E&P 101 (The Short Course)E&P 101 (The Short Course)

Contango is in the "upstream" sector of the U.S. energy business, Contango is in the "upstream" sector of the U.S. energy business, as opposed to the refining and other "downstream" sectors of as opposed to the refining and other "downstream" sectors of marketing refined products such as heating oil, gasoline, and marketing refined products such as heating oil, gasoline, and distribution of natural gas.  The exploration for oil and natural distribution of natural gas.  The exploration for oil and natural gas is a very mature business (N.B. mature does not equate to gas is a very mature business (N.B. mature does not equate to stable) that has been around for over a hundred and forty years.  stable) that has been around for over a hundred and forty years.  As a result, all of the easy to identify and obvious oil and gas As a result, all of the easy to identify and obvious oil and gas fields have already been discovered.  Thus, the U.S. domestic fields have already been discovered.  Thus, the U.S. domestic industry has had to rely on improving technology to industry has had to rely on improving technology to economically find and produce increasingly geologically economically find and produce increasingly geologically complex and smaller oil and gas accumulations.complex and smaller oil and gas accumulations.

E&P 101 (Continued)E&P 101 (Continued)

Contango, like other exploration and production ("E&P") Contango, like other exploration and production ("E&P") companies, is in the business of creating and drilling the very companies, is in the business of creating and drilling the very best reward/ risk oil and natural gas prospects at hopefully best reward/ risk oil and natural gas prospects at hopefully economically attractive prices.  The difficulty of actually economically attractive prices.  The difficulty of actually executing and achieving this modest business plan should not be executing and achieving this modest business plan should not be under estimated.  In addition to the challenges that face virtually under estimated.  In addition to the challenges that face virtually all companies in all industries - i.e., lots of smart, aggressive, all companies in all industries - i.e., lots of smart, aggressive, well-capitalized competitors - E&P companies face several well-capitalized competitors - E&P companies face several additional challenges as well.  First, we produce a commodity additional challenges as well.  First, we produce a commodity (oil or natural gas) whose prices can and frequently do vary (oil or natural gas) whose prices can and frequently do vary widely and sometimes wildly.  widely and sometimes wildly. 

E&P 101 (Continued)E&P 101 (Continued)

Further, the core of our business involves geoscientists trying to Further, the core of our business involves geoscientists trying to piece together a multi-variable, 3-dimensional puzzle to piece together a multi-variable, 3-dimensional puzzle to determine if conditions existed over geologic time (30-100 determine if conditions existed over geologic time (30-100 million years) to source, trap and profitably produce oil and million years) to source, trap and profitably produce oil and natural gas.  Further complicating the puzzle is that only some natural gas.  Further complicating the puzzle is that only some of the variables are knowable and, oftentimes, some of the of the variables are knowable and, oftentimes, some of the variables that you think you know, may in fact, be wrong.variables that you think you know, may in fact, be wrong.

3 Types of E&P Costs3 Types of E&P Costs

In the E&P business, there are three major cost components:In the E&P business, there are three major cost components:

- Discovery costs - known as “finding and development” costs ("F&D")- Discovery costs - known as “finding and development” costs ("F&D")

- Extraction costs - known as “lease operating expense” ("LOE")- Extraction costs - known as “lease operating expense” ("LOE")

- Everything else  - known as “general and administrative” ("G&A"),- Everything else  - known as “general and administrative” ("G&A"), interest expense and income taxesinterest expense and income taxes

F&D costs include the costs to acquire a mineral lease (leasehold costs), costs to F&D costs include the costs to acquire a mineral lease (leasehold costs), costs to acquire seismic data (seismic data are reflected sound waves that image beneath acquire seismic data (seismic data are reflected sound waves that image beneath the surface of the earth and are used to identify potential accumulations of oil the surface of the earth and are used to identify potential accumulations of oil and natural gas), costs to evaluate this data and put together a "prospect" to be and natural gas), costs to evaluate this data and put together a "prospect" to be drilled and the actual costs of drilling and developing an oil or natural gas field.  drilled and the actual costs of drilling and developing an oil or natural gas field. 

