will continue dewatering
this well until approximately the end of March 2005. Phase II We have elected to enter into Phase II, which requires us to drill two horizontal wells in the
Shouyang block by December 31, 2005. We have agreed to use our best commercial efforts to drill
each of the horizontal wells to 4,000 meters of horizontal drilling in coal seam with a minimum
requirement under the farmout agreement of 2,000 meters drilled in coal seam per well. Phase III If we elect to commit to Phase III in the Shanxi Province, we will be required to drill one
horizontal well, under which we will attempt to drill to 4,000 meters in coal seam. Phase III terminates on July 1,
2007. Our total work commitment in Phases II and III, if we elect to commit to Phase III, will
consist of a total of 12,000 meters of horizontal drilling in coal seam for the three wells
combined. We have agreed to make the following payments in connection with the production sharing
contracts with CUCBM:  
    During the exploration period, we must reimburse CUCBM for government-imposed fees for
CBM exploration rights. During 2004, we reimbursed CUCBM $56,000 for these fees. The CBM
exploration rights will be allocated to CUCBM and us in proportion to our participating
interest in the development and production periods;
    We have agreed to pay signature fees totalling $300,000, which will be due within 30
days after first approval of the overall development plan following the exploration period;
    We must pay assistance fees to CUCBM totaling $100,000 per year during the exploration
period and $240,000 per year during the development and production periods; 6




---



##### Table of Contents




    We have agreed to pay training fees for Chinese personnel working on the projects of
$120,000 per year during the exploration period, and $300,000 per year during the
development and production periods; and
    During the exploration period, we have agreed to pay salary and benefits for CUCBM
professionals, which are expected to be $13,500 per month through June 2005. The
allocation of salary and benefits for CUCBM professionals during the development and
production period shall be determined by CUCBM and us through consultation. The Shanxi Agreements required that we post a $1.0 million bank guarantee or surety bond by
May 14, 2004 to guarantee performance of the evaluation and work program to test existing wells.
On May 14, 2004, we placed $1.0 million into escrow to satisfy this bond. The $1.0 million escrow
account will continue to be held until December 31, 2005. In the event that we have not completed
drilling of the first horizontal well in Phase II by June 30, 2005, we will be required to increase
the escrow account to $2.6 million. Notwithstanding the requirement to increase the amount of the
escrow account to $2.6 million on June 30, 2005, subject to the prior written consent of Phillips,
we will be able to drawdown amounts from this escrow account required to fund operations in Phase
II after June 30, 2005. Each drawdown may not exceed $250,000. Transportation of Our
CBM in China The marketability of any production will depend, in part, upon the availability, proximity and
capacity of pipelines, gas gathering systems and processing
facilities. We may transport our CBM through pipelines or by
compressing or liquefying the CBM for transportation. No facilities presently
exist to transport or process CBM near our Yunnan Province projects,
and, although larger pipelines exist in proximity to our Shanxi
Province projects, pipelines must be built to connect to larger pipelines that do
exist or facilities must be added to compress or liquefy and transport our CBM. CBM projects traditionally
require multiple wells to properly dewater the coal and generate predictable volumes of gas.  It
is not yet possible to predict volumes so decisions about marketing the CBM cannot yet be made. Once we have initial
production of CBM from our Shanxi or Yunnan Province projects, we can begin to market the CBM
produced to local markets as compressed natural gas (CNG), which is an alternative to earn
revenues from any early production.  Production of CNG would require the installation of a
compressor which we could purchase and install for approximately $220,000.  Installation of the
compressor could be completed in approximately 90 days and could be funded from existing cash resources. We also have the alternative
to market CBM by connecting to a large pipeline in the Shanxi Province, building a pipeline in
the Yunnan Province or constructing LNG facilities in the two
provinces. We do not currently have the funds to build these facilities. We will be required to
raise additional funds through financings or other means or to find a strategic partner to complete
these facilities. It is not likely that any such facilities will be built until favorable results
are obtained from several more wells. We are delaying any decision regarding the construction of
LNG facilities or pipelines until such time as significant CBM production volumes are achieved. We
believe this delay may allow us to avoid construction costs to the extent other strategic partners
attracted by our CBM production or prospects, have constructed, are constructing or are planning to
construct, such facilities. Yunnan Province No gas pipeline, LNG plant, or other offtake candidate currently exists to take CBM from our
properties in Yunnan Province, and it is not likely that any such facilities will be built until
favorable results are obtained from several more wells. At the present time, because there are no
pipelines to move gas for any great distance in the Yunnan Province, natural gas will have to be
sold to the local communities. As described above, CNG transportation
is an opportunity until sufficient volume is produced to attract
pipeline or LNG construction. We believe we would need to develop as many as 10 wells to attract
a transportation company to build either a pipeline or an LNG plant near our wells. We may construct pipelines to move CBM from our fields to either municipalities or other
pipelines. We estimate the cost to construct a pipeline 50 miles in length with a capacity of 350
million cubic feet per day capacity (MMcfpd) to connect to the Enhong and Laochang areas of the
Yunnan Province to be approximately $50 million. Shanxi Province Two existing pipelines could support our project in the Shanxi Province. The West-East
pipeline runs approximately 10 kilometers south of the Qinnan Block in the Shanxi Province. This
pipeline has the capacity of 1,000 MMcfpd. The Shanjing II pipeline to Beijing is a 40 line that
has a 1,000 MMcfpd capacity and runs approximately 40 kilometers north of our Shouyang Block in the
Shanxi Province. In the Qinnan and Shouyang blocks, we estimate the cost to construct two pipeline
connections with 850 MMcfpd of capacity from the Shouyang and Qinnan blocks to the Shangjing II and
West-East pipelines, respectively, to be approximately $63 million (about 30 miles in total for the
two connecting pipelines). LNG Facility To generate revenue in China prior to the point at which production reaches pipeline
quantities, we may elect to 7




---



##### Table of Contents



construct LNG facilities on our properties. However, we believe a LNG
company, attracted by our CBM production or prospects, may decide to
construct such facilities near our properties at
their own cost. This would allow CBM to be produced and sold in the period before we achieve
production in sufficient quantities to justify constructing short connecting pipelines to the
Shangjing II and West-East pipelines in the Shanxi Province, or before a pipeline or other offtake
facility is operational in the Yunnan Province. We estimate that a 100-ton per day LNG facility,
which would liquefy approximately five MMcfpd of gas per day, would cost $10 to $15 million to
construct and take about two years for construction. We estimate that
a 1,000-ton per day facility capable of liquefying 50 MMcfpd would cost approximately $75 million with
construction time close to two years. Our Competition The energy industry is highly competitive in all its phases. Competition is particularly
intense with respect to the acquisition of desirable producing properties, the acquisition of
coalbed methane prospects suitable for enhanced production efforts, and the hiring of experienced
personnel. Our competitors in coalbed methane acquisition, development, and production include
major integrated oil and gas companies and substantial independent energy companies, many of which
possess greater financial and other resources. Regulations Impacting Our Business Our operations will be subject to numerous laws and regulations governing the discharge of
materials into the environment or otherwise relating to environmental protection. These laws and
regulations require the acquisition of a permit before drilling commences, restrict the types,
quantities and concentration of various substances that can be released into the environment in
connection with drilling and production activities, limit or prohibit drilling activities on
certain lands lying within wilderness, wetlands and other protected areas, and impose substantial
liabilities for any pollution resulting from our operations. Executive Officers The following table sets forth information concerning our executive officers: Executive Officers
    
    Age
    
    Title/PositionMichael R.
McElwrath
    
    
    53
    
    
    President, Chief Executive Officer,
Secretary and TreasurerBruce N. Huff
    
    
    54
    
    
    Chief Financial and Chief Accounting OfficerTun Aye Sai
    
    
    58
    
    
    Director of China OperationsGarry R. Ward
    
    
    46
    
    
    Senior Vice President, EngineeringAlex Yang
    
    
    60
    
    
    Senior Vice President, Exploration and Production
 Michael
R. McElwrathhas served as our President, Chief Executive
Officer, Secretary and Treasurer since October
2003. He became a Director in October 2003, and served as Chairman of the Board from October 2003 until
January 2005. He was employed as Vice President of Hudson Highland (formerly known as TMP Worldwide) from
1999 until joining us in October 2003. He also served as Acting Assistant Secretary of Energy in
the first Bush Administration, as Director of the National Institute
for Petroleum and Energy
Research, Director of British Petroleums outsourced exploration and production lab for the
Americas and as Deputy Assistant Secretary for Policy for the U.S. Department of Interior in the
last year of the Reagan Administration. Mr. McElwrath holds a J.D. from the University of Texas
School of Law, as well as a B.A. from the Plan II Honors Program at the University of Texas. He is
also a member of the Society of Petroleum Engineers, the Independent Petroleum Association of
America, and the Texas Independent Producers and Royalty Owners Association. Bruce N. Huffwas appointed Chief Financial Officer and Chief Accounting Officer in May 2004. Prior to joining the Company, Mr. Huff
spent 13 years at Harken Energy Corporation beginning as Senior Vice President and Chief Financial
Officer and eventually becoming the 8




---



##### Table of Contents



President and Chief Operating Officer in 1998. He is a
graduate of Abilene Christian University and a Certified Public Accountant. Tun Aye Saihas served as a Director and as our Director of China Operations since 2001. Mr.
Sai has over 30 years of international mining and exploration experience, developing and managing
mining projects in China and Southeast Asia. Since 1995, Mr. Sai
has also served as a director and consultant for
Kensam Enterprises Inc.
He holds a Bachelor of Engineering degree in mining from Rangoon Institute of Technology,
Rangoon, Burma and a Postgraduate Diploma in management and administration from the Institute of
Economics, Rangoon, Burma. Garry
R. Wardwas appointed as our Senior Vice President, Engineering
in February 2004. Mr. Ward has 23
years work experience in the energy business evaluating oil and gas properties throughout the
United States. Prior to joining our company, Mr. Ward served as Reservoir Manager for Plains E&P
between June 2003 and February 2004. Mr. Ward also served as the Reservoir Manager for 3TEC Energy
from November 1999 to June 2003. Mr. Ward holds a M.S. degree in petroleum engineering from the
University of Houston and a B.S. degree in petroleum engineering from the University of
Missouri-Rolla. Additionally, Mr. Ward is a Registered Professional Engineer in the State of
Texas. Alex Yangjoined our company in September 2002 and was appointed as Senior Vice President,
Exploration and Production in November 2003. Dr. Yang has 22 years of working experience in
Chinas energy industry and universities. From April 2002 through August 2002, Dr. Yang was a
research fellow at Baylor College of Medicine. From 1999 to March 2002, Dr. Yang served as Chief
Executive Officer and President of YT International, LLC, a consulting services company for the
petroleum industry. He holds a B.S. degree in geology and exploration from Hefei Industrial
University, a M.S. degree in geology from Nanjing University and a Ph.D in geology from Texas A&M
University. Our Employees As of March 4, 2005, we had a total of 20 employees, all of whom were employed by us on a
full-time basis. 
 ITEM 2. PROPERTIES Undeveloped Lease Acreage As of December 31, 2004, we owned leasehold interests (or, in the case of our properties in
China, had rights under production sharing contracts) covering the following undeveloped lease
acreage. China: Net AcresGross Acres
    
    
    Maximum
    
    
    MinimumEnhong and Laochang Areas, Yunnan Province
    
    
    265,000
    
    
    
    265,000
    
    
    
    159,000Qinnan and Shouyang Blocks, Shanxi Province
    
    
    1,058,000
    
    
    
    1,058,000
    
    
    
    423,200
 United States: Gross Acres
    
    
    Net AcresPhillips and Valley Counties, Montana
    
    
    167,153
    
    
    
    149,419
   (1)
    
    For further discussion of our interests in these properties, see the discussion of our
production sharing contracts and farmout agreements under Our Holdings in the Peoples
Republic of China contained in Item 1, Business.(2)
    
    We sold our oil and gas leasehold interests and other property interests in Montana on
February 2, 2005. Other Properties Our principal office is located at 400 N. Sam Houston Parkway East, Suite 205, Houston, Texas
77060. The principal office, which presently consists of approximately 2,200 square feet at
December 31, 2004, will increase to
4,343 square feet on April 1, 2005. The monthly rental is
$2,900 through August 31, 2005, after which it will increase to $5,790 per month through May 31,
2007. We also maintain offices in Beijing, China and Kunming, Yunnan Province, China. 9




---



##### Table of Contents



ITEM 3. LEGAL PROCEEDINGS On December 31, 2004, we entered into a settlement agreement with Jawaharlal Gondi and The
Arthi Trust pursuant to which Mr. Gondi resigned as a director of the Company. Pursuant to the
terms of the settlement agreement, we paid Mr. Gondi a total gross amount of $165,000 minus all
applicable withholding, and reimbursed Mr. Gondi certain out-of-pocket expenses. The settlement
agreement also provides that Mr. Gondi and The Arthi Trust, for a period of two years after the
date of the settlement agreement, without our prior written consent, will refrain from certain
activities related to seeking control of the Company. Pursuant to the settlement agreement, Mr.
Gondi and The Arthi Trust also agreed to execute and deliver to us one or more proxies naming the
members of our board of directors who are not our officers, as agents and proxies, with full power
of substitution and re-substitution, to vote all shares of our capital stock or our other voting
securities. We have no knowledge of any other pending or threatened material litigation, settlement of
litigation, or other material claim involving us. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. 
 PART II 
 ITEM 5. MARKET FOR THE
REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES Our common stock is not listed for trading on a registered exchange or quoted on the National
Association of Securities Dealers Automated Quotation system (NASDAQ). Shares of our common stock
are traded over the counter and quoted on the OTC Bulletin Board under the symbol FEEC. The
OTC Bulletin Board provides information to professional market makers who match sellers with
buyers. The high and low bid quotations of our common stock presented below includes intra-day
trading prices. These quotations represent inter-dealer prices, without retail mark-up, mark-down,
or commissions, and may not represent actual transactions. High
    
    
    Low2004First Quarter
    
    $
    3.29
    
    
    $
    1.95Second Quarter
    
    $
    2.75
    
    
    $
    1.45Third Quarter
    
    $
    1.84
    
    
    $
    1.06Fourth Quarter
    
    $
    1.50
    
    
    $
    1.062003First Quarter
    
    $
    4.40
    
    
    $
    2.70Second Quarter
    
    $
    2.70
    
    
    $
    0.35Third Quarter
    
    $
    2.34
    
    
    $
    0.55Fourth Quarter
    
    $
    3.76
    
    
    $
    1.28
 On March 4, 2005, we had 77,439,910 shares of common stock outstanding. There were
approximately 169 stockholders of record as of March 4, 2005. We currently intend to retain all future earnings to fund the development and growth of our
business. We have not paid dividends on our common stock and do not anticipate paying cash
dividends in the immediate future. We did not repurchase any of our equity securities in 2004 and
have not adopted a stock repurchase program. 10




---



##### Table of Contents



Recent Sales of Unregistered Securities The following is a description of the unregistered securities we granted or issued
during the period subsequent to December 31, 2004 and through the date of this report:  On February 9, 2004,
we granted to one of our technical advisors an option to purchase
280,000 shares of our common stock at an exercise price of
$2.00 per share in consideration for his service as a technical advisor. The option expires on
February 9, 2009. The securities, which were taken for investment and were subject to
appropriate
transfer restrictions, were issued without registration under the Securities Act in reliance upon
the exemption provided in Section 4(2) of the Securities Act.  On January 10, 2005, we issued a warrant to an accredited investor to purchase 375,000
shares of common stock at an exercise price of $1.25 per share in settlement of claimed
anti-dilution rights granted in a previously completed private placement. The warrant expires on
December 16, 2007. The securities, which were taken for investment and were subject to appropriate
transfer restrictions, were issued without registration under the Securities Act in reliance upon
the exemption provided in Section 4(2) of the Securities Act.  On January 19, 2005, we granted an option to a gas marketing consultant to purchase
80,000 shares of common stock at an exercise price of $2.00 per share in consideration for
consulting services to be rendered by the consultant. The option expires on January 19, 2010. The
securities, which were taken for investment and were subject to appropriate transfer restrictions,
were issued without registration under the Securities Act in reliance upon the exemption provided
in Section 4(2) of the Securities Act.  On January 20, 2005, we entered into two option agreements whereby an investor
relations consulting firm, in consideration for certain investor relation services, received an
option to purchase 50,000 shares of common stock at an exercise price of $4.40 per share and
received an option to purchase 50,000 shares of common stock at an exercise price of $3.30 per
share. The options expire on the second anniversary of the date on which the Securities and
Exchange Commission declares a Registration Statement (as defined in the option agreement) filed by
us effective. The securities, which were taken for investment and were subject to appropriate
transfer restrictions, were issued without registration under the Securities Act in reliance upon
the exemption provided in Section 4(2) of the Securities Act.  On January 31, 2005 and February 28, 2005, we issued 5,000 shares of our common stock,
or a total of 10,000 shares of our common stock, to a consultant in consideration for certain
investor relations services. The securities, which were taken for investment and were subject to
appropriate transfer restrictions, were issued without registration under the Securities Act in
reliance upon the exemption provided in Section 4(2) of the Securities Act. 11




---



##### Table of Contents



ITEM 6. SELECTED FINANCIAL DATA The following selected financial data should be read in conjunction with the consolidated
financial statements and supplementary information included in Item 8, Financial Statements and
Supplementary Data. As of and for the Years Ended December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001Operating Results DataRevenues
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Operating expenses:Geologic and engineering
    
    
    575,000
    
    
    
    239,000
    
    
    
    380,000
    
    
    
    Exploration costs
    
    
    550,000
    
    
    
    
    
    
    
    
    
    
    
    Impairment loss
    
    
    450,000
    
    
    
    3,328,000
    
    
    
    
    
    
    
    Other consulting and professional
services
    
    
    788,000
    
    
    
    424,000
    
    
    
    296,000
    
    
    
    Compensation
    
    
    1,440,000
    
    
    
    839,000
    
    
    
    596,000
    
    
    
    Stock compensation
    
    
    583,000
    
    
    
    930,000
    
    
    
    
    
    
    
    Travel
    
    
    608,000
    
    
    
    334,000
    
    
    
    575,000
    
    
    
    Legal and accounting
    
    
    1,508,000
    
    
    
    411,000
    
    
    
    66,000
    
    
    
    3,000Loss on investment in joint venture
    
    
    
    
    
    
    22,000
    
    
    
    
    
    
    
    Amortization of contract rights
    
    
    23,000
    
    
    
    58,000
    
    
    
    
    
    
    
    General and administrative
    
    
    1,487,000
    
    
    
    468,000
    
    
    
    231,000
    
    
    
    12,000Total operating expenses
    
    
    8,012,000
    
    
    
    7,053,000
    
    
    
    2,144,000
    
    
    
    15,000Other Expense (Income):Interest income
    
    
    (17,000
    )
    
    
    (6,000
    )
    
    
    (13,000
    )
    
    
    Interest expense
    
    
    9,000
    
    
    
    168,000
    
    
    
    
    
    
    
    Foreign currency exchange loss (gain)
    
    
    

    
    
    
    2,000
    
    
    
    (1,000
    )
    
    
    Total other expense (income)
    
    
    (8,000
    )
    
    
    164,000
    
    
    
    (14,000
    )
    
    
    Loss before income taxes
    
    
    (8,004,000
    )
    
    
    (7,217,000
    )
    
    
    (2,130,000
    )
    
    
    (15,000
    )Income taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net loss
    
    
    (8,004,000
    )
    
    
    (7,217,000
    )
    
    
    (2,130,000
    )
    
    
    (15,000
    )Accumulated
deficit-beginning of period
    
    
    (9,373,000
    )
    
    
    (2,156,000
    )
    
    
    (26,000
    )
    
    
    (11,000
    )Accumulated
deficit-end of period
    
    $
    (17,377,000
    )
    
    $
    (9,373,000
    )
    
    $
    (2,156,000
    )
    
    $
    (26,000
    )Earnings per share-basic and diluted
    
    $
    (0.13
    )
    
    $
    (0.14
    )
    
    $
    (0.05
    )
    
    $
    Cash flow used in operating activities
    
    $
    (5,711,000
    )
    
    $
    (2,178,000
    )
    
    $
    (1,871,000
    )
    
    $
    (16,000
    )Cash flow used in investing activities
    
    
    (2,411,000
    )
    
    
    (1,920,000
    )
    
    
    (198,000
    )
    
    
    Cash flow provided by financing activities
    
    
    17,216,000
    
    
    
    5,416,000
    
    
    
    3,052,000
    
    
    
    Financial Position DataTotal assets
    
    $
    15,413,000
    
    
    $
    4,614,000
    
    
    $
    1,450,000
    
    
    $
    28,000Total liabilities
    
    
    940,000
    
    
    
    870,000
    
    
    
    503,000
    
    
    
    1,000Stockholders equity
    
    
    14,473,000
    
    
    
    3,744,000
    
    
    
    947,000
    
    
    
    27,000
 12




---



##### Table of Contents



ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis of our financial condition and results of operations
should be read in conjunction with our audited consolidated financial statements and related notes
contained elsewhere in this report. Overview We are a development stage company, and our objective is to become a recognized leader in
coalbed methane gas property acquisition, exploration, development and production. Our activities
to date have been principally limited to organizational activities, including developing a
strategic operating plan, capital funding, hiring personnel, entering into contracts, acquiring
rights to explore, develop, produce and sell oil and gas or coalbed
methane (CBM), and beginning in 2003, the drilling, testing and
completion of exploratory wells. Our operations concentrate on CBM exploration and development in the Yunnan Province in
Southern China and in the Shanxi Province in Northern China. During 2004, we completed drilling
two wells in the Yunnan Province and fractured one existing well in the Shanxi Province. We incurred
exploration and development costs of approximately $1.2 million in the Yunnan Province and
approximately $1.0 million in the Shanxi Province during the year ended December 31, 2004.
Additionally, we deposited $1.0 million in an escrow account to guarantee our performance under the
Shanxi Agreements. Although we believe the results of our exploration activities in the Yunnan
and Shanxi Provinces have been favorable, we will need to complete several more wells to achieve
commercial viability in these provinces,  which will require significant
capital expenditures. No gas pipeline, liquefied natural gas plant, or other
off-take candidate currently exists to transport CBM from our properties in the Yunnan Province,
and it is not likely that any such facilities will be built until favorable results are obtained
from several more wells. No liquefied natural gas plant, or other
offtake candidate currently exists near our Shanxi Province projects,
and pipelines must also be built on those projects to connect
to larger pipelines to transport any CBM that may be produced from those projects. Actual
production may vary materially from preliminary test results. Actual
sustainable production from the wells may
be at recovery rates and gas quality materially worse than our first indications. Until recently, we also owned undeveloped oil, gas and mineral rights and interests in
approximately 149,000 net acres located in the eastern portion of Montana. On February 2, 2005,
our wholly owned subsidiary, Newark Valley Oil & Gas, Inc., entered into a purchase and sale
agreement with Zier & Associates, Ltd. for the sale of our oil and gas leasehold interests and
other property interests in Montana. As a condition to the sale of our Montana properties, we
acquired certain overriding royalty interests in adjoining acreage for $100,000, which were also
sold under the terms of the purchase and sale agreement. The transaction closed on February 2,
2005. At the closing, we received gross proceeds of $1,135,000 from the sale of our Montana
properties (including the overriding royalty interests described above). We consider our Montana
properties to be non-core assets of our company. We sold these assets in order to focus our
efforts on the exploration and development of our coalbed methane holdings located in China. We
have not recognized any revenues from our operations and do not
anticipate recognizing significant revenues prior to late 2006. We incurred a net loss of approximately $8.0 million for the year ended December 31,
2004, and we expect to incur losses and negative cash flows for the foreseeable future. As we are
a development stage company concentrating on exploration and development of CBM, our expenditures
primarily consist of geological and engineering services, exploration costs and travel expenses
between our headquarters and China. Our expenses also consist of consulting and professional
services (including fund raising expenses), compensation, legal and accounting and general and administrative expenses which we
incurred in order to address necessary organizational activities. During the year ended December 31, 2004, we raised net proceeds of approximately $14.4 million
from the sale of our common stock and warrants to purchase our common stock in private placements
and $2.8 million from the exercise of warrants sold in previously completed private equity
offerings. Management believes that we can fund our operations and planned exploration and
development activities in China with our existing cash resources through the fourth quarter of
2005. During 2005, we estimate total capital expenditures in China will be approximately $6.5
million and our total operating expenditures will be
$6.1 million. We will also require resources to fund significant
capital expenditures for exploration and development activities and to
fund operating expenses in future periods. As we do not have a source of
revenue, we will require additional financing in order to continue our exploration and development
in China and sustain our operating losses. We intend to finance our operations by various methods,
which might include issuing equity securities, the continued exercise of warrants issued to
investors in conjunction with the previously completed private offerings, and entering into farmout
agreements and other arrangement with strategic partners, among other
alternatives. If we fail to raise the necessary funds to complete our
exploration activities, and we cannot obtain extensions to the
requirements under our production sharing contracts, we would not be
able to successfully complete our exploration activities, and we may
lose rights under our production sharing contracts. 13




