10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.    20549
FORM 10-Q
[X]   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter ended		Commission File No.
June 30, 2004		0-9120
THE EXPLORATION COMPANY OF DELAWARE, INC.
(Exact Name of Registrant as Specified in its Charter)
DELAWARE		84-0793089
(State or other jurisdiction of		(I.R.S. Employer I.D. No.)
incorporation or organization)
500 NORTH LOOP 1604 E.,  SUITE 250    SAN ANTONIO, TEXAS  78232
(Address of principal executive offices)
Registrant's telephone number, including area code:   (210) 496-5300
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
YES [X]		NO  [  ]
Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).
YES [X]		NO  [  ]
Indicate the number of shares outstanding of each of the issuer's classes of common stock as of July 31, 2004.
Common Stock $0.01 par value		27,959,063
(Class of Stock)		(Number of Shares)
For more information and a print friendly version of this document go to www.txco.com.
Total number of pages is 18
1

PART I - FINANCIAL INFORMATION
ITEM 1.     FINANCIAL STATEMENTS.
THE EXPLORATION COMPANY
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
	June 30, 2004	December 31, 2003
Assets
Current Assets
Cash and equivalents	$7,352,143	$  6,180,560
Accounts receivable, net	10,101,547	4,837,965
Prepaid expenses	1,485,260	718,853
Total Current Assets	18,938,950	11,737,378
Property and Equipment, net - successful efforts    method of accounting for oil and gas properties	74,843,434	66,155,827
Other Assets
Deferred tax asset	5,232,718	5,232,718
Other assets	1,110,098	1,080,290
Total Other Assets	6,342,816	6,313,008
	$100,125,200	$84,206,213
See notes to consolidated financial statements
2

THE EXPLORATION COMPANY
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
	June 30, 2004		December 31, 2003
Liabilities and Stockholders' Equity
Current Liabilities
Accounts payable, trade	$9,734,405		$  8,186,705
Other payables and accrued liabilities	6,002,882		3,709,016
Undistributed revenue	1,127,759		416,399
Current portion of long-term debt	1,725,405		1,752,286
Total Current Liabilities	18,590,451		14,064,406
Long-term Liabilities
Long-term debt, net of current portion	6,061,914		15,425,598
Redeemable preferred stock, Series B       (redemption value - $16 million)	10,550,572		10,135,335
Accrued dividends - preferred stock	137,730		57,732
Asset retirement obligation	1,648,600		1,537,600
Total Long-Term Liabilities	18,398,816		27,156,265
Minority Interest in Consolidated Subsidiaries	214,856		193,441
Stockholders' Equity
Preferred stock, Series A; authorized 10,000,000 shares       issued and outstanding -0- shares	- -		- -
Common stock, par value $.01 per share; authorized       50,000,000 shares; issued 28,058,863 and 22,242,849 shares,       outstanding 27,959,063 and 22,143,049 shares	280,588		222,428
Additional paid-in capital	83,605,611		63,976,021
Accumulated deficit	(20,719,115	)	(21,160,341	)
Less treasury stock, at cost, 99,800 shares	(246,007	)	(246,007	)
Total Stockholders' Equity	62,921,077		42,792,101
Total Liabilities and Stockholders' Equity	$100,125,200		$84,206,213
See notes to consolidated financial statements
3

THE EXPLORATION COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
	Three Months Ended				Three Months Ended
		June 30, 2004			June 30, 2003
Revenues
Oil and gas sales			$  6,956,443		$6,574,218
Gas gathering operations			7,666,582		3,291,401
Other operating income			1,484		3,150
Total revenues			14,624,509		9,868,769
Costs and Expenses
Lease operations			1,428,241		977,967
Production taxes			455,660		434,869
Exploration expenses			575,385		626,570
Impairment and abandonments			516,900		537,075
Gas gathering operations			7,040,536		3,417,324
Depreciation, depletion and amortization			2,437,143		2,821,148
General and administrative			1,027,040		854,798
Total costs and expenses			13,480,905		9,669,751
Income from Operations			1,143,604		199,018
Other Income (Expense)
Interest income			15,487		5,955
Interest expense			(727,910	)	(156,839	)
Loan fee amortization			(53,695	)	(4,401	)
Total Other Income (Expense)			(766,118	)	(155,285	)
Income before income taxes and minority interest			377,486		43,733
Minority interest in income of subsidiaries			19,823		15,855
Income before income taxes			397,309		59,588
Income tax expense			(25,000	)	(50,000	)
Net Income			$     372,309		$       9,588
Earnings Per Share
Basic earnings per share			$0.015		$0.000
Diluted earnings per share			$0.014		$0.000
See notes to consolidated financial statements
4

