Historically the price of natural gas has followed the price of oil as it has increased and decreased regularly since the initial price surge in 1979.  As one analyst stated "there was a time when all you had to know about natural gas prices was what was happening to oil prices."  The two moved in virtual lock step.

In December of 1997 the two energy sources became decoupled. (see graph below) Natural gas has remained above $2.00 per MCF even as oil prices have collapsed.  Just one year ago the price of natural gas was $1.57 during the shoulder months of April to June when there is very little demand for gas for winter heating or natural gas generated electricity for cooling during the hot summer. This surprising strength, in spite of low oil prices and a warm winter that left a high amount of natural gas in storage, reflects the new fundamentals in natural gas.

A combination of events are working to make natural gas the fastest growing energy source.  In 1978 President Carter passed the Fuel Use Act that forbid the burning of natural gas to generate electricity. The reasoning was to preserve a precious natural resource.  In 1987 congress repealed the Fuel Use Act, and now we have the Clean Air Act and the National Energy Act that require certain levels of cleaner sources of energy to generate electricity. Natural gas "combined cycle generation" is the most efficient and clean burning of all the major sources of electric energy and its use should accelerate in the new competitive environment sweeping the country.  A coal powered generating unit requires a heat rate of 10,000 British thermal units to generate one kilowatt-hour. New gas-fired combined cycle units require heat rates of 6,700 to 7,000 per kilowatt-hour.  While natural gas fueled only 8.5% of the power  generated in 1986, gas fired power plants accounted for 59% of 1996 generating capacity.  With the growing economy, industrial use of natural gas has been growing rapidly.  In the residential sector 65% of new homes in America are being equipped with natural gas.  Natural gas is the most environmentally acceptable fuel of all the major fuel sources.  Consumption has increased 3.1% annually since 1987.  The current reserve to production ratio of 8.5 years is the lowest in the history of the industry.  Natural gas use in the U.S. has grown to 22 trillion cubic feet a year compared to 19 trillion a few years ago and demand is projected to increase to 30 trillion by 2010.

Oil prices will eventually bounce back.  Venezuela is depleting its proven reserves by 20 percent a year, while older fields in the North Sea are shrinking 12 percent a year.  In the U.S. we are pumping 97 percent of existing proven producing capacity and we are losing production each year through depletion.  Natural gas will continue to hold it's own. "The supply/demand balance is a lot more closely aligned for natural gas than it is for the world crude market," says Steve Bergstrom, president and chief operating officer of Natural Gas Clearing House, the gas marketing unit of Houston-based NGC Corporation. As Thomas Robinson, senior director, natural gas, for the consulting firm Cambridge Energy Research Associates, stated "There's no Saudi Arabia of natural gas."  The long term demand picture is bullish.

On the supply side, production of natural gas from key areas like the Gulf of Mexico is going at full throttle, making for a genuinely tight supply/demand picture.  "There's been little response from U.S. producers to what has been a multi-year period of demand increases,"  says Mark Gilman, an oil analyst for UBS.

The May 26, 1998, issue of the Wall Street Journal gave insight into the key factors controlling both near term and  beyond natural gas prices.  In this article Mr. Terzah Ewing, Staff Report for the Wall Street Journal, stated "despite the short-term pessimism in the trading pits - and a ballooning abundance of the fuel in underground storage tanks - the markets long range view for prices is, relatively bullish."  Mr. Ewing's analysis of the recent decline in natural gas prices is based on the belief that "natural gas wholesalers who control storage tanks, are betting that they can buy cheaper gas now on the spot market, hoarding it, then retail it later this year at higher prices."  In doing so natural gas wholesalers are betting on a hot summer spurring demand for air conditioning and a cold winter resulting in high heating usage.

It is normal for gas suppliers to build up at this time of year. However, the recent steep increase in reserves was unexpected. Although, storage is up for now, new production of natural gas isn't keeping pace with overall demand growth. Joseph Blorento, vice president of Unocal Corporation's natural gas trading unit stated that "natural gas is the fuel of the future - almost all power plants built in the U.S. from now on will run on natural gas instead of coal or nuclear power."  The growing  penetration  of  gas  into heating  markets,  where in  the  past  its not  the  traditional  fuel, should U.S demand to 30 trillion cubic feet a year by 2010 from the current 22 trillion cubic feet, according to Energy Department statistics.

