Item 1A Risk Factors 13
Item 1B Unresolved Staff Comments 22
Item 2 Properties 22
Item 3 Legal Proceedings 23
Item 4 Mine Safety Disclosures 24
PART II
Item 6 Selected Financial Data 25
Item 7A Quantitative and Qualitative Disclosures about Market Risk 39
Item 8 Financial Statements and Supplementary Data 39
Item 9A Controls and Procedures 40
Item 9B Other Information 41
PART III
Item 10 Directors, Executives Officers and Corporate Governance 42
Item 11 Executive Compensation 42
Item 14 Principal Accountant Fees and Services 42
PART IV
Item 15 Exhibits, Financial Statement Schedules 43
i
FORWARD
LOOKING STATEMENTS
This
Annual Report on Form 10-K (herein, “Annual Report”) and the documents included or incorporated by reference in this
Annual Report contain statements concerning our expectations, beliefs, plans, objectives, goals, strategies, future events or
performance and underlying assumptions and other statements that are not historical facts. These statements are “forward-looking
statements” within the meaning of the Private Securities Litigation Reform Act of 1995. You generally can identify our forward-looking
statements by the words “anticipate,” “believe,” “budgeted,” “continue,” “could,”
“estimate,” “expect,” “forecast,” “goal,” “intend,” “may,”
“objective,” “plan,” “potential,” “predict,” “projection,” “scheduled,”
“should,” “will” or other similar words. These forward-looking statements include, among others, statements
regarding:
● The going concern qualification in our consolidated financial statements;
● the outcome of the current SEC investigation against us;
● Business interruptions from COVID-19 pandemic;
● changes in our exploration plans and related budgets;
● anticipated trends in our business;
● our future results of operations;
● our capital expenditure program;
● future market conditions in the oil and gas industry
● the demand for oil and natural gas, both locally in Israel and globally; and
● The impact of fluctuating oil and gas prices on our exploration efforts
ii
More specifically, our forward-looking statements may include,
among others, statements relating to our schedule, business plan, targets, estimates or results of our applications for new exploration
rights and future exploration plans, including the number, timing and results of wells, the timing and risk involved in drilling
follow-up wells, planned expenditures, prospects budgeted and other future capital expenditures, risk profile of oil and gas exploration,
acquisition and interpretation of seismic data (including number, timing and size of projects), planned evaluation of prospects,
probability of prospects having oil and natural gas, expected production or reserves, acreage, working capital requirements, hedging
activities, the availability of expected sources of liquidity to implement our business strategy, future hiring, future exploration
activity, production rates, all and any other statements regarding future operations, consolidated financial results, business
plans and cash needs and other statements that are not historical fact.
Such
statements involve risks and uncertainties, including, but not limited to, those relating to the uncertainties inherent in exploratory
drilling activities, the volatility of oil and natural gas prices, operating risks of oil and natural gas operations, our dependence
on our key personnel, factors that affect our ability to manage our growth and achieve our business strategy, risks relating to
our limited operating history, technological changes, our significant capital requirements, the potential impact of government
regulations, adverse regulatory determinations, litigation, competition, the uncertainty of reserve information and future net
revenue estimates, property acquisition risks, industry partner issues, availability of equipment, weather and other factors detailed
herein and in our other filings with the Securities and Exchange Commission (the “SEC”).
We
have based our forward-looking statements on our management’s beliefs and assumptions based on information available to
our management at the time the statements are made. We caution you that assumptions, beliefs, expectations, intentions and projections
about future events may and often do vary materially from actual results. Therefore, we cannot assure you that actual results
will not differ materially from those expressed or implied by our forward-looking statements.
Some
of the factors that could cause actual results to differ from those expressed or implied in forward-looking statements are described
under “Risk Factors” in this Annual Report and in our other periodic reports filed with the SEC. Should one or more
of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual outcomes may vary materially
from those indicated. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf
are expressly qualified in their entirety by reference to these risks and uncertainties. You should not place undue reliance on
our forward-looking statements. Each forward-looking statement speaks only as of the date of the particular statement, and we
undertake no duty to update any forward-looking statement.
iii
PART
I
ITEM
1. BUSINESS
Overview
Zion
Oil and Gas, Inc., a Delaware corporation, is an oil and gas exploration company with a history of 21 years of oil and gas exploration
in Israel. We were incorporated in Florida on April 6, 2000 and reincorporated in Delaware on July 9, 2003. We completed
our initial public offering in January 2007. Our common stock, par value $0.01 per share (the “Common Stock”) currently
trades on the OTCQX Market under the symbol “ZNOG” and our Common Stock warrant under the symbol “ZNOGW.”
The Company currently
holds one active petroleum exploration license onshore Israel, the New Megiddo License 428, which was granted on December 3, 2020
and overlaps the previous Megiddo-Jezreel License 401, comprising approximately 99,000 acres. The terms of the new license
are effective through June 2, 2021 and is extendable for a six-month period.