THE EXPLORATION COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
	Six Months Ended		Six Months   Ended
	June 30, 2004		June 30, 2003
Revenues
Oil and gas sales	$13,111,625		$12,456,934
Gas gathering operations	12,875,475		6,499,786
Other operating income	4,806		(78	)
	25,991,906		18,956,642
Costs and Expenses
Lease operations	2,675,627		2,052,316
Production taxes	842,240		803,273
Exploration expenses	749,782		1,001,601
Impairment and abandonments	1,033,800		876,150
Gas gathering operations	11,934,670		7,014,560
Depreciation, depletion and amortization	4,772,440		4,494,468
General and administrative	2,032,661		1,630,903
Total costs and expenses	24,041,220		17,873,271
Income from Operations	1,950,686		1,083,371
Other Income (Expense)
Interest income	19,411		10,560
Interest expense	(1,457,903	)	(263,280	)
Loan fee amortization	(58,951	)	(8,802	)
Total Other Income (Expense)	(1,497,443	)	(261,522	)
Income before income taxes, minority interest and    cumulative effect of change in accounting principle	453,243		821,849
Minority interest in income of subsidiaries	37,983		36,274
Income before income taxes and cumulative effect of change    in accounting principle	491,226		858,123
Income tax expense	(50,000	)	(50,000	)
Cumulative effect of change in accounting principle, net of tax	-		(74,000	)
Net Income	$     441,226		$     734,123
Earnings Per Share
Basic earnings before cumulative effect of change          in accounting principle	$0.018		$0.040
Cumulative effect of change in accounting principle	-		(0.003	)
Basic earnings per share	$0.018		$0.037
Diluted earnings before cumulative effect of change          in accounting principle	$0.018		$0.040
Cumulative effect of change in accounting principle	-		(0.004	)
Diluted earnings per share	$0.018		$0.036
See notes to consolidated financial statements
5

THE EXPLORATION COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
	Six Months Ended			Six Months   Ended
	June 30, 2004			June 30, 2003
Operating Activities
Net income		$     441,226		$    734,123
Adjustments to reconcile net income to    net cash provided by operating activities:
Depreciation, depletion and amortization		4,772,440		4,494,468
Impairment and abandonments		1,033,800		876,150
Minority interest in income of subsidiaries		(37,983	)	(36,274	)
Cumulative effect of change in accounting principle		-		74,000
Non-cash interest expense and accretion of liability        - redeemable preferred stock		535,238		- -
Net cash provided by operating activities,                before changes in operating assets and liabilities:		6,744,721		6,142,467
Changes in operating assets and liabilities:
Receivables		(5,263,582	)	(1,628,364	)
Prepaid expenses and other		(766,407	)	(163,631	)
Accounts payable and accrued expenses		4,512,923		6,955,691
Net cash provided by operating activities		5,227,655		11,306,163
Investing Activities
Development and purchases of oil and gas properties		(13,026,412	)	(18,932,655	)
Purchase of other equipment		(150,618	)	(282,401	)
Net changes in minority interests		59,398		55,844
Net cash used by investing activities		(13,117,632	)	(19,159,212	)
Financing Activities
Proceeds from issuance of common stock, net of expenses		18,452,125		-
Proceeds from long-term debt obligations		116,739		10,928,082
Payments on long-term debt obligations		(9,507,304	)	(979,499	)
Deferred financing fees		-		17,876
Net cash provided by financing activities		9,061,560		9,966,459
Change in Cash and Equivalents		1,171,583		2,113,410
Cash and equivalents at beginning of period		6,180,560		2,333,688
Cash and Equivalents at End of Period		$7,352,143		$4,447,098
See notes to consolidated financial statements
6

THE EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
PERIODS ENDED JUNE 30, 2004 AND JUNE 30, 2003 (Unaudited)
1.     Basis of Presentation
The accompanying unaudited consolidated financial statements of The Exploration Company ("TXCO" or "the Company") have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. The accounting policies followed by the Company are set forth in Note A to the audited consolidated financial statements contained in the Company's annual report on Form 10-K for the year ended December 31, 2003.
In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Certain reclassifications have been made to the prior period to conform to the current presentation. For further information, refer to the consolidated financial statements and footnotes thereto included in the Registrant Company's annual report on Form 10-K for the year ended December 31, 2003, which is incorporated herein by reference.
2.     Fair Value of Stock Options
At June 30, 2004, the Company had a stock-based employee compensation plan which is described more fully in Note F, "Stockholders' Equity," to the audited consolidated financial statements contained in the Company's annual report on Form 10-K for the year ended December 31, 2003. The Company accounts for this plan under the recognition and measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to Employees," and related Interpretations. No stock-based employee compensation cost related to stock options is reflected in net income, as all options granted under the plan had an exercise price equal to, or greater than, the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provision s of SFAS No. 123, "Accounting for Stock-Based Compensation," to stock-based employee compensation for the three month periods ended June 30:
Six Months Ended June 30:	2004	2003
Net income as reported	$441,226	$734,123
Deduct: Total stock-based compensation expense determined under the fair value    based method for all awards, net of related tax effects	106,007	- -
Pro forma earnings	$335,219	$734,123
Earnings per common share:
Basic, as reported	$0.018	$0.037
Basic, pro forma	0.014	0.037
Diluted, as reported	0.018	0.036
Diluted, pro forma	0.013	0.036
7