3 Types of E&P Costs (Cont’d)3 Types of E&P Costs (Cont’d)

Also included are the costs for prospects that are generated and Also included are the costs for prospects that are generated and never drilled and "dusters" or a "dry hole" where a well was never drilled and "dusters" or a "dry hole" where a well was drilled, but no reserves were found.  Acquisition costs of drilled, but no reserves were found.  Acquisition costs of purchasing already proven and producing reserves are also purchasing already proven and producing reserves are also included in F&D costs.included in F&D costs.

A major goal for Contango will be to control F&D costs through an A major goal for Contango will be to control F&D costs through an alliance with a premier group of explorationists - Juneau alliance with a premier group of explorationists - Juneau Exploration, LLC ("JEX").  This alliance shifts the up-front Exploration, LLC ("JEX").  This alliance shifts the up-front people costs of generating prospects and identifying acquisition people costs of generating prospects and identifying acquisition opportunities to these proven prospect generators.  These opportunities to these proven prospect generators.  These explorationists prefer to free lance because they believe they explorationists prefer to free lance because they believe they will make more money from overrides than they would as will make more money from overrides than they would as salaried employees.  Thus, Contango is getting some of the salaried employees.  Thus, Contango is getting some of the industry's very best talent on risk-shifted favorable terms.industry's very best talent on risk-shifted favorable terms.

3 Types of E&P Costs (Cont’d)3 Types of E&P Costs (Cont’d)

LOE costs are the costs incurred to extract the oil and gas from beneath LOE costs are the costs incurred to extract the oil and gas from beneath the earth's surface to a central gathering or shipping point.  These the earth's surface to a central gathering or shipping point.  These costs are, to a large extent, a function of the reservoir.  Typically, costs are, to a large extent, a function of the reservoir.  Typically, the more energy a reservoir has to "push" the produced reserves to the more energy a reservoir has to "push" the produced reserves to the well bore, the lower the LOE costs will be.  Also, included in the well bore, the lower the LOE costs will be.  Also, included in these costs, are the severance and ad valorem taxes owed to states these costs, are the severance and ad valorem taxes owed to states and municipalities. A cost conscious, efficient operator can play an and municipalities. A cost conscious, efficient operator can play an important role in keeping LOE costs down.  important role in keeping LOE costs down. 

All other costs include various management, accounting, insurance, All other costs include various management, accounting, insurance, legal costs, etc. involved in the day-to-day running of a company as legal costs, etc. involved in the day-to-day running of a company as well as interest on debt (if any) and income taxes on profits (if well as interest on debt (if any) and income taxes on profits (if any).  Contango will undoubtedly borrow money as it grows and any).  Contango will undoubtedly borrow money as it grows and thus, interest and principal payments will be incurred.  Since the thus, interest and principal payments will be incurred.  Since the company's overarching goal is to be profitable, hopefully we will company's overarching goal is to be profitable, hopefully we will also be paying income taxes.also be paying income taxes.

RevenuesRevenues

Oil and natural gas are commodities that trade off of Oil and natural gas are commodities that trade off of highly visible reference prices (Nymex futures highly visible reference prices (Nymex futures pricing, field postings, and various pipeline hubs) with pricing, field postings, and various pipeline hubs) with adjustments for gravity, Sulfur, etc., and nearness to a adjustments for gravity, Sulfur, etc., and nearness to a pipeline in the case of crude oil; and btu content, pipeline in the case of crude oil; and btu content, impurities, etc., and nearness to a pipeline in the case impurities, etc., and nearness to a pipeline in the case of natural gas.  Contango has no ability to increase the of natural gas.  Contango has no ability to increase the market price of oil or natural gas, but there are ways to market price of oil or natural gas, but there are ways to improve the company's margins through diligent improve the company's margins through diligent marketing, laying pipeline gathering systems, building marketing, laying pipeline gathering systems, building gas plants and other strategies to capture a share of the gas plants and other strategies to capture a share of the "downstream" value chain."downstream" value chain.