The Megiddo Jezreel #1
(“MJ #1”) site was completed in early March 2017, after which the drilling rig and associated equipment were mobilized
to the site. Performance and endurance tests were completed, and the MJ #1 exploratory well was spud on June 5, 2017 and drilled
to a total depth (“TD”) of 5,060 meters (approximately 16,600 feet). Thereafter, the Company obtained three open-hole
wireline log suites (including a formation image log), and the well was successfully cased and cemented. The Ministry of Energy
approved the well testing protocol on April 29, 2018.
During the fourth quarter
of 2018, the Company testing protocol was concluded at the MJ #1 well. The test results confirmed that the MJ #1 well did not
contain hydrocarbons in commercial quantities in the zones tested. As a result, in the year ended December 31, 2018, the Company
recorded a non-cash impairment charge to its unproved oil and gas properties of $30,906,000. During the year ended December 31,
2020, the Company did not record any post-impairment charges. The Company recorded a post-impairment charge of $314,000 for the
year ended December 31, 2019.
While the well was
not commercially viable, Zion learned a great deal from the drilling and testing of this well. We believe that the drilling and
testing of this well carried out the testing objectives which would support further evaluation and potential further exploration
efforts within our License area. Zion believed it was prudent and consistent with good industry practice to try and answer some
of these questions with a focused 3-D seismic imaging shoot of approximately 72 square kilometers surrounding the MJ#1 well. As
of the date of this report, Zion has completed all of the acquisition, processing and interpretation of the 3-D data and has incorporated
its expanded knowledge base into the drilling of our current drilling MJ-02 exploratory well.
On March 12, 2020,
Zion entered into a Purchase and Sale Agreement with Central European Drilling kft, a Hungarian corporation, to purchase an onshore
oil and gas drilling rig, drilling pipe, related equipment and spare parts for a purchase price of $5.6 million in cash, subject
to acceptance testing and potential downward adjustment. We remitted to the Seller $250,000 on February 6, 2020 as earnest money
towards the Purchase Price. The Closing anticipated by the Agreement took place on March 12, 2020 by the Seller’s execution
and delivery of a Bill of Sale to us. On March 13, 2020, the Seller retained the earnest money deposit, and the Company remitted
$4,350,000 to the seller towards the purchase price and $1,000,000 (the “Holdback Amount”) was deposited in escrow
with American Stock Transfer and Trust Company LLC. On January 6, 2021, Zion completed its acceptance testing of the I-35 drilling
rig and the Holdback Amount was remitted to Central European Drilling.
The MJ-02 drilling plan
was approved by the Ministry of Energy on July 29, 2020. On January 6, 2021, Zion officially spudded its MJ-02 exploratory well.
Zion plans to reach a total depth of approximately 5,800 meters (~19,024 feet) and the drilling is expected to take approximately
150 days.
As of the date of this
report, our drilling of the MJ-02 well is continuing as planned.
At
present, we have no revenues or operating income. Our ability to generate future revenues and operating cash flow will depend
on the successful exploration and exploitation of our current and any future petroleum rights or the acquisition of oil and/or
gas producing properties, and the volume and timing of such production. In addition, even if we are successful in producing oil
and gas in commercial quantities, our results will depend upon commodity prices for oil and gas, as well as operating expenses
including taxes and royalties.
Our
executive offices are located at 12655 North Central Expressway, Suite 1000, Dallas, Texas 75243, and our telephone number is
(214) 221-4610. Our branch office’s address in Israel is 9 Halamish Street, North Industrial Park, Caesarea 3088900, and
the telephone number is +972-4-623-8500. Our website address is: www.zionoil.com.
Company
Background
In
1983, during a visit to Israel, John M. Brown (our CEO, Founder and Chairman of the Board of Directors) became inspired and dedicated
to finding oil and gas in Israel. During the next 17 years he made several trips each year to Israel, hired oil and gas consultants
in Israel and Texas, met with Israeli government officials, made direct investments with local exploration companies, and assisted
Israeli exploration companies in raising money for oil and gas exploration in Israel. This activity led Mr. Brown to form Zion
Oil & Gas, Inc. in April 2000, in order to receive the award of a small onshore petroleum license from the Israeli government.
1
Zion’s
vision, as guided by John Brown, of finding oil and/or natural gas in Israel, is biblically inspired. The vision is based, in
part, on biblical references alluding to the presence of oil and/or natural gas in territories within the State of Israel that
were formerly within certain ancient biblical tribal areas. While John Brown provides the broad vision and goals for our company,
the actions taken by the Zion Board of Directors and management team as it actively explores for oil and gas in Israel, are based
on modern science and good business practice. Zion’s oil and gas exploration activities are supported by appropriate geological,
geophysical and other science-based studies and surveys typically carried out by companies engaged in oil and gas exploration
activities.
Upon
the award of our first petroleum right in May 2000, the Israeli government provided us access to most of its data with respect
to previous exploration in the area, including geologic reports, seismic records and profiles, drilling reports, well files, gravity
surveys, geochemical surveys and regional maps. We also gathered information concerning prior and ongoing geological, geophysical
and drilling activity relevant to our planned activities from a variety of publicly accessible sources. Subsequently, we have
acquired additional studies on our own such as seismic and other geophysical and geological surveys.