Three Months Ended June 30:		2004		2003
Net income as reported		$372,309		$    9,588
Deduct: Total stock-based compensation expense determined under the fair value    based method for all awards, net of related tax effects		106,007		- -
Pro forma earnings		$266,302		$    9,588
Earnings per common share:
Basic, as reported		$0.015		$0.000
Basic, pro forma		0.010		0.000
Diluted, as reported		0.014		0.000
Diluted, pro forma		0.010		0.000
3.     Common Stock and Basic Income Per Share
As of June 30, 2004, the Company had outstanding warrants and options to purchase 3,276,333 shares of common stock at prices ranging from $0.98 to $6.00 per share. Of these, warrants and options to purchase 1,996,333 shares were exercisable at quarter end. The warrants and options expire at various dates through August 2013.
The following is a reconciliation of the numerator and denominator of the basic and diluted earnings per share computation:
	Shares	Income			Per Share     Amount
Six Months Ended June 30, 2004
Basic EPS:
Net income	24,136,546	$441,226			$0.018
Effect of dilutive options	839,869	-			-
Dilutive EPS	24,976,415	$441,226			$0.018
Three Months Ended June 30, 2004
Basic EPS:
Net income	25,388,092	$372,309			$0.015
Effect of dilutive options	619,506	-			(0.001	)
Dilutive EPS	26,007,598	$372,309			$0.014
Six Months Ended June 30, 2003
Basic EPS:
Net income before cumulative effect of        change in accounting principle	20,009,716	$  808,123			$0.040
Cumulative effect of change in accounting principle	-	(74,000	)		(0.003	)
Net income	20,009,716	734,123			$0.037
Effect of dilutive options	420,709	-			(0.001	)
Dilutive EPS	20,430,425	$  734,123			$0.036
Three Months Ended June 30, 2003
Basic EPS:
Net income	20,009,716	$      9,588			$0.000
Effect of dilutive options	562,757	-			-
Dilutive EPS	20,572,473	$      9,588			$0.000
8

4.     Income Taxes

The Company has recorded a deferred tax asset for the amount expected to be realized through taxable earnings. In determining taxable earnings, the Company uses income projections reduced by graduating percentages to compensate for uncertainties inherent in future years' projections. TXCO computes total income tax expense based on the Company's estimated annualized federal income tax for the year, considering the impact of any change in the amount of deferred tax asset. The Company expects its current income tax to be minimized through utilization of net operating loss carryforwards. A current charge of $50,000 has been recorded for its corporate alternative minimum tax for the six months ended June 30, 2004.

5.     Long-Term Debt

Bank Credit Facility: On June 30, 2004, the Company closed on a $50 million senior secured revolving credit facility with Guaranty Bank (the "Facility" or "credit facility"). The new Facility, which has a three-year term expiring in 2007, replaced the Company's prior $25 million credit facility with Hibernia National Bank (the "prior facility") scheduled to mature in 2006.

The credit facility is collateralized by all of the Company's proven oil and gas properties, with an initial borrowing base of $12.3 million, based on current levels of TXCO's oil and gas reserves, and features bi-annual redeterminations. The borrowing base may be increased to $14.6 million if TXCO chooses to hedge 50% of its production. If borrowing under the agreement exceeds 50% of the borrowing base, the Company will be required to hedge 50% of its production. At closing, approximately $6.1 million was advanced under the new credit facility to repay the outstanding balance of the prior facility. Interest under the Facility will be based on, at TXCO's option, (a) the London Interbank Offered Rate (LIBOR) plus an applicable margin ranging from 2.00% to 2.50% or (b) prime plus an applicable margin ranging from 0.00% to 0.25%. At June 30, 2004, the effective interest rate was 4.25%. During early July the Company took advantage of its LIBOR options for $6 million of its o utstanding loan amount.

The Facility contains additional terms and conditions consistent with similarly positioned companies. These conditions include various restrictive covenants such as minimum levels of interest coverage, tangible net worth and current ratio, a maximum debt to EBITDAX ratio, restricting the payment of dividends other than the dividends payable under the redeemable preferred stock, and prohibiting a change of control or incurring additional debt.

9

ITEM 2.     MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                   CONDITION AND RESULTS OF OPERATIONS

Certain statements in this report are not historical in nature, including statements of TXCO's and management's expectations, intentions, plans and beliefs, are inherently uncertain and are "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934. The following discussion should be read in conjunction with the unaudited consolidated financial statements and notes thereto included in this Form 10-Q, and with the Company's latest audited consolidated financial statements and notes thereto, as reported in its Form 10-K for the year ended December 31, 2003. See "Disclosure Regarding Forward Looking Statements."

