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NGAS Grows Reserves, Production in Core Kentucky Area

It pays to know the territory, particularly if you're an oil and gas driller in competition with Kentucky coal miners. NGAS Resources Inc., based in Lexington, KY, made its 20 years of experience in eastern Kentucky pay off in 2004, increasing total production by 77%, revenues by 75% and most importantly, completing an acquisition that helped bump up oil and gas assets by 316% to a value of $68.2 million from $16.4 million in 2003.

Earnings haven't caught up, but Bill Daugherty, founder and CEO of NGAS, points to a large asset acquisition in 2004, valued at $35 million, including 90,000 leased acres and 141 wells, as providing momentum for 2005. The company drilled 155 wells in 2004, up from 89 in 2003, and plans to drill another 165 this year, as well as increase its gathering system and lease position and look out for more acquisitions.Production for 2004 was 861 MMcfe from 609 wells. The company realized an average sales price in 2004 of $6.70/Mcf.

NGAS picked up the new assets for between $1.16 and $1.20/Mcf, a good value in the current market, Daugherty points out. The company's estimated proved oil and gas reserves as of Dec. 31, 2004 were 66,074 MMcfe, up 34,703 MMcfe or 111% from Dec. 31, 2003.

Even though there are large areas in southeastern Kentucky that haven't been drilled, it's a land where coal is king and there aren't many large tracts available. "There are lots of 10,000-acre tracts, but we're concentrating on larger tracts," and those are often tied up by the coal companies, Daugherty said. "We keep a close watch on coal mining activities," and when the mining plays out on a large tract, NGAS goes after the mineral rights. "We recently leased an area of interest from Equitable and the Kentucky River Coal Co."

The Company, which changed its name from Daugherty Resources to NGAS Resources in June 2004, is one of the few public companies operating in the southeastern Kentucky region, where mom-and-pop style companies dominate. The larger companies concentrate farther to the east.

"There are lots of folks looking here, but we have a big advantage in a large lease position and lots of wells to drill. It wasn't easy putting these together," Daugherty said. Besides surface rights, there are coal rights and oil and gas rights, and the winner is usually whoever got there first."Typically, it's the coal owner who got there first. Coal has been mined around here for the last 80-100 years. In the early part of the century Henry Ford and Bill Mayo [of theMayo Clinic] leased a lot of the mineral rights for coal. To put a deal together today usually takes a roomful of lawyers."

Daugherty credits the fact that most of his 62 employees are native to the area and his landmen are familiar with area mineral rights as critical factors. He notes also that with natural gas prices up, "there is a lot more investment money available." Unlike the Gulf Coast wells popular with mezzanine financiers, that pay out big and play out in three years, the Appalachian wells typically produce 50-200 Mcf/d for 25 years. But with a "very predictable decline rate and a 99% hit rate" and a cost off between $320,000 and $350,000 per well, the economics are good for the long term, Daugherty maintains. The average well depth is 4,800 feet, although NGAS drilled three wells below 6,000 feet last year.

NGAS put in 59 miles of gathering line last year for a company total of 171 miles, and is working on another 50-60 miles this year. The company signed an agreement with Duke Energy last year to operate and maintain Duke's 150-mile Stone Mountain gathering system in the area, which gives NGAS "a competitive advantage in its core area," according to CFO Michael P. Windisch.

The company has 132 producible wells awaiting completion of its gathering line construction, expected in mid-2005, which will significantly contribute to our overall profitability in the future, Windisch said.

Income for the year was $1.6 million or $0.12/per share for 2004 on 13,994,282 weighted average basic shares outstanding for the year, compared to $3.7 million or $0.46/share on 8,032,647 weighted average basic shares outstanding for 2003. Windisch noted however, that EBITA went from $5.5 million in 2003 to $6.1 million in 2004. Part of the bottom line problem was increased costs for steel and other drilling items for its contract drilling business.

Daugherty sees the core value of the company in the substantial lease position of 255,000 acres and its pipeline infrastructure. "Our ability to drill a large number of wells, year after year, is important in today's market where many companies are struggling to find drilling opportunities," Daugherty said.

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