ZION’S
CURRENT EXPLORATION LICENSE AREA
Zion currently holds
one active petroleum exploration license onshore Israel, the New Megiddo License 428 (covering an area of approximately 99,000
acres – See Map 1). Under Israeli law, Zion has an exclusive right to oil and gas exploration in our license area in that
no other company may drill there. In the event we drill an oil or gas discovery in our license area, current Israeli law entitles
us to convert the relevant portions of our license to a 30-year production lease, extendable to 50 years, subject to compliance
with a field development work program and production.
The New Megiddo License
428 was awarded on December 3, 2020 for a six-month term with the possibility of an additional six-month extension. The New Megiddo
License 428 area lies onshore, south and west of the Sea of Galilee and we continue our exploration focus here as it appears to
possess the key geologic ingredients of an active petroleum system with significant exploration potential.
Map 1. Zion’s New Megiddo Petroleum
Exploration License as of December 31, 2020.
2
Summary
of Current and Former Company License Areas
Megiddo-Jezreel
Petroleum License
The Megiddo-Jezreel License
401 was awarded on December 3, 2013 for a three-year primary term through December 2, 2016 with the possibility of additional
one-year extensions up to a maximum of seven years. The Megiddo-Jezreel License 401 lies onshore, south and west of the Sea of
Galilee, and we continue our exploration focus here as it appears to possess the key geologic ingredients of an active petroleum
system with significant exploration potential. In November 2016, the State of Israel’s Petroleum Commission officially approved
Zion’s drilling date and license extension request to December 2, 2017.
On January 31, 2019, Zion submitted its Application for Extension
of Continued Work Program Due Date on the Megiddo-Jezreel License 401. The additional time was necessary to finalize the
work program. On February 3, 2019 Israel’s Petroleum Commissioner granted Zion’s work program report extension to February
28, 2019, as shown below:
Number Activity Description Execution by:
1 Submit program for continuation of work under license 28 February 2019
On February 24, 2019
and thereafter on February 26, 2019 Zion submitted its proposed 2019 Work Program on the Megiddo-Jezreel License 401.
On February 28, 2019 Israel’s
Petroleum Commissioner officially approved the revised and updated Work Program on the Megiddo-Jezreel License 401 as shown below:
Number Activity description Execution by:
4 Submit interpretation report 20 February 2020
3
On April 30, 2019 Zion submitted its Application for Extension
of Continued Work Program Due Date on the Megiddo-Jezreel License 401. The additional time was necessary for Zion to conduct a
3-D survey in an area of approximately 72 square kilometers. This required, among others, extensive permitting activities with
relevant local landowners, the Israel Land Authority (“ILA”), certain authorities and others, and the seismic survey
might not conclude prior to the beginning of the rainy season in Israel. This in turn would result in additional delay, as rain
and mud are not conducive to the performance of a seismic survey which includes extensive use of vibrators.
Zion
proposed new timelines and activity descriptions are shown below:
Number Activity description Execution by:
4 Submit interpretation report 15 November, 2020
On
May 1, 2019, Israel’s Petroleum Commissioner granted Zion’s work program report extension.
Zion
fulfilled all of its commitments and activities per the new timelines shown above.
As
previously disclosed, the Company required authorization from the ILA, the formal lessor of the land to Kibbutz Sde Eliyahu, on
whose property the drilling pad is currently situated, to access and utilize the drill site (“surface use agreement”).
The Company received this authorization on July 4, 2016. This was preceded by the Company’s May 15, 2016 signed agreement
with the kibbutz. On January 11, 2017, an agreement was signed by the Company and the ILA by which the surface usage agreement
was extended through December 3, 2017. On December 31, 2017, an agreement was signed by the Company and the ILA by which the surface
usage agreement was extended through December 3, 2019. On July 1, 2019, an agreement was signed by the Company and the ILA by
which the surface usage agreement was extended through December 3, 2020.
The MJ-02 drilling plan was approved by the Ministry of Energy
on July 29, 2020. The New Megiddo License 428 was awarded on December 3, 2020 for a six-month term with the possibility of an additional
six-month extension. The New Megiddo License 428 area is the same area as the Megiddo-Jezreel License 401 area and lies onshore,
south and west of the Sea of Galilee and we continue our exploration focus here as it appears to possess the key geologic ingredients
of an active petroleum system with significant exploration potential.
On January 6, 2021, Zion officially spudded its MJ-02 exploratory
well. Zion plans to reach a total depth of approximately 5,800 meters (~19,024 feet) and the drilling is expected to take approximately
150 days. As of the date of this report, our drilling of the MJ-02 well is continuing as planned.
Zion’s
Former Joseph License
Zion
has plugged all of its exploratory wells on its former Joseph License area, and the reserve pits have been evacuated, but acknowledges
its obligation to complete the abandonment of these well sites in accordance with guidance from the Energy Ministry, Environmental
Ministry and local officials.
4
Exploration
Plans Going Forward
The Company currently holds one active petroleum exploration
license onshore Israel, the New Megiddo License 428, comprising approximately 99,000 acres. The Megiddo Jezreel #1 (“MJ
#1”) site was completed in early March 2017, after which the drilling rig and associated equipment were mobilized to the
site. Performance and endurance tests were completed, and the MJ #1 exploratory well was spud on June 5, 2017 and drilled to a
total depth (“TD”) of 5,060 meters (approximately 16,600 feet). Thereafter, the Company obtained three open-hole wireline
log suites (including a formation image log), and the well was successfully cased and cemented. The Ministry of Energy approved
the well testing protocol on April 29, 2018.