Overview

The Exploration Company is an independent oil and gas enterprise with interests primarily in the Maverick Basin in Southwest Texas. Its long-term business strategy is to build shareholder value by acquiring undeveloped mineral interests and internally developing a multi-year drilling inventory through the use of advanced technologies, such as 3-D seismic and horizontal drilling. The Company accounts for its oil and gas operations under the successful efforts method of accounting and trades its common stock on the Nasdaq Stock Market^SM under the symbol "TXCO." The Company currently has seven rigs in operation on its extensive 554,000-acre position in the Maverick Basin, targeting at least seven separate formations for the production of oil and natural gas. Through the first half of 2004, drilling operations emphasized the Georgetown and Glen Rose formations. The initial 2004 capital expenditures budget (CAPEX) included funds for 51 new wells and four re-entries, as well as funds for completion of a number of wells in progress at year-end 2003 and for infrastructure improvements. The 2004 CAPEX called for the second-largest drilling program in the Company's history, somewhat more modest than the record 2003-drilling program. In May, TXCO announced plans to use $10 million from its recent private placement of common stock (see discussion below), to expand its drilling program, including an additional 15-well program targeting Glen Rose reefs across its 80,000-acre Burr/Wipff, 100% working interest (WI), prospect. These reefs, recently identified using new 3-D seismic data, are on trend with nearby, gas-producing Glen Rose reefs on TXCO's lease block. The revised 2004 CAPEX budget now totals just over $33 million and targets 66 new wells, including 25 Glen Rose wells and 28 Georgetown wells.

TXCO reported net income of $372,000 and $441,000 for the quarter and six-month periods ended June 30, 2004, compared to $9,600 and $734,000 for the prior-year periods, respectively. While production was down 12.3% and 3.2% on a Bcfe basis, oil and gas revenues were up 5.8% and 5.3% as compared to the second-quarter and six-month periods of 2003, respectively. The $293,000 decline in net income for the first half of 2004 compared to the 2003 period reflects the impact of $1.2 million in interest expense on the redeemable preferred stock debt issued in August of 2003 and higher lease operation expenses, up $623,000, due to its growing number of operated wells, both of which were partially offset by positive margins, up $1.5 million, on TXCO's gas gathering operations. The increase of $363,000 in net income for the second quarter of 2004 over second quarter 2003 reflects the items mentioned for the first half of 2004 and lower depletion charges for the current quarter. These factors are discussed in the Results of Operations section.