Competitive AdvantageCompetitive AdvantageWhat is Contango's strategy to achieve a competitive edge?  In all What is Contango's strategy to achieve a competitive edge?  In all

commodity businesses, the only real competitive advantage is to be a commodity businesses, the only real competitive advantage is to be a low-cost producer.  Contango's strategy to be a low cost producer low-cost producer.  Contango's strategy to be a low cost producer includes the following:includes the following:

F&D cost - shift as much as possible of the day-to-day people costs F&D cost - shift as much as possible of the day-to-day people costs associated with generating and screening prospects through  its alliance associated with generating and screening prospects through  its alliance with JEX.  Stay focused on the funding and drilling of a prospect, the with JEX.  Stay focused on the funding and drilling of a prospect, the most value added part of the value chain. Make sure the explorationists most value added part of the value chain. Make sure the explorationists who work for us have the “right stuff”.who work for us have the “right stuff”.

Interest Cost - keep leverage modest.  Debt can allow a company to grow Interest Cost - keep leverage modest.  Debt can allow a company to grow faster and sometimes earn a higher ROE.  The trade-off, though, is a loss faster and sometimes earn a higher ROE.  The trade-off, though, is a loss in financial flexibility and an inability to jump on opportunities. Also, in financial flexibility and an inability to jump on opportunities. Also, time is not on you side when you're over-leveraged, and in a highly time is not on you side when you're over-leveraged, and in a highly cyclical business, timing cycles is critical to success.cyclical business, timing cycles is critical to success.

Competitive Advantage (Cont’d)Competitive Advantage (Cont’d)LOE - Outsource.  Contango intends to use contract operators or rely on LOE - Outsource.  Contango intends to use contract operators or rely on

other working interest owners for the day-to-day operations in producing other working interest owners for the day-to-day operations in producing its production.  Contango will be charged for its proportionate share of its production.  Contango will be charged for its proportionate share of these costs including G&A or Copas accounting charges.  Thus, while these costs including G&A or Copas accounting charges.  Thus, while there's never a "free lunch", the company is only incurring these costs there's never a "free lunch", the company is only incurring these costs when and as there is a revenue producing well to offset the costs.  The when and as there is a revenue producing well to offset the costs.  The other advantage is that these "variable" costs have a way of becoming other advantage is that these "variable" costs have a way of becoming "fixed" as staff grows to support operations.  It is important that the "fixed" as staff grows to support operations.  It is important that the company pick reliable, prudent operators, however, as there is a loss of company pick reliable, prudent operators, however, as there is a loss of control, to some extent, involved in outsourcing.control, to some extent, involved in outsourcing.

General & Administrative - Outsource.  Contango has outsourced its General & Administrative - Outsource.  Contango has outsourced its accounting and relies on outside lawyers and insurance brokers for legal accounting and relies on outside lawyers and insurance brokers for legal and insurance advice.  Interest expense is a function of the company's and insurance advice.  Interest expense is a function of the company's debt level, which we intend to keep modest.  Income taxes are inevitable debt level, which we intend to keep modest.  Income taxes are inevitable if the company achieves its ultimate goal of being profitable and an if the company achieves its ultimate goal of being profitable and an industry leader in profit margin.industry leader in profit margin.