During
the fourth quarter of 2018, the Company testing protocol was concluded at the MJL well. The test results confirmed that the MJ
#1 well did not contain hydrocarbons in commercial quantities in the zones tested. As a result, in the year ended December 31,
2018, the Company recorded a non-cash impairment charge to its unproved oil and gas properties of $30,906,000. The Company recorded
a post-impairment charge of $314,000 for the year ended December 31, 2019. During the year ended December 31, 2020, the Company
did not record any post-impairment charges.
The
MJ#1 well provided Zion with information Zion believes is important for potential future exploration efforts within its license
area. As with many frontier wildcat wells, the MJ#1 also left several questions unanswered.
While
not meant to be an exhaustive list, a summary of what Zion believes to be key information learned in the MJ#1 well is as follows:
A
summary of what Zion believes to be some key questions left to be answered are:
5
As
a result of these unanswered questions and with the information gained drilling the MJ#1 well, Zion believes it is prudent and
consistent with good industry practice to try and answer some of these questions with a focused 3-D seismic imaging shoot of approximately
72 square kilometers surrounding the MJ#1 well. Zion has completed all of the acquisition, processing and interpretation of the
3-D data and has incorporated its expanded knowledge base into the drilling of our current MJ-02 exploratory well.
The Geology team is continuing on a larger interpretation of
3-D areas, along with potential exploration locations located in the western portion of the New Megiddo License 428 area.
On March 12, 2020, Zion
entered into a Purchase and Sale Agreement with Central European Drilling kft (“CED”), a Hungarian corporation, to
purchase an onshore oil and gas drilling rig, drilling pipe, related equipment and spare parts for a purchase price of $5.6 million
in cash, subject to acceptance testing and potential downward adjustment. We remitted to the Seller $250,000 on February 6, 2020
as earnest money towards the Purchase Price. The Closing anticipated by the Agreement took place on March 12, 2020 by the
Seller’s execution and delivery of a Bill of Sale to us. On March 13, 2020, the Seller retained the earnest money deposit,
and the Company remitted $4,350,000 to the seller towards the purchase price and $1,000,000 (the “Holdback Amount”)
was deposited in escrow with American Stock Transfer and Trust Company LLC.
I-35 Drilling Rig
& Associated Equipment
31 December 2020
Other Drilling
I-35 Drilling Rig Rig Spare Parts Assets Total
US$ thousands US$ thousands US$ thousands US$ thousands
Restricted Cash as Holdback in Escrow (1) 500 500 - 1,000
Purchase Price Allocations (88 ) 40 48 -
Asset Disposals - - - -
On
January 6, 2021, Zion completed its acceptance testing of the I-35 drilling rig and the Holdback Amount was remitted to Central
European Drilling on January 8, 2021.
As mentioned previously,
the MJ-02 drilling plan was approved by the Ministry of Energy on July 29, 2020. The New Megiddo License 428 was awarded on December
3, 2020 for a six-month term with the possibility of an additional six-month extension. The New Megiddo License 428 area is the
same area as the Megiddo Jezreel license 401 area and lies onshore, south and west of the Sea of Galilee and we continue our exploration
focus here as it appears to possess the key geologic ingredients of an active petroleum system with significant exploration potential.
On January 6, 2021, Zion officially spudded its MJ-02 exploratory
well. Zion plans to reach a total depth of approximately 5,800 meters (~19,024 feet) and the drilling is expected to take approximately
150 days. As of the date of this report, our drilling of the MJ-02 well is continuing as planned.
6
Exploration
Expenditures
The
following table summarizes the amounts we expended on our exploration efforts between 2019 and 2020:
I-35 Drilling Rig & Associated Equipment Megiddo License 428 7,568 -
Geological & Geophysical Operations 762 3,119
Location construction 236 25
Plug & Abandonment Operations - 78
Exploratory Drilling Operations 649 1,005
Joseph License (expired on October 10, 2013) Plug & Abandonment Operations 13 -
Employees
& Contractors
As
of December 31, 2020, we had 26 employees and contractors of whom all but four are on a full-time basis. Included in this number
are certain contractors who provide services to Zion on an ongoing basis. Of the 26 total headcount, 18 work out of our Dallas
office and 8 work out of the Caesarea, Israel office. None of our current employees or contractors are subject to any collective
bargaining agreements, and there have been no strikes.
We
regularly utilize independent consultants and contractors to perform various professional services, particularly for services
connected to drilling operations, such as specialized drilling, health and safety, engineering, logging, cementing and well-testing.
Competition
and Markets
The
oil and gas exploration industry in Israel currently consists of a number of exploration companies. These include relatively small
local or foreign companies (such as Zion Oil & Gas, Genie Oil & Gas/Afek, and Givot Olam), as well as larger consortia
of local Israeli and foreign participants (Noble Energy Inc./Delek Group Ltd.). Most groups are engaged primarily in offshore
activities, which is not an area in which we are currently active. So long as we hold our current license, Israeli law conveys
an exclusive exploration right to Zion such that no additional companies may compete in our license area.