---



##### Table of Contents



Results of Operations Year Ended December 31, 2004 Compared to Year Ended December 31, 2003 For the Year Ended December 31,Increase
    
    
    Percent2004
    
    
    2003
    
    
    (Decrease)
    
    
    ChangeGeologic and engineering services
    
    $
    575,000
    
    
    $
    239,000
    
    
    $
    336,000
    
    
    
    141
    %Exploration costs
    
    
    550,000
    
    
    
    
    
    
    
    550,000
    
    
    
    Impairment loss
    
    
    450,000
    
    
    
    3,328,000
    
    
    
    (2,878,000
    )
    
    
    -86
    %Other consulting and professional
services
    
    
    788,000
    
    
    
    424,000
    
    
    
    364,000
    
    
    
    86
    %Compensation
    
    
    1,440,000
    
    
    
    839,000
    
    
    
    601,000
    
    
    
    72
    %Stock compensation
    
    
    583,000
    
    
    
    930,000
    
    
    
    (347,000
    )
    
    
    -37
    %Travel
    
    
    608,000
    
    
    
    334,000
    
    
    
    274,000
    
    
    
    82
    %Legal and accounting
    
    
    1,508,000
    
    
    
    411,000
    
    
    
    1,097,000
    
    
    
    267
    %Loss on investment in joint venture
    
    
    
    
    
    
    22,000
    
    
    
    (22,000
    )
    
    
    -100
    %Amortization
    
    
    23,000
    
    
    
    58,000
    
    
    
    (35,000
    )
    
    
    -60
    %General and administrative
    
    
    1,487,000
    
    
    
    468,000
    
    
    
    1,019,000
    
    
    
    218
    %Total
    
    $
    8,012,000
    
    
    $
    7,053,000
    
    
    $
    959,000
    
    
    
    14
    %
 Geologic and engineering services increased due to a full year of leasehold costs on our
Montana properties, surveying of sites for two wells completed in 2004 in the Yunnan Province and
geological costs in the Shanxi Province. Exploration costs consist of the expense to drill the first Yunnan Province well, FCY-LC01,
which was completed in November 2003. Costs related to the well were recorded as unevaluated well
costs in property and equipment pending determination of whether proved reserves would be
attributed to the well within one year; however, proved reserves have not been attributed to the
well as it is still in the dewatering and testing phase. Statement of Financial Accounting
Standards No. 19 (SFAS 19) requires that all costs for wells
which are not attributed proved reserves
within one year after completion be expensed. We anticipate incurring additional costs on the
first well, which we will also expense. We completed two additional  wells in the
Enhong-Laochang block of the Yunnan Province in February 2004 and April 2004. The costs
capitalized related to these two wells at December 31, 2004 were approximately $380,000 and
$400,000. Because we anticipate that we may not be able to attribute proved reserves within the one year allowed
under SFAS 19, we expect that we will expense the capitalized costs related to these wells in the
first and second quarter of 2005. We
incurred
an impairment loss of $450,000 during the year ended December 31, 2004 as compared to
$3,328,000 in 2003. In February 2005, our wholly owned subsidiary, Newark Valley Oil & Gas, Inc.,
sold our Montana properties to Zier & Associates, Ltd. for gross proceeds of $1,135,000. As a
condition of that sale, we purchased overriding royalty interests on adjacent properties for
$100,000, which were also sold under the terms of the purchase and sale agreement.The net
proceeds, which we believe to be a measure of the value of properties, were compared to the
carrying value, and an impairment of $450,000 was recorded. Any remaining loss on the sale of our
Montana assets will be recognized in the first quarter of 2005. We will remain responsible for the
payment of expenses and related accounts payable attributable to the Montana properties to the
extent they relate to the time prior to February 2, 2005. The increase in our other consulting and professional fees in 2004 compared to 2003 is
primarily attributed to expenses incurred in connection with our capital raising activities and
higher expenses related to investor relations. The increase, to a lesser
extent, is the result of CUCBM salaries incurred in 2004 under the
terms of our production sharing contracts for the Shanxi Province project, which we
did not incur in 2003, and financial printing costs related to the restatement of our
previously filed Form 10-KSB and our quarterly reports and our registration statement filed with
the SEC in July 2004 and declared effective in February 2005. 14




---



##### Table of Contents



Compensation expense increased primarily due to an increase in the number of permanent
employees, including hiring permanent employees in engineering, finance and field operations, and
bonus compensation earned in 2004. Additionally, the increase is partly attributed to training
fees to train Chinese personnel in 2004 under the terms of our production sharing contracts for the
Shanxi Province, which we did not incur in 2003. We record stock compensation under Accounting Principles Board Opinion 25, Accounting for
Stock Issued to Employees (APB 25), which requires that we recognize compensation expense for the
amount by which the market price exceeds the grant price on the grant date. Compensation expense
decreased from 2003 to 2004 primarily as a result of our board of directors approving the vesting
of our former chief executive officers unvested options in the third quarter of 2003. This
resulted in all of the compensation expense related to these options being recorded in 2003. Additionally, fewer options with an exercise price below
the market price were granted in 2004. Travel expense increased in 2004 compared to the prior year due primarily to additional travel
to China as a result of our increased operations and additional travel for our capital raising
efforts. Legal and accounting expenses have increased during 2004 compared to 2003 as a result of our
registration statement filed with the SEC in July 2004 and declared effective in February 2005, our
response to the SECs investigation regarding the ownership of our stock, our amendments to our
previously filed Form 10-KSB and quarterly reports, Sarbanes Oxley Section 404 reporting, legal
assistance with our private placements of equity and legal assistance in China with regulations as
we have expanded our operations. General and administrative costs increased primarily due to a settlement with a former
director, settlement of an asserted claim for warrants to purchase shares of our common stock,
CUCBM assistance fees incurred for the first time under the Shanxi Agreements, increased expenses
in China due to increased activity on our China projects and the granting of options to our
technical advisors, which were formerly known as our advisory board, which is not elected by our
stock holders. Interest
expense decreased in 2004 compared to 2003 primarily as a result of expenses
incurred in 2003 related to the beneficial conversion feature for our notes payable in the
principal amount of $300,000. These notes payable were executed in the second and third quarters
of 2003. We incurred no similar debt obligations in 2004. Year Ended December 31, 2003 Compared to Year Ended December 31, 2002 For the Year Ended December 31,Increase
    
    
    Percent2003
    
    
    2002
    
    
    (Decrease)
    
    
    changeGeologic and engineering services
    
    $
    239,000
    
    
    $
    380,000
    
    
    $
    (141,000
    )
    
    
    -37
    %Exploration costs
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Impairment loss
    
    
    3,328,000
    
    
    
    
    
    
    
    3,328,000
    
    
    
    Other consulting and professional
services
    
    
    424,000
    
    
    
    296,000
    
    
    
    128,000
    
    
    
    43
    %Compensation
    
    
    839,000
    
    
    
    596,000
    
    
    
    243,000
    
    
    
    41
    %Stock compensation
    
    
    930,000
    
    
    
    
    
    
    
    930,000
    
    
    
    Travel
    
    
    334,000
    
    
    
    575,000
    
    
    
    (241,000
    )
    
    
    -42
    %Legal and accounting
    
    
    411,000
    
    
    
    66,000
    
    
    
    345,000
    
    
    
    523
    %Loss on investment in joint venture
    
    
    22,000
    
    
    
    
    
    
    
    22,000
    
    
    
    Amortization
    
    
    58,000
    
    
    
    
    
    
    
    58,000
    
    
    
    General and administrative
    
    
    468,000
    
    
    
    231,000
    
    
    
    237,000
    
    
    
    103
    %Total
    
    $
    7,053,000
    
    
    $
    2,144,000
    
    
    $
    4,909,000
    
    
    
    229
    %
 15




---



##### Table of Contents



Geologic and engineering services decreased in 2003 compared to 2002 as we reduced our
dependence on outside consultants and employed in-house geologists. Impairment loss for the year ended December 31, 2003 increased to $3,328,000, as a result of
the acquisition of Newark Valley Oil & Gas, Inc. The aggregate acquisition price was $4,778,000,
which included 1,600,000 shares of our common stock valued at $3,600,000 among other consideration.
The value of the common stock was determined based on the market price of the shares on the
date of the consummation of the agreement. Simultaneous to the consummation of the agreement,
assets were deemed to be impaired and written down to their fair value. Fair value, which was
determined by valuation of the reserves estimated for the assets acquired, indicated a revised
carrying value of approximately $1,450,000. Accordingly, an impairment loss of $3,328,000 has been
charged to operations in 2003. A reduction in natural gas prices, increase in exploration costs or
increase in production costs could result in additional impairment in subsequent periods. Other consulting and professional services increased in 2003 compared to 2002 due to the
professional fees paid to CUCBM for the first time in 2003. Compensation increased in 2003 compared to 2002 due to hiring certain individuals who provided
consulting services in 2002 and also due to severance expenses resulting from changes in senior
management during 2003. Stock compensation expense was $930,000 during 2003 due to the granting of options at exercise
prices below market at the date of the grant. We recognize compensation expense for the difference
between the exercise price and the market value as the options vest. Additionally, our board of
directors approved vesting of our former chief executive officers unvested options in the third
quarter of 2003, resulting in all compensation expense related to these options being recorded in
2003. Travel costs decreased in 2003 compared to 2002, as we focused on planning a development
program for the concessions won during 2002. During 2002, we incurred significantly more overseas
travel by U.S. personnel as management and consultants pursued several potential foreign
concessions and capital raising activities during 2002. The increase in our legal and accounting expenses during 2003 as compared to 2002 was
primarily attributed to greater professional fees required to comply with SEC reporting
requirements as a result of our planning and development of properties and expanded operations
during 2003, costs incurred in response to SECs investigation regarding the ownership of our
stock, and to address other ongoing legal matters related to the
threatened litigation at December 31, 2003, which was subsequently
settled in 2004. The
increase was also partially attributed to costs incurred related to our private placement offering
of stock to investors outside of the United States. General and administrative expense increased $248,000 in 2003 compared to 2002 due primarily
to assistance fees paid to CUCBM pursuant to our production sharing contracts for the Yunnan
Province project. Additionally, the increase in general and administrative expense was due to
management and accounting personnel temporarily engaged on a contract basis during 2003 and
increased overhead expenditures as we established and expanded operations in China. Interest expense increased $168,000 due to the recognition of interest expense related to the
beneficial conversion feature of our loan  in the principal amount of
$200,000 from Clarion Finance AG and our  loan in the principal
amount of $100,000 from
Professional Trading Services, which were executed in the second and third quarters of 2003. 16




---



##### Table of Contents



Capital Resources and Liquidity We have no source of revenue or cash flow from operations, and our primary source of cash flow
has been cash proceeds from private placements of our common stock and warrants to purchase our
common stock. Our principal requirements for cash are exploration and development of our CBM
properties in China. We believe that we have adequate cash resources to fund our operations and
exploration and development operations in China through the fourth quarter of 2005; however, to
continue to operate after 2005 and to complete our projects in China, we will be required to raise
additional funds. Cash flow As of December 31, 2004, our cash and cash equivalents were $11,418,000, excluding the
$1,000,000 of restricted cash held in escrow pursuant to our Shanxi Province farmout agreements.
Cash and cash equivalents was $2,326,000 at December 31, 2003 and $1,008,000 at December 31, 2002. Cash
used in operating activities for the year ended December 31,
2004 was $5,711,000 as
compared to $2,178,000 for 2003 and $1,871,000 for 2002. We generated no revenue in each of those
years, and we have experienced increased cash operating expenses, including compensation, geologic
and engineering services, legal and accounting and general and administrative due to the factors
described above. Cash
used in investing activities for the year ended December 31,
2004 was $2,411,000 as
compared to $1,920,000 for 2003 and $198,000 for 2002. During 2004, we deposited $1,000,000 in
escrow for a performance guarantee required under our Shanxi Province farmout agreements.
Additionally, in 2004, approximately $1,404,000 was spent in China with the completion of three
wells in the Yunnan Province and fracturing performed on one well in the Shanxi Province. Cash
used in investing activities for the year ended December 31, 2003 was primarily attributed to
acquisition of oil and gas properties and exploration and development
costs in China. In 2003, we
acquired our Montana properties for consideration including approximately $600,000 in cash, and the
remaining $1,282,000 was expended in China in 2003. In 2002, we paid the initial mineral
rights amount to acquire the Yunnan Province production sharing
contract. Cash provided by financing activities increased to $17,216,000 for the year ended December 31,
2004 as compared to $5,416,000 for 2003 and $3,052,000 for 2002. The increase in cash provided by
financing activities reflects proceeds from the private placement of our common stock and warrants
to purchase our common stock as well as the exercise of warrants from previously completed equity
offerings. Net proceeds from these capital raising transactions were approximately $14.4 million
in 2004 compared to $5.1 million in 2003. Additionally, during the year ended December 31, 2004,
we have received approximately $2,827,000 upon the exercise of
warrants to purchase 2,827,286 shares
of our common stock. In 2003, we received approximately $33,000 upon the exercise of warrants to
purchase 32,692 shares of our common stock. Capital Resources and
Requirements In February 2005, our wholly owned subsidiary, Newark Valley Oil & Gas, Inc. entered into a
purchase and sale agreement with Zier & Associates, Ltd. for the sale of our oil and gas interests
and other property interests in Montana. As a condition of the sale, we acquired certain
overriding royalty interests in adjoining acreage for $100,000, which were also sold under the
terms of the purchase and sale agreement. At the closing, we received gross proceeds of $1,135,000
from the sale of our Montana properties. The Shanxi Agreements required that we post a $1.0 million bank guarantee or surety bond by
May 14, 2004 to guarantee performance of the evaluation and work program to test existing wells.
On May 14, 2004, we placed $1.0 million into escrow to satisfy this bond. The $1.0 million escrow
account will continue to be held until December 31, 2005. In the event that we have not completed
drilling of the first horizontal well in Phase II by June 30, 2005, we will be required to increase
the escrow account to $2.6 million. We believe that we can satisfy this requirement, if necessary
with our current cash resources. Notwithstanding the requirement to increase the amount of the
escrow account to $2.6 million on June 30, 2005, subject to the prior written consent of Phillips,
we will be able to drawdown amounts from this escrow account required to fund operations in Phase
II after June 30, 2005. Each drawdown may not exceed $250,000. 17




---



##### Table of Contents



We anticipate that we will be able to draw down the total amount of the escrow during 2005. Our board of directors has the authority, without further action by the stockholders, to issue
up to 500.0 million shares of preferred stock in one or more series and to designate the rights,
preferences, privileges and restrictions of each series. We also have 500.0 million shares of
common stock authorized under our charter documents, of which 76.5 million shares was issued and
outstanding as of December 31, 2004. The issuance of preferred stock could have the effect of
restricting dividends on the common stock or delaying or preventing our change in control without
further action by the stockholders. While we have no present plans to issue any shares of
preferred stock, we may need to do so in the future in connection with capital raising
transactions. In addition, we may issue additional shares of common stock in connection with
fundraising activities. The issuance of additional common stock would also have a dilutive impact
on our stockholders ownership interest in our company. The
exploration and development of coalbed methane gas reserves requires substantial capital
expenditures. In order to reduce our investment in a particular project, we may form joint ventures
and seek joint venture partners to share the costs. We incurred $2.5 million of costs related to
exploration and development during the year ended December 31, 2004. We anticipate that cash
expenditures for planned 2005 exploration and development activities would include:  
    Yunnan Province Phase I.We have completed our Phase I obligations under our
production sharing contract for the Yunnan Province in the first
quarter of 2005, which required us to perform a
hydraulic fracture and test one of the three wells drilled previously and to drill two
slim hole vertical wells. Our expected expenditures are approximately $767,000 for the completion
of these Phase I expenditures.
    Yunnan Province Phase II.We elected to continue to Phase II, and our obligations
will require us to drill at least one additional horizontal well with a minimum of two
laterals. Our Phase II obligations are required to be completed by December 31, 2005.
We expect to incur capital expenditures associated with these Phase II obligations of
approximately $2.0 million.
    Shanxi Province Phase II.We have completed our Phase I obligations, and we have
elected to enter into Phase II under the Shanxi Agreements. Our Phase II obligations
require us to drill two horizontal wells in the Shouyang block by December 31, 2005.
We expect to incur capital expenditures associated with these Phase II obligations of
approximately $3.5 million. We will also require resources to fund significant capital
expenditures for exploration and development activities and to fund
operating expenses in future periods. We do not anticipate
recognizing significant revenues prior to late 2006.
CBM
projects traditionally require multiple wells to properly dewater the
coal and generate predictable volumes of gas. It is not yet possible
to predict volumes so decisions about marketing the CBM cannot yet be
made.
To generate revenue in China
prior to the point at which production reaches pipeline quantities, we may elect to
install compressors and produce compressed natural gas (CNG), which
could be sold to local communities. This alternative would cost
approximately $220,000 for each compressor. Installation of the
compressor could be completed in approximately 90 days, and could be
funded from existing cash resources. We could also elect to construct LNG
facilities on our properties. We estimate that a 100-ton per day LNG
facility, which would liquefy approximately five million cubic feet of gas per day, would cost
approximately $10 to $15 million to construct. We estimate that a 1,000-ton per day facility
capable of liquefying 50 million cubic feet of gas per day would cost approximately $75 million.
However, we believe  it is possible that an LNG concern attracted by our CBM production
or prospects, may
decide to construct such facilities near our properties at their own cost. We may construct
pipelines to move CBM from our fields to either municipalities or other pipelines. We estimate the
cost to construct a pipeline in the Enhong and Laochang areas of the Yunnan Province to be
approximately $50 million. Our farmout agreement from Phillips provides us with rights to two
separate blocks, including the Shouyang block, approximately 40 km south of the Shangjing II pipeline to
Beijing, and the Qinnan block, approximately 10 km north of the West-East pipeline to Shanghai. We
estimate the cost to construct pipeline connections from the Shouyang and Qinnan blocks to the
Shangjing II and West-East pipelines, respectively, to be approximately $63 million. We are
delaying any decisions regarding the construction of LNG facilities or pipelines until such time as
significant CBM volumes are achieved. We believe this delay may allow us to avoid construction
costs to the extent other strategic partners have constructed, are constructing or
are planning to construct, such facilities. We do not currently have the funds to complete our current and proposed business operation in
China or sustain our operating losses. Therefore, our ability to continue as a going concern
depends upon our ability to raise additional, 18




---



##### Table of Contents



substantial funds for use in our planned exploration and development activities, and upon the
success of these activities. To develop our projects in China over the long term, we need to
obtain project funding to satisfy significant expenditures for exploration and development of those
projects, if they are successful. If we fail to raise the necessary
funds to complete our exploration activities, and we cannot obtain
extensions to the requirements under our production sharing contracts,
we would not be able to successfully complete our exploration
activities, and we may lose rights under our production sharing
contracts. We intend to obtain the funds for our planned exploration and development activities by
various methods, which might include the issuance of equity securities, continued exercise of
warrants issued to investors in conjunction with the recently completed private offerings,
obtaining farm-out partners and the potential sale of property interests among other alternatives.
Therefore, we intend to continue to seek to raise equity or debt financing. No assurance can be
given that we will be able to obtain any additional financing on favorable terms, if at all. If
our operating requirements vary materially from those currently planned, we may require more
financing than currently anticipated. Borrowing money may involve pledging some or all or our
assets. Raising additional funds by issuing common stock or other types of equity securities would
further dilute our existing stockholders. If we cannot obtain additional financing in a timely
manner, we will not be able to continue our operations. Since there can be no guarantee of future
fundraising success, and since the success of exploratory drilling can never, by definition be
guaranteed, there is substantial doubt about our ability to continue as a going concern. The
reports we received from our independent auditors for our years ended December 31, 2004, 2003 and
2002 financial statements contain an explanatory paragraph that states that our net losses since
our inception and no established source of revenues raise substantial doubt about our ability to
continue as a going concern. The consolidated financial statements do not include any adjustments
that might result from the outcome of that uncertainty. Although there can be no assurances,
management believes that we will continue to be successful in raising the funds necessary to
explore for CBM, and, assuming success in those exploratory efforts, to raise the funds necessary
for production and development. Contractual Obligations Table Obligations under non-cancelable agreements at December 31, 2004 were as follows: Payments Due by PeriodMoreLess than
    
    
    
    
    
    
    3-5
    
    
    ThanTotal
    
    
    One Year
    
    
    1-3 Years
    
    
    Years
    
    
    5 YearsLong-Term Debt Obligations
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Capital Lease Obligations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Operating Lease Obligations (1)
    
    
    152,000
    
    
    
    52,000
    
    
    
    100,000
    
    
    
    
    
    
    
    Purchase Obligations (2)
    
    
    946,000
    
    
    
    938,000
    
    
    
    8,000
    
    
    
    
    
    
    
    Other Long-Term Liabilities Reflected on the
Registrants Balance Sheet Under GAAP
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Totals
    
    $
    1,098,000
    
    
    $
    990,000
    
    
    $
    108,000
    
    
    $
    
    
    
    $
    
   (1)
    We enter into operating leases in the normal course of business primarily for our office
space and equipment.(2)
    We include in purchase obligations contractual agreements to purchase goods or services
that are legally enforceable and that specify all significant terms, including fixed or
minimum quantities, fixed, minimum or variable price provisions and the approximate timing
of the transaction. We have included our obligations under the production sharing
contracts for the Yunnan Province and Shanxi Province project for which the amounts were
specified in the contracts. We have committed to Phase II for each of these projects and
have included contractual expenses through Phase II, both of which
are required to be completed by December 31,
2005. We did not include the drilling and completion costs required under the production
sharing contract as those amounts are not specified in the contract, but are performance
requirements. We have disclosed our estimate of the costs to perform those required
actions as described under Capital Resources and Requirements above. Off-Balance Sheet Arrangements As part of our ongoing business, we do not participate in transactions that generate
relationships with unconsolidated entities or financial partnerships, such as entities often
referred to as structure finance or special purpose entities (SPEs), which would have been
established for the purpose of facilitating off-balance sheet arrangements or other contractually
narrow or limited purposes. As of December 31, 2004, we were not involved in any unconsolidated
SPE transactions. 19




---



##### Table of Contents



Critical Accounting Policies Our discussion and analysis of our financial condition and results of operations is based on
our consolidated financial statements, which have been prepared in accordance with accounting
principles generally accepted in the United States (GAAP). The preparation of our consolidated
financial statements requires us to make estimates and assumptions that affect the reported amounts
of assets, liabilities, revenues and expenses. We consider an accounting estimate to be critical
if (1) it requires assumptions to be made that were uncertain at the time the estimate was made;
and (2) changes in the estimate or different estimates that could have been selected could have a
material impact on our results of operations or financial condition. Management has discussed the development and selection of its critical accounting policies
with our Audit Committee, and the Audit Committee has reviewed the disclosure presented below
relating to them. We believe the following
critical accounting policies reflect our significant estimates and judgments used in the
preparation of our financial statements: Accounting for Oil and Gas Properties.We use the successful efforts method of accounting for
our oil and gas properties. Under this method, oil and gas lease acquisition costs and intangible
drilling costs associated with exploration efforts that result in the discovery of proved reserves
and costs associated with development drilling, whether or not successful, are capitalized when
incurred. Certain costs of exploratory wells are capitalized pending determination that proved
reserves have been found. If the determination is dependent upon the results of planned
additional wells and required capital expenditures to produce the reserves found, the drilling
costs will be capitalized as long as sufficient reserves have been found to justify completion of
the exploratory well and additional wells are underway or firmly planned to complete the evaluation
of the well. All costs related to unsuccessful exploratory wells are expensed when such wells are
determined to be non-productive or at the one year anniversary of completion of the well if proved
reserves have not been attributed and capital expenditures as described in the preceding sentence
are not required. We assess our capitalized exploratory wells pending evaluation each quarter to
determine whether costs should remain capitalized or should be charged to earnings. Other
exploration costs, including geological and geophysical costs, are expensed as incurred. We
recognize gains or losses on the sale of properties on a field basis. The application of the successful efforts method of accounting requires managements judgment
to determine the proper designation of wells as either developmental or exploratory, which will
ultimately determine the proper accounting treatment of the costs incurred. The results from a
drilling operation can take considerable time to analyze, and the determination that commercial
reserves have been discovered requires both judgment and application of industry experience. Wells
may be completed that are assumed to be productive and actually deliver oil and gas in quantities
insufficient to be economic, which may result in the abandonment of the wells at a later date.
Seismic costs incurred to select development locations within a productive oil and gas field are
typically treated as development costs and capitalized. Judgment is required to determine when the
seismic programs are not within proved reserve areas and therefore would be charged to expense as
exploratory. The evaluation of oil and gas leasehold acquisition costs requires managements
judgment to estimate the fair value of exploratory costs related to drilling activity in a given
area. For our Montana properties, drilling activities in an area by other companies may also effectively condemn leasehold
positions. The successful efforts method of accounting can have a significant impact on the operational
results reported when we enter a new exploratory area in hopes of finding oil and gas reserves.
Seismic costs can be substantial which will result in additional exploration expenses when
incurred. The initial exploratory wells may be unsuccessful and the associated costs will then be
expensed as dry hole costs and any associated leasehold costs may be impaired. Coalbed methane
wells require a period of time to dewater the wells prior to testing and determining whether proved
reserves can be attributed to the well. If this period exceeds one year, and we anticipate that it
will for our initial wells in the Yunnan and Shanxi Provinces, we will be required to charge the
costs of these wells to exploration expense. Impairment of unproved oil and gas properties.Unproved leasehold costs and exploratory
drilling in progress are capitalized and are reviewed periodically for impairment. Costs related to
impaired prospects or unsuccessful exploratory drilling are charged to expense. The estimated fair
value of unproved leasehold costs includes the present value of probable reserves discounted at
rates commensurate with the risks involved in each classification of reserve. Our assessment of
the results of exploration activities, commodity price outlooks, planned future sales or expiration
of all or a portion of such leaseholds impacts the amount and timing of impairment provisions. An
impairment expense could result if oil and gas prices decline in the future, as it may not be
economic to develop some of these unproved properties. 20