CompetitionCompetition

There are two types of competition in the oil and gas business.  The There are two types of competition in the oil and gas business.  The first is present in all industries - other companies who are first is present in all industries - other companies who are competing to generate and control the same assets, or in our competing to generate and control the same assets, or in our case, the same oil and gas leases, prospects or producing case, the same oil and gas leases, prospects or producing properties that we are seeking.  Virtually all of these companies properties that we are seeking.  Virtually all of these companies are significantly larger and better capitalized than Contango.  are significantly larger and better capitalized than Contango.  Moreover, they are staffed with smart, competent individuals Moreover, they are staffed with smart, competent individuals who are dedicated to building their companies.  As formidable who are dedicated to building their companies.  As formidable as these companies are, however, they are not our only or as these companies are, however, they are not our only or necessarily most formidable competitive challenge.  necessarily most formidable competitive challenge. 

Competition (Cont’d)Competition (Cont’d)

The second challenge is to avoid overpaying for leases, seismic data The second challenge is to avoid overpaying for leases, seismic data and producing reserves, and managing our capital and the risk and producing reserves, and managing our capital and the risk profile of the wells we decide to drill.  There are always lots of profile of the wells we decide to drill.  There are always lots of developing "hot plays" and "deals" available in the oil and gas developing "hot plays" and "deals" available in the oil and gas industry.  The scarce skill set and managements largest value industry.  The scarce skill set and managements largest value added opportunity/ challenge is sorting through these "hot plays" added opportunity/ challenge is sorting through these "hot plays" and "deals" and avoiding the temptation to drill the inferior and "deals" and avoiding the temptation to drill the inferior reward/ risk prospects.  Of course, no one purposefully drills a dry reward/ risk prospects.  Of course, no one purposefully drills a dry hole, and identifying the wells that are going to be successful in hole, and identifying the wells that are going to be successful in advance of drilling is impossible because of the many variables advance of drilling is impossible because of the many variables involved and the numerous and entirely feasible interpretations of involved and the numerous and entirely feasible interpretations of both reward (expected profit) and risk (the probability of an both reward (expected profit) and risk (the probability of an undesired outcome).  Nonetheless, this skill set, or combination of undesired outcome).  Nonetheless, this skill set, or combination of skill, hard work, and perhaps luck is the single most important skill, hard work, and perhaps luck is the single most important ingredient for success in the E&P business.ingredient for success in the E&P business.

What Are the Risks?What Are the Risks?

In the energy business, like all other investing endeavors, In the energy business, like all other investing endeavors, risk/reward go hand in hand. Our goal is to minimize risk to an risk/reward go hand in hand. Our goal is to minimize risk to an “irreducible uncertainty” I.e., we have done all we can to reduce “irreducible uncertainty” I.e., we have done all we can to reduce risk and the next step is to drill a well.risk and the next step is to drill a well.

Some of the more common errors made by the industry that we Some of the more common errors made by the industry that we hope to avoid are summarized as follows:hope to avoid are summarized as follows:

- Gambler's Ruin- Gambler's Ruin - Winner's Curse - Winner's Curse - Confirmation Bias - Confirmation Bias - Commodity Price Volatility - Commodity Price Volatility - Too Much Debt - Too Much Debt

What Are the Risks? (Cont’d)What Are the Risks? (Cont’d)

Gambler's Ruin is also referred to as the law of large numbers.  In Gambler's Ruin is also referred to as the law of large numbers.  In the oil business, it means not giving yourself enough "rolls of the the oil business, it means not giving yourself enough "rolls of the dice" or drilling a large enough number of wells to allow the dice" or drilling a large enough number of wells to allow the probabilities of success to work for you.  The way to avoid probabilities of success to work for you.  The way to avoid gambler's ruin is to be judicious in sizing the dollar commitment gambler's ruin is to be judicious in sizing the dollar commitment to each individual well and to always have excess capital to each individual well and to always have excess capital available.available.