Historically,
Israel (particularly onshore) has not been an area of interest for international integrated or large or mid-size independent oil
and gas exploration companies for various reasons, one of which is likely geopolitical. Since the announcement of the Tamar and
Leviathan discoveries during 2009 and 2010, this situation has changed somewhat. Limited availability in Israel of oil field service
companies, equipment and personnel continues to present obstacles, especially during periods of decreased activity and risk aversion
in the current market. We attempt to enhance our position by developing and maintaining good professional relations with oil field
service providers and by demonstrating a high level of credibility in making and meeting commercial commitments.
The
oil and gas industry is cyclical, and from time to time there is a shortage of drilling rigs, equipment, supplies and qualified
personnel. During these periods, the costs and delivery times of rigs, equipment and supplies can vary greatly. If the unavailability
or high cost of drilling and completion rigs, equipment, supplies or qualified personnel was particularly severe in the areas
where we operate, we could be materially and adversely affected. We will continue to monitor the market and build service provider
relationships in order to help mitigate concentration risk.
If
any exploratory well that we drill is commercially productive, we would install the appropriate production equipment which includes,
among other items, oil and gas separation facilities and storage tanks. Under the terms of the Petroleum Law, we may be required
by the Minister of Energy and Water Resources to offer first refusal for any oil and gas discovered to Israeli domestic purchasers
at market prices.
7
Since
Israel imports almost all of its crude oil needs and the market for crude oil in Israel is limited to two local oil refineries,
no special marketing strategy needs to be adopted initially with regard to any oil that we may ultimately discover. We believe
that we would have a ready local market for our oil at market prices in addition to having the option of exporting to the international
market, if any of our future exploratory wells are commercially productive.
Israel’s
Petroleum Law
Our business in Israel
is subject to regulation by the State of Israel under the Petroleum Law. The administration and implementation of the Petroleum
Law are vested in the Minister of Energy (“Energy Minister”), the Petroleum Commissioner and an advisory council. The
following discussion includes a brief summary review of certain provisions of the Petroleum Law as currently in effect. This review
is not complete, and it should not be relied on as a definitive restatement of the law related to petroleum exploration and production
activities in Israel.
Petroleum resources
are owned by the State of Israel, regardless of whether they are located on state lands or the offshore continental shelf. No person
is allowed to explore for or produce petroleum without being granted a specific right under the Petroleum Law. Israeli law provides
for three types of rights, two relevant to the exploration stage and the third for the production stage.
Preliminary permit.
The "preliminary permit" allows a prospector to conduct preliminary investigations, such as field geology, airborne magnetometer
surveys and seismic data acquisition, but does not allow test drilling. It may be granted for a period not to exceed 18 months.
The holder of a preliminary permit is entitled to request a priority right on the permit area, which, if granted, prevents an award
of petroleum rights on the permit area to any other party. There are no restrictions as to size of the permit area or to the number
of permits that may be held by one prospector. However, Israeli policy is to award an area no larger than that for which the applicant
has a reasonable plan of operation and has shown evidence of the necessary financial resources to execute the plan.
License. The next
level of petroleum right is the “license,” bestowing an exclusive right for further exploration work and requiring
the drilling of one or more test wells. The initial term of a license is up to three years, and it may be extended for up to an
additional four years (in one year increments). In the event of a discovery, the license may be extended for an additional two
years. A license area may not exceed 400,000 dunams (approximately 98,842 acres). One dunam is equal to 1,000 square meters
(approximately 0.24711 of an acre). No one entity may hold more than 12 licenses or hold more than a total of four million
dunam in aggregate license area.
Production
lease. Upon discovery of petroleum in commercial quantities, a licensee has a statutory “right” to receive a production
“lease.” The initial lease term is 30 years, extendable for an additional 20 years (up to a maximum period of 50 years).
A lease confers upon the lessee the exclusive right to explore for and produce petroleum in the lease area and requires the lessee
to produce petroleum in commercial quantities (and pursue test and development drilling). The lessee is entitled to transport
and market the petroleum produced, subject, however, to the right of the government to require the lessee to supply local needs
first, at market price.
Petroleum
rights fees. The holders of licenses and leases are required to pay fees to the government of Israel to maintain the rights.
The fees vary according to the nature of the right, the size and location (onshore or offshore) of the right, acreage subject
to the right and, in the case of a license, the period during which the license has been maintained.
Requirements
and entitlements of holders of petroleum rights. The holder of a petroleum right (license or lease) is required to conduct
its operations in accordance with a work program set as part of the petroleum right, with due diligence and in accordance with
the accepted practice in the petroleum industry. The holder is required to submit progress and final reports; provided, however,
the information disclosed in such reports remains confidential for as long as the holder owns a petroleum right on the area concerned.