---



##### Table of Contents



As of December 31, 2004, we had total unproved oil and gas property costs of approximately
$1.3 million consisting of undeveloped leasehold costs of $1.0 million in Montana, $0.3 million in
China and unevaluated exploratory drilling costs of $1.3 million incurred in China. Estimates of future dismantlement, restoration, and abandonment costs. The accounting for
future development and abandonment costs changed on January 1, 2003, with the adoption of Statement
of Financial Accounting Standards (SFAS) No. 143. SFAS No. 143 requires the fair value of a
liability for an asset retirement obligation to be recognized in the period in which it is incurred
if a reasonable estimate of fair value can be made. The associated asset retirement costs are
capitalized as part of the carrying amount of the long-lived asset. The accrual is based on
estimates of these costs for each of our properties based upon the type of production structure,
reservoir characteristics, depth of the reservoir, market demand for equipment, currently available
procedures and consultations with construction and engineering consultants. Because these costs
typically extend many years into the future, estimating these future costs is difficult and
requires management to make estimates and judgments that are subject to future revisions based on
numerous factors, including changing technology, the political and regulatory environment and
estimates as to the proper discount rate to use and timing of abandonment. We have drilled three wells in the Yunnan Province, and Phillips drilled three wells in the
Shanxi Province, which we acquired through our farmout  agreements with Phillips. We will be required to plug
and abandon those wells and restore the well site upon completion of their production. Sufficient
testing on the wells has not been completed to determine the lives of these wells and therefore we
have insufficient information to determine the timing of the obligations related to plugging,
abandoning and restoring the site and cannot determine the present value of the obligation. Due to
the small number of wells, we do not believe the obligation is material, and we will recognize the
liability when a reasonable estimate of fair value can be made. Therefore, there is no provision in
the accompanying consolidated financial statements. Assessments of functional currencies.Our Chinese operations use the Chinese Yuan as their
functional currency. Management determines the functional currencies of our subsidiaries based on
an assessment of the currency of the economic environment in which a subsidiary primarily realizes
and expends its operating revenues, costs and expenses. The assessment of functional currencies can
have a significant impact on periodic results of operations and financial position. We have also adopted SFAS No. 52, Foreign Currency Translation, which requires that the
translation of the applicable foreign currency into U.S. dollars be performed for balance sheet
accounts using current exchange rates in effect at the balance sheet date and for revenue and
expense accounts using a weighted average exchange rate during the period. The gains or losses
resulting from such translation are included in the consolidated statements of stockholders equity
and comprehensive income. Stock Based Compensation.We apply Accounting Principles Board Opinion 25, Accounting for
Stock Issued to Employees(APB 25), and related interpretations in accounting for our stock option
grants to employees and members of our board of directors. Compensation cost for stock options
granted has been recognized for certain options granted at an exercise price below market value.
Other options granted had an exercise price equal to or greater than the market value of the
underlying common stock on the day of grant. We apply Statement of Accounting Standards No. 123 as
amended by SFAS No. 148, Accounting for Stock-Based Compensation,for our technical advisors and
consultants who are granted options. Compensation cost for stock
options granted to technical advisors and consultants has been
recognized as the fair value of the options granted on the grant date. New Accounting Pronouncements Stock Based Compensation On December 16, 2004, the Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 123 (revised 2004), Share-Based Payment (SFAS 123(R)), which is a
revision of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based
Compensation (SFAS 123). SFAS 123(R) supersedes APB 25 and amends Statement of Financial
Accounting Standards No. 95, Statement of Cash Flows. Generally, the approach in SFAS 123(R) is
similar to the approach described in SFAS 123. However, SFAS 21




---



##### Table of Contents



123(R) will require all share-based payments to employees, including grants of stock
options to employees and members of the board of directors, to be recognized in our consolidated statements of operations based on their fair values.
Pro forma disclosure is no longer an alternative. SFAS 123(R) must be adopted no later than July 1, 2005 and permits public companies to adopt
its requirements using one of two methods:  
    A modified prospective method in which compensation cost is recognized
beginning with the effective date based on the requirements of SFAS 123(R) for all
share-based payments granted after the effective date and based on the requirements
of SFAS 123 for all awards granted to employees and members of the
board of directors prior to the adoption date of SFAS
123(R) that remain unvested on the adoption date.
    A modified retrospective method which includes the requirements of the
modified prospective method described above, but also permits entities to restate
either all prior periods presented or prior interim periods of the year of adoption
based on the amounts previously recognized under SFAS 123 for purposes of pro forma
disclosures. We have elected to adopt the provisions of SFAS 123(R) on July 1, 2005 using the modified
prospective method. As
permitted by SFAS 123, we currently account for share-based payments
to employees and members of the board of directors using the
intrinsic value method prescribed by APB 25 and related interpretations. As such, we recognize
compensation expense to the extent that the exercise price of the options is below the market price
on the date of grant for employee and director stock options. Accordingly, we anticipate that the
adoption of SFAS 123(R)s fair value method will have a significant impact on our future result of
operations. If we had adopted SFAS 123(R) in prior periods, the impact would have approximated the
impact of SFAS 123 as described in the pro forma net income and earnings per share disclosures in
Note 1 of Notes to Consolidated Financial Statements included in Item 8. Financial Statements and
Supplementary Data. We have recorded options granted to our technical advisors and consultants at
fair value on the date of grant, and there will be no effect on our results of operations for those
options. We estimate that the adoption of SFAS 123(R), based on the outstanding unvested stock
options at December 31, 2004, will result in future compensation charges to stock compensation
expense and general and administrative expense of approximately $500,000 during the period from July 1, 2005 through December 31, 2005,
and approximately $1.5 million during 2006. Mineral Rights of Oil- and Gas-Producing Entities On September 2, 2004, the Financial Accounting Standards Board Staff issued FASB Staff
Position No. 142-2, which addressed the classification and disclosure for drilling and mineral
rights of oil- and gas-producing entities that are within the scope of Statement of Financial
Accounting Standards No. 19, Financial Accounting and Reporting by Oil and Gas Producing Entities
(SFAS 19). FASB Staff Position 142-2 states that the scope exception in paragraph 8(b) of
Statement of Financial Standards No. 142, Goodwill and Other Intangible Assets(SFAS 142) includes
the balance sheet classification and disclosures for drilling and mineral rights of oil- and
gas-producing entities that are within the scope of SFAS 19. The drilling and mineral rights are
not intangible assets under SFAS 142. As a result, we reclassified our intangible assets to
property and equipment on the balance sheets and discontinued amortizing the balance.
Subsequently, we will periodically review individual mineral rights to determine whether an
impairment has occurred, and whether loss should be recognized. Accounting for Suspended Well Costs On February 4, 2005, the Financial Accounting Standards Board Staff posted proposed FASB Staff
Position FAS 19-a, Accounting for Suspended Well Costs, which addresses whether there are
circumstances under the successful efforts method of accounting for oil and gas producing
activities that would permit the continued capitalization of exploratory well costs beyond one
year, other than when additional exploration wells are necessary to justify major capital
expenditures and those wells are under way or firmly planned for the near future. The proposed
FASB Staff Position states that the staff believes that exploratory well costs should continue to
be capitalized when the well has found a sufficient quantity of reserves to justify its completion
as a producing well and the enterprise is making sufficient progress assessing the reserves and the
economic and operating viability of the project. The proposed Staff Position provides a list of
indicators that an enterprise is making sufficient progress and provides for new disclosures
concerning 22




---



##### Table of Contents



the capitalized exploratory well costs that are pending the determination of proved reserves.
Comments were due on the proposed FASB staff position on March 7, 2005, and we cannot predict the
outcome at this time. Forward-Looking Statements This report includes forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933 and Section 21B of the Exchange Act. All statements other than statements
of historical facts contained in this report, including statements regarding our future financial
position, business strategy and plans and objectives of management for future operations, are
forward-looking statements. The words believe, may, will, estimate, continue,
anticipate, intend, expect and similar expressions, as they relate to us, are intended to
identify forward-looking statements. We have based these forward-looking statements largely on our
current expectations and projections about future events and financial trends that we believe may
affect our financial condition, results of operations, business strategy and financial needs.
These forward-looking statements are subject to a number of known and unknown risks, uncertainties
and assumptions described in this report. Although we believe that the expectations reflected in these forward looking statements are
reasonable, there can be no assurance that the actual results or developments we anticipate will be
realized or, even if substantially realized, that they will have the expected effects on our
business or operations. Actual results could differ materially from those projected in such
forward-looking statements. Factors that could cause actual results to differ materially from
those projected in such forward-looking statements include: our lack of operating history; limited
and potentially inadequate management of our cash resources; risk and uncertainties associated with
exploration; development and production of coalbed methane; expropriation and other risks
associated with foreign operations; matters affecting the energy
industry generally; lack of
availability of oil and gas field goods and services; environmental
risks; drilling and production
risks; changes in laws or regulations affecting our operations, as well as other risks described in
this report and subsequent filings with the SEC. When you consider these forward-looking statements, you should keep in mind these risk factors
and the other cautionary statements in this report. Our forward-looking statements speak only as
of the date made. All subsequent oral and written forward looking statements attributable to us or
persons acting on our behalf are expressly qualified in their entirety by these factors. We assume
no obligation to update any of these statements. Additional risks include, among others, the following: Risks Relating to Our Business We must obtain additional financing in order to continue our operations. Additionally, our
independent accountants have reported that we may not be able to continue as a going concern if we
do not obtain additional financing or achieve profitability. As of December 31, 2004, our net working capital was $10,826,000 and our total cash and cash
equivalents were $11,418,000, excluding $1,000,000 of restricted cash. We do not anticipate
recognizing significant revenues prior to late 2006, so we expect to experience operating losses and
negative cash flow for the foreseeable future. We believe we currently have cash resources to fund
our operations and planned exploration and development activities in China through the fourth
quarter 2005. However, as we do not have a source of revenue, we will require additional financing
in order to continue our exploration and development in China and sustain our operating losses. To
develop our projects over the long term, we need to obtain funding to satisfy very significant
expenditures for exploration and development of those projects. Furthermore, no facilities exist
to transport or process CBM near our Yunnan Province projects, and
pipelines must be built on our
Shanxi Province projects to connect to larger pipelines to transport our CBM. Significant
expenditures would be required to build out these facilities to the extent a strategic partner does
not do so. We intend to finance our operations by various methods, which might include issuing
equity securities, the continued exercise of warrants issued to investors in conjunction with the
previously completed private offerings, and entering into farmout agreements and other arrangement
with strategic partners, among other alternatives. Therefore, we intend to continue to seek to
raise equity or debt financing. No assurance can be given that we will be able to obtain any
additional financing on favorable terms, if at all. If our operating requirements differ
materially from those currently planned, we may require more financing than currently anticipated.
Borrowing money may involve pledging some or all of our assets. Raising 23




---



##### Table of Contents



additional funds by issuing common stock or other types of equity securities would further dilute our existing
stockholders. If we cannot obtain additional financing in a timely manner, we will not be able to
continue as a going concern. The reports received from our auditors for the years ended December
31, 2004, 2003 and 2002 contained in our financial statements contain an explanatory paragraph that
states that our net losses since our inception and no established source of revenues raise
substantial doubt about our ability to continue as a going concern. The consolidated financial
statements do not include any adjustments that might result from the outcome of that uncertainty. We have a limited operating history. Since we began our exploration and development activities in 2002, we have been engaged
principally in organizational activities, including developing a strategic operating plan, capital
funding, hiring personnel, entering into contracts, acquiring rights to explore, develop, produce
and sell CBM and, beginning in 2003, the drilling, testing and completion of exploratory wells. We
are considered a development stage company for accounting purposes because we have generated no
revenues to date. Accordingly, we have no relevant operating history upon which you can evaluate
our performance and prospects. In addition, we cannot forecast operating expenses based on our
historical results and our ability to accurately forecast future revenues is limited. As a result
of our limited operating history, we are more susceptible to business risks including risks of
unforeseen capital requirements, failure to establish business relationships, and competitive
disadvantages against larger and more established companies. We have no current source of revenue. We will not generate material revenues from our existing properties until we have successfully
completed exploration and development, and started production of coalbed methane gas in China. We
do not anticipate recognizing significant revenues from operations in China prior to late 2006.
Additionally, no facilities exist to transport or process CBM near our Yunnan Province projects,
and pipelines must be built on our Shanxi Province projects to connect to larger pipelines to
transport our CBM. Our ability to realize revenues from any producing wells may be impaired until
these facilities are built out or arrangements are made to deliver our production to market. We have a history of losses, and expect to incur losses in the foreseeable future. If we do not
achieve profitability, our financial condition and the price of our common stock will suffer. To date, we have no revenues from the sale of coalbed methane gas. We incurred net losses
applicable to common stockholders of $8,004,000 and $7,217,000 for the years ended December 31,
2004 and 2003, respectively. We expect to experience operating losses and negative cash flow for
the foreseeable future. We must obtain additional financing and generate significant revenues to
fund anticipated drilling, exploration and operation costs and to achieve and maintain
profitability. We cannot assure you we will ever generate sufficient revenues to achieve
profitability, which will negatively impact the price of our common stock. If we do achieve
profitability, we cannot assure you that we will be able to sustain or increase profitability in
the future. The development of coalbed methane properties involves substantial risks and we cannot assure you
that our exploration and drilling efforts will be successful. The business of exploring for and, to a lesser extent, developing and operating coalbed
properties involves a high degree of business and financial risk that even a combination of
experience, knowledge and careful evaluation may not be able to overcome. The selection of
prospects for coalbed methane gas drilling, the drilling, ownership and operation of CBM wells and
the ownership of interests in CBM properties are highly speculative. We cannot predict whether any
prospect will produce CBM or commercial quantities of CBM. Drilling for coalbed methane gas may involve unprofitable efforts, not only from dry wells,
but also from wells that are productive but do not produce coalbed methane in sufficient quantities
or quality to realize enough net revenues to return a profit after drilling, operating and other
costs. The cost of drilling, completing and operating wells is often uncertain and cost overruns
are common. Our drilling operations may be curtailed, delayed or canceled as a result of numerous
factors, many of which are beyond our control, including title problems, weather conditions,
compliance with governmental requirements and shortages or delays in the delivery of equipment and
services. In addition, other factors such as permeability may hinder, restrict or even make
production impractical or impossible. 24




---



##### Table of Contents



Acquisition and completion decisions generally are based on subjective judgments and
assumptions that are speculative. We may drill wells that, although productive, do not produce CBM
in economic quantities. It is impossible to predict with certainty the production potential of a
particular property or well. Furthermore, a successful completion of a well does not ensure a
profitable return on the investment. A variety of geological, operational, or market-related
factors, including, but not limited to, unusual or unexpected geological formations, pressures,
equipment failures or accidents, fires, explosions, blowouts, cratering, pollution and other
environmental risks, shortages or delays in the availability of drilling rigs and the delivery of
equipment, loss of circulation of drilling fluids or other conditions may substantially delay or
prevent completion of any well, or otherwise prevent a property or well from being profitable. A
productive well may also become uneconomic in the event water or other deleterious substances are
encountered, which impair or prevent the production of oil and/or natural gas from the well. In
addition, production from any well may be unmarketable if it is contaminated with water or other
deleterious substances. We cannot assure you that wells drilled by us will be productive or, even
if productive, that will produce CBM in economic quantities so that we will recover all or any
portion of our investment. We are in the initial
exploration phase and have substantial capital requirements that, if not
met, will hinder our growth and operations. We face significant challenges, expenses and difficulties as a development stage company
seeking to explore, develop and produce coalbed methane gas. The development of our projects in
China will require that we obtain funding to satisfy very significant expenditures for exploration
and development of these projects, if they are successful. We expect to incur approximately $6.5
million of exploration and development expenditures in 2005. We will
also require resources to fund significant capital expenditures for
exploration and development activities in future periods. In addition, there is currently no
gas pipeline, LNG plant or other offtake candidate in place in Yunnan
Province, and an LNG plant or two connecting
pipelines will be required to be constructed to transport coalbed
methane gas produced in the Qinnan and Shouyang
areas of Shanxi Province. We estimate that the cost to construct pipelines in the Yunnan Province
and Shanxi Province will total approximately $113 million. We do not currently have sufficient
funds to complete our exploration and development activities and build these pipeline or LNG
facilities. Our success will depend on our ability to obtain additional financing to fund our
capital expenditures and build out CBM delivery facilities or to find a strategic partner with
funds to do so. If we cannot obtain adequate capital, and we cannot
obtain extensions to the requirements under our production sharing
contracts, we would not be able to successfully complete our
exploration and development activities, and we may lose rights under
our production sharing contracts. This would materially and adversely
affect our business, financial condition and
results of operations. No facilities presently exist to transport or process CBM near our Yunnan Province projects, and, although larger pipelines exist in proximity to our Shanxi Province
projects, pipelines must be built to connect to larger pipelines or
facilities must be added to compress or liquefy and  transport
any CBM that may be produced from those projects. The marketability of any production will depend, in part, upon the availability, proximity and
capacity of pipelines, gas gathering systems and processing
facilities. We may transport our CBM through pipelines or by
compressing or liquefying the CBM for transportation. No gas pipeline, liquefied
natural gas plant, or other offtake candidate currently exists to
transport CBM from our properties
in Yunnan Province, and it is not likely that any such facilities will be built until favorable
results are obtained from several more wells. No liquefied natural
gas plant exists near our properties in the Shanxi Province, and pipelines must also be built on our Shanxi Province
projects to connect to larger pipelines to transport any CBM that may be produced from those
projects. At the present time, because there are no pipelines to move gas for any great distance in the
Yunnan Province, natural gas will have to be sold to the local communities. We may construct
pipelines to move CBM from our fields to either municipalities or other pipelines. We estimate the
cost to construct a pipeline 50 miles in length with a capacity of 350 MMcfpd to connect to the
Enhong and Laochang areas of the Yunnan Province to be approximately $50 million. In the Quinnan and Shouyang blocks of the Shanxi Province,
we estimate that we must eventually expend approximately $63 million for two short connecting
pipelines with 850 MMcfpd capacity. We believe we would need to
develop as many as ten wells to attract a transportation company to
build either a pipeline or a LNG plant near our wells in the Yunnan
Province and Shanxi Province. CBM sales from the Yunnan and Shanxi Provinces can also be
achieved through development of a LNG plant. We estimate that a 100-ton per day LNG plant will
cost approximately $10 to $15 million to develop and take about two years for construction. We
estimate that a 1,000-ton per day LNG plant would cost approximately $75 million with construction
time close to two years. We do not have funds to build any of these facilities. Our success will
depend on our ability to raise additional funds through financings or other means or to find a
strategic partner to complete these facilities. 25




---



##### Table of Contents



We must complete multiple CBM wells on our Yunnan Province and Shanxi Province projects before we
can commence production. We have drilled three CBM wells on our Yunnan Province project. We have also performed a
hydraulic fracture and test on one of these three wells and drilled two slim hole vertical wells,
which completed our Phase I obligations under our Yunnan Province production sharing contract with
CUCBM. We have also performed a hydraulic fracture of one of three exploration wells previously
drilled by Phillips, which completed our Phase I obligations under the Shanxi Agreements. The
wells we have drilled to date alone cannot produce enough coalbed methane gas to achieve commercial
viability. For each project, we must complete as many as ten wells in close proximity to one
another in order to begin production from any of the wells in the Yunnan Province. We
must also complete additional wells in the Shanxi Province to commence commercial production. We
cannot make any assurances that we will have the resources to drill enough additional wells in the
Yunnan and Shanxi Provinces to commence production in the areas. As a result, even though we may
have producing properties in the region, we may not be in a position to derive any revenues from
such wells. Actual production may vary materially from preliminary test results. Actual
production from the wells may be at recovery rates and gas quality
materially different than our first
indications. All of our operations are located in China. China is a developing country, has only recently begun participating in global trade with its
accession to the World Trade Organization, and has only a limited history of trade practices as a
nation. We are subject to the laws, rules, regulations, and political authority of the government
of the PRC. We may encounter material problems while doing business in China, such as interactions
with the Chinese government and uncertain foreign legal precedent pertaining to developing coalbed
methane gas in China. Risks inherent in international operations also include the following:  
    Local currency instability;
    Inflation;
    The risk of realizing economic currency exchange losses when transactions are
completed in currencies other than U.S. dollars;
    The ability to repatriate earnings under existing exchange
control laws; and
    Political unrest. Changes in domestic and foreign import and export laws and tariffs can also materially impact
international operations. In addition, foreign operations involve political, as well as economic
risks, including:  
    Nationalization;
    Expropriation;
    Contract renegotiations; and
    Changes in laws resulting from governmental changes. In
addition, CUCBM may be subject to rules and regulations of the PRC or
the jurisdiction of other governmental agencies in the PRC that may
adversely affect CUCBMs ability to perform under, or our rights
and obligations in, our production sharing contracts with CUCBM. In the event of a dispute, we may be subject to the exclusive jurisdiction of foreign courts
or may not be successful in subjecting foreign persons to the jurisdiction of courts in the United
States. We may also be hindered or prevented from enforcing our rights with respect to a
governmental instrumentality because of the doctrine of sovereign immunity. We may have difficulty managing growth in our business. Because of our small size and the relatively large scale of operations required for our
business to yield revenue, growth in accordance with our business plan, if achieved, will place a
significant strain on our financial, technical, operational and management resources. As we expand
our activities and increase the number of projects we are evaluating or in which we participate,
there will be additional demands on these resources. The failure to continue to upgrade our
technical, administrative, operating and financial control systems or the occurrence of unexpected
expansion difficulties, including the recruitment and retention of experienced managers,
geoscientists and engineers, could have a material adverse effect on our business, financial
condition and results of operations and our ability to timely execute our business plan. If we are
unable to implement these actions in a timely manner, our results may be adversely affected. 26




