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Clients and Solutions
We are pleased to provide our investors with an update for Q3/2008.
We have had a very busy summer and of particular importance, we are very pleased to report that the total number of oil & gas leases now under KOS control is over 30,000 and we are well on target to close out the year with almost 50,000 acres. Over 90% of these leases are owned 100% by KOS with royalty over-rides to the landowner typically less than 20%.
The majority of our leases are in the South/Central region of Kentucky but we are also building an exciting relationship with landowners in the Illinois Basin of Western. We will have a significant controlling interest in these wells and will begin to develop them in early 2009. These are old wells from the 1950’s and 1960’s which in many cases produced 200 to 300 barrels of oil per day (bopd) in their early stages.
Government research for Kentucky shows that less than 30% of all oil in the state was ever recovered and we believe that these wells are prime candidates for workover with our new downhole tool which allows horizontal jet drilling from the original vertical bore. This is explained in greater detail below.
Our large acreage position in the south/central region does not consist of large random blocks of land. These were carefully chosen leases that are a few hundred acres on average (with a few blocks of one or two thousand acres). All the properties have older wells on them that were abandoned decades ago. They stopped producing or were shut in for a number of reasons (mainly economic with the low price of oil) but many leases might have several wells on a couple hundred acres. All indicated to be known producing regions and prime candidates for new drilling and workover with our new tool.
Honesty and Business Ethics Critical to Success in Kentucky
KOS began accumulating Kentucky leases in June and in just over 3 months we have been highly successful thanks to the hard work and reputation of our landmen and head of field operations. An entire generation is missing from the oilfield in Kentucky (most involved now are older than 50 or in their 20’s and just learning). Because the state is known to be oil rich with shallow wells, it was a magnet for oil promoters and crooks. Many landowners and investors were taken advantage of. We were able to get a very promising lease in a situation where the landowner would not talk to anyone oil related for the past 15 years.
On her property we found 3 very shallow drill holes within a 6ft radius where the driller raised money and said he would drill 3 wells – he drilled 3 wells alright. Just enough to pocket several hundred thousand dollars and say he hit dry holes (photo to your bottom right). This was a common scenario in the state.
KOS however is building their reputation on solid business ethics and this has lead to very early success that will benefit us long term. A prime example is land we wanted to lease near a large dam that was flooded almost twenty years ago and buried an old oilfield that had been highly productive in its time - but shut in to accommodate construction. In June we saw a nearby farmer who was covering oil seeping to the surface (seemed impossible but picture small scale Beverly Hillbillies). The farmer for whatever reason had no interest in drilling on his land.
The Dam over twenty years, appears to be creating a waterflood situation and because the oil bearing formation is shallow, the pressure after all these years appears to be forcing the oil to surface in some areas and in a known direction.
Our landman (unable to get the property mentioned above), approached the local sheriff who we knew owned good acreage in the area. The sheriff wanted roads built on his land for small scale farming, etc. and would lease the land to us if we accommodated him. We have dedicated access to a young fellow who started a construction company (dozer, gravel truck, and backhoe). The rate he charges us is amazingly low and in this case we built a tremendous road system (using the landowners gravel) for a terrific cost.
Not only did we secure some great oil leases, but the neighbors in the area have been so impressed, they have approached “us” and we have secured a sizeable acreage position in this area.
We are hoping to drill this property before year end. This is just one example of the proper way to do business in Kentucky and it is what we have based our business principals on.
Early Drilling Success
As part of an original land package we picked up, we received a 20% carried interest on 4 wells that were already funded to be drilled (and 50% on a 5th). In August those wells were drilled and hit oil on all 5. They were not big wells but appear will sustain about 5 to 10 bopd – although 1 is currently flowing 200 ft uphill at approx. 30 bopd. The flowing well hit a new formation for this county, so we have been accumulating surrounding leases for future drilling. We have also not used the jet drilling tool on these wells yet (the unit was not available when drilled) so the possibility exists over time to improve production significantly.
Although KOS’s interest on these wells is the smallest we have, the early drilling success is very important as it clearly demonstrates the expertise of our field operations manager.
June through August was focused on securing oil leases (before prices started to move), drilling these first wells, and negotiating with the owner of the new downhole jet drilling tool (a critical aspect of our business plan). Now that we have been very successful on all fronts and raised a bit more capital, we will start drilling our own wells in a couple weeks and working over old wells with horizontal jet drilling.
New Technology and an Important Acquisition
As most everyone will know, we secured the rights to a new jet drilling technology developed over the past 10 
years by a well known physics professor from Kentucky. This month the Dr. was kind enough to sell us his truck (pictured left) for an excellent price. He will use a smaller unit for testing and we will likely share any out of state business when our yellow unit is free.
We will do a bit of retro-fitting the next couple weeks and then will have this unit available 24/7 for our own wells (both new drilling and workovers). In addition to the large number of leases we have built in such a short period of time, this is probably the next most important development for our shareholders. We now have no restrictions on timing, have full time operators for the unit along with a workover rig, and a dedicated driller who only needs 1 weeks notice.
To accompany our new truck, we have also purchased a very large pump capable of 30,000 psi (photo right). 
In this photo to your left you will see where the professor’s jet drilling 
tool cut through solid rock using only water and about 3000 psi. If you picture this same rock as an oil bearing formation, a portion of it will be made of small holes, fractures, and oil. The individual holes in this photo are several inches in diameter.
If we use acid mixed with very high pressure and are drilling horizontally (starting out from the vertical well bore) through an oil bearing formation, the jet drilling head will likely create a very large cavernous opening through which oil or gas can flow back to the vertical well bore for significantly enhanced recovery. At each level we would likely drill out 30 feet to a couple hundred feet in 4 directions and possibly at a few different levels depending upon where well logs show the oil formation exists.
This specific technology and its application is new to the industry and because it was initially designed with 
Kentucky formations in mind, we believe we are on the cutting edge of something very important. Until we have had an opportunity to thoroughly test its application for 4 to 6 months, we will not know its full capability. However, the professor who is an expert in physics and fluid dynamics believes this has important implications for wells below 3000ft (where multi-million dollar horizontal drilling is uneconomic), Jet drilling has been around for a decade or two but his advancements in the nozzle head (cutting tool) sets this technology far apart from competition.
In Summary
We have built a significant land position (and will continue to add more), have highly qualified employees, have committed access to a driller, and have cutting edge technology with our own truck/rig for unrestricted usage and low cost.
We have accomplished all of this while still maintaining a very tight share structure (just over 10 million shares outstanding). While more money would also mean more aggressive drilling, we are trying to manage our growth very carefully to avoid dilution.
Towards the end of September we will start drilling our own 100% wells and utilizing this exciting new tool on both new wells and workovers. We are cautiously optimistic that this will result in rapid growth for KOS over the next year. There are inherent risks to anything in the oil & gas exploration business but we have done everything possible to mitigate risks and establish a strategy for significant growth.
Should you have any questions, please do not hesitate to contact me by phone (1-877-278-6430) or email bbergstrom@kosenergy.com
Barry Bergstrom
CEO – KOS Energy