If
the holder of a petroleum right does not comply with the work program provided by the terms of the right, the Petroleum Commissioner
may issue a notice requiring that the holder cure the default within 60 days of the giving of the notice, together with a warning
that failure to comply within the 60-day cure period may entail cancellation of the right. If the petroleum right is cancelled
following such notice, the holder of the right may, within 30 days of the date of notice of the Commissioner’s decision,
appeal such cancellation to the Energy Minister. No petroleum right shall be cancelled until the Energy Minister has ruled on
the appeal.
We
are obligated, according to the Petroleum Law, to pay royalties to the Government of Israel on the gross production of oil and
gas from the oil and gas properties of Zion located in Israel (excluding those reserves serving to operate the wells and related
equipment and facilities). The royalty rate stated in the Petroleum Law is 12.5% of the produced reserves. At December 31,
2020 and 2019, the Company did not have any outstanding obligation with respect to royalty payments, since it is in the development
stage and, to this date, no proved reserves have been found.
8
In
March 2011, the Israeli parliament enacted the Petroleum Profits Taxation Law, 2011, which imposes a new levy on oil and gas production.
Under the new tax regime, the Israeli Government repealed the percentage depletion deduction and imposed a levy at an initial
rate of 20% on profits from oil and gas which will gradually rise to 45.52% for 2016 onwards, depending on the levy coefficient
(the R-Factor). The R-Factor refers to the percentage of the amount invested in the exploration, the development and the establishment
of the project, so that the 20% rate will be imposed only after a recovery of 150% of the amount invested (R-Factor of 1.5) and
will range linearly up to 45.52% after a recovery of 230% of the amount invested (R-Factor of 2.3). For purposes of the levy rate
calculation, the minimal gas sale price that will be accepted by the State is the bi-annual average local price. The present 12.5%
royalty imposed on oil revenues remains unchanged.
The
grant of a petroleum right does not automatically entitle its holder to enter upon the land to which the right applies or to carry
out exploration and production work thereon. Entry requires the consent of the private or public holders of the surface rights
and of other public regulatory bodies (e.g. planning and building authorities, Nature Reserves Authority, municipal and security
authorities, etc.). The holder of a petroleum right may request the government to acquire, on its behalf, land needed for petroleum
purposes. The petroleum right holder is required to obtain all other necessary approvals.
Petroleum
Taxation. Our activities in Israel will be subject to taxation both in Israel and in the United States. Under the U.S. Internal
Revenue Code, we will be entitled to claim either a deduction or a foreign tax credit with respect to Israeli income taxes paid
or incurred on our Israeli source oil and gas income. As a general rule, we anticipate that it will be more advantageous for us
to claim a credit rather than a deduction for applicable Israeli income taxes on our U.S tax return. A tax treaty exists between
the U.S. and Israel that would provide opportunity to use the tax credit.
Exploration
and development expenses. Under current US and Israeli tax laws, exploration and development expenses incurred by a holder
of a petroleum right can, at the option of such holder, either be expensed in the year incurred or capitalized and expensed (or
amortized) over a period of years. Most of our expenses to date have been expensed for both U.S. and Israeli income tax purposes.
Depletion
allowances. Until 2011, the holder of an interest in a petroleum license or lease was allowed a deduction for income tax purposes
on account of the depletion of the petroleum reserve relating to such interest. This may have been by way of percentage depletion
or cost depletion, whichever is greater. In 2010, the Finance Minister of Israel established an advisory committee to study the
country’s fiscal policy as it relates to the upstream oil and natural gas sector, as well as various options, including
an increase in royalties or cancellation of tax incentives. In January 2011, the Finance Ministry advisory committee issued its
final recommendations which included cancellation of currently existing tax incentives, including the depletion allowance. In
2011, the depletion allowance was abolished.
Corporate
tax. Under current Israeli tax laws, whether a company is registered in Israel or is a foreign company operating in Israel
through a branch, it is subject to Israeli Companies Tax on its taxable income (including capital gains) from Israeli sources
at a flat rate of 23%, effective January 1, 2019.
Import
duties. Insofar as similar items are not available in Israel, the Petroleum Law provides that the owner of a petroleum right
may import into Israel, free of most customs, purchase taxes and other import duties, all machinery, equipment, installations,
fuel, structures, transport facilities, etc. (apart from consumer goods and private cars and similar vehicles) that are required
for the petroleum exploration and production purposes, subject to the requirement that security be provided to ensure that the
equipment is exported out of Israel within the agreed upon time frame.
9
Israeli
Energy Related Regulations
Our
operations are subject to legal and regulatory oversight by energy-related ministries or other agencies of Israel, each having
jurisdiction over certain relevant energy or hydrocarbons laws.
The
Onshore Petroleum Exploration Permitting Process in Israel
The
permitting process in Israel with respect to petroleum exploration continues to undergo significant modification, the result of
which is to considerably increase the complexity, time period, and expenditures needed to obtain the necessary permits to undertake
exploratory drilling once a drilling prospect has been identified. Applications for new exploration licenses need to comply with
more demanding requirements relating to a license applicant’s financial capability, experience and access to experienced
personnel. Various guidelines have been published in Israel by the State of Israel’s Petroleum Commissioner and Energy and
Environmental Ministries since 2012 as it pertains to oil and gas activities. Mention of these guidelines was included in previous
Zion Oil & Gas filings.