---



##### Table of Contents



We are dependent on our key executives and may not be able to hire and retain key employees to
fully implement our business strategy. Our success will depend largely on our senior management, which includes, among others,
Michael R. McElwrath, our chief executive officer, and Bruce N. Huff, our chief financial officer.
As we grow our business, we must attract, retain and integrate additional experienced managers,
geoscientists and engineers in order to successfully operate and grow our businesses. The number
of available, qualified personnel in the oil and gas industry to fill these positions may be
limited. Our inability to attract, retain and integrate these additional personnel or the loss of
the services of any of our senior executives or key employees could delay or prevent us from fully
implementing our business strategy and could significantly and negatively affect our business. We are exposed to foreign currency risk. In recent years, the Chinese government has fixed the exchange rate between U.S. dollars and
Chinese Yuan. Because the exchange rate has been fixed, instead of variable, we have experienced
no fluctuations in the value of goods and services we purchase in China because of currency
exchange. However, the United States and other foreign governments have repeatedly sought to
establish a floating exchange rate between the Chinese Yuan and other foreign currencies. If, in
the future, China accedes to these requests and permits currency float against the U.S. dollar, we
must either adopt cash management strategies to hedge U.S. dollars against the Yuan or be subject
to the exchange rate risks. In such case, if the value of U.S. dollar falls in relation to the
Chinese Yuan, the cost to us of funding our Chinese operations would rise because more dollars
would be required to fund the same expenditures in Yuan. Conversely, if the value of U.S. dollars
rises in relation to the Chinese Yuan, the change in exchange rates would decrease our dollar cost
to fund operations in China. We risk the effects of general economic conditions in China. Any CBM sales we secure could be adversely affected by a sustained economic recession in
China. As our operations and end user markets are primarily in China, a sustained economic
recession in that country could result in lower demand or lower prices for the natural gas to be
produced by us. We are not diversified and we concentrate on one industry. Our business strategy will concentrate in exploration and development of coalbed methane gas
in China. There is an inherent risk in not having a diverse base of properties in exploration and
development, because we will not have alternate sources of revenue if we are not successful with
our current exploration and development activities. As we will invest a high percentage of our
assets in this market, we may be more affected by any single adverse economic, political or
regulatory event than a more diversified entity. Our failure in the exploration and development of
CBM property rights in China would have a material adverse affect on our business. We may depend on a few customers. At
present, we have no coalbed methane gas sales contracts pending. As we may only contract with a small
number of entities that will purchase any gas we may produce, losing any such potential contract or
client would have a material negative impact on our business. If we borrow money to expand our business, we will face the risks of leverage. We anticipate that we may in the future incur debt for financing our growth. Our ability to
borrow funds will depend upon a number of factors, including the condition of the financial
markets. The risk of loss in such circumstances is increased because we would be obligated to meet
fixed payment obligations on specified dates regardless of our revenue. If we do not meet our debt
service payments when due, we may sustain the loss of our equity investment in any of our assets
securing such debt upon the foreclosure on such debt by a secured lender. 27




---



##### Table of Contents



Risk Related to the Oil & Gas Industry The volatility of natural gas and oil prices could harm our business. Our future revenues, profitability and growth and the carrying value of the oil and gas
properties depend to a large degree on prevailing oil and gas prices. Commercial lending sources
are not currently available to us because of our lack of operating history or income. Our ability
to borrow and to obtain additional equity funding on attractive terms also substantially depends
upon oil and gas prices. Prices for oil and gas are subject to large fluctuations in response to
relatively minor changes in the supply and demand for oil and gas, uncertainties within the market
and a variety of other factors beyond our control. These factors include weather conditions in
China, the condition of the Chinese economy, the activities of the Organization of Petroleum
Exporting Countries, governmental regulation, political stability in the Middle East and elsewhere,
the foreign supply of oil and gas, the price of foreign imports and the availability of alternative
fuel sources. The prices for oil and natural gas production have varied substantially over time
and may in the future decline, which would adversely affect us and consequently, our stockholders.
Prices for oil and natural gas have been and are likely to remain extremely unstable. We may not be able to successfully compete with rival companies. The energy industry is highly competitive in all its phases. Competition is particularly
intense with respect to the acquisition of desirable producing properties, the acquisition of
coalbed methane prospects suitable for enhanced production efforts, and the hiring of experienced
personnel. Our competitors in coalbed methane acquisition, development, and production include
major integrated oil and gas companies in addition to substantial independent energy companies.
Many of these competitors possess and employ financial and personnel resources substantially
greater than those that are available to us and may be able to pay more for desirable producing
properties and prospects and to define, evaluate, bid for, and purchase a greater number of
producing properties and prospects than we can. Our financial or personnel resources to generate
revenues in the future will depend on our ability to select and acquire suitable producing
properties and prospects in competition with these companies. The production and producing life of wells is uncertain and production will decline. It is not possible to predict the life and production of any well. The actual lives could
differ from those anticipated. Sufficient coalbed methane may not be produced for us to receive a
profit or even to recover our initial investment. In addition, production from our CBM gas wells,
if any, will decline over time, and does not indicate any consistent level of future production. We may suffer losses or incur liability for events for which the operator of a property or we have
chosen not to obtain insurance. Our operations are subject to hazards and risks inherent in producing and transporting oil and
natural gas, such as fires, natural disasters, explosions, pipeline ruptures, spills, and acts of
terrorism, all of which can result in the loss of hydrocarbons, environmental pollution, personal
injury claims and other damage to our properties and others. The occurrence of any of these events
could result in the following:  
    Substantial losses due to injury and loss of life,
    Severe damage to and destruction of property, natural resources and equipment,

    Pollution and other environmental damage,
    Clean-up responsibilities, and
    Regulatory investigation and penalties and suspension of operations. As protection against operating hazards, we maintain insurance coverage against some, but not all,
potential losses. In addition, we believe any operators of properties in which we have or may
acquire an interest will maintain similar insurance coverage. The occurrence of an event that is
not covered, or not fully covered, by insurance could have a material adverse effect on our
business, financial condition and results of operations. 28




---



##### Table of Contents



Environmental hazards and liabilities may adversely affect us and result in liability. There are numerous natural hazards involved in the drilling of CBM wells, including unexpected
or unusual formations, pressures, blowouts involving possible damages to property and third
parties, surface damages, bodily injuries, damage to and loss of equipment, reservoir damage and
loss of reserves. We could also be liable for environmental damages caused by previous property
owners. As a result, substantial liabilities to third parties or governmental entities may be
incurred which could have a material adverse effect on our financial condition and results of
operations. We maintain insurance coverage for our operations in amounts we deem appropriate, but we do
not believe that insurance coverage for environmental damages that occur over time, or complete
coverage for sudden and accidental environmental damages, is available at a reasonable cost.
Accordingly, we may be subject to liability or may lose the privilege to continue exploration or
production activities upon substantial portions of our properties if certain environmental damages
occur. The insurance coverage we do maintain may also be insufficient. In that event, our assets
would be utilized to pay personal injury and property damage claims and the costs of controlling
blowouts or replacing destroyed equipment rather than for additional drilling activities. We face substantial governmental regulation and environmental risks. Our business is subject to various laws and regulations that may be changed from time to time
in response to economic or political conditions. Matters subject to regulation include the
following:  
    Discharge permits for drilling operations,
    Drilling bonds,
    Reports concerning operations,
    The spacing of wells,
    Unitization and pooling of properties,
    Taxation, and
    Environmental protection. Regulatory agencies may also impose price controls and limitations on production by
restricting the rate of flow of oil and gas wells below actual production capacity in order to
conserve oil and gas. We are subject to environmental regulation that can materially adversely affect the timing and cost
of our operations. Our exploration and proposed production activities are subject to certain laws and regulations
relating to environmental quality and pollution control. Our operations in China are governed by
production sharing contracts between CUCBM and us and the Shanxi Agreements. We are subject to the
laws, decrees, regulations and standards on environmental protection and safety promulgated by the
Chinese government. Various government laws and regulations concerning the discharge of incidental
materials into the environment, the generation, storage, transportation and disposal of waste or
otherwise relating to the protection of public health, natural resources, wildlife and the
environment, affect our current exploration efforts and future development, processing and
production operations and the costs related to them. This consists of obtaining environmental
permits to conduct seismic acquisition, drilling or construction activities. Such regulations also
typically include requirements to develop emergency response plans, waste management plans,
environmental plans and spill contingency plans. Existing environmental laws and regulations may be revised or new laws and regulations may be
adopted or become applicable to us. Revised or additional laws and regulations that result in
increased compliance costs or additional operating restrictions, particularly if those costs are
not fully recoverable from insurance or our customers, could have a material adverse effect on our
business, financial condition or results of operations. 29




---



##### Table of Contents



Risks Relating to our Securities The SEC is currently investigating whether anyone has manipulated the price of our stock, profited
from selling stock at artificially high prices and failed to file the appropriate SEC ownership
forms. In December 2003, we learned that we are the subject of an investigation by the SEC. We
understand that the SEC may be investigating whether anyone has issued false or misleading
statements in connection with purchases and sales of our common stock, whether anyone has profited
from selling stock at artificially high prices due to the manipulative statements, and whether any
individual or group has failed to file ownership reports with the SEC as required for 10% or more
beneficial owners under Section 16 of the Exchange Act or failed to file ownership reports with the
SEC as required for 5% or more beneficial owners under Section 13 of the Exchange Act. Management
does not know of any acquisitions in excess of 5% of its outstanding shares, except for those
described in previous filings with the SEC under Section 13 and Section 16 of the Exchange Act. We
have supplied information to the SEC in response to their information requests, including, but not
limited to, information on record ownership, stock transfers, sales of our securities and board of
director and committee meetings, and we intend to continue to cooperate with their investigation.
We do not know what the outcome of their investigation may be. The Exchange Act and SEC rules require that a person or group of persons who acquire
beneficial ownership of more than 5% of a class of equity securities that are registered under the
Exchange Act must report their holdings in a Schedule 13D. The Schedule 13D with the SEC within 10
days after they become 5% stockholders, and must thereafter report changes in their beneficial
ownership of their securities. In addition, Section 16(a) of the Exchange Act generally requires
that beneficial owners of more than 10% of a class of stock that is registered under the Exchange
Act report changes in their holdings within 48 hours of an acquisition or disposition of
securities. If a person or group owns a large block of stock of a publicly traded company, particularly if
that stock is not subject to restrictions on its purchase and sale on the open market, there is a
risk that the person or group could sufficiently control the market for the stock to drive the
stocks trading price up or down, and thereby the undisclosed control group could reap trading
profits at the expense of other public investors. In addition, Schedule 13D requires owners of a
control group of stock to disclose their intentions with respect to management or control of the
company. If an undisclosed group owns or obtains control of a block of our stock sufficient to
control our company, they could change the management and direction of our company in ways we
cannot predict. A substantial amount of our outstanding securities will have resale restrictions lifted under Rule
144 within the next six months. We cannot predict the effect future sales of our common stock will
have on the market price of our common stock. On March 4, 2005, we had 77,439,910 shares of common stock outstanding, of which 43,504,491,
or 56%, were subject to resale restrictions. Of the 43,504,491 restricted shares, 17,170,000
shares have been held in the name of the holder of record for more than two years and, presuming
all other Rule 144 requirements have been met, are currently eligible to have resale restrictions
lifted without limitation. Of the 43,504,491 restricted shares 6,743,769 shares have been held for
over one year and are eligible to have resale restriction lifted with limitation. Of the
43,504,491 restricted shares, 3,043,825 will become eligible to have resale restrictions lifted
with limitation within the next six months by virtue of having been outstanding for more than one
year. We have also registered 2,425,000 shares on a registration statement and during its
effectiveness these shares will not be subject to resale restrictions. We cannot predict the effect, if any, that future sales of our common stock will have on the
market price of our common stock prevailing from time to time. Sales of substantial amounts of
common stock, such as the outstanding securities that will be available for resale in the coming
months, or the perception that such sales could occur, may adversely affect prevailing market
prices for our common stock. We do not currently intend to pay dividends. We currently intend to retain any profits to fund the development and growth of our business.
As a result, we have not paid dividends on our common stock and our board of directors currently
does not intend to declare dividends or make any other distributions in the foreseeable future.
Consequently, it is uncertain when, if ever, we will declare dividends to our stockholders. 30




---



##### Table of Contents



The price of our common stock could be volatile. The market price of our common stock will likely fluctuate significantly in response to the
following factors, some of which are beyond our control:  
    Variations in our quarterly operating results;
    Changes in market valuations of oil and gas companies;
    Announcements by us of significant contracts, acquisitions, strategic
partnerships, joint ventures or capital commitments;
    Additions or departures of key personnel;
    Future sales of our common stock;
    Stock market price and volume fluctuations attributable to inconsistent trading
volume levels of our stock; and
    Commencement of or involvement in litigation. In addition, the trading volume of our common stock is relatively small, and the market for
our stock may not be able to efficiently accommodate significant trades on any given day. As a
result, sizable trades of our common stock may cause volatility in the market price of our common
stock to a greater extent than in more actively traded securities. These broad fluctuations may
adversely affect the market price of our common stock. We may issue our capital stock without the consent of stockholders. The issuance of any additional
equity securities would further dilute our stockholders. Our board of directors has the authority, without further action by the stockholders, to issue
up to 500.0 million shares of preferred stock in one or more series and to designate the rights,
preferences, privileges and restrictions of each series. We also have 500.0 million shares of
common stock authorized under our charter documents, of which 76.5 million shares are issued and
outstanding as of December 31, 2004. The issuance of preferred stock could have the effect of
restricting dividends on the common stock or delaying or preventing our change in control without
further action by the stockholders. While we have no present plans to issue any shares of
preferred stock, we may need to do so in the future in connection with capital raising
transactions. In addition, we may issue additional shares of common stock in connection with
fundraising activities. The issuance of additional common stock would also have a dilutive impact
on our stockholders ownership interest in our company. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We do not engage in hedging activities and do not use commodity futures or forward contracts
in our cash management functions. We also do not currently hedge our exposure to currency rate
changes. In recent years, the Chinese government has fixed the exchange rate between U.S. dollars
and Chinese Yuan. Because the exchange rate has been fixed, instead of variable, we have
experienced no fluctuations in the value of goods and services we purchase in China because of
currency exchange. However, the United States and other foreign governments have repeatedly sought
to establish a floating exchange rate between the Chinese Yuan and other foreign currencies. If,
in the future, China accedes to these requests and permits currency float against the U.S. dollar,
we must either adopt cash management strategies to hedge U.S. dollars against the Yuan or be
subject to the exchange rate risks. In general, we hold cash reserves in U.S. dollars and transfer
funds to China as needed to operate our Chinese offices and conduct exploration operations. We do
not expect to generate significant revenues from activities in China prior to late 2006. 31




---



##### Table of Contents



ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Managements Report on Internal Control Over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over
financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). Our internal control
over financial reporting is designed, under the supervision and with the participation of our chief
executive officer and chief financial officer, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of our published financial statements. All
internal control systems, no matter how well designed, have inherent limitations. Therefore, even
those systems determined to be effective can provide only reasonable assurance with respect to
financial statement preparation and
presentation. Further, because of changes in conditions, the
effectiveness of internal controls may vary over time. Our management assessed the effectiveness of our internal control over financial reporting as
of December 31, 2004. In making this assessment, our management used the criteria set forth by the
Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated
Framework. Our management has concluded that, as of December 31, 2004, our internal control over
financial reporting is effective based on these criteria. Our independent registered public accounting firm, Payne, Falkner, Smith & Jones, P.C., that
audited our consolidated financial statements included in this report, has issued an audit report
on managements assessment of the effectiveness of our internal control over financial reporting as
of December 31, 2004, which is included on page 34 of this report. 32




---



##### Table of Contents



Report of Independent Registered Public Accounting Firm The Board of Directors
Far East Energy Corporation and Subsidiaries We have audited the accompanying consolidated balance sheet of Far East Energy Corporation and
Subsidiaries (a development stage Company) as of December 31, 2004 and 2003 and the related
consolidated statements of operations, changes in stockholders equity and cash flows for each of
the years in the three-year period ended December 31, 2004 and for the period from the date of
incorporation on February 4, 2000 to December 31, 2004. Our
audits also included the financial statement schedule listed in
Item 15. These consolidated financial statements
and schedule are the responsibility of the Companys management. Our responsibility is to express an opinion on
these financial statements and schedule based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of Far East Energy Corporation and Subsidiaries as of
December 31, 2004 and 2003, and the results of its operations and its cash flows for each of the
years in the three-year period ended December 31, 2004 and for the period from the date of
incorporation on February 4, 2000 to December 31, 2004, in conformity with accounting principles
generally accepted in the United States of America. Also, in our
opinion, the financial statement schedule, when considered in
relation to the basic financial statements taken as a whole, presents
fairly in all material respects the information set forth therein. The accompanying consolidated financial statements and schedule have been prepared assuming that the Company
will continue as a going concern. As discussed in Note 2 to the consolidated financial statements,
the Company has incurred net losses since its inception and has no established source of revenues.
Those conditions raise substantial doubt about its ability to continue as a going concern.
Managements plans regarding those matters are described in
Note 2. The consolidated financial
statements and schedule do not include any adjustments relating to the recoverability and classification of
recorded assets, or the amounts and classification of liabilities that might be necessary in the
event the Company cannot continue in existence. As described in Note 3 to the consolidated financial statements, the accompanying consolidated
financial statements as of and for the year ended December 31, 2003 have
been restated. We also have audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the effectiveness of Far East Energy Corporations internal control over
financial reporting as of December 31, 2004, based on criteria established in Internal
ControlIntegrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO), and our report dated February 23, 2005, expressed an unqualified opinion on
managements assessment of internal control over financial reporting and an unqualified opinion on
the effectiveness of internal control over financial reporting. February 23, 2005 /s/ Payne Falkner Smith & Jones, P.C.
Payne Falkner Smith & Jones, P.C. Dallas, Texas 33




---



##### Table of Contents



Report of Independent Registered Public Accounting Firm To the Board of Directors and
Stockholders of Far East Energy Corporation We have audited managements assessment, included in the accompanying Managements Report on
Internal Control Over Financial Reporting, that Far East Energy Corporation (FEEC) maintained
effective internal control over financial reporting as of December 31, 2004, based on criteria
established in Internal ControlIntegrated Frameworkissued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). FEECs management is responsible for maintaining
effective internal control over financial reporting and for its assessment of the effectiveness of
internal control over financial reporting. Our responsibility is to express an opinion on
managements assessment and an opinion on the effectiveness of FEECs internal control over
financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control over financial reporting was
maintained in all material respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating managements assessment, testing and evaluating the
design and operating effectiveness of internal control, and performing such other procedures as we
considered necessary in the circumstances. We believe that our audit provides a reasonable basis
for our opinion. A companys internal control over financial reporting is a process designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted accounting principles. A
companys internal control over financial reporting includes those policies and procedures that (1)
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the company; (2) provide reasonable assurance that
transactions are recorded as necessary to permit preparation of financial statements in accordance
with generally accepted accounting principles, and that receipts and expenditures of the company
are being made only in accordance with authorizations of management and directors of the company;
and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the companys assets that could have a material effect on the
financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or
detect misstatements. Also, projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because of changes in conditions, or that
the degree of compliance with the policies or procedures may deteriorate. In our opinion, managements assessment that FEEC maintained effective internal control over
financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on
criteria established in Internal ControlIntegrated Frameworkissued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). Also, in our opinion, FEEC maintained, in all
material respects, effective internal control over financial reporting as of December 31, 2004,
based on criteria established in Internal ControlIntegrated Frameworkissued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO). We also have audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the consolidated balance sheets of Far East Energy Corporation, as of
December 31, 2004 and 2003 and the related consolidated statements of operations, stockholders
equity, and cash flows of FEEC, and our report dated February 23, 2005 expressed an unqualified
opinion. February 23, 2005 /s/ Payne Falkner Smith & Jones P.C.
Payne Falkner Smith & Jones, P.C. Dallas, Texas 34




---



##### Table of Contents



FAR EAST ENERGY CORPORATION
(A Development Stage Company)
Consolidated Balance Sheet December 31,2004
    
    
    2003(Restated)ASSETSCurrent assetsCash and cash equivalents
    
    $
    11,418,000
    
    
    $
    2,326,000Stock subscriptions receivable
    
    
    250,000
    
    
    
    Prepaids and other current assets
    
    
    98,000
    
    
    
    4,000Total current assets
    
    
    11,766,000
    
    
    
    2,330,000Restricted cash
    
    
    1,000,000
    
    
    
    Property and equipment, net
    
    
    2,647,000
    
    
    
    2,284,000Total assets
    
    $
    15,413,000
    
    
    $
    4,614,000LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilitiesAccounts payable
    
    $
    940,000
    
    
    $
    664,000Other liabilities
    
    
    
    
    
    
    106,000Note payable
    
    
    
    
    
    
    100,000Total current liabilities
    
    
    940,000
    
    
    
    870,000Commitments and contingenciesStockholders equityPreferred stock, $.001 par value, 500,000,000 shares authorized,
none outstanding
    
    
    
    
    
    
    Common stock, $0.001 par value, 500,000,000 shares authorized,
76,542,410 and 56,379,153 issued and outstanding, respectively
    
    
    77,000
    
    
    
    57,000Additional paid in capital
    
    
    29,716,000
    
    
    
    12,132,000Additional paid in capital-outstanding stock options
    
    
    2,061,000
    
    
    
    930,000Deficit accumulated during the development stage
    
    
    (17,377,000
    )
    
    
    (9,373,000
    )Accumulated other comprehensive loss
    
    
    (4,000
    )
    
    
    (2,000
    )Total stockholders equity
    
    
    14,473,000
    
    
    
    3,744,000Total liabilities and stockholders equity
    
    $
    15,413,000
    
    
    $
    4,614,000
 See accompanying notes to consolidated financial statements. 35




---



##### Table of Contents



FAR EAST ENERGY CORPORATION
(A Development Stage Company)
Consolidated Statement of Operations CumulativeDuringDevelopment
    
    
    Year ended December 31,Stage
    
    
    
    
    
    
    2003(Restated)
    
    
    2004
    
    
    (Restated)
    
    
    2002Revenues
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Expenses:Geologic and engineering services
    
    
    1,194,000
    
    
    
    575,000
    
    
    
    239,000
    
    
    
    380,000Exploration costs
    
    
    550,000
    
    
    
    550,000
    
    
    
    
    
    
    
    Impairment loss
    
    
    3,778,000
    
    
    
    450,000
    
    
    
    3,328,000
    
    
    
    Other consulting and professional
services
    
    
    1,319,000
    
    
    
    788,000
    
    
    
    424,000
    
    
    
    296,000Compensation
    
    
    2,865,000
    
    
    
    1,440,000
    
    
    
    839,000
    
    
    
    596,000Stock compensation
    
    
    1,513,000
    
    
    
    583,000
    
    
    
    930,000
    
    
    
    Travel
    
    
    1,517,000
    
    
    
    608,000
    
    
    
    334,000
    
    
    
    575,000Legal and accounting
    
    
    1,990,000
    
    
    
    1,508,000
    
    
    
    411,000
    
    
    
    66,000Loss on investment in joint venture
    
    
    22,000
    
    
    
    
    
    
    
    22,000
    
    
    
    Amortization of contract rights
    
    
    81,000
    
    
    
    23,000
    
    
    
    58,000
    
    
    
    General and administrative
    
    
    2,406,000
    
    
    
    1,487,000
    
    
    
    468,000
    
    
    
    231,000Total expenses
    
    
    17,235,000
    
    
    
    8,012,000
    
    
    
    7,053,000
    
    
    
    2,144,000Other Expenses (Income):Interest expense
    
    
    177,000
    
    
    
    9,000
    
    
    
    168,000
    
    
    
    Interest income
    
    
    (36,000
    )
    
    
    (17,000
    )
    
    
    (6,000
    )
    
    
    (13,000
    )Foreign currency exchange loss
    
    
    1,000
    
    
    
    
    
    
    
    2,000
    
    
    
    (1,000
    )Total other expense (income)
    
    
    142,000
    
    
    
    (8,000
    )
    
    
    164,000
    
    
    
    (14,000
    )Loss before income taxes
    
    
    (17,377,000
    )
    
    
    (8,004,000
    )
    
    
    (7,217,000
    )
    
    
    (2,130,000
    )Income taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net loss
    
    
    (17,377,000
    )
    
    
    (8,004,000
    )
    
    
    (7,217,000
    )
    
    
    (2,130,000
    )Accumulated deficit-beginning of period
    
    
    
    
    
    
    (9,373,000
    )
    
    
    (2,156,000
    )
    
    
    (26,000
    )Accumulated deficit-end of period
    
    $
    (17,377,000
    )
    
    $
    (17,377,000
    )
    
    $
    (9,373,000
    )
    
    $
    (2,156,000
    )Earnings per share:Basic and diluted
    
    
    
    
    
    $
    (0.13
    )
    
    $
    (0.14
    )
    
    $
    (0.05
    )Weighted average shares outstanding:Basic and diluted
    
    
    
    
    
    
    60,113,000
    
    
    
    50,614,000
    
    
    
    45,467,000
 See the accompanying notes to consolidated financial statements. 36




---



##### Table of Contents



FAR EAST ENERGY CORPORATION
(A Development Stage Company)
Consolidated Statement of Stockholders Equity
For the Years Ended December 31, 2004, 2003, 2002, 2001 and 2000 AdditionalPaid-In
    
    
    DeficitCapital
    
    
    Accumulated
    
    
    AccumulatedCommon Stock
    
    
    Additional
    
    
    Outstanding
    
    
    During the
    
    
    Other
    
    
    
    
    
    
    TotalDate of
    
    
    Number of
    
    
    Par
    
    
    Paid-In
    
    
    Stock
    
    
    Development
    
    
    Comprehensive
    
    
    
    
    
    
    StockholdersTransaction
    
    
    Shares
    
    
    Value
    
    
    Capital
    
    
    Options
    
    
    Stage
    
    
    Loss
    
    
    Loss
    
    
    EquityShares issued
    
    
    4/00-8/00
    
    
    
    2,250,000
    
    
    $
    2,000
    
    
    $
    51,000
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    53,000Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (11,000
    )
    