10

Liquidity and Capital Resources
Liquidity is a measure of ability to access cash. The Company's primary needs for cash are for exploration, development and acquisitions of oil and gas properties, repayment of contractual obligations and working capital requirements. TXCO has historically addressed its long-term liquidity requirements through cash provided by operating activities, issuance of equity securities when market conditions permit, and sale of non-strategic assets. More recently, TXCO has used borrowings under its Credit Facility and cash proceeds from the issuance of its stock to supplement its historical sources of liquidity. The prices for future oil and natural gas production and the level of production have significant impacts on operating cash flows and cannot be predicted with any degree of certainty. Management continues to examine alternative sources of long-term capital, including bank borrowings, issuance of debt instruments, issuance of stock, sales of non-strategic assets, and joint-ve nture financing. Availability of these sources of capital and, therefore, TXCO's ability  to  execute  its  operating strategy  will  depend  upon a  number of  factors, some of  which are beyond its control. Management believes projected operating cash flows, cash on hand, and borrowings under the Credit Facility, will be sufficient to meet the requirements of TXCO's business. However, because future cash flows are subject to a number of variables, no assurances can be made that operations and other capital resources will provide cash in sufficient amounts to maintain planned levels of capital expenditures. Conversely, with increased levels of production and prices, capital expenditures could be raised over levels currently budgeted.
Private Placement: In May 2004, TXCO closed on a private placement of 4,266,668 shares of its common stock at a purchase price of $3.75 per share for net proceeds of $15.0 million. Included are warrants for an additional 1,280,000 common shares exercisable at $4.25 per share. The warrants become exercisable in November 2004 and expire in May 2008. Purchasers were private, U.S.-based investment funds. Proceeds from the private placement will be used to expand the Company's capital expenditure program, restore balance sheet liquidity, complement on-going operations and provide for general corporate purposes.
Bank Credit Facility: On June 30, 2004, the Company closed on a $50 million senior secured revolving credit facility with Guaranty Bank (the "Facility" or "credit facility"). The new facility has a three-year term expiring in 2007. It replaces TXCO's prior $25 million credit facility with Hibernia National Bank, scheduled to mature in 2006.
The credit facility is collateralized by all of the Company's proven oil and gas properties, with an initial borrowing base of $12.3 million, based on current levels of TXCO's oil and gas reserves, and features bi-annual redeterminations. The borrowing base may be increased to $14.6 million if TXCO chooses to hedge 50% of its production. If borrowing under the agreement exceeds 50% of the borrowing base, the Company will be required to hedge 50% of its production. At closing, approximately $6.1 million was advanced under the new credit facility to repay the outstanding balance of the prior facility. Interest under the new facility will be as much as 0.25 percentage point less than the former credit agreement, based on, at TXCO's option, (a) the London Interbank Offered Rate (LIBOR) plus an applicable margin ranging from 2.00% to 2.50% or (b) prime plus an applicable margin ranging from 0.00% to 0.25%. At June 30, 2004, the effective interest rate was 4.25%. During early July the Company took advantage of its LIBOR options for $6 million of its outstanding loan amount.
The Facility contains additional terms and conditions consistent with similarly positioned companies. These conditions include various restrictive covenants such as minimum levels of interest coverage, tangible net worth and current ratio, a maximum debt to EBITDAX ratio, restricting the payment of dividends other than the dividends payable under the redeemable preferred stock, and prohibiting a change of control or incurring additional debt.
Management believes the Facility, along with the Company's positive cash flow from existing production and anticipated production increases from new drilling, will provide adequate capital to fund operating cash requirements and complete its scheduled exploration and development goals for 2004. TXCO expects to further increase its borrowing base commensurate with the expected growth of its proved oil and gas reserves throughout the base term of the Facility.
11
Sources and Uses of Cash: During the first half of 2004, TXCO increased cash reserves from $6.2 million at December 31, 2003, through cash provided by operating activities of $5.2 million. In addition, proceeds from a private placement of common stock, approximately $15.0 million net of expenses, along with net proceeds totaling $3.5 million from the exercise of warrants (purchasing 1,238,096 shares of common stock), resulted in total cash available of $29.9 million for use in meeting the Company's ongoing operational and development needs.
During the first quarter of 2004, TXCO used portions of the available cash to fund payments on debt totaling $2.5 million and related interest of $784,000. The Company applied $6.1 million to fund the ongoing development of its oil and gas producing properties.
During the second quarter, payments on debt totaled $7.0 million with $956,000 of related interest. This reflects a $6.8 million payment on bank debt made out of the proceeds from the private placement of common stock and warrants in May. In addition, approximately $6.9 million was invested in drilling activities during this period.