Winner's Curse, which is sometimes referred to as buyers remorse, Winner's Curse, which is sometimes referred to as buyers remorse, is what you feel after you bid for an asset - and win.  Oil and gas is what you feel after you bid for an asset - and win.  Oil and gas properties/ prospects are frequently auctioned or "shopped" to a properties/ prospects are frequently auctioned or "shopped" to a number of potential buyers.  The challenge for Contango is to number of potential buyers.  The challenge for Contango is to avoid the temptation to get in a bidding contest, overpaying and avoid the temptation to get in a bidding contest, overpaying and thus regretting our purchase.  Since we will almost always face thus regretting our purchase.  Since we will almost always face some competition for every asset, property or lease that we buy, some competition for every asset, property or lease that we buy, staying disciplined is crucial.staying disciplined is crucial.

What Are the Risks? (Cont’d)What Are the Risks? (Cont’d)Confirmation bias is that totally human propensity to look for data that Confirmation bias is that totally human propensity to look for data that

confirms one's conviction and explain away or ignore data that is confirms one's conviction and explain away or ignore data that is disconfirming.  The whole art and science of generating and selecting disconfirming.  The whole art and science of generating and selecting the right prospects to drill or acquisitions to purchase involves the right prospects to drill or acquisitions to purchase involves reviewing a multitude of variables with multiple interpretations.  reviewing a multitude of variables with multiple interpretations.  Accepting the fact that one of the assumptions you most want to Accepting the fact that one of the assumptions you most want to believe may not be right is difficult.  Maintenance of this type of believe may not be right is difficult.  Maintenance of this type of objectivity is critical to success.  objectivity is critical to success. 

Commodity price volatility is a fact of life with oil and gas.  The ups are Commodity price volatility is a fact of life with oil and gas.  The ups are fun, but the downs are devastating for high debt, high cost companies.  fun, but the downs are devastating for high debt, high cost companies.  We intend to work very hard to keep our costs and leverage low, We intend to work very hard to keep our costs and leverage low, which should help reduce our vulnerability to price dips.  We also which should help reduce our vulnerability to price dips.  We also will, from time-to-time, hedge our production including swaps, will, from time-to-time, hedge our production including swaps, collars, selling calls/ buying puts, seek off-balance sheet financing, or collars, selling calls/ buying puts, seek off-balance sheet financing, or enter into joint-venture arrangements with purchasers that "lock in" enter into joint-venture arrangements with purchasers that "lock in" our commodity prices.our commodity prices.

What Are the Risks? (Cont’d)What Are the Risks? (Cont’d)

Too Much Debt.  High debt in a volatile, depreciating asset Too Much Debt.  High debt in a volatile, depreciating asset commodity business is a prescription for disaster.  While a little commodity business is a prescription for disaster.  While a little debt can help avoid dilution and leverage rates of return, too debt can help avoid dilution and leverage rates of return, too much debt has meant the demise of many an independent.  We much debt has meant the demise of many an independent.  We are targeting to maximize debt at about 35% of the PV10 of our are targeting to maximize debt at about 35% of the PV10 of our properties. properties.

SummarySummary

In summary, we're optimistic about the opportunities we think are In summary, we're optimistic about the opportunities we think are in front of us, despite being fully cognizant that most in front of us, despite being fully cognizant that most independent oil and natural gas exploration and production independent oil and natural gas exploration and production companies over the last two decades have been "value companies over the last two decades have been "value destroyers" rather than "value creators".  We think a renewed destroyers" rather than "value creators".  We think a renewed industry commitment to profitability is absolutely essential.  We industry commitment to profitability is absolutely essential.  We believe Contango's sole focus on the highest value added believe Contango's sole focus on the highest value added component of the value chain, and low cost structure are key to component of the value chain, and low cost structure are key to this profitability.  Finally, and perhaps the single most important this profitability.  Finally, and perhaps the single most important investment criteria of all: Incentives Drive Behavior. investment criteria of all: Incentives Drive Behavior. Contango’s management and the Board of Directors own Contango’s management and the Board of Directors own collectively ± 60% of Contango's stock and are incentivized to collectively ± 60% of Contango's stock and are incentivized to grow asset value and earnings per share.  grow asset value and earnings per share.