    
    
    
    
    
    (11,000
    )
    
    
    (11,000
    )Balance at December 31, 2000
    
    
    
    
    
    
    2,250,000
    
    
    
    2,000
    
    
    
    51,000
    
    
    
    
    
    
    
    (11,000
    )
    
    
    
    
    
    
    
    
    
    
    42,000Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (15,000
    )
    
    
    
    
    
    
    (15,000
    )
    
    
    (15,000
    )Balance at December 31, 2001
    
    
    
    
    
    
    2,250,000
    
    
    
    2,000
    
    
    
    51,000
    
    
    
    
    
    
    
    (26,000
    )
    
    
    
    
    
    
    
    
    
    
    27,00018 for 1 stock split
    
    
    1/1/2002
    
    
    
    38,250,000
    
    
    
    38,000
    
    
    
    (38,000
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Shares issued
    
    
    1/24-4/1/02
    
    
    
    5,250,500
    
    
    
    5,000
    
    
    
    3,047,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,052,000Stock issued in Newark Valley
Oil & Gas, Inc. acquisition
    
    
    12/30/02
    
    
    
    1,600,000
    
    
    
    2,000
    
    
    
    3,598,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,600,000Stock issued subject to
acquisition completion
    
    
    
    
    
    
    (1,600,000
    )
    
    
    (2,000
    )
    
    
    (3,598,000
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,600,000
    )Comprehensive loss:Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,130,000
    )
    
    
    
    
    
    
    (2,130,000
    )
    
    
    (2,130,000
    )Other comprehensive loss,
net of income taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Foreign currency translation
adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,000
    )
    
    
    (2,000
    )
    
    
    (2,000
    )Total comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    (2,132,000
    )Balance at December 31, 2002
    
    
    
    
    
    
    45,750,500
    
    
    $
    45,000
    
    
    $
    3,060,000
    
    
    $
    
    
    
    $
    (2,156,000
    )
    
    $
    (2,000
    )
    
    
    
    
    
    $
    947,000
 continued on next page 37




---



##### Table of Contents



FAR EAST ENERGY
CORPORATION(A Development Stage Company)
Consolidated Statement of Stockholders Equity
For the Years Ended December 31, 2004, 2003, 2002, 2001 and 2000
(continued from the previous page) AdditionalPaid-In
    
    
    DeficitCapital
    
    
    Accumulated
    
    
    AccumulatedCommon Stock
    
    
    Additional
    
    
    Outstanding
    
    
    During the
    
    
    Other
    
    
    
    
    
    
    TotalDate of
    
    
    Number of
    
    
    Par
    
    
    Paid-In
    
    
    Stock
    
    
    Development
    
    
    Comprehensive
    
    
    
    
    
    
    StockholdersTransaction
    
    
    Shares
    
    
    Value
    
    
    Capital
    
    
    Options
    
    
    Stage
    
    
    Loss
    
    
    Loss
    
    
    EquityBalance at December 31, 2002
    
    
    
    
    
    
    45,750,500
    
    
    $
    45,000
    
    
    $
    3,060,000
    
    
    $
    
    
    
    $
    (2,156,000
    )
    
    $
    (2,000
    )
    
    
    
    
    
    $
    947,000Shares issued
    
    
    2/12/2003
    
    
    
    60,000
    
    
    
    1,000
    
    
    
    134,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    135,0004/30-10/7/03
    
    
    
    8,628,269
    
    
    
    9,000
    
    
    
    4,939,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,948,000Warrants exercised
    
    
    11/26, 12/4,12/29/03
    
    
    
    32,692
    
    
    
    
    
    
    
    33,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    33,000Stock options outstanding
    
    
    10/1-12/31/03
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    930,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    930,000Issuance of debt with beneficial
conversion feature
    
    6/12/03 and7/23/03
    
    
    
    
    
    
    
    
    
    
    
    168,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    168,000Conversion of notes payable
    
    
    10/6/03
    
    
    
    307,692
    
    
    
    
    
    
    
    200,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    200,000Stock issued upon completion
of Newark Valley Oil & Gas,
Inc. acquisition
    
    
    8/21/03
    
    
    
    1,600,000
    
    
    
    2,000
    
    
    
    3,598,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,600,000Comprehensive loss:Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (7,217,000
    )
    
    
    
    
    
    
    (7,217,000
    )
    
    
    (7,217,000
    )Other comprehensive loss, net
of income taxesForeign currency translation
adjustmentTotal comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    (7,217,000
    )Balance at December 31, 2003
    
    
    
    
    
    
    56,379,153
    
    
    $
    57,000
    
    
    $
    12,132,000
    
    
    $
    930,000
    
    
    $
    (9,373,000
    )
    
    $
    (2,000
    )
    
    
    
    
    
    $
    3,744,000
 continued on next page 38




---



##### Table of Contents



FAR EAST ENERGY CORPORATION
(A Development Stage Company)
Consolidated Statement of Stockholders Equity
For the Years Ended December 31, 2004, 2003, 2002, 2001 and 2000
(continued from the previous page) AdditionalPaid-In
    
    
    DeficitCapital
    
    
    Accumulated
    
    
    AccumulatedCommon Stock
    
    
    Additional
    
    
    Outstanding
    
    
    During the
    
    
    Other
    
    
    
    
    
    
    TotalDate of
    
    
    Number of
    
    
    Par
    
    
    Paid-In
    
    
    Stock
    
    
    Development
    
    
    Comprehensive
    
    
    
    
    
    
    StockholdersTransaction
    
    
    Shares
    
    
    Value
    
    
    Capital
    
    
    Options
    
    
    Stage
    
    
    Loss
    
    
    Loss
    
    
    EquityBalance at December 31, 2003
    
    
    
    
    
    
    56,379,153
    
    
    $
    57,000
    
    
    $
    12,132,000
    
    
    $
    930,000
    
    
    $
    (9,373,000
    )
    
    $
    (2,000
    )
    
    
    
    
    
    $
    3,744,000Warrants exercised
    
    
    1/15, 3/5, 3/23-4/28, 5/21, 8/6,and 12/10/04
    
    
    2,827,286
    
    
    
    3,000
    
    
    
    2,824,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,827,000Warrants redeemed unexercised
    
    
    3/23-4/28
    
    
    
    
    
    
    
    
    
    
    
    (2,000
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,000
    )Conversion of notes payable
    
    
    2/20/04
    
    
    
    153,846
    
    
    
    
    
    
    
    100,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    100,000Shares issued to compensate
consultant
    
    
    2/29-12/31/04
    
    
    
    37,000
    
    
    
    
    
    
    
    58,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    58,000Shares issued
    
    
    3/30-5/19/04
    
    
    
    1,280,000
    
    
    
    1,000
    
    
    
    2,226,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,227,000Shares issued
    
    
    5/31/04
    
    
    
    550,000
    
    
    
    1,000
    
    
    
    1,055,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,056,000Stock options outstanding
    
    
    1/1-12/31/04
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,131,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,131,000Shares issued
    
    
    12/7/04
    
    
    
    250,000
    
    
    
    
    
    
    
    250,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    250,000Shares issued
    
    
    12/21-12/23/04
    
    
    
    12,812,500
    
    
    
    13,000
    
    
    
    9,417,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,430,000Shares issued
    
    
    12/31/04
    
    
    
    2,252,625
    
    
    
    2,000
    
    
    
    1,656,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,658,000Comprehensive loss:Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (8,004,000
    )
    
    
    
    
    
    
    (8,004,000
    )
    
    
    (8,004,000
    )Other comprehensive loss,
net
of income taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Foreign currency translation
adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,000
    )
    
    
    (2,000
    )
    
    
    (2,000
    )Total comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    (8,006,000
    )Balance at
December 31, 2004
    
    
    
    
    
    
    76,542,410
    
    
    $
    77,000
    
    
    $
    29,716,000
    
    
    $
    2,061,000
    
    
    $
    (17,377,000
    )
    
    $
    (4,000
    )
    
    
    
    
    
    $
    14,473,000
 See the accompanying notes to consolidated financial statements.   (1)
    
    Additional paid in capital and deficit accumulated during the development stage were
restated in 2003 and 2002. 39




---



##### Table of Contents



FAR EAST ENERGY CORPORATION
(A Development Stage Company)
Consolidated Statement of Cash Flows CumulativeDuringDevelopment
    
    
    For the Year Ended December 31,Stage
    
    
    
    
    
    
    2003(Restated)
    
    
    2004
    
    
    (Restated)
    
    
    2002Cash flows from operating activitiesNet loss
    
    $
    (17,377,000
    )
    
    $
    (8,004,000
    )
    
    $
    (7,217,000
    )
    
    $
    (2,130,000
    )Adjustments to reconcile net loss to cash used
In operating activities:Depreciation and amortization
    
    
    132,000
    
    
    
    48,000
    
    
    
    77,000
    
    
    
    7,000Stock issued to pay expense
    
    
    58,000
    
    
    
    58,000
    
    
    
    
    
    
    
    Stock compensation
    
    
    2,061,000
    
    
    
    1,131,000
    
    
    
    930,000
    
    
    
    Loss on investment in joint venture
    
    
    22,000
    
    
    
    
    
    
    
    22,000
    
    
    
    Impairment expense
    
    
    3,778,000
    
    
    
    450,000
    
    
    
    3,328,000
    
    
    
    Unsuccessful exploratory well
    
    
    550,000
    
    
    
    550,000
    
    
    
    
    
    
    
    Interest expensebeneficial conversion
feature
    
    
    168,000
    
    
    
    
    
    
    
    168,000
    
    
    
    Increase in prepaids and other current assets
    
    
    (98,000
    )
    
    
    (94,000
    )
    
    
    (3,000
    )
    
    
    (1,000
    )Increase in accounts payable
    
    
    920,000
    
    
    
    256,000
    
    
    
    411,000
    
    
    
    253,000Increase (decrease) in other liabilities
    
    
    
    
    
    
    (106,000
    )
    
    
    106,000Net cash used in operating activities
    
    
    (9,786,000
    )
    
    
    (5,711,000
    )
    
    
    (2,178,000
    )
    
    
    (1,871,000
    )Cash flows used in investing activitiesLoss on investment in joint venture
    
    
    (22,000
    )
    
    
    
    
    
    
    
    
    
    
    Additions to unproved oil and gas properties
    
    
    (3,354,000
    )
    
    
    (1,404,000
    )
    
    
    (1,882,000
    )
    
    
    (90,000
    )Additions to other property
    
    
    (153,000
    )
    
    
    (7,000
    )
    
    
    (38,000
    )
    
    
    (108,000
    )Increase in restricted cash
    
    
    (1,000,000
    )
    
    
    (1,000,000
    )
    
    
    
    
    
    
    Net cash used in investing activities
    
    
    (4,529,000
    )
    
    
    (2,411,000
    )
    
    
    (1,920,000
    )
    
    
    (198,000
    )Cash flows from financing activitiesNet proceeds from the issuance of notes payable
    
    
    300,000
    
    
    
    
    
    
    
    300,000
    
    
    
    Net proceeds from the sale of common stock
    
    
    22,579,000
    
    
    
    14,391,000
    
    
    
    5,083,000
    
    
    
    3,052,000Net proceeds from the exercise of warrants
    
    
    2,858,000
    
    
    
    2,825,000
    
    
    
    33,000
    
    
    
    Net cash provided by financing activities
    
    
    25,737,000
    
    
    
    17,216,000
    
    
    
    5,416,000
    
    
    
    3,052,000Effect of exchange rate changes on cash
    
    
    (4,000
    )
    
    
    (2,000
    )
    
    
    
    
    
    
    (2,000
    )Increase in cash and cash equivalents
    
    
    11,418,000
    
    
    
    9,092,000
    
    
    
    1,318,000
    
    
    
    981,000Cash and cash equivalentsbeginning of period
    
    
    
    
    
    
    2,326,000
    
    
    
    1,008,000
    
    
    
    27,000Cash and cash equivalentsend of period
    
    $
    11,418,000
    
    
    $
    11,418,000
    
    
    $
    2,326,000
    
    
    $
    1,008,000
 See the accompanying notes to consolidated financial statements. 40




---



##### Table of Contents



Notes to Consolidated Financial Statements
(A Development Stage Company)
December 31, 2004 1. Summary of Significant Accounting Policies Business We were incorporated in the state of Nevada on February 4, 2000 under the name Egoonline.com.
We changed our name to EZfoodstop.com on April 26, 2000 and to Far East Energy Corporation on
January 10, 2002. We are an independent energy company engaged in the acquisition, exploration and
development of coalbed methane gas properties in the Peoples Republic of China (PRC) and, prior to
the sale of our properties in Montana in February 2005, natural gas in Montana. We are a
development stage company, and our activities have been limited
to organizational activities, including developing a strategic operating
plan, capital funding, hiring personnel, entering into
contracts acquiring rights to explore for, develop, produce and sell oil and gas or coalbed
methane (CBM), and drilling, testing and completion of exploratory
wells. Basis of Presentation The accompanying consolidated financial statements have been prepared in conformity with
generally accepted accounting principles, which contemplate that we will continue as a going
concern. We have been in the development stage since our formation on February 4, 2000. We have
incurred net losses since our inception and have not established a source of revenue. Accordingly,
realization of a major portion of the assets in the accompanying consolidated balance sheet is
dependent upon our continued operations, which in turn is dependent upon our ability to meet our
financing requirements, and the success of our future operations. Management believes that the
funds available to the Company will finance our operations through the end of 2005; however,
additional funds will be required for exploration and development of our China projects and
operations. Management expects to raise additional funds through equity offerings or debt, and
management believes that this will provide us the opportunity to continue as a going concern.
These factors raise substantial doubt about our ability to continue as a going concern. The
accompanying consolidated financial statements do not include any adjustments that might result
from the outcome of this uncertainty. Principles of Consolidation Our consolidated financial statements include the accounts of our wholly owned subsidiaries
after the elimination of all significant intercompany accounts and transactions. Our wholly owned
subsidiaries include: Newark Valley Oil & Gas, Inc., organized under the laws of the state of
Nevada, Yunnan Huayi Eco-Tech Consulting Co. Ltd., a Chinese company, Far East (BVI), Inc.,
organized under the laws of the British Virgin Islands, and its Chinese joint venture entity,
Guihzou Far East Panjiang Chemical Co. Ltd., which is a Chinese joint venture and was liquidated
during 2004. Our consolidated financial statements for prior periods include reclassifications that were
made to conform to the current year presentation. Those reclassifications have no impact on the
reported net loss or stockholders equity. Use of Estimates The preparation of our financial statements in conformity with accounting principles generally
accepted in the United States of America requires management to make estimates and assumptions that
affect the reported amounts of assets, liabilities, revenues, expenses and disclosure of contingent
assets and liabilities that exist at the date of the financial statements. While we believe our
estimates are appropriate, actual results can, and often do, differ from those estimates. 41




---



##### Table of Contents



Cash and Cash Equivalents We consider short-term investments with little risk of change in value because of changes in
interest rates and purchased with an original maturity of three months or less to be cash
equivalents. Restricted Cash We have restricted cash deposited in escrow to guarantee our performance under the farmout
agreements with Conoco Phillips. We have classified the restricted cash as a non-current asset as
it is designated for expenditure on our Shanxi production sharing
contracts. Stock Subscriptions Receivable We have a receivable for stock subscriptions at December 31, 2004, which we classified as an
asset as funds were readily available within 30 days of December 31, 2004. Property and Equipment We use the successful efforts method of accounting for our oil and gas properties. Under this
method, oil and gas lease acquisition costs and intangible drilling costs associated with
exploration efforts that result in the discovery of proved reserves and costs associated with
development drilling, whether or not successful, are capitalized when incurred. Certain costs of
exploratory wells are capitalized pending determination that proved reserves have been found. If
the determination is dependent upon the results of planned additional wells and required capital
expenditures to produce the reserves found, the drilling costs will be capitalized as long as
sufficient reserves have been found to justify completion of the exploratory well and additional
wells are underway or firmly planned to complete the evaluation of the well. All costs related to
unsuccessful exploratory wells are expensed when such wells are determined to be non-productive or
at the one year anniversary of completion of the well if proved reserves have not been attributed
and capital expenditures as described in the preceding sentence are not required. We assess our
capitalized exploratory wells pending evaluation each quarter to determine whether costs should
remain capitalized or should be charged to earnings. Other exploration costs, including geological
and geophysical costs, are expensed as incurred. We recognize gain or losses on the sale of
properties on a field basis. Unproved leasehold costs are capitalized and reviewed periodically for impairment on a
property-by-property basis, considering factors such as drilling and exploitation plans and lease
terms. The estimated fair value of unproved leasehold costs includes the present value of probable
reserves discounted at rates commensurate with the risks involved in each classification of
reserve. Costs related to impaired prospects are charged to expense. An impairment expense could
result if oil and gas prices decline in the future or if downward reserves revisions are recorded,
as it may not be economic to develop some of these unproved properties. Costs of proved leaseholds are depleted on the unit-of-production method based on proved
reserves on a field basis. The depreciation of capitalized production equipment and drilling costs
is based on the unit-of-production method using proved developed reserves on a field basis. The cost of unproved properties not being amortized is assessed quarterly to determine whether
such properties have been impaired. In determining whether such costs should be impaired, we
evaluate current drilling results, lease expiration dates, current oil and gas industry conditions,
international economic conditions, capital availability, foreign currency exchange rates, political
stability in the countries in which the Company has an investment, and available geological and
geophysical information. Any impairment assessed is charged to expense. Intangible Assets During 2002, we implemented the provisions of Statement of Financial Accounting Standard No.
142, Goodwill and Other Intangible Assets(SFAS No. 142) which, among other things, eliminated the
amortization of goodwill and required that an annual impairment test for goodwill be performed.
SFAS No. 142 also requires that intangible assets, 42




---



##### Table of Contents



with a finite life be amortized over their estimated useful life and be recorded separate and
apart from goodwill. At December 31, 2002 and 2003 our contract rights to explore foreign oil
concessions for coalbed methane (CBM) were recorded as intangible assets on the accompanying
consolidated financial statements and were amortized over three years. On September 2, 2004, the Financial Accounting Standards Board Staff issued FASB Staff
Position No. 142-2, which addressed the classification and disclosure for drilling and mineral
rights of oil- and gas-producing entities that are within the scope of Statement of Financial
Accounting Standards No. 19, Financial Accounting and Reporting by Oil and Gas Producing Entities
(SFAS 19). FASB Staff Position 142-2 states that the scope exception in paragraph 8(b) of
Statement of Financial Standards No. 142, Goodwill and Other Intangible Assets, (SFAS 142) includes
the balance sheet classification and disclosures for drilling and mineral rights of oil- and
gas-producing entities that are within the scope of SFAS 19. The drilling and mineral rights are
not intangible assets under SFAS 142. As a result, we reclassified our intangible assets to
property and equipment on the balance sheets and discontinued amortizing the balance.
Subsequently, we will periodically review individual mineral rights to determine whether an
impairment has occurred, and whether loss should be recognized. Income Taxes Deferred income taxes are accounted for under the asset and liability method of accounting for
income taxes. Under this method, deferred income taxes are recognized for the tax consequences of
temporary differences by applying enacted statutory tax rates applicable to future years to
differences between the financial statements carrying amounts and the tax basis of existing assets
and liabilities. The effect on deferred taxes of a change in tax rate is recognized in income in
the period the change occurs. Valuation allowances are established when necessary to reduce
deferred tax assets to the amount expected to be realized. Environmental Matters Environmental expenditures are expensed or capitalized depending on their future economic
benefit. Expenditures that relate to an existing condition caused by past operations, and do not
contribute to current or future revenue generation are expensed. Liabilities are recorded when
assessments and/or remediation are deemed probable and the costs can be reasonably estimated. Net Loss Per Share We apply Statement of Financial Accounting Standard No. 128, Earnings Per Share,(SFAS 128),
for the calculation of Basic and Diluted earnings per share. Basic earnings per share includes
no dilution and is computed by dividing income available to common stockholders by the weighted
average number of common shares outstanding for the period. Diluted earnings per share reflects
the potential dilution of securities that could share in our earnings. Stock-based Compensation We account for our stock-based compensation to employees and directors under Accounting
Principles Board Opinion 25, Accounting for Stock Issued to Employees, (APB 25) and related
interpretations, and we have adopted the disclosure-only provisions of Statement of Financial
Accounting Standards No. 123, Accounting for Stock-Based Compensation,(SFAS No. 123), as amended
by Statement of Financial Accounting Standards Accounting for Stock-Based CompensationTransition
and Disclosurean amendment of FASB Statement No. 123,(SFAS No. 148). Had compensation cost for these plans been determined consistent with the provisions of SFAS
No. 123, our stock-based compensation expense, net loss and loss per share would have been adjusted
to the following pro forma amounts: 43




---



##### Table of Contents



Year Ended December 31,2004
    
    
    2003
    
    
    2002Net loss as reported
    
    $
    (8,004,000
    )
    
    $
    (7,217,000
    )
    
    $
    (2,130,000
    )Add:Stock-based employee compensation
costs included in net loss
    
    
    583,000
    
    
    
    930,000
    
    
    
    Deduct:Stock-based employee compensation
expense determined under
fair value
method for all awards, net
of related
tax effects
    
    
    (3,014,000
    )
    
    
    (3,722,000
    )
    
    
    (252,000
    )Pro forma net loss
    
    $
    (10,435,000
    )
    
    $
    (10,009,000
    )
    
    $
    (2,382,000
    )Basic and diluted loss per share:As reported
    
    $
    (0.13
    )
    
    $
    (0.14
    )
    
    $
    (0.05
    )Pro forma
    
    $
    (0.17
    )
    
    $
    (0.20
    )
    
    $
    (0.05
    )
 We estimated the fair value of each stock award in 2004, 2003 and 2002 at the grant date by
using the Black-Scholes option-pricing model with the following weighted-average assumptions:
dividend yield at 0%; expected volatility of approximately 50%; risk-free interest rate of 0.9% to
3.6% and expected lives of five to ten years for the options. We account for options granted to contractors and our technical advisors under SFAS 123,
recording compensation expense at the fair value of the options. Foreign Currency Translation Foreign currency transactions and financial statements are translated in accordance with
Statement of Financial Accounting Standards No. 52, Foreign Currency Translation, (SFAS 52). The
functional currency for our foreign operations is the applicable foreign currency, the Chinese
Yuan. The translation of the applicable foreign currency into U.S. dollars is performed for balance
sheet accounts using current exchange rates in effect at the balance sheet date and for revenue and
expense accounts using a weighted average exchange rate during the period. The gains or losses
resulting from such translation are included in the consolidated statements of stockholders equity
and comprehensive income. There was no aggregate foreign currency translation gain or loss in 2003. Foreign currency
translation resulted in an aggregate loss of $2,000 in 2004 and 2002. Fair Values of Financial Instruments The following table presents the carrying amounts and estimated fair values of the Companys
financial instruments at December 31, 2004 and 2003. As of December 31, 2004
    
    
    As of December 31, 2003Carrying
    
    
    Estimated
    
    
    Carrying
    
    
    EstimatedValue
    
    
    Fair Value
    
    
    Value
    
    
    Fair ValueCash and cash equivalents
    
    $
    11,418,000
    
    
    $
    11,418,000
    
    
    $
    2,326,000
    
    
    $
    2,326,000Stock subscription
receivable
    
    
    250,000
    
    
    
    250,000
    
    
    
    
    
    
    
    Restricted cash
    
    
    1,000,000
    
    
    
    1,000,000
    
    
    
    
    
    
    
    Other liabilities
    
    
    
    
    
    
    
    
    
    
    106,000
    
    
    
    106,000Note payable
    
    
    
    
    
    
    
    
    
    
    100,000
    
    
    