As a result of these activities, the Company ended the second quarter of 2004 with positive working capital of $348,000, compared to negative working capital of $2.3 million at December 31, 2003, while its current ratio improved to 1.02 to 1 compared to 0.83 to 1 at year end. The Company exited the second quarter with an unused borrowing base of $6.2 million available under its new credit facility. Its ending working capital was impacted by higher cash and accounts receivable balances, partially offset by an increase in current liabilities. Cash flow from operating activities for the first half of 2004 decreased to $5.2 million from $11.3 million in the comparative prior-year period, reflecting the impact of the working capital changes. Adjusting for changes in operating assets and liabilities, first-half 2004 cash flow from operating activities was $6.7 million in 2004 compared to $6.1 million for the first half of 2003, a 9.8% increase over the same period a year ago. Cha nges in operating assets include increases or decreases in accounts receivable, accounts payable and prepaid expenses from the prior year-ends.
Results of Operations
The following table highlights the change from comparable periods in 2003:
Change in Selected Items:			Second Quarter					First Half
Income Statement items:
Oil and gas revenues			+382,226		+5.8		%	+$654,691	+5.3	%
Lease operations			+450,274		+46.0		%	+623,311	+30.4	%
Impairment & abandonments			-20,175		-3.8		%	+157,650	+18.0	%
Depreciation, depletion & amortization			-384,005		-13.6		%	+277,972	+6.2	%
Income from operations			+944,586		+474.6		%	+867,315	+80.1	%
Net income			+362,721		+3,783.1		%	-292,897	-39.9	%
Operational data
Gas production (Mcf)			+287,132		+57.9		%	+374,463	+35.8	%
Oil  production (Bbls)			-75,466		-53.5		%	-75,022	-33.8	%
Combined production (Mcfe)			-165,664		-12.3		%	-75,669	-3.2	%
Gas sales price per Mcf			+$0.29		+5.1		%	-$0.09	-1.5	%
Oil sales price per Bbl			+$8.09		+30.4		%	+$4.82	+17.0	%
Oil and gas revenues increased 5.8% and 5.3%, respectively, for the second quarter and first half of 2004, over the comparable prior-year periods. These increases are attributable to increased natural gas production volumes and higher oil and natural gas prices, partially offset by a decline in oil production. Gas sales volumes increased 57.9% and 35.8%, respectively, for the second quarter and first half of 2004, respectively, primarily due to Georgetown and Glen Rose shoal wells put on production since June 30, 2003. This increase was offset by lower oil production, primarily related to a decline in the number of oil wells drilled by an operating partner, compared to  the  same 2003  periods. The  lower operating  levels in  the first  half contributed to a 3.2%  decline in overall
12
production levels from the first half of 2003.  While average gas sales prices increased during the second quarter of 2004 and exceeded the comparable 2003 levels, year-to-date averages remain lower than those for the first half of 2003 due to lower prices in the first quarter of 2004.
The increase in lease operating expenses for the first half of 2004 over the prior period primarily reflects costs related to 44 additional Maverick Basin oil and gas wells placed on production since June 30, 2003. Lease operation expenses were impacted by approximately $94,000 in non-recurring charges for repairs related to severe weather and flooding on the southern portion of our lease block in the first half of 2004.
The Company's gas gathering system is generally operated on a break-even basis. It sells gas at several points along the system with a significant portion being delivered to purchasers through the El Paso/Gulf Terra Pipeline System ("El Paso"). El Paso processes gas delivered through it to remove natural gas liquids, which it markets separately. The Company receives a share of the revenues for these liquids. Natural gas pricing fluctuations are reflected at the wellhead for the Company's operated gas properties.
During the second quarter and first half of 2004, gas gathering operations revenues increased 132.9% and 98.1%, respectively, due to higher sales volumes and prices for both residue gas and natural gas liquids, when compared to the same periods of 2003. The increase is consistent with the increased number of gas wells connected to the gathering system compared to the prior period.
The following table summarizes the change from comparable periods in 2003:
Change in Gas Gathering Results:			Second Quarter					First Half
Revenues:
Third-party natural gas sales			+$3,445,000		+129.7		%	+$5,006,000	+96.6	%
Natural gas liquids sales			+939,000		+167.9		%	+1,383,000	+121.8	%
Transportation and other revenue			-9,000		-10.8		%	-13,000	-7.7	%
Total gas gathering revenues			+4,375,000		+132.9		%	+6,376,000	+98.1	%
Expense:
Third-party gas purchases			+3,491,000		+110.0		%	+4,734,000	+72.5	%
Transportation and marketing expenses			+78,000		+86.4		%	+85,000	+50.5	%
Direct operating costs			+54,000		+35.3		%	+101,000	+31.8	%
Total gas gathering operations expense			+3,623,000		106.0		%	+4,920,000	+70.1	%
Gross margin			+752,000		+597.2		%	+1,456,000	+282.8	%
Operational data
Total sales volumes (MMbtu)			+534,308		+87.0		%	+788,768	+65.9	%
Average sales price (per MMbtu)			+$1.38		+26.4		%	+$1.12	+21.2	%
Depreciation, depletion and amortization (DD&A) increased 6.2% for the first six months of 2004 over the comparable prior-year period. The increase was primarily in higher depletion, up $207,000, consistent with the growing number of producing wells subject to depletion and with increased depletion rates due to the maturing profile of existing producing wells. DD&A for the second quarter of 2004 decreased 13.6% from the prior-year quarter, reflecting higher depletion recorded in 2003's second quarter due to an increase in production levels during that time period.
General and administrative expense increased 24.6% for the first half of 2004 as compared to the same period in 2003, while declining slightly as a percentage of total revenues (7.8% in 2004 vs. 8.6% in 2003). The increase in expense was primarily due to five additional employees hired across the organization since June 30, 2003, with their associated salaries, wages, benefits and office-related expenses. Staffing at June 30, 2004, was 46, as compared with 41 at mid-year 2003. In addition, higher costs were incurred for information systems, independent engineers services, franchise taxes and increased investor communications activities. Partially offsetting  these  higher  costs  were  lower  consulting  costs,  down $63,000,  primarily due to  bringing in-house
13
certain functions that were previously performed by consultants. The majority of the increases in general and administrative costs are consistent with the expanded compliance burden mandated by the Sarbanes-Oxley Act (SOA). For the first half of 2004, management estimates its total direct costs associated with SOA compliance to be approximately $60,000. Management also anticipates these costs to increase in the final two quarters of 2004 in conjunction with consulting costs incurred for SOA section 404 compliance.