Michael Rothman a senior energy analyst with Merrill Lynch and Co., stated production from key areas like the Gulf of Mexico continues to be flat - rig counts and drilling rates are at  record  levels, "they're running  hard just  to  stay  even."

Paul Ziff,  CEO of Ziff Energy Group, Canada's largest energy consulting firm, does not foresee that the eventual increase of natural gas coming into the U.S. from Canada will create a long term dampener on U.S. natural gas prices, but rather "an upward surge on the Canadian side."

John Saucer, an energy analyst for Salomon Smith Barney in Houston stated "At the end of the day, we may need every molecule they stick in storage."  Simply stated as long as demand is rising and production is level or declining the long term outlook for natural gas will remain bullish.

The winter of 1998 was an exceptionally wet period which totally curtailed or seriously delayed all drilling in the Sacramento and San Joaquin basins of California.  Royale's operational activity is now proceeding at full speed to reach the Company's objective to drill 20 new wells in 1998.  It appears El Nino will be a lesser threat into the future.

The following recaps activity now occurring in the basins:

The West Grimes 20-3 well was drilled and completed in October 1997 and placed in production on May 22, 1998.  The initial daily production of gas from this well was 750 MCF.  The Bowerbank 9 well was drilled and completed in March 1998 and placed in production on June 25, 1998.  The Bowerbank 10 well has been successfully drilled and completed and will e in production in July 1998.  The North Lathrop well was drilled and completed in June 1998.  It is anticipated that this well will be in production in the Fall of 1998. Initial daily production is anticipated to be 1,000 MCF.  The Bowerbank 12 well was drilled and completed in June 1998.  It is anticipated that this well will begin production in July 1998.  The Bowerbank 11 well is being drilled at press time.  If the drilling of this well is successful it is estimated that natural gas production ca begin in July 1998.  The Snowbird 1-2 wells was drilled and completed in March 1997.  Due to a series of pipeline access delays this well has not been placed in production.  It is expected that the well will be connected after gaining the necessary County road access permit which is expected July 14th.  A mandatory waiting period of 30 days is required between ganging approval and commencement of pipeline installation.  The estimated date for first production is September 1998.

Five new wells are being scheduled for drilling during the Summer and Fall.  The Stone Lake well is anticipated to be drilled by July 21st.  The North Arbuckle 1,2,3, and 4, 3D seismic wells will commence drilling by October 1998.  The 3D seismic shoot made over a 33 square mile area which encompasses these wells has been completed.  The Selection of the first four drilling sites in the Arbuckle field will be completed in July.

A new high capacity pipeline was placed in service in the Bowerbank field on June 25, 1998.  This new pipeline has allowed an increase in production for several Bowerbank wells whose e production was previously restricted due to pipeline capacity.

Victor Ranch 12, the first well Royale Energy drilled in California basins was off lien for 22 days during February due to flooded conditions in the Sacramento basin.  It resumed production on February 28th producing 38,373 MCF of natural gas in March 1998.  The Victor Ranch 12 well went into production  on December 8, 1993, and has produced 1.7 billion cubic feet of gas since 1993.  Current daily production of natural gas from this well exceeds 1,0000  MCF per day.

From the field, tends of thousands of raw second wave reflections recorded digital computer tapes are sent to a geophysical processing center.  Specialists at the center turn the raw date into several different 3 D seismic data "volumes".  Signal enhanced 3D seismic  volumes are primarily used to map the structural geology of subsurface rock layers.  In some rock formations and areas.  Such as the Cretaceous Forbes in the eh Northern California Sacramento Basin, Preserved Amplitude 3D data volumes are used to identify unusually high amplitude reflection, called "bright spots", which are commonly associated with natural gas saturated reservoirs.  Seismic wave data in the eh "gather" from is used to perform Amplitude vs. Offset distance (AVO) analysis on the bright spot.  The ultimate goal of all the analysis is to select promising drilling locations.

In general, an individual seismic trace can be thought of as a single reflection of the surface shockwave directed downward throughout the subsurface rock layers.  The seismic wave travels down throughout the many rock layers, both changing shape as it encounters different rock horizons and reflecting a bit of its energy back to the surface depending upon the velocity and density differences of the stratigraphic boundaries it penetrates.  Upon close inspection, a single seismic wave appears to look like a profile of surface waves turned sideways, similar to a bow wave created by a  boat on the surface of a still lake.  Seismic waves, like all waves have peaks and throughout of varying size.  The peaks and troughs represent approximate stratigraphic boundaries of rock formation, although it is important to note that not all rock  layers necessarily cause reflections.  Natural gas in certain rock formations and situations dramatically lowers the velocity of the fluid-filled reservoir rock and often helps create a very intense reflection signal as the seismic wave encounters it.