    100,000
 44




---



##### Table of Contents



The following methods and assumptions were used to estimate the fair value of the financial
instruments summarized in the table above. The carrying values of accounts receivable, other
assets, accounts payable and accrued expenses included in the accompanying consolidated balance
sheets approximated fair market value at December 31, 2004 and 2003. Cash and Cash Equivalents The carrying amounts approximate fair value due to the short-term maturity of the instruments. Notes Payable The carrying amounts of notes payable approximated their fair value due to the short-term
maturity of the instruments. Other Liabilities and Commitments The fair value of other liabilities and commitments is the present value of amounts to be paid
determined at appropriate current interest rates for long-term liabilities. Credit Concentration We had deposited in one financial institution approximately $9.0 million in cash at December
31, 2004, which exceeded the limit of the Federal Deposit Insurance Corporation. We did not
require collateral from the bank on this deposit. Comprehensive Income Comprehensive income is included in the consolidated statement of changes in stockholders
equity and reported for all periods. Comprehensive income includes both net income and other
comprehensive income, which includes the foreign currency translation adjustments. Advertising We incurred no advertising costs in 2004, 2003 or 2002. Recent Accounting Pronouncements Stock Based Compensation On December 16, 2004, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (SFAS 123(R)),
which is a revision of Statement of Financial Accounting Standards No. 123, Accounting for
Stock-Based Compensation (SFAS 123), SFAS 123(R) supersedes APB 25 and amends Statement of Financial Accounting Standards No. 95,
Statement of Cash Flows. Generally, the approach in SFAS 123(R) is similar to the approach
described in SFAS 123. However, SFAS 123(R) will require all share-based payments to employees, including grants
of stock options to employees and members of the board of directors, to be recognized in our consolidated statements of operations based
on their fair values. Pro forma disclosure is no longer an alternative. SFAS 123(R) must be adopted no later than July 1, 2005 and permits public companies to adopt
its requirements using one of two methods:  
    A modified prospective method in which compensation cost is recognized beginning with
the effective date based on the requirements of SFAS 123(R) for all share-based payments
granted after the effective date and based on the requirements of SFAS 123 for all awards
granted to employees and members of the board of directors prior to the adoption date of SFAS 123(R) that remain unvested on the
adoption date. 45




---



##### Table of Contents




    A modified retrospective method which includes the requirements of the modified
prospective method described above, but also permits entities to restate either all prior
periods presented or prior interim periods of the year of adoption based on the amounts
previously recognized under SFAS 123 for purposes of pro forma disclosures. We have elected to adopt the provisions of SFAS 123(R) on July 1, 2005 using the modified
prospective method. As
permitted by SFAS 123, we currently account for share-based payments
to employees and members of the board of directors using the
intrinsic value method prescribed by APB 25 and related interpretations. As such, we recognize
compensation expense to the extent that the exercise price of the options is below the market price
on the date of grant for employee and director stock options. Accordingly, we anticipate that the
adoption of SFAS 123(R)s fair value method will have a significant impact on our future result of
operations. If we had adopted SFAS 123(R) in prior periods, the impact would have approximated the
impact of SFAS 123 as described in the pro forma net income and earnings per share disclosures in
Note 1 of Notes to Consolidated Financial Statements included in Item 8. Financial Statements and
Supplementary Data. We have recorded options granted to our technical advisors and consultants at
fair value on the date of grant, and there will be no effect on our results of operations for those
options. We estimate that the adoption of SFAS 123(R), based on the outstanding unvested stock
options at December 31, 2004, will result in future compensation charges to stock compensation and
general and administrative expenses of approximately $500,000 during the period from July 1, 2005
through December 31, 2005, and approximately $1.5 million during 2006. Mineral Rights of Oil- and Gas-Producing Entities See Intangible Assets for the description of the FASB Staff Position 142-2. Accounting for Suspended Well Costs On February 4, 2005, the Financial Accounting Standards Board Staff posted proposed FASB Staff
Position FAS 19-a, Accounting for Suspended Well Costs, which addresses whether there are
circumstances under the successful efforts method of accounting for oil and gas producing
activities that would permit the continued capitalization of exploratory well costs beyond one
year, other than when additional exploration wells are necessary to justify major capital
expenditures and those wells are under way or firmly planned for the near future. The proposed
FASB Staff Position states that the staff believes that exploratory well costs should continue to
be capitalized when the well has found a sufficient quantity of reserves to justify its completion
as a producing well and the enterprise is making sufficient progress assessing the reserves and the
economic and operating viability of the project. The proposed Staff Position provides a list of
indicators that an enterprise is making sufficient progress and provides for new disclosures
concerning the capitalized exploratory well costs that are pending the determination of proved
reserves. Comments were due on the proposed FASB staff position on March 7, 2005, and we cannot
predict the outcome at this time. 2. Going Concern Our financial statements are prepared using generally accepted accounting principles
applicable to a going concern, which contemplates the realization of assets and the liquidation of
liabilities in the normal course of business. We currently have no source of revenue, and because
we have acquired an undeveloped natural resource that will require substantial exploration and
development, management does not expect to generate meaningful revenues until at least 2006. Management
believes that we will be able to satisfy our operating capital needs, plans and
financial obligations through the fourth quarter of 2005. Management intends to continue financing
efforts to support the proposed business operations in China. Our ability to continue as a going
concern is dependent upon our ability to raise substantial funds for use in development activities
and upon the success of our planned exploration and development activities. There can be no
guarantee of future fund raising success. The success of exploratory drilling is uncertain.
However, management believes that we will continue to be successful in raising the funds necessary
to explore for gas and, assuming success in those exploratory efforts, to raise the funds necessary
for production and development. 46




---



##### Table of Contents



3. Restatement of Financial Statements Our previously issued consolidated financial statements have been restated for the year ended
December 31, 2003 for the items described below: Acquisition For the year ended December 31, 2003, we recorded a stock and cash for stock acquisition at
the estimated realizable value of the assets of $1,450,000. We have determined that the assets
should have been valued using the value of the stock as quoted in the OTC exchange at the date of
the consummation of the agreement (August 21, 2003) thereby resulting in an acquisition value of
the assets of $4,778,000. Simultaneous to the consummation of the agreement, we recorded an
impairment loss of $3,328,000 to reduce the acquired assets to their estimated realizable value of
$1,450,000. Accordingly, an impairment loss of $3,328,000 is recorded in the accompanying
consolidated financial statements with a resulting increase in the loss and a corresponding
increase in additional paid in capital. Beneficial Conversion Feature For the year ended December 31, 2003, we issued convertible debt with a conversion rate below
fair value at issuance. We have determined that interest expense of approximately $168,000 should
have been recognized for the beneficial conversion feature inherent in the debt instruments.
Accordingly, interest expense of approximately $168,000 has been recognized in the accompanying
consolidated financial statements with a resulting increase in the loss and a corresponding
increase in additional paid in capital. Stock Options We granted options to employees at a grant price below the market price at the date of grant.
We recorded the stock compensation expense and a current liability. We determined that the amount
recorded as a liability should be recognized as additional paid in capital-outstanding stock
options. This restatement had no effect on net income and related earnings per share. The aggregate impact of all 2003 restatement items resulted in an increase in net loss of
approximately $3,496,000 to a restated loss available to common stockholders of $7,217,000 compared
to a previously reported amount of $3,721,000. The effects of the restatement items described above
on our net income available to common stockholders and earnings per share are as follows: Earnings perNet Loss
    
    
    ShareAs previously reported
    
    $
    (3,721,000
    )
    
    $
    (0.07
    )Impact of adjustments for:Impairment loss
    
    
    (3,328,000
    )
    
    
    (0.07
    )Interest expense
    
    
    (168,000
    )
    
    
    As restated
    
    $
    (7,217,000
    )
    
    $
    (0.14
    )
 47




---



##### Table of Contents



The cumulative impact of all restatements described above on our deficit accumulated during
the development stage as of December 31, 2003 is an increase in the deficit of $3,496,000. The
aggregate impact of these restatements on the consolidated balance sheets as of December 31, 2003
is as follows: December 31, 2003As PreviouslyReported
    
    
    As RestatedProperty and equipment, net
    
    $
    3,026,000
    
    
    $
    2,284,000Outstanding stock options
    
    
    930,000
    
    
    
    Additional paid in capital
    
    
    9,595,000
    
    
    
    12,132,000Additional paid in capital-outstanding stock options
    
    
    
    
    
    
    930,000Deficit accumulated during the development stage
    
    
    (5,877,000
    )
    
    
    (9,373,000
    )
 4. Statement of Cash Flows We use the indirect method to present cash flows from operating activities. Other
supplemental cash flow information for the years ended December 31, 2004, 2003 and 2002 is
presented as follows: For the Year Ended December 31,2004
    
    
    2003
    
    
    2002Cash transactions:Cash paid for interest
    
    $
    9,000
    
    
    $
    5,000
    
    
    $
    Cash paid for income taxes
    
    
    
    
    
    
    
    
    
    
    Non-cash transactions:Issuance of common stock with subscriptions
receivable
    
    
    250,000
    
    
    
    
    
    
    
    Commission payable on common stock issuance
    
    
    20,000
    
    
    
    
    
    
    
    Issuance of common stock to pay consulting
expenses
    
    
    58,000
    
    
    
    
    
    
    
    Acquisition of contract rights
    
    
    
    
    
    
    
    
    
    
    150,000Net acquisition of mineral leases
    
    
    
    
    
    
    272,000
    
    
    
    Issuance of common stock in acquisition
    
    
    
    
    
    
    3,600,000
    
    
    
    Increase in outstanding stock options
    
    
    1,131,000
    
    
    
    930,000
    
    
    
    Conversion of notes payable to common stock
    
    
    100,000
    
    
    
    200,000
    
    
    
    
 5. Acquisition and Disposition of Montana Properties Effective December 31, 2002, our wholly owned subsidiary, Far East Montana, Inc., executed a
Plan of Merger (Agreement) with Newark Valley Oil & Gas, Inc, a Nevada corporation (Newark) wholly
owned by North American Oil and Gas, Inc.. (North American). Newark survived the merger and became
our wholly owned subsidiary. Pursuant to the Agreement, in exchange for one hundred percent (100%)
of the outstanding equity of Newark, we issued: 1,600,000 shares of our common stock and agreed to
pay $600,000 in cash ($100,000 paid at closing, $200,000 to be paid five months after closing and
$300,000 to be paid 12 months after closing), and assumed liabilities with a fair value of
$375,000. This acquisition was recorded as an asset purchase, and assets and liabilities were
recorded at fair value at the date of acquisition. As a result of the Agreement, we acquired certain undeveloped oil, gas and mineral rights and
interests in approximately 147,535.10 net acres located in the eastern portion of the State of
Montana. Of the total net acres, approximately 134,530.16 acres constitute federal leases,
approximately 5,141.80 acres constitute state of Montana leases, and approximately 7,863.14 acres
constitute freehold leases. The Agreement contained a contingency that we use our best efforts to secure additional
financing in the amount 48




---



##### Table of Contents



of $2,000,000 within 120 days from the date of closing (December 31, 2002). In the event such
financing was not secured within 120 days of closing, we would have been in default of the
Agreement and the transaction would have been subject to rescission. In the event of rescission, we
would have transferred all of the outstanding equity interests in Newark to North American. North
American would have returned to us our 1,600,000 shares of common stock; however, North American
would have retained any monies tendered pursuant to the Agreement. Due to the significance and uncertainty of this contingency, we did not record the acquisition
until the contingency was resolved in August 2003. Accordingly, the statement of stockholders
equity as of December 31, 2002 reflects both the issuance of stock and the effect of the
contingency. The results of operations of Newark have been included in the accompanying
consolidated financial statements from September 2003 forward. The aggregate acquisition price was $4,778,000, which included cash in the amount of $600,000,
assumption of liabilities of $375,000, ongoing payment of annual lease expense and legal fees, and
1,600,000 shares of our common stock valued at $3,600,000. The value of the common stock was
determined based on the market price of the shares on the date of the consummation of the
Agreement. Simultaneous to the consummation of the Agreement, assets were deemed to be impaired
and written down to their fair value. Fair value, which was determined by the valuation of reserves
estimated for the assets acquired, indicated a revised carrying value of approximately $1,450,000.
Accordingly, an impairment loss of $3,328,000 has been charged to operations in 2003. Following is a condensed balance sheet showing the fair values of the assets acquired and the
liabilities assumed as of the date of acquisition: Property and equipment
    
    $
    1,450,000Current liabilities
    
    
    535,000Net assets acquired
    
    $
    915,000
 On February 2, 2005, Newark entered into a purchase and sale agreement with Zier & Associates,
Ltd. for the sale of our oil and gas leasehold interests and other property interests in Montana.
As a condition to the sale of our Montana properties, we acquired certain overriding royalty
interests in adjoining acreage for $100,000, which were also sold to Zier & Associates, Ltd. under
the terms of the purchase agreement. The transaction closed on February 2, 2005. At the closing,
we received gross proceeds of $1,135,000 from the sale of the Montana properties (including the
overriding royalty interests) described above. We recorded an impairment loss of $450,000 in the
fourth quarter of 2004 as a result of comparing the net proceeds, which we believe to be a measure
of the value of properties, to the carrying value. Any remaining loss on the sale of our Montana
assets will be recognized in the first quarter of 2005. We will remain responsible for the payment
of expenses and related accounts payable attributable to the Montana properties to the extent they
relate to the time prior to February 2, 2005. 6. Property and Equipment Property and equipment includes the following: December 31,2004
    
    
    2003Unproved leasehold costs
    
    $
    1,375,000
    
    
    $
    1,725,000Unevaluated wells costs
    
    
    1,251,000
    
    
    
    497,000Furniture and equipment
    
    
    147,000
    
    
    
    146,0002,773,000
    
    
    
    2,368,000Accumulated depreciation and amortization
    
    
    (126,000
    )
    
    
    (84,000
    )$
    2,647,000
    
    
    $
    2,284,000
 Unproved leasehold costs include our Montana properties described in note 5. and the mineral
rights acquired on January 25, 2002, when we entered into a Production Sharing Contract with the
China United Coal Bed Methane 49




---



##### Table of Contents



Corporation (CUCBM). Pursuant to the Production Sharing Contract, we received the authority from
CUCBM to jointly explore, develop, produce and sell coalbed methane gas in and from a total area of
1,072 unevaluated square kilometers in the Enhong and Laochang areas of Yunnan Province, PRC. On
December 30, 2002, the PRCs Ministry of Foreign Trade and Economic Cooperation (MOFTEC) ratified
this Production Sharing Contract. Under the contract we paid $150,000 to CUCBM upon ratification,
and we are required to pay an annual payment of $100,000 on the anniversary date for two subsequent
years, and we have included these amounts in unproved leasehold costs. We have the right to earn a
minimum of a 60% participating interest in the joint venture, with
CUCBM retaining the remaining 40% participating interest. In the event
CUCBM elects to participate at a level less than 40%, their interest will be reduced
proportionately, increasing our participating interest. Unevaluated well costs include our exploratory well costs pending determination of whether
proved reserves have been discovered. The capitalized exploratory well costs pending determination
of proved reserves was $1,251,000 at December 31, 2004 and $497,000 at December 31, 2003. These
costs relate to wells for which drilling has been completed for less that one year, but which have
not been attributed proved reserves. We are currently dewatering these wells to enable us to
evaluate the wells. We have no wells or capital costs associated with (1) wells in areas requiring
a major capital expenditure before production could begin, where additional drilling efforts are
not underway or firmly planned for the near future, and (2) wells in areas not requiring a major
capital expenditure before production could begin, where more than one year has elapsed since the
completion of drilling. As described in note 1, Summary of Significant Accounting Policies, Recent Accounting
Pronouncements, Accounting for Suspended Well Costs, the FASB Staff has posted a proposed FASB
Staff Position, FSP FAS 19-a concerning suspended well costs. The proposed FSP would not have
affected the amount of exploratory wells capitalized pending evaluation at the end of 2004 or 2003. The following table provides an aging of capitalized exploratory well costs based on the date
the drilling was completed and the number of wells for which exploratory well costs have been
capitalized for a period greater than one year since the completion of drilling: 2004
    
    
    2003Capitalized exploratory well costs that have been
capitalized for a period of one year or less
    
    $
    1,251,000
    
    
    $
    497,000Capitalized exploratory well costs that have been
capitalized for a period greater than one year
    
    
    
    
    
    
    Balance at December 31
    
    $
    1,251,000
    
    
    $
    497,000Number of wells that have exploratory well costs
that have been capitalized for a period greater
than one year
    
    
    
    
    
    
    
 The following table reflects the net changes in capitalized exploratory well costs during 2004
and 2003: 2004
    
    
    2003Beginning balance at January 1
    
    $
    497,000
    
    
    $
    Additions to capitalized exploratory well costs
pending the determination of proved reserves
    
    
    1,304,000
    
    
    
    497,000Reclassifications to wells, facilities, and equipment
based on the determination of proved reserves
    
    
    
    
    
    
    Capitalized exploratory well costs charged
to expense
    
    
    (550,000
    )
    
    
    Ending balance at December 31
    
    $
    1,251,000
    
    
    $
    497,000
 50




---



##### Table of Contents



Depreciation expense for the years ended December 31, 2004, 2003 and 2002 was approximately
$48,000, $19,000 and $7,000. We amortized the mineral rights acquired under the Yunnan PSC during
2003 and the first quarter of 2004 as described under Intangible Assets in note 1. 7. Investment in Joint Venture On June 5, 2002, we executed a Sino-Foreign Joint Venture Contract (the Contract) with
Panjiang Coal-Electricity (Group) Co. Ltd. (Panjiang) to establish a joint venture limited
liability company in the PRC to extract and use coalmine methane gas from six operating Panjiang
coalmines which cover an area of 120 square kilometers. This Contract was entered into by our
wholly owned subsidiary, Far East BVI. In accordance with certain provisions of the Contract during 2003, we notified Panjiang of our
intention to withdraw from the project, which effectively eliminates all assets and obligations
associated with the project. If we had withdrawn from the project in 2002 the
total
stockholders equity and net income in the accompanying consolidated financial statements would
have been decreased by approximately $22,000. 8. Notes Payable A
loan in the principal amount of $25,000 was made to us by one of our former Directors, Ramesh Kalluri on May 1,
2003. The loan was due and payable on May 1, 2004. The interest rate of the loan was 10% with the
accrued interest payable in four installments on August 1, 2003, on November 1, 2003, on February
1, 2004 and on May 1, 2004. We repaid the loan principal in December 2003. In June 2003, we entered into a loan agreement with Professional Trading Services in the
principal amount of $100,000. The loan had a conversion privilege, at the exclusive option of the lender.
The conversion rate of the debt was below fair value at issuance. Accordingly, interest expense to
reflect the beneficial conversion feature has been recorded in the second quarter of 2003. The
lender exercised the conversion option in October 2003. The lender received 153,846 shares of
common stock at $0.65 per share and warrants to purchase 153,846 shares of common stock,
exercisable at $1.00. The lender also converted warrants exercisable in February 2004 into 39,231
shares of common stock. On
July 23, 2003, we entered into a loan agreement with Clarion
Finanz AG in the principal amount of
$200,000. The loan had a conversion privilege, at the exclusive option of the lender. The
conversion rate of the debt was below fair value, and interest expense was recorded to reflect the
beneficial conversion feature in the third quarter of 2003. The lender exercised the conversion
feature on October 6, 2003 with regard to $100,000 of the outstanding balance of the loan and in
February 2004 with regard to the remaining $100,000 of the outstanding balance of the loan. The
lender received 153,846 shares of common stock at $0.65 per share and warrants to purchase 153,846
shares of common stock exercisable at $1.00, for each conversion. The lender also converted
warrants exercisable in February 2004 into 76,923 shares of common stock. 51




---



##### Table of Contents



9. Income Taxes Deferred income taxes reflect the net tax effects of temporary differences between the
recorded amounts of assets and liabilities for financial reporting purposes and the amounts used
for income tax purposes. Significant components of our deferred tax assets and
liabilities as of December 31, 2004 and 2003 are as follows: 2004
    
    
    2003Deferred tax assets:Net operating loss
    
    $
    3,603,000
    
    
    $
    1,696,000Intangibles
    
    
    
    
    
    
    16,000Unproven oil and gas property
    
    
    284,000
    
    
    
    1,131,000Accrued expense
    
    
    60,000
    
    
    
    Stock-based compensation
    
    
    514,000
    
    
    
    316,000Total deferred tax assets
    
    
    4,461,000
    
    
    
    3,159,000Deferred tax liabilities:Premises and equipment
    
    
    1,000
    
    
    
    9,000Net deferred tax asset
    
    
    4,460,000
    
    
    
    3,150,000Less valuation allowance
    
    
    (4,460,000
    )
    
    
    (3,150,000
    )$
    
    
    
    $
    
 At December 31, 2004 and 2003, we had net operating loss carryforwards for federal income tax
purposes of approximately $10,596,000 and $4,988,000, respectively, which will expire beginning in
2016. At December 31, 2004 and 2003, management believed that the above indicated valuation
allowance was necessary in order to comply with the provisions of Statement of Financial Accounting
Standard No. 109, as discussed in Note 1. Income taxes for financial reporting purposes differed from the amounts computed by applying
the statutory federal income tax rates due to the recording of the valuation allowance. The net
change in the valuation allowance for the years ended December 31, 2004 and 2003 was an increase of
$1,310,000 and $2,389,000, respectively. 10. Commitments and Contingencies We are periodically named in legal actions arising from normal business activities. We
evaluate the merits of these actions and, if we determine that an unfavorable outcome is probable
and can be estimated, we will establish the necessary accruals. We do not anticipate any material
losses as a result of commitments and contingent liabilities. We are involved in no material legal
proceedings. Production Sharing Contract for Yunnan Province project On January 25, 2002, we entered into a production sharing contract to develop two areas in the
Yunnan Province, the Enhong and Laochang areas. We act as operator under the production sharing
contract. The term of the production sharing contract with CUCBM consists of an exploration
period, a development period and a production period. The exploration period is divided into two
phases called Phase I and Phase II.  Our Phase I obligations
required us to drill and complete three wells on the project, perform a hydraulic fracture and test
of one of these three wells and drill two slim hole vertical wells. On February 23, 2005, we
committed to begin Phase II. Under Phase II,  we will be required to begin one horizontal well with a
minimum of two laterals by December 31, 2005 to satisfy the original requirement of eight pilot
development wells on the Enhong and Laochang fields. During the exploration period, we hold a 100% participating interest in the properties, and we
must bear all exploration costs for discovering and evaluating CBM bearing areas. Prior to the
beginning of the development period of any CBM field in the Enhong-Laochang project, CUCBM may
elect to participate in the development of that CBM field at a level of between zero and 40%.
Therefore, depending upon CUCBMs participation, should we elect to develop a CBM field, our
working interest in that CBM field will range from 60% to 100%. If any CBM field is discovered,
the 52




---



##### Table of Contents



development costs for that CBM field will also be borne by CUCBM and us in proportion to the
respective participating interests. Following completion of Phase II of the exploration period, we may elect to continue the
production sharing contract and conduct development and production operations on any CBM
discoveries. The development period as to any CBM field in the Enhong-Laochang project will begin
after the approval of a development plan submitted by us with respect to that field by the State
Council of the PRC and confirmed by CUCBM. The production period as to any CBM field in the
Enhong-Laochang project will begin after the date of commencement of commercial production of that
CBM field. Our agreement with CUCBM expires 20 years from the start date of the production period
of the Enhong-Laochang project. In addition to the wells we must drill, we are required to make other expenditures over the
term of the production sharing contract, including, (1) CUCBM assistance fees and training fees for
Chinese personnel costs $45,000 each per year during the exploration
phase and $80,000 each per year
during the development and production phase; (2) reimbursement of
CUCBM for government-imposed fees for CBM exploration rights ($8,000
for the year ended December 31, 2004 and in proportion to our
participating interest in the development and production periods); and (3)
salary and benefits paid to CUCBM professionals, which are currently $15,800 per month. The
allocation of salary and benefits for CUCBM professionals during the development and production
period shall be determined by CUCBM and us through consultation. We also entered into a production sharing contract (Zhaotong) dated January 25, 2002, which
has not been ratified by MOFTEC. We have informed CUCBM that we do not anticipate pursuing this
contract. Shanxi Province Agreements On
June 2003, we entered into two farmout agreements and assignment
agreements with Phillips China Inc., a
subsidiary of ConocoPhillips, Inc., (Phillips) pursuant to which we acquired a
40% net undivided interest from Phillips in two production
sharing contracts between Phillips and CUCBM  for the Shanxi Province
(the Shanxi Agreements). The project areas covered by the Shanxi
Agreements are located in the Shouyang Block (near Taiyuan City) and the
Qinnan Block (near Jincheng and Qinshui). As currently structured, we
have a 40% participating interest, Phillips
has retained a 30% participating interest and CUCBM has a 30% participating interest in the projects. The assignment agreement
and appropriate amendments to the PSCs substituting us for Phillips as the principal party and
operator was approved by CUCBM on March 15, 2004, and ratified by the PRC Ministry of Commerce on
March 22, 2004. The term of the Shanxi Agreements consists of an exploration period, a development period
and a production period. The exploration period is divided into three phases called Phase I, Phase
II and Phase III. We have completed our Phase I obligations. These obligations required us to
perform a hydraulic fracture of one of three exploration wells previously drilled by Phillips. We
committed to begin Phase II wherein we will be required to drill two horizontal wells in the
Shouyang block by December 31, 2005. We have agreed to use our best commercial efforts to drill
each of the horizontal wells to 4,000 meters in coal seam with a minimum requirement under our
farmout agreements of 2,000 meters drilled in coal seam per well. If we elect to commit to Phase
III we will be required to drill one horizontal well, under which we
will attempt to drill to 4,000 meters in coal
seam. We are required to complete Phase III by July 1, 2007. Our total work commitment in Phases II and III, if we
elect to commit to Phase III, will consist of a total of 12,000 meters of horizontal drilling in
coal seam for the three wells completed during the exploration period. We must bear all exploration costs for discovering and evaluating CBM bearing areas during
Phase II. If we successfully complete Phase II, Phillips will have the option to elect to retain a
net undivided 30% participating interest or an overriding royalty interest up to 3.5% of the total
participating interest. Additionally, prior to the beginning of the development period of any CBM
field in the Shanxi project, CUCBM may elect to participate in the development of that CBM field at
a level of between zero and 30%. Therefore, depending upon whether Phillips and CUCBM elect to
participate in the project, our interest will range from 40% (assuming full participation by
Phillips and CUCBM) to 96.5% (assuming both CUCBM and Phillips choose not to participate). Following completion of Phase III of the exploration period, we may elect to continue the
production sharing contracts and conduct development and production operations on any CBM
discoveries. The development period as to any CBM field in the Shanxi Province will begin after
the approval of a development plan submitted by us with respect to that field by the State Council
of the PRC and confirmed by CUCBM. The production period as to any CBM field in the 53