Interest expense for the first half of 2004 increased by $1,245,000 over the same period of 2003 primarily due to the issuance of $16 million in redeemable preferred stock debt in August 2003. Of this, $446,000 reflects non-cash charges for accretion of the debt to its full redemption value by August of 2009 and amortization of related issue costs. For the second quarter of 2004, interest on the preferred was $588,000, of which $228,000 represented non-cash charges. The income tax expense recorded in the first half of 2004 reflects corporate alternative minimum taxes expected to be incurred for 2004.
Drilling Activities
The Company drilled or participated in drilling 28 new wells on its lease block in the Maverick Basin in the first half of 2004. At June 30, 2004, 14 of these wells were producing, seven wells were in completion, two wells were awaiting pipeline connection, four wells remained drilling and one well was shut in pending further evaluation. By comparison, the Company drilled 42 wells during first half of 2003. The Company exited the second quarter of 2004 with total net daily production of 837 barrels of oil per day (BOPD) and 10.1 million cubic feet per day (MMcfd) of natural gas, equal to 2,522 BOE or 15.1 MMcfe. The comparable daily production rates at year-end 2003 were 1,200 BOPD and 8.9 MMcfd, equal to 2,674 BOE or 16,041 MMcfe. TXCO also participated in one new well, which is awaiting completion, and two re-entries on its Williston Basin acreage.
The Company expects drilling activity to increase substantially in the third quarter of 2004 with seven rigs currently drilling on our Maverick Basin leases. There were as few as two rigs running during portions of the first half of 2004. A combination of poor weather and corporate restructuring by one of our operating partners reduced drilling activity during the first six months of this year. During July 2004, TXCO drilled or participated in seven new wells. The Company projects a total of 65 new wells and four re-entries on its Maverick Basin lease block for 2004. At July 31, 2004, total net daily production was 18.0 MMcfe.
Georgetown - The Company's success continues with its Georgetown horizontal drilling program through the application of improved seismic processing techniques. The 28 wells targeting the Georgetown represents the largest share of TXCO's drilling program for 2004. The Company spudded six new Georgetown wells in the second quarter in addition to two re-entries, bringing total wells spudded to 14 of the 28 Georgetown wells now projected for this year. Two additional Georgetown horizontal wells were spudded in July 2004.
TXCO placed nine Georgetown horizontal gas wells on production in the first half of 2004, including two spudded in December 2003. At June 30, 2004, two additional Georgetown horizontal gas wells awaited pipeline connections, one was pending completion, two were shut-in for further evaluation and two remained drilling. Net Georgetown production at June 30, 2004, was 4.2 MMcfd and 117 BOPD. In July, one well drilling at quarter end flow tested at rates as high as 3.3 MMcfd, while a re-entry well flow tested at rates as high as 456 BOPD. Georgetown gas wells typically have hyperbolic production profiles with high initial flow rates that provide a quick payout potential, followed by a comparatively sharp decline, then longer-term production at lower rates. Net Georgetown production at July 31, 2004 was 4.4 MMcfd and 251 BOPD.
Glen Rose Shoal - Through June 30, TXCO has spudded seven Glen Rose shoal wells, with five producing, one awaiting completion and one currently drilling. Production began in mid-July from the Chittim 3-130H, 49.9% working interest (WI). In tests, the well flowed at rates as high as 1.7 MMcfd (gross) from the Glen Rose C shoal. Completion has begun on the Chittim 3-142H (38.1% WI). In tests, this well flowed as much as 1.05 MMcfd and 2 BOPD (gross). An eighth Glen Rose shoal well was spudded in July. Net Glen Rose shoal production at June 30, 2004, was 4.1 MMcfd and 12 BOPD, and at July 31 it was 4.5 MMcfd and 17 BOPD.
14
Glen Rose Reefs - To date, four new reef wells have been spudded, including three in the expanded 15-well Glen Rose reef drilling program on the Burr/Wipff prospect (100% WI) announced in May. Initial drilling had been delayed by a lack of rig availability and inclement weather. The 15 reefs were identified using new 3-D seismic data and are on trend with similarly situated gas-producing Glen Rose reefs on TXCO's lease block nearby.
Meanwhile, the Paloma E 1-54 (62.4% WI), went on production in mid July at 721 Mcfd and 10 BOPD. In initial tests, the well flowed at rates as high as 1.6 MMcfd and 5 BOPD (gross). Net Glen Rose reef production at June 30 was 1.4 MMcfd and 13 BOPD. At July 31, net Glen Rose reef production was 1.6 MMcfd and 53 BOPD.
Glen Rose Oil - TXCO (50% WI) and its operating partner, CMR Energy L.P., Houston, spudded the first new Glen Rose oil porosity well of 2004 in mid July, the Comanche 2-39H. Petrohawk Energy Corp. (Nasdaq:HAWK), Houston, is acting operator under contract to CMR. The vertical well may be converted to a horizontal completion depending on test results. Third-quarter plans include re-entering two existing vertical Glen Rose porosity wells for horizontal re-completions as a workover rig becomes available.
CMR's recent corporate restructuring has delayed 2004 Glen Rose drilling activity to date. By comparison, six Glen Rose porosity wells were drilled during the first half of 2003 while none were drilled in the first half of 2004. Glen Rose oil production has continued to decline since the last porosity well was spudded in September 2003. TXCO's budget now calls for four new Glen Rose porosity wells and four re-entries prior to the end of 2004. Net Glen Rose porosity production at June 30, 2004 was 252 BOPD. At July 31, net Glen Rose porosity production had risen to 307 BOPD.