On
March 15, 2018, the Energy Ministry issued new guidelines regarding a uniform reporting manner by which the operator must submit
to the Commissioner data and materials regarding lawful exploration and production activities. The guidelines detail the timeline,
data, forms, format, media and materials (such as rock cuttings, cores, gas and oil samples) that must be submitted for seismic
and drilling activities.
On
April 8, 2019 the Energy Ministry issued new procedural guidelines regarding a uniform reporting manner by which the rights holder
in a license must submit a quarterly report regarding a summary of license history, the nature, scope, location and results of
the exploration work, specification of the amounts expended for the exploration work, and the results and interpretation of the
exploration work and basic data on which these results and interpretation are based. The guidelines are binding as from the date
of submission of the report for the third quarter 2019.
On
July 18, 2019, the Energy Ministry issued a guidance document entitled “Instructions for Submitting Guarantees with respect
to Oil Rights granted pursuant to the Petroleum Law” which states that onshore license applicants are required to deposit
a base bank guarantee of $500,000. Furthermore, prior to drilling, an onshore license holder is required to deposit an additional
bank guarantee in the amount as determined by the Petroleum Commissioner in accordance with the characteristics of the drilling
and the drilling plan but no less than $250,000. The guarantee, as determined by the Commissioner, shall be deposited with the
Commissioner Office for each well separately drilled. The Petroleum Commissioner has discretion to raise or lower those amounts
or may also forfeit a Company’s existing guarantee and/or cancel a petroleum right under certain circumstances.
In
addition, new and extended insurance policy guidelines were added. The Petroleum Commissioner may also view non-compliance with
the new insurance provisions as breaching the work plan and the rights granted and act accordingly.
On June 2, 2020, the
Energy Ministry issued a guidance document titled “Commissioner for Petroleum Affairs Guidelines: Extraordinary Incidences
Report.” These guidelines describe the reporting procedure regarding incidences that are out of the ordinary during pre-drilling,
drilling and production activities including incidences that cause bodily injury or damage to property or environment or incidences
that are a cause of delay or abort of drilling activities.
On September 15, 2020,
the Energy Ministry issued a guidance document titled “Principles for Submission of an Application for a Preliminary Permit
with Priority Rights.” Pursuant to this document, applicants for a Preliminary Permit need to comply with more demanding
requirements relating to a preliminary permit applicant’s financial capability, experience and access to experienced personnel.
The
Company believes that these new regulations are likely to result in an increase in the expenditures associated with obtaining
new exploration rights and drilling new wells. The Company expects that an additional financial burden could occur as a result
of requiring cash reserves that could otherwise be used for operational purposes. In addition, these new regulations are likely
to continue to increase the time needed to obtain all of the necessary authorizations and approvals to drill and production test
exploration wells.
Environmental&
Safety / Planning & Building
Oil
and gas drilling operations could potentially harm the environment if there are polluting spills caused by the loss of well control.
The Petroleum Law and regulations provide that the conduct of petroleum exploration and drilling operations be pursued in compliance
with “good oil field practices” and that measures of due care be taken to avoid seepage of oil, gas and well fluids
into the ground and from one geologic formation to another. The Petroleum Law and regulations also require that, upon the abandonment
of a well, it be adequately plugged and marked. Recently, as a condition for issuing the required permit for the construction
of a drilling site, the planning commissions have required the submission of a site remediation plan, subject to approval of the
environmental authorities. Our operations are also subject to claims for personal injury and property damage caused by the
release of chemicals or petroleum substances by us or others in connection with the conduct of petroleum operations on our behalf.
Various guidelines have been published in Israel by the State of Israel’s Petroleum Commissioner and Energy and Environmental
Ministries since 2012 as it pertains to oil and gas activities. Mention of these guidelines was included in previous Zion Oil&
Gas filings.
10
We
do not know and cannot predict whether any new legislation in this area will be enacted and, if so, in what form and which of
its provisions, if any, will relate to and affect our activities, how and to what extent or what impact, if any, it might have
on our financial statements. There are no known proceedings instituted by governmental authorities, pending or known to be contemplated
against us under any environmental laws. We are not aware of any events of noncompliance in our operations in connection with
any environmental laws or regulations. However, we cannot predict whether any new or amended environmental laws or regulations
introduced in the future will have a material adverse effect on our future business.
The
Company believes that these new and/or revised regulations will significantly increase the complexity, time, and expenditures
associated with obtaining new exploration rights, drilling, and plugging/abandoning new wells, coupled with the heavy financial
burden of “locking away” significant amounts of cash that could otherwise be used for operational purposes.
Political
Climate
We
are directly influenced by the political, economic and military conditions affecting Israel. Specifically, we could be adversely
affected by:
● any major hostilities involving Israel;
● a full or partial mobilization of the reserve forces of the Israeli army; and
● a significant downturn in the economic or financial condition of Israel.
Since
the establishment of the State of Israel in 1948, a number of armed conflicts have taken place between Israel and its Arab neighbors,
and a state of hostility, varying from time to time in intensity and degree, has led to security and economic problems for Israel.