---



##### Table of Contents



Shanxi Province project will begin after the date of commencement of commercial production of
that CBM field. Our agreement with CUCBM on April 1, 2034. In addition to the wells we must drill, we are required to make other expenditures over the
term of the PSC, including: (1) CUCBM assistance fees totaling $100,000 per year during the
exploration period and $240,000 per year during the development and production periods; (2)
training fees for Chinese personnel working on the projects for $120,000 per year during the
exploration phase and $240,000 per year during the development and production periods; (3)
signature fees totaling $300,000 which will be due within 30 days after first approval of the
overall development plan following the exploration period;
(4) reimbursement of CUCBM for government-imposed fees for CBM
exploration rights ($56,000 for the year ended
December 31, 2004 and in proportion to our participating
interest in the development and production periods); and (5) salary and
benefits paid to CUCBM professionals, which are expected to be $13,500 per month through June 2005.
The allocation of salary and benefits for CUCBM professionals during the development and
production period shall be determined by CUCBM and us through consultation. Our agreement with Phillips required that we post a $1,000,000 bank guarantee or surety bond
by May 14, 2004 to guarantee performance of the evaluation and work program to test existing wells.
On May 14, 2004, we placed $1 million into escrow to satisfy this bond, and the $1,000,000 escrow
account shall continue to be held until December 31, 2005. In the event that we have not completed
the drilling of the first horizontal well in Phase II by June 30, 2005, we will be required to
increase the escrow account to $2,600,000. Notwithstanding the requirement to increase the amount
of the escrow account to $2.6 million on June 30, 2005, subject to certain events described above,
we shall have the right, each time subject to the prior written consent of Phillips, to drawdown
amounts from this escrow account required to fund operations in Phase II after June 30, 2005. Each
drawdown shall not exceed $250,000. Required funding for these activities is expected to come from
existing capital. Employment Agreements On October 13, 2003, we entered into an employment agreement with Michael R. McElwrath, Chief
Executive Officer, which was approved by the Board of Directors. Mr. McElwrath received a $56,250
signing bonus and is entitled to participate in all benefit plans that we offer. In addition, Mr.
McElwrath received 1,200,000 stock options that vest over four years, 240,000 which vested upon the
effective date of this employment agreement. The stock options have an exercise price of $0.65,
which was $0.65 below fair market value on the effective date of the contract. Accordingly,
additional compensation cost of $156,000 has been recognized in the accompanying consolidated
financial statements. On May 1, 2004 we entered into an employment agreement with Bruce N. Huff, Chief Financial
Officer, which was approved by the Board of Directors. Mr. Huff received a $25,000 signing bonus
and is entitled to participate in all benefit plans that we offer. In addition, Mr. Huff received
500,000 stock options that vest over four years, 100,000 of which
vested upon the effective date of
this employment agreement. The stock options have an exercise price of $2.00 which was $0.07 below
fair market value on the effective date of the contract. Accordingly, additional compensation cost
of $7,000 has been recognized in the accompanying consolidated financial statements. On
December 23, 2004, we amended and restated the employment agreements with Mr.
McElwrath and Mr. Huff. The employment agreements, as amended
and restated, provide that the chief executive officer and
chief financial officer will receive (i) an annual base salary of not less than $236,250 in the
case of Mr. McElwrath and $168,000 in the case of Mr. Huff and (ii) performance bonuses of (A) not
less than $20,000 payable on or before the 13th of April and October of each year in the case of
Mr. McElwrath and (B) between 15% to 25% of his base salary in the case of Mr. Huff. The
performance criteria for bonuses will be established by our Compensation Committee. Unless extended, the employment agreements for Messrs. McElwrath and Huff terminate on October
13, 2008 and May 1, 2009, respectively. The employment agreements provide that if we terminate an
executive for cause (as defined in the employment agreements), we shall pay his base salary and all
amounts actually earned, accrued or owing as of the date of termination, and the executive shall be
entitled to exercise all options granted to him under his employment agreement or otherwise to the
extent vested and exercisable on the date of termination. 54




---



##### Table of Contents



If an executives employment is terminated by us (other than as a result of death, disability
(as defined in his employment agreement) or cause), or if the executive terminates his employment
for good reason (as defined in his employment agreement), the executive shall be entitled to the
following:  
    a lump sum payment of two times the sum of executives base salary and bonus paid during
the immediately preceding twelve month period;
    continued participation in all employee benefit plans, programs or arrangements
available to our executive officers in which executive was participating on the date of
termination for a specified period of time following termination, and
    the exercise of all options and restricted stock awards granted to him to the extent
vested and exercisable at the date of termination of executives employment, provided, that
if the date of termination of executives employment is on or before April 13, 2006 in the
case of Mr. McElwrath and May 1, 2006 in the case of Mr. Huff, then all options and
restricted stock granted to him and exercisable within the first anniversary of the date of
termination in the case of Mr. McElwrath and within 30 months of the date of termination in
the case of Mr. Huff, shall be immediately and fully vested as of the date of termination. Notwithstanding the foregoing, if an executives termination of employment by the registrant
(other than for cause, disability or death) or by the executive for good reason (as defined in the
employment agreements) occurs within 24 months following a change of control (as defined in the employment agreements), then the
executive shall be entitled to a lump sum payment of three times the sum of executives base salary
and bonus during the immediately preceding twelve-month period and all options and restricted stock
granted to executive will immediately vest and become exercisable as of the date of termination.
The employment agreements also entitle each executive to certain gross up payments for excise taxes
in the event of a change of control. In connection with the employment agreements, we amended and restated our three stock option
agreements with Messrs. McElwrath and Huff, in order to make the option agreements consistent with
the terms of the employment agreements. The amendments to those stock option agreements did not
change the vesting and exercise price provisions of the original option agreements. The stock
option agreements provide that the shares of common stock subject to such options vest 20% on the
award date (as defined therein) and vest 20% on each succeeding anniversary of the award date.
These amendments were accounted for as modifications to the option agreements and remeasurement of
the intrinsic value was performed as of December 23, 2004 in accordance with APB 25 and its
interpretations. Accordingly, additional compensation expense of $42,000 was recorded for the year
ended December 31, 2004. Operating Leases Rent expense for the years ended December 31, 2004, 2003 and 2002 was approximately $73,000,
$26,000 and $49,000. The future minimum lease payments under our operating lease commitments as of
December 31, 2004 are as follows: 2005
    
    $
    46,0002006
    
    
    69,0002007
    
    
    29,0002008
    
    
    2009
    
    
    Thereafter
    
    
    Total minimum lease payments
    
    $
    144,000
 Settlement Agreement On December 31, 2004, we entered into a settlement agreement with Jawaharlal Gondi and The
Arthi Trust pursuant to which Mr. Gondi resigned as a director of the Company. Pursuant to the
terms of the settlement agreement, we paid Mr. Gondi a total gross amount of $165,000 minus all
applicable withholding, and reimbursed Mr. Gondi certain out-of-pocket expenses. The settlement
agreement also provides that Mr. Gondi and The Arthi Trust, for a period of two years after the
date of the settlement agreement, without our prior written consent, will refrain from certain
activities 55




---



##### Table of Contents



related to seeking control of the Company. Pursuant to the settlement agreement, Mr. Gondi
and The Arthi Trust also agreed to execute and deliver to us one or more proxies naming the members
of our Board of Directors who are not our officers, as agents and proxies, with full power of
substitution and re-substitution, to vote all shares of our capital stock or our other voting
securities. Securities and Exchange
Commission In December 2003, we learned that we are the subject of an investigation by the SEC. We
understand that the SEC may be investigating whether anyone has issued false or misleading
statements in connection with purchases and sales of our common stock, whether anyone has profited
from selling stock at artificially high prices due to the manipulative statements, and whether any
individual or group has failed to file ownership reports with the SEC as required for 10% or more
beneficial owners under Section 16 of the Securities Exchange Act of 1934 (the Exchange Act) or
failed to file ownership reports with the SEC as required for 5% or more beneficial owners under
Section 13 of the Exchange Act. Management does not know of any acquisitions in excess of 5% of
its outstanding shares, except for those described in previous filings with the SEC under Section
13 and Section 16 of the Exchange Act. We have supplied information to the SEC in response to
their information requests, including, but not limited to, information on record ownership, stock
transfers, sales of our securities and board of director and committee meetings, and we intend to
continue to cooperate with their investigation. We do not know what the outcome of their
investigation may be. The Exchange Act and SEC rules require that a person or group of persons who acquire
beneficial ownership of more than 5% of a class of equity securities that are registered under the
Exchange Act must report their holdings in a Schedule 13D. The Schedule 13D with the SEC within 10
days after they become 5% stockholders, and must thereafter report changes in their beneficial
ownership of their securities. In addition, Section 16(a) of the Exchange Act generally requires
that beneficial owners of more than 10% of a class of stock that is registered under the Exchange
Act report changes in their holdings within 48 hours of an acquisition or disposition of
securities. If a person or group owns a large block of stock of a publicly traded company, particularly if
that stock is not subject to restrictions on its purchase and sale on the open market, there is a
risk that the person or group could sufficiently control the market for the stock to drive the
stocks trading price up or down, and thereby the undisclosed control group could reap trading
profits at the expense of other public investors. In addition, Schedule 13D requires owners of a
control group of stock to disclose their intentions with respect to management or control of the
company. If an undisclosed group owns or obtains control of a block of our stock sufficient to
control our company, they could change the management and direction of our company in ways we
cannot predict. 11. Employee Savings Plan We established a defined contribution plan covering all of our U.S. employees in 2004.
Employees participating in the plan may select from several investment options. We match the
participants contribution ranging from one percent to a maximum of three percent of the
participants salary. The amounts contributed by the participants and us vest immediately. We
expensed $4,000 under this plan for the year ended December 31, 2004. 12. Related Party Transactions On December 21, 2004, we sold 6,406,250 investment units for net proceeds of $9,430,000 to
certain investors outside the United States. In connection with the private placement, we agreed
(i) to nominate a representative of the investors to our Board
of Directors for election by the stockholders, (ii) to provide exclusive rights for a
period of 18 months after closing to purchase debt or
equity securities offered by us, (iii) to use our commercially reasonable efforts to list or
include our common stock on a recognized exchange by June 30, 2005, (iv) to provide the right to purchase a pro rata
share of securities sold by us in a capital raising transaction for
18 months after closing, and (v) to
consult with the representative and consider in good faith, any proposal from any person relating
to any joint venture, partnership or other arrangement providing for the manufacture, production or
construction of drilling rigs for the drilling of CBM in the
Peoples Republic of China until December 21, 2006. Pursuant
to the agreement, Tim Whyte was appointed as a director of the Company on January 10, 2005 and was
appointed as representative of the investors. 56




---



##### Table of Contents



On December 31, 2004, we entered into a settlement agreement with Jawaharlal Gondi and
The Arthi Trust pursuant to which Mr. Gondi resigned as a director of the Company. Pursuant to the
terms of the settlement agreement, we paid Mr. Gondi a total gross amount of $165,000 minus all
applicable withholding, and reimbursed Mr. Gondi certain out-of-pocket expenses. The settlement
agreement also provides that Mr. Gondi and The Arthi Trust, for a period of two years after the
date of the settlement agreement, without our prior written consent, will refrain from certain
activities related to seeking control of the Company. Pursuant to the settlement agreement, Mr.
Gondi and The Arthi Trust also agreed to execute and deliver to us one or more proxies naming the
members of our Board of Directors who are not our officers, as agents and proxies, with full power
of substitution and re-substitution, to vote all shares of our capital stock or our other voting
securities. Through May of 2003, we leased our Houston office from an entity owned in part by an officer
and stockholder. The lease was classified as an operating lease and provided for minimum monthly
rentals of $3,000 through May 2003. Subsequent to May 2003, we leased office space from an
unaffiliated party. 13. Stockholders Equity Common Stock Holders of our common stock are entitled to one vote for each share held on all matters
submitted to a vote of stockholders and do not have cumulative voting rights. Accordingly, holders
of a majority of the shares of common stock entitled to vote in any election of Directors may elect
all other Directors standing for election. Holders of common stock are entitled to receive
proportionately any dividends that may be declared by our Board of Directors, subject to any
preferential rights of outstanding preferred stock. In the event of our liquidation, dissolution
or winding up, holders of common stock will be entitled to receive proportionately any of our
assets remaining after the payment of liabilities and subject to the prior rights of any
outstanding preferred stock. Holders of common stock have no preemptive, subscription, redemption
or conversion rights. Stock Split On January 1, 2002, the Board of Directors authorized an 18 for 1 stock split of our $0.001
par value common stock. As a result of the split, 38,250,000 additional shares were issued, and
additional paid-in capital was reduced by $38,000. All references in the accompanying financial
statements to the number of shares of our common stock and per-share amounts since inception have been restated
to reflect the stock split. Private Placement Offerings and Issuances of Common Stock The table below summarizes our private placements during the years ended December 31, 2004,
2003 and 2002: Common SharesPurchasableGross
    
    
    Net
    
    
    Common
    
    
    With WarrantsDate
    
    Proceeds
    
    
    Proceeds
    
    
    Shares
    
    
    Issued (9)January through March 2002 private placement
(1)
    
    $
    3,412,825
    
    
    $
    3,052,000
    
    
    
    5,250,000
    
    
    
    February 2003 private placement (2)
    
    
    150,000
    
    
    
    135,000
    
    
    
    60,000
    
    
    
    April through October 2003 private placement (3)
    
    
    5,607,000
    
    
    
    4,948,000
    
    
    
    8,628,269
    
    
    
    8,628,269March through May 2004 private placement (4)
    
    
    2,560,000
    
    
    
    2,227,200
    
    
    
    1,280,000
    
    
    
    1,358,000April through June 2004 private placement (5)
    
    
    1,100,000
    
    
    
    1,056,000
    
    
    
    550,000
    
    
    
    550,000December 7, 2004 private placement (6)
    
    
    250,000
    
    
    
    250,000
    
    
    
    250,000
    
    
    
    December 21, 2004 private placement (7)
    
    
    10,250,000
    
    
    
    9,430,000
    
    
    
    12,812,500
    
    
    
    7,943,750December 31, 2004 private placement (8)
    
    
    1,552,100
    
    
    
    1,427,932
    
    
    
    1,940,125
    
    
    
    965,465$
    24,881,925
    
    
    $
    22,526,132
    
    
    
    30,770,894
    
    
    
    19,445,484
 57




---



##### Table of Contents



(1)
    
    This offering is pursuant to Rule 506 of the Securities Act of 1933, to a
group of 22 accredited foreign investors and two accredited United States individuals. A
commission of 11% was paid to the broker and escrow agent utilized to affect the European sales.
The proceeds from the US investors were not subject to a commission.(2)
    
    These shares were sold to an accredited investor for $2.50 per share. Net
proceeds were $135,000 after a 10% commission paid to a broker who had an existing relationship
with the investor.(3)
    
    Beginning April 30, 2003 and concluding on
October 7, 2003, we sold
 8,628,269 investment units in a private placement at $0.65 per unit  in a private placement to approximately 96
accredited investors, of whom 12 reside in the United States or are U.S. citizens. This private
placement was made pursuant to exemptions from registration under Sections 3(b) and 4(2) of the
Securities Act of 1933 and required that the purchaser hold the stock for one year from the date of
purchase.(4)
    
    This private placement contained price protection rights that ceased on
August 14, 2004.(5)
    
    The offering was made pursuant to exemption from registration under Section
4(2) of the Securities Act of 1933. This private placement contains price protection rights, and,
in January 2005, 825,000 shares of our common stock were issued. Additionally, in
January 2005,  warrants to purchase 687,500 shares of our common
stock at $2.50 were issued and warrants to purchase 550,000 shares of our common stock at $2.50 per share were surrendered by the investors under
this private placement.(6)
    
    No commissions were paid on this private placement. The purchaser is an
accredited investor. The offering was made pursuant to exemption from registration under Section
4(2) of the Securities Act of 1933. This private placement contains price protection, and in
January 2005, we issued 62,500 shares of our common stock and warrants to
purchase 62,500 shares of our common stock at $1.50 per share.(7)
    
    In connection with the sale, commissions of $820,000 were paid and
placement agent warrants to purchase 1,537,500 shares of our common stock at $2.50 per share were
issued. The shares were sold to certain investors outside the United States. The private
placement was made pursuant to an exemption from registration under Regulation S of the Securities
Act of 1933.(8)
    
    On December 31, 2004, we sold investment units in a private placement for
gross proceeds of $1.8 million. As of December 31, 2004, $1,550,000 of the gross proceeds were
determined to be good funds, and we included them in cash and cash equivalents, and $250,000 of the
gross proceeds were not good funds, and we recorded a subscription receivable for $250,000 and
commission payable for $20,000. We paid the placement agent $144,000 and sold to them for a total
of $100, warrants to purchase shares of our common stock on the basis of forty warrants exercisable
at $0.80 per share for each 100 units sold and either eight warrants exercisable at $1.50 per share
for each 100 units sold or 20 warrants exercisable at $2.50 per share for each 100 units sold. The
placement agent warrants will have a five year term. This private placement was made pursuant to
exemptions from registration pursuant to Rule 506 of Regulation D.(9)
    
    Details of the warrants are included below under the caption Warrants. The conversion rate of convertible debt incurred during 2003 was below fair value at issuance.
Accordingly, interest expense of approximately $168,000 has been recognized in the accompanying
consolidated financial statements. On October 6, 2003 certain lenders exercised their option to
convert $200,000 of their total notes payable of $300,000 to common stock. The lenders received
307,693 shares of common stock at $0.65 per share and one full warrant exercisable at $1.00. The
lender exercised the conversion feature on February 20, 2004 with regard to the remaining $100,000
of the outstanding balance of the loan. The lender received 153,846 shares of common stock at
$0.65 per share and one full warrant exercisable at $1.00 per share. The stock is restricted for
two years from the date of conversion. In
February 2004, we entered into an investor relations and
consulting contract whereby the
consultant will receive $2,500 in cash and 3000 shares of our common stock. In October of 2004,
the number of shares increased to 5,000 each month. We value the services at the price of the
stock on the last trading day of the month they are awarded. As of December 31, 2004, 5,000 shares
were issuable to the consultant for services rendered. These shares are included in total shares
outstanding in the accompanying consolidated financial statements. Net Loss Per Share As discussed in note 1, net loss per share is calculated in accordance with SFAS No. 128. Our
basic and diluted earnings per share and weighted average shares outstanding were the same in each
year presented because we had net losses. There were (1) 10,218,000 options 5,990,000 options and
3,990,000 options for the years ended December 31, 2004, 2003, and 2002; (2) 16,800,680 warrants and
8,903,269 warrants for the years ended December 31, 2004 and 58




---



##### Table of Contents



2003; and (3) convertible notes for the year ended December 31, 2003 excluded from the
determination of the weighted average common shares outstanding as they would be antidilutive. Resale Restrictions On March 4, 2005, we had 77,439,910 shares of common stock outstanding, of which 43,504,491,
or 56%, were subject to resale restrictions. Of the 43,504,491 restricted shares, 17,170,000
shares have been held in the name of the holder of record for more than two years and, presuming
all other Rule 144 requirements have been met, are currently eligible to have resale restrictions
lifted without limitation. Of the 43,504,491 restricted shares 6,743,769 shares have been held for
over one year and are eligible to have resale restriction lifted with limitation. Of the
43,504,491 restricted shares, 3,043,825 will become eligible to have resale restrictions lifted
with limitation within the next six months by virtue of having been outstanding for more than one
year. We have also registered 2,425,000 shares on a registration statement and during its
effectiveness these shares will not be subject to resale restrictions Preferred Stock Our Board of Directors has the authority, without further action by the shareholders, to issue up
to 500,000,000 shares of preferred stock in one or more series and to designate the rights,
preferences, privileges and restrictions of each series. The issuance of preferred stock could
have the effect of restricting dividends on the common stock, diluting the voting power of the
common stock, impairing the liquidation rights of the common stock or delaying or preventing our
change in control without further action by the stockholders. We have no present plans to issue
any shares of preferred stock. Warrants The following table summarizes warrants transactions for the years ended December 31, 2004 and
2003. There were no warrants issued or outstanding in 2002. 2004
    
    
    2003Outstanding at beginning of year
    
    
    8,903,269
    
    
    
    Issued:April - October 2003 private placement (1)
    
    
    
    
    
    
    8,628,269March -
May 2004 private placement-investor warrants (2)
    
    
    1,280,000March -
May 2004 private placement-placement agent warrants (2)
    
    
    78,000April through June 2004 private placement (3)
    
    
    550,000December 21, 2004 private placement-investor warrants (4)
    
    
    6,406,250December 21, 2004 private placement-private placement warrants (4)
    
    
    1,537,500December 31, 2004 private placement-investor warrants (5)
    
    
    727,088December 31, 2004 private placement-placement agent warrants (5)
    
    
    238,377Conversion of debt (6)
    
    
    153,846
    
    
    
    307,692Exercised (7)
    
    
    (2,827,286
    )
    
    
    (32,692
    )Redeemed (7)
    
    
    (246,355
    )16,800,689
    
    
    
    8,903,269
   (1)
    
    The warrants have an exercise price of $1.00 per common share, and the
term is two years. The warrants may be exercised immediately after issuance until the earlier
of (i) two (2) years from the date of the warrant agreement, or (ii) the date upon which the
warrants are redeemed by us (which may occur at $0.01 per share in the event we provide at
least 30 days prior written notice, the average closing price of the common stock for the 15
days prior to such written notice exceeds $2.00, and we limit its redemption to 25% of the
warrant holders total purchasable shares per month).(2)
    
    The investor and placement agent warrants have an exercise price of
$2.50 per share. The warrants may be exercised immediately after issuance until the earlier
of (i) two years from the date of the warrant agreement, or (ii) the date 59




---



##### Table of Contents



upon which the warrants are redeemed by us (which may occur at $0.01 per share in the event we
provide at least forty days prior written notice, the average closing price of our common stock
for the fifteen days prior to such written notice exceeds $3.50, and we limit our redemption to
25% of the warrant holders total purchasable shares per month).(3)
    
    The warrants have an exercise price of $2.50 per share and a term of two
years. In January 2005, under price protection requirements related to this private
placement, warrants to purchase 687,500 shares of our common stock at $2.50 for a three-year term were issued and
warrants to purchase 550,000 shares of our common stock at $2.50 per
share were surrendered by the
investors under this private placement.(4)
    
    The investor warrants have an exercise price of $2.50 per share with a
three-year term. Placement agent warrants to purchase 1,537,500 shares of our common stock at
$2.50 per share were issued.(5)
    
    The investors in this private placement were given a choice of two
warrants. Warrants to purchase 460,938 shares of common stock at $2.50 per share with a three
year term and warrants to purchase 266,150 shares of common stock for $1.50 with a two year
term were issued under this private placement. We sold to the placement agent, for a total of
$100, warrants to purchase 180,210 shares of our common stock exercisable at $0.80 per share
and warrants to purchase 21,292 shares of common stock exercisable at $1.50 per share and
warrants to purchase 36,875 shares of common stock exercisable at $2.50 per share. The
placement agent warrants have a five year term.(6)
    
    On October 6, 2003, lenders exercised their option to convert $200,000
of their total notes payable of $300,000 to our common stock. The
lender received shares of our common stock and a
warrant to purchase 307,693 shares of common stock exercisable at $1.00 per share. On
February 20, 2004 the lender exercised the conversion feature with regard to the remaining
$100,000 of the outstanding loan balance. The lender received shares
of common stock and a warrant to purchase 153,846 common shares exercisable at $1.00 per share.(7)
    