For the North Arbuckle Prospect are, Vector Seismic, Inc., In Houston, Texas created a very large 3D volume covering more than 30 square miles and 90 cubic miles.  2, 575 individual shots were made (one at a time) with up to 1,200 live receiver-geophone stations arrayed on the surface to record the reflections of the surface shockwave directed to rock layers deep in the earth. Reflections were recorded down to more than 4 seconds of two way time (down from and back to the surface from the deep rocks at about 20,000 feet.) This design insured that potential gas reservoirs in the eh Forbes formation, believed to be present from 1.1 to 1.7 seconds (about 4,300 to 6,800 feet deep were adequately sampled.

The individual seismic wave traces totaled  2,617,193.  In 3D processing traces that sample the same point in the subsurface and  are "gathered" together into a  common reflection bins. Binning is essentially a three dimensional grinding and sorting process.  The seismic grid area at Arbuckle was 232 bins wide and 410 bins long and contained a total of 95,120 bins which are  110 feet apart at bin center.

Traces collected in a bin are called the gather.  Although traces gathered together in a bin share a common reflection point in the subsurface, they have varying distances between their respective source and receiver stations on the surface, normally from 150 feet to over 8000 feet.  Looking at these traces in a single bin before there are combined is the essence of Amplitude vs. Offset distance analysis. In 1984 Chevron Oil Company in San Francisco California revealed publicly that, based on seismic data in the Sacramento Basin, the traces with greater offsets distance tended to have more amplitude than the near traces when reflected off the same gas filled strata.  This was called Amplitude vs. Offset analysis.  Although several companies had been using variations of the technique in other parts of the world AVO was officially born.

Once gathered, traces assigned to a bin in  are mathematically combined or "stacked" to reduce ambient noise and bring out the true rock reflection peaks and troughs. A single composite trace is generated for each of the 95,125 bins.  This trace approximates what a single seismic wave would appear to be if one could direct a single shot straight down and straight back to a geophone in the center of the bin on the surface.

The 95,120 traces are then stacked and  filtered into a variety of 3D seismic volumes. such as the Preserved Amplitude version to search for bright spots.  The volumes are interpreted on Royale's 3D workstation in their San Diego office.  The geologist creates geophysical cross section views of the earth called seismic sections to identify bright spots, faults and other subsurface geological phenomenon.  It is also used to make geophysical and geological maps, predict the depth and a real extent of the objective reservoir and select the final drilling locations.

Seismic data is expensive and requires a great deal of planning and exacting execution to insure a successful 3D seismic program.  The program is considered a success if the data quality and coverage is sufficient to allow the selection of drill sites that yields commercial gas wells. Royale Energy believes that the North Arbuckle 3D seismic volume, the first of its kind in the area, will yield a significant of new gas pools.  Judging by the initial analysis several promising  drill sites have been selected.  By the end of 1998 the results of the initial drilling should herald the beginning of several years of successful drilling in the area.

On August 10th, following the San Francisco Money Show, Royale Energy will host its annual visit to the field.  Plan to join in the excitement of seeing a well underway and enjoy a real Western barbecue. 

Frequently management is asked "why isn't Royale Energy stock moving higher when its equity is growing by 30% a year?"  Analysts believe that investors have a perception that when oil prices are significantly lower all energy company earnings are negatively impacted.

Royale Energy's production and reserves are in natural gas and its earnings should not be affected by the decline in oil prices.  1998 has been Royale Energy's greatest year in growth of earnings, natural gas production, new well drilling and discovery of gas reserves.  Over 30 square miles of new 3D seismic has identified excellent bright spots that the Company will drill and develop this year.  The Company is also shooting 4 separate 3D seismic surveys in different producing fields in the Sacramento Basin giving sufficient inventory of prospects to meet Royale's expanding need for new drilling sites.  Natural gas revenue for the first 3 months of 1998 was up 101% over one year ago and continues to climb in the second quarter.  With higher prices than a year ago for natural gas sales and no current litigation, the Company's earnings are escalating more rapidly.

1998 is proving to be Royale's best year for growth.