Any ongoing or future violence between Israel and the Palestinians, armed conflicts, terrorist activities, tension along Israel’s
borders, or political instability in the region could possibly disrupt international trading activities in Israel and may materially
and negatively affect our business conditions and could harm our prospects and business.
Civil
unrest could spread throughout the region or grow in intensity, leading to more regime changes resulting in governments that are
hostile to the United States and Israel, civil wars, or regional conflict. More recently, Russia initiated significant and
direct military intervention in Syria consisting of air strikes against ISIS and other parties. With ongoing operations by Russia,
the U.S. and other countries in areas in close proximity to Israel, there is an increased risk of deliberate and/or inadvertent
mishaps that could give rise to grave military and political consequences.
We
cannot predict the effect, if any, on our business of renewed hostilities between Israel and its neighbors or any other changes
in the political climate in the area.
Foundations
If
we are successful in finding commercial quantities of hydrocarbons in Israel, 6% of our gross revenues from production will go
to fund two charitable foundations that we established with the purpose of donating to charities in Israel, the U.S. and elsewhere
in the world.
For
charitable activities concerning Israel, the Bnei Joseph Foundation (R.A.) was established. On November 11, 2008, both the
Articles of Association and Incorporation Certificate were certified by the Registrar of Amutot (i.e. Charitable Foundations)
in Israel.
For
the U.S. and worldwide charitable activities, the Abraham Foundation in Geneva, Switzerland was established. On June 20,
2008, the Articles of Incorporation were executed and filed by the Swiss Notary in the Commercial Registrar in Geneva. On June
23, 2008, the initial organizational meeting of the founding members was convened in Israel. Regulations for the Organization
of the Abraham Foundation, signed by the founding members, were then filed with the Registrar. On November 19, 2008, the
Swiss Confederation approved the Foundation as an international foundation under the supervision of the federal government.
On December 8, 2008, the Republic of Geneva and the Federal government of Switzerland issued a tax ruling providing complete tax
exemption for the Foundation.
Our
shareholders, in a resolution passed at the 2002 Annual Meeting, gave authority to the Zion Board of Directors to transfer a 3%
overriding royalty interest to each of the two foundations with regard to the Joseph and Asher-Menashe licenses. In accordance
with that resolution, we took steps to legally donate a 3% overriding royalty interest to the Bnei Joseph Foundation (in Israel)
and a 3% overriding royalty interest to the Abraham Foundation (in Switzerland).
11
On
June 22, 2009, we received an official letter from the Commissioner informing us that the 3% overriding royalty interest to each
of the Bnei Joseph Foundation and the Abraham Foundation had been registered in the Israeli Oil Register with regard to the Joseph
and Asher-Menashe licenses. On November 9, 2011, we received an official letter from the Commissioner informing us that the 3%
overriding royalty interest to each of the Bnei Joseph Foundation and the Abraham Foundation had been registered in the Israeli
Oil Register with regard to the Jordan Valley License.
On February 5, 2014,
the Company submitted applications to the Petroleum Commissioner, requesting royalty interest transfers from the Megiddo-Jezreel
License 401 of 3% overriding royalties to the Bnei Joseph Amutot and the Abraham Foundation, respectively. On April 8, 2014, the
transfers were approved by the Petroleum Commissioner and duly registered.
On January 14, 2021, the
Company submitted applications to the Petroleum Commissioner, requesting royalty interest transfers from the New Megiddo License
428 of 3% overriding royalties to each of the Bnei Joseph Amutot and the Abraham Foundation, respectively. The transfers are waiting
for approval by the Petroleum Commissioner and for registration.
Subsidiaries
On January 24, 2020, Zion
incorporated a wholly owned subsidiary, Zion Drilling, Inc., a Delaware corporation, for the purpose of owning a drilling rig
and related equipment and spare parts, and on January 31, 2020, Zion incorporated another wholly owned subsidiary, Zion Drilling
Services, Inc., a Delaware corporation, to act as the contractor providing such drilling services. When Zion is not using the
rig for its own exploration activities, Zion Drilling Services may contract with other operators in Israel to provide drilling
services at market rates then in effect.
Zion
has the trademark “ZION DRILLING” filed with the United States Patent and Trademark Office. Zion has the trademark
filed with the World Intellectual Property Organization in Geneva, Switzerland, pursuant to the Madrid Agreement and Protocol.
In addition, Zion has the trademark filed with the Israeli Trademark Office in Israel.
Available
Information
Zion’s
internet website address is “www.zionoil.com.” We make available, free of charge, on our website, and on our Zion
mobile application, under “SEC Reports,” our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports
on Form 8-K, Forms 3, 4 and 5 filed on behalf of directors and executive officers and amendments to those reports, as soon as
reasonably practicable after providing the SEC such reports.
Our
Corporate Governance Policy, the charters of the Audit Committee, the Compensation Committee and the Nominating and Governance
Committee, and the Code of Ethics for directors, officers, employees and financial officers are also available on our website
under “Corporate Governance” and in print to any stockholder who provides a written request to the Corporate Secretary
at Zion Oil & Gas, Inc., 12655 North Central Expressway, Suite 1000, Dallas, Texas 75243, Attn: Corporate Secretary.