    Purchasers exercised warrants to purchase 32,692
shares of our common stock at $1.00 in 2003. During the first
half of 2004, we initiated redemption of 25% of the warrants issued in the offering that
closed October 7, 2003 pursuant to the warrant agreement. Warrant holders had to exercise
these warrants by April 10, 2004, or these warrants would have been redeemed. During the
first half of 2004, certain stockholders exercised 2,716,036 warrants at an exercise price of
$1.00 for 2,716,036 shares of common stock. We also redeemed warrants
covering 246,355 shares of our common stock during the
first half of 2004 at $0.01 per share. In August 2004, warrants
to purchase 11,250 shares of our common stock at $1.00 per share were exercised. In December 2004, we issued 100,000 shares of common stock
upon the exercise of warrants at $1.00 per share. At
December 31, 2004 and 2003, 16,800,689 shares and 8,903,269 shares of our common stock were
reserved for the exercise of warrants. On January 10, 2005, we
issued a warrant to an accredited investor to purchase
375,000 shares of common stock at an exercise price of
$1.25 per share in settlement of claimed anti-dilution rights
granted in a previously completed private placement. The warrant
expires on December 16, 2007. The securities which were subject
to appropriate transfer restrictions, were issued without
registration under the Securities Act in reliance upon the exemption
provided in Section 4(2) of the Securities Act. An accrual of
the loss was recorded at December 31, 2004. Stock Options We grant stock options to employees, directors, technical advisors and consultants under
individual option agreements to attract and retain the services of these individuals. Option
grants are approved by the Compensation Committee of the Board of Directors. The following table summarizes stock option transactions for the years ended December 31,
2004, 2003 and 2002:  2004
    
    
    2003
    
    
    2002Weighted
    
    
    
    
    
    
    Weighted
    
    
    
    

    
    
    WeightedShares
    
    
    Average
    
    
    Shares
    
    
    Average
    
    
    Shares
    
    
    AverageUnderlying
    
    
    Exercise
    
    
    Underlying
    
    
    Exercise
    
    
    Underlying
    
    
    ExerciseOptions
    
    
    Price
    
    
    Options
    
    
    Price
    
    
    Options
    
    
    PriceOutstanding, beginning of year
    
    
    5,990,000
    
    
    $
    0.65
    
    
    
    3,990,000
    
    
    $
    0.65
    
    
    
    
    
    
    $
    Granted
    
    
    4,590,000
    
    
    
    2.02
    
    
    
    2,600,000
    
    
    
    0.65
    
    
    
    3,990,000
    
    
    
    0.65Exercised
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Forfeited
    
    
    (362,000
    )
    
    
    0.65
    
    
    
    (600,000
    )
    
    
    0.65
    
    
    
    
    
    
    
    Outstanding, end of year
    
    
    10,218,000
    
    
    $
    1.27
    
    
    
    5,990,000
    
    
    $
    0.65
    
    
    
    3,990,000
    
    
    $
    0.65Options exercisable, end of
year
    
    
    5,026,500
    
    
    $
    1.02
    
    
    
    3,076,000
    
    
    $
    0.65
    
    
    
    798,000
    
    
    $
    0.65
 60




---



##### Table of Contents



We estimated the fair value of each stock award in 2004, 2003 and 2002 at the grant date by
using the Black-Scholes option-pricing model with the following weighted-average assumptions:
dividend yield at 0%; expected volatility of approximately 50%; risk-free interest rate of 0.9% to
3.6% and expected lives of five to ten years for the options. The Black-Scholes weighted average fair value of options granted during 2004, 2003 and 2002 was
$0.78, $1.59 and $1.50 per share. A summary of options outstanding as of December 31, 2004 is as follows: Options Outstanding
    
    
    Options ExercisableWeighted
    
    
    Weighted
    
    
    
    
    
    
    WeightedAverage
    
    
    Average
    
    
    
    
    
    
    AverageRange of
    
    Number
    
    
    Remaining
    
    
    Exercise
    
    
    Number
    
    
    ExerciseExercise Prices
    
    Outstanding
    
    
    Contractual Life
    
    
    Price
    
    
    Exercisable
    
    
    Price0.65 to $1.00
    
    
    5,728,000
    
    
    4.7 years
    
    $
    0.66
    
    
    
    3,794,000
    
    
    $
    0.65$1.01 to $2.00
    
    
    4,330,000
    
    
    4.5 years
    
    $
    2.00
    
    
    
    1,072,500
    
    
    $
    2.00$2.01 to $4.40
    
    
    160,000
    
    
    4.4 years
    
    $
    3.23
    
    
    
    160,000
    
    
    $
    3.2310,218,000
    
    
    
    
    
    
    
    
    
    
    
    5,026,500
 14. Supplemental Quarterly
Financial Information (Unaudited) Quarter EndedMarch 31
    
    
    June 30
    
    
    September 30
    
    
    December 31
    
    
    Year2004Revenues
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Total expenses
    
    
    1,269,000
    
    
    
    1,196,000
    
    
    
    2,019,000
    
    
    
    3,528,000
    
    
    
    8,012,000Net loss
    
    
    (1,268,000
    )
    
    
    (1,192,000
    )
    
    
    (2,013,000
    )
    
    
    (3,531,000
    )
    
    
    (8,004,000
    )Basic and diluted earnings
per share
    
    $
    (0.02
    )
    
    $
    (0.02
    )
    
    $
    (0.03
    )
    
    $
    (0.06
    )
    
    $
    (0.13
    )Weighted average shares
outstanding basic and diluted
    
    
    56,307,401
    
    
    
    60,019,451
    
    
    
    61,103,728
    
    
    
    62,326,992
    
    
    
    60,113,3422003Revenues
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Total expenses
    
    
    672,000
    
    
    
    675,000
    
    
    
    3,365,000
    
    
    
    2,341,000
    
    
    
    7,053,000Net loss
    
    
    (672,000
    )
    
    
    (716,000
    )
    
    
    (3,491,000
    )
    
    
    (2,338,000
    )
    
    
    (7,217,000
    )Basic and diluted earnings
per share(1)
    
    $
    (0.02
    )
    
    $
    (0.02
    )
    
    $
    (0.07
    )
    
    $
    (0.04
    )
    
    $
    (0.14
    )Weighted average shares
outstanding basic and diluted
    
    
    45,785,833
    
    
    
    46,183,639
    
    
    
    49,198,125
    
    
    
    55,885,092
    
    
    
    50,614,000
   (1)
    
    The sum of the quarterly earnings per share
amount does not equal the amount for the year due to rounding in the
individual quarters. 61




---



##### Table of Contents



SCHEDULE II FAR EAST ENERGY CORPORATION
VALUATION AND QUALIFYING ACCOUNTS For Years Ended December 31, 2004, 2003 and 2002 AdditionsBalance at
    
    
    Charged to
    
    
    Charged
    
    
    
    
    
    
    BalanceBeginning
    
    
    Cost and
    
    
    To Other
    
    
    
    
    
    
    at End ofDescription
    
    of Period
    
    
    Expense
    
    
    Accounts
    
    
    Deductions
    
    
    Period2004 deferred tax
valuation allowance
    
    $
    3,150,000
    
    
    $
    1,310,000
    
    
    $
    
    
    
    $
    
    
    
    $
    4,460,0002003 deferred tax
valuation allowance
    
    
    761,000
    
    
    
    2,389,000
    
    
    
    
    
    
    
    
    
    
    
    3,150,0002002 deferred tax
valuation allowance
    
    
    4,000
    
    
    
    757,000
    
    
    
    
    
    
    
    
    
    
    
    761,000
 62




---



##### Table of Contents



ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. 
 ITEM 9A. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures We carried out an evaluation under the supervision and with the participation of our
management, including our chief executive officer and chief financial officer, of the effectiveness
of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act), as
of the end of the period covered by this report. Based upon that evaluation, our chief executive
officer and chief financial officer concluded that our disclosure controls and procedures were
effective as of the end of the period covered by this report to provide reasonable assurance that
information required to be disclosed by us in the reports that we file or submit under the
Exchange Act is recorded, processed, summarized and reported within the time period specified in
the SEC rules and forms. Managements Report on Internal Control over Financial Reporting Managements
report on internal control over financial reporting as of December 31, 2004 is included on
page 32. Additionally,
our independent registered public accounting firm, Payne, Falkner,
Smith & Jones, P.C., that audited our consolidated financial
statements included in this report, has issued an audit report on
managements assessment of the effectiveness of our internal control
over financial reporting as of December 31, 2004, which is included
on page 34 of this report. Changes in Internal Controls In connection with the evaluation described above, our management, including our chief
executive officer and chief financial officer, identified no change in our internal control over
financial reporting that occurred during our quarter ended December 31, 2004, and that has
materially affected, or is reasonably likely to materially affect, our internal controls over
financial reporting. 
 ITEM 9B. OTHER INFORMATION Not Applicable. 
 PART III 
 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Certain information regarding our executive officers has been presented under Executive
Officers included in Item 1. Business, above. Reference is made to the sections entitled Election of Directors and Consideration of
Director Nominees of our Proxy Statement for our 2005 Annual Meeting of Stockholders, which
sections are incorporated herein by reference. Reference is made to the section entitled Section 16(a) Beneficial Ownership Reporting
Compliance of our Proxy Statement for our 2005 Annual Meeting of Stockholders, which section is
incorporated herein by reference. We have adopted a Code of Business Conduct and Ethics, which applies to all employees,
including our chief executive officer and our chief financial officer and principal accounting
officer. The full text of our Code of Business Conduct and Ethics is published on our website, at
www.fareastenergy.com, under the Investor-Relations caption. We intend to disclose future
amendments to, or waivers from, certain provisions of this Code on our website within four business
days following the date of such amendment or waiver. 63




---



##### Table of Contents



ITEM 11. EXECUTIVE COMPENSATION Reference is made to the section entitled Executive Compensation of our Proxy Statement for
our 2005 Annual Meeting of Stockholders, which section is incorporated herein by reference. The
portion of the incorporated material from the Compensation Committee Report references to the
independence of directors, and the Stock Performance Graph are not deemed to be soliciting
material or filed  with the SEC, are not subject to the liabilities of Section 18 of the
Exchange Act and shall not be deemed incorporated by reference into any of the filings previously
made or made in the future by our company under the Exchange Act or the Securities Act of 1933, as
amended (except to the extent our company specifically incorporates any such information into a
document that is filed). 
 ITEM 12. SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS Reference is made to the section entitled Security Ownership of our Proxy Statement for its
2005 Annual Meeting of Stockholders, which section is incorporated herein by reference. Information regarding our equity compensation plans, including both stock holder approved
plans and non-stockholder approved plans, is set forth in the section entitled Equity Compensation
Plan Information of our Proxy Statement for our 2005 Annual Meeting of Stockholders, which section
is incorporated herein by reference. 
 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Reference is made to the section entitled Certain Transactions of our Proxy Statement for
our 2005 Annual Meeting of Stockholders, which section is incorporated herein by reference. 
 ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES The information required by this item is incorporated herein by reference from the section
entitled Independent Registered Public Accounting Firm Fee Information of our Proxy Statement for our 2005 Annual Meeting
of Stockholders. 
 PART IV 
 ITEM 15. EXHIBITS AND
FINANCIAL STATEMENT SCHEDULES  (a)
    The following documents are filed as part of this report:1.
    Financial Statements.Our consolidated financial statements are included in Part II, Item 8 of this report: Report of
Independent Registered Public Accounting Firm

    
    33Consolidated Balance Sheet

    
    35Consolidated
Statement of Operations
    
    36Consolidated
Statement of Stockholders Equity
    
    37Consolidated Statement of Cash Flows

    
    40Notes to the Consolidated Financial Statements.

    
    41
  2.
    Financial statement schedules and supplementary information required to be submitted. Schedule II  Valuation and qualifying accounts.
    
    62Schedules other than that listed above are omitted because they are not applicable.
  3.
    Exhibits A list of the exhibits filed or furnished with this report on Form 10-K (or incorporated by
reference to exhibits previously filed or furnished by us) is provided in the Exhibit Index
beginning on page 67 of this report. Those exhibits incorporated by reference herein are
indicated as such by the information supplied in the parenthetical thereafter. Otherwise,
the exhibits are filed herewith. 64




---



##### Table of Contents



SIGNATURES Pursuant to the requirements of Section 13 or 15(d) the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized, on March 14, 2005. FAR EAST ENERGY CORPORATIONBy:
    /s/ Michael R. McElwrathMichael R. McElwrathChief Executive Officer 65




---



##### Table of Contents



Pursuant to the requirements of the Securities Exchange Act of 1934, this report is signed below by
the following persons on behalf of the registrant and in the capacities and on the dates indicated. By:
    
    /s/ Michael R. McElwrath
    
    Date:
    
    March 14, 2005Michael R. McElwrathChief Executive Officer, President and Director(Principal Executive Officer)By:
    
    /s/ Bruce N. Huff
    
    Date:
    
    March 14, 2005Bruce N. HuffChief financial Officer(Principal Financial and Accounting Officer)By:
    
    /s/ John C. Mihm
    
    Date:
    
    March 14, 2005John C. Mihm,Chairman of the BoardBy:
    
    
    
    Date:Thomas CavanaghDirectorBy:
    
    /s/ Donald A. Juckett
    
    Date:
    
    March 14, 2005Donald JuckettDirectorBy:
    
    /s/ Randall D. Keys
    
    Date:
    
    March 14, 2005Randall D. KeysDirectorBy:
    
    /s/ Tun Aye Sai
    
    Date:
    
    March 14, 2005Tun Aye SaiDirectorBy:
    
    /s/ Tim Whyte
    
    Date:
    
    March 14, 2005Tim WhyteDirectorBy:
    
    /s/ Thomas E. Williams
    
    Date:
    
    March 14, 2005Thomas E. WilliamsDirector
 66




---



##### Table of Contents



INDEX OF EXHIBITS ExhibitNumber
    
    Description3.1
    
    Articles of Incorporation of the Company, as amended.3.2
    
    Bylaws of the Company (filed as an exhibit to the Companys Form 10SB12G filed on March 16, 2001,
and incorporated herein by reference).3.3
    
    Certificate of Amendment to the Bylaws of the Company, ratified on March 3, 2003 (filed as
Exhibit 3(v) to the Companys Amendment No. 2 to its Annual Report on Form 10KSB/A for the year
ended December 31, 2003, which was filed on November 9, 2004, and incorporated herein by
reference).3.4
    
    Certificate of Amendment to the Bylaws of the Company, ratified on October 14, 2003 (filed as
Exhibit 3(ii) to the Companys Amendment No. 1 to its Quarterly Report on Form 10QSB/A for the
quarter ended September 30, 2003, which was filed on May 13, 2004, and incorporated herein by
reference).4.1
    
    Articles of Incorporation of the Company, as amended (included as Exhibit 3.1).4.2
    
    Bylaws of the Company (included as Exhibit 3.2).4.3
    
    Certificate of Amendment to the Bylaws of the Company, ratified on March 3, 2003 (included as Exhibit 3.3).4.4
    
    Certificate of Amendment to the Bylaws of the Company, ratified on October 14, 2003 (included
as Exhibit 3.4).4.5
    
    Specimen stock certificate.10.1*
    
    Amended and Restated Employment Agreement, dated December 23, 2004, by and between the Company
and Michael R. McElwrath (filed as Exhibit 10.1 to the Companys Current Report on Form 8-K filed
on December 28, 2004, and incorporated herein by reference).10.2*
    
    Amended and Restated Employment Agreement, dated December 23, 2004, by and between the Company
and Bruce N. Huff (filed as Exhibit 10.2 to the Companys Current Report on Form 8-K filed on
December 28, 2004, and incorporated herein by reference).10.3*
    
    Employment Agreement, dated February 1, 2004, by and between the Company and Garry R. Ward.10.4*
    
    Employment Agreement, dated November 1, 2003, by and between the Company and Zhendong Alex Yang.10.5*
    
    Amended and Restated Nonqualified Stock Option Agreement, dated December 23, 2004, by and between
the Company and Michael R. McElwrath (filed as Exhibit 10.3 to the Companys Current Report on
Form 8-K filed on December 28, 2004, and incorporated herein by reference).10.6*
    
    Amended and Restated Nonqualified Stock Option Agreement, dated December 23, 2004, by and between
the Company and Michael R. McElwrath (filed as Exhibit 10.4 to the Companys Current Report on
Form 8-K filed on December 28, 2004, and incorporated herein by reference).10.7*
    
    Amended and Restated Nonqualified Stock Option Agreement, dated December 23, 2004, by and between
the Company and Bruce N. Huff (filed as Exhibit 10.5 to the Companys Current Report on Form 8-K
filed on December 28, 2004, and incorporated herein by reference).
 67




---



##### Table of Contents



ExhibitNumber
    
    Description10.8*
    
    Nonqualified Stock Option Agreement, dated December 23, 2004, by and between the Company and
Michael R. McElwrath (filed as Exhibit 10.6 to the Companys Current Report on Form 8-K filed on
December 28, 2004, and incorporated herein by reference).10.9*
    
    Nonqualified Stock Option Agreement, dated December 23, 2004, by and between the Company and
Bruce N. Huff (filed as Exhibit 10.7 to the Companys Current Report on Form 8-K filed on
December 28, 2004, and incorporated herein by reference).10.10*
    
    Nonqualified Stock Option Agreement, dated December 23, 2004, by and between the Company and Tun
Aye Sai (filed as Exhibit 10.8 to the Companys Current Report on Form 8-K filed on December 28,
2004, and incorporated herein by reference).10.11*
    
    Nonqualified Stock Option Agreement, dated December 23, 2004, by and between the Company and
Garry Ward (filed as Exhibit 10.9 to the Companys Current Report on Form 8-K filed on December
28, 2004, and incorporated herein by reference).10.12*
    
    Stock Option Agreement, dated May 18, 2004, by and between the Company and Thomas Cavanagh.10.13*
    
    Stock Option Agreement, dated May 18, 2004, by and between the Company and Donald Juckett.10.14*
    
    Stock Option Agreement, dated June 18, 2004, by and between the Company and Randall D. Keys.10.15*
    
    Stock Option Agreement, dated May 24, 2004, by and between the Company and John C. Mihm.10.16*
    
    Stock Option Agreement, dated February 24, 2004, by and between the Company and Thomas Williams.10.17*
    
    Stock Option Agreement, dated February 1, 2004, by and between the Company and Garry Ward.10.18*
    
    Stock Option Agreement, dated January 29, 2002, by and between the Company and Tun Aye Sai.10.19*
    
    Stock Option Agreement, dated December 1, 2003, by and between the Company and Zhendong Alex
Yang.10.20
    
    Production Sharing Contract for Exploitation of Coalbed Methane Resources in Enhong and Laochang,
Yunnan Province, the Peoples Republic of China, dated January 25, 2002, by and between China
United Coalbed Methane Corp. Ltd. and the Company (filed as Exhibit 2(i) to the Companys Current
Report on Form 8-K filed on February 11, 2002, and incorporated herein by reference).10.21
    
    Production Sharing Contract for
Exploitation of Coalbed Methane Resources for the Qinnan Area in
Shanxi Province, Qinshui Basin, the Peoples Republic of China, dated April 16, 2002, by and between China United
Coalbed Methane Corporation Ltd. and Phillips China Inc.10.22
    
    Approval Certificate from the Ministry of Foreign Trade and Economic Cooperation dated December
30, 2002 (filed as Exhibit 2(i) to the Companys Current Report on Form 8-K filed on January 13,
2003, and incorporated herein by reference).10.23
    
    Memorandum of Understanding, dated March 18, 2003, by and between Phillips China Inc., a Delaware
corporation, and the Company (filed as Exhibit 10.1 to the Companys Amendment No. 1 to its
Quarterly Report on Form 10QSB/A for the quarter ended June 30, 2003, which was filed on December
24, 2003, and incorporated herein by reference).10.24
    
    Farmout AgreementQinnan PSC, dated June 17, 2003, by and between Phillips China Inc., a Delaware
corporation, and the Company (filed as Exhibit 10.2 to the Companys Amendment No. 1 to its
Quarterly Report on Form 10QSB/A for the quarter ended June 30, 2003, which was filed on December
24, 2003, and incorporated herein by reference).
 68




---



##### Table of Contents



ExhibitNumber
    
    Description10.25
    
    Assignment AgreementQinnan PSC, dated June 17, 2003, by and between Phillips China Inc., a
Delaware corporation, and the Company (filed as Exhibit 10.4 to the Companys Amendment No. 1 to
its Quarterly Report on Form 10QSB/A for the quarter ended June 30, 2003, which was filed on
December 24, 2003, and incorporated herein by reference).10.26
    
    First Amendment to Farmout AgreementQinnan PSC, dated December 15, 2003, by and between Phillips
China Inc., a Delaware corporation, and the Company.10.27
    
    Second Amendment to Farmout AgreementQinnan PSC, dated December 17, 2004, by and between
Phillips China Inc., a Delaware corporation, and the Company (filed as Exhibit 10.01 to the
Companys Current Report on Form 8-K filed on December 23, 2004, and incorporated herein by
reference).10.28
    
    Farmout AgreementShouyang PSC, dated June 17, 2003, by and between Phillips China Inc., a
Delaware corporation, and the Company (filed as Exhibit 10.3 to the Companys Amendment No. 1 to
its Quarterly Report on Form 10QSB/A for the quarter ended June 30, 2003, which was filed on
December 24, 2003, and incorporated herein by reference).10.29
    
    Assignment AgreementShouyang PSC, dated June 17, 2003, by and between Phillips China Inc., a
Delaware corporation, and the Company (filed as Exhibit 10.5 to the Companys Amendment No. 1 to
its Quarterly Report on Form 10QSB/A for the quarter ended June 30, 2003, which was filed on
December 24, 2003, and incorporated herein by reference).10.30
    
    First Amendment to Farmout AgreementShouyang PSC, dated December 15, 2003, by and between
Phillips China Inc., a Delaware corporation, and the Company.10.31
    
    Second Amendment to Farmout AgreementShouyang PSC, dated December 17, 2004, by and between
Phillips China Inc., a Delaware corporation, and the Company (filed as Exhibit 10.02 to the
Companys Current Report on Form 8-K filed on December 23, 2004, and incorporated herein by
reference).10.32
    
    Amended and Restated Escrow Agreement, dated January 19, 2005, by and among the Company, Phillips
China, Inc. and J.P. Morgan Trust Company, N.A. (filed as Exhibit 10.01 to the Companys Current
Report on Form 8-K filed on January 21, 2005, and incorporated herein by reference).10.33
    
    Settlement Agreement, dated December 31, 2004, by and between Jawaharlal Gondi, The Arthi Trust
and the Company (filed as Exhibit 10.1 to the Companys Current Report on Form 8-K filed on
January 4, 2005, and incorporated herein by reference).10.34
    
    Stock Subscription Agreement, dated December 21, 2004, by and between Sofaer Capital Global Fund,
Sofaer Capital Asian Fund, Restructuring Investors Limited, Persistency, and Passlake Limited,
Tim Whyte and the Company.10.35
    
    Registration Rights Agreement, dated December 21, 2004, by and among Sofaer Capital Global Fund,
Sofaer Capital Asian Fund, Restructuring Investors Limited, Persistency and the Company.10.36
    
    Registration Rights Agreement, dated December 31, 2004, by and among Bathgate Capital Partners
LLC and the Company.10.37
    
    Registration rights Agreement, dated December 1, 2004, by and among RAB Europe Fund Ltd., RAB
Special Situations, L.P., Roytor & Co., James Palmer and the Company.10.38
    
    Purchase and Sale Agreement, dated February 2, 2005, by and between Newark Valley Oil & Gas,
Inc., a wholly-owned subsidiary of the Company, and Zier & Associates, Ltd. (filed as Exhibit
10.1 to the Companys Current Report on Form 8-K filed on February 7, 2005, and incorporated
herein by reference).10.39
    
    Production Sharing Contract for
Exploitation of Coalbed Methane Resources for the Shouyang Area in
Shanxi Province, Qinshui Basin, the Peoples Republic of China, dated
April 16, 2002, by and between China United Coalbed Methane
Corporation Ltd. and Phillips China Inc.
 69




---



##### Table of Contents



ExhibitNumber
    
    Description21.1
    
    Subsidiaries of Registrant (filed as Exhibit 21 to the Companys Amendment No. 3 to its
Registration Statement on Form S-2/A (No. 333-117635) filed on January 19, 2005, and incorporated
herein by reference).31.1
    
    Certification of Chief Executive Officer of the Company under Section 302 of the Sarbanes-Oxley
Act of 2002.31.2
    
    Certification of Chief Financial Officer of the Company under Section 302 of the Sarbanes-Oxley
Act of 2002.32.1
    
    Certification of Chief Executive Officer of the Company Pursuant to 18 U.S.C. § 1350.32.2
    
    Certification of Chief Financial Officer of the Company Pursuant to 18 U.S.C. § 1350.
   *
    
    Management contract or compensatory plan arrangement. 70