San Miguel Waterflood - TXCO spudded five San Miguel oil wells on its Pena Creek unit (100% WI) in the second quarter. At June 30, 2004, two were on production while three were in completion. These three wells were put on production in July. Four additional wells have been spudded thus far in the third quarter with one currently on production, two in completion and one still drilling. To date, 11 water injection well workovers have been completed as part of a program to enhance water injection efficiency and increase oil output. The Company has budgeted 10 new San Miguel oil wells this year. Severe weather and flooding interrupted Pena Creek-area operations multiple times during the first-half of 2004, temporarily reducing net San Miguel oil production at June 30, 2004 to 293 BOPD. By July 31, net San Miguel production had reached 333 BOPD as wells continued to be placed back on production.
Sligo/Pearsall- The Taylor 132-1 (62.5% WI) has been producing gas through temporary production facilities from Sligo perforations while Company engineers evaluated the formation. They have determined Sligo production could not be enhanced with stimulation. Consequently, TXCO plans to perforate and test the overlying Pearsall formation. Both of these lower Cretaceous intervals lie below the Glen Rose formation but above 7,500 feet.
Jurassic - Blue Star Oil and Gas, Ltd., Dallas, the Company's operating partner in the Jurassic play, has reaffirmed plans to drill a second Jurassic wildcat in the Maverick Basin utilizing formation data gained from the Taylor wildcat to select a location. TXCO's 2004 drilling budget currently includes no provision for a second Jurassic well as Blue Star would pay 100 percent of drilling costs while carrying TXCO for a 25 percent working interest if a second well is drilled on TXCO's lease block.
Coalbed Methane - New horizontal well technology may increase gas production from TXCO's Olmos/coalbed methane (CBM) project by year-end. The Company is re-entering an existing CBM dewatering well (100% WI), to attempt a horizontal re-completion using new multiple short-radius lateral (MSRL) technology. If successful, the MSRL technique could significantly increase dewatering volumes and associated CBM gas production.
TXCO exited 2003 with 36 wells dewatering in its CBM pilot program targeting production from the multiple seams of high-volatile bituminous coal present under its leases. At June 30, 2004, the net total CBM production rate was approximately 127 Mcfd with 1,300 barrels of water per day. The Company believes the next phase of this project will require 25 to 50 wells initially, during which the Company expects to establish economic production quantities.  The Company may seek an industry partner or project-type financing,  which it believes is
15
more suitable for this project due to its cash flow profile, as well as complementing the Company's existing capital structure. The Company may sell an interest in the CBM project to an industry partner with CBM expertise. To date, several potential industry partners have expressed an interest in TXCO's project. There are no new CBM wells included in the 2004 CAPEX budget. The Company expects this project will add significant reserves in the coming years.
Red River B Zone - The Company participated in the drilling of one new well (0.24% WI) and two re-entries (30% and 0.24% WI), all horizontal laterals, in the Williston Basin with its operating partner Luff Exploration Company. All three are currently producing. Net Williston Basin production at June 30, 2004, was 132 BOPD and 71 Mcfd.
Seismic Acquisition: In late June 2004, TXCO acquired a 75% WI in existing seismic option agreements on approximately 62,000 gross acres, in exchange for 187,500 shares of its common stock, from Pedernales Energy LLC, Verus Energy Inc. and Texas Hondo Petroleum LLC, all of Houston. TXCO will serve as operator. The agreements give the Company an option to purchase oil and gas leases on the acreage after acquiring and interpreting 3-D seismic data. The parcels are adjacent to TXCO's existing Burr and Wipff leases. This acquisition increased the Company's Maverick Basin leasehold acreage block to over 860 square miles. The new acreage is on trend with the existing lease block and appears prospective for many of the same formations and plays.
Disclosure Regarding Forward Looking Statements
Statements in this Quarterly Report on Form 10-Q which are not historical, including statements regarding TXCO's or management's intentions, hopes, beliefs, expectations, representations, projections, estimations, plans or predictions of the future, are forward-looking statements and are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such statements include those relating to expected drilling plans, including timing, category, number, depth, cost and/or success of wells to be drilled, expected geological formations or the availability of specific services or technologies. It is important to note that actual results may differ materially from the results predicted in any such forward-looking statements. Investors are cautioned that all forward-looking statements involve risks and uncertainty, including without limitation, the costs of exploring and developing new oil and natural gas reserves, the price for which such rese rves can be sold, environmental concerns affecting the drilling of oil and natural gas wells, as well as general market conditions, competition and pricing. Please refer to TXCO's Securities and Exchange Commission filings for additional information. This and all TXCO's previously filed documents are on file at the Securities and Exchange Commission and can be viewed on TXCO's website at www.txco.com. Copies of which are available from the Company without charge.
ITEM 3.     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
There have been no material changes in the reported market risks faced by the Company since December 31, 2003. See the Company's Annual Report on Form 10-K, "Item 7A. Quantitative and Qualitative Disclosures About Market Risk"
ITEM 4.     CONTROLS AND PROCEDURES.
a.      The Company's Chief Executive Officer and the Chief Financial Officer have carried out an evaluation of the effectiveness of the design and operation of the Company's disclosure controls and procedures pursuant to Exchange Act Rule 13a-14 and Rule 15d-14 as of June 30, 2004. Based upon that evaluation, the Company's Chief Executive Officer along with the Chief Financial Officer concluded that the disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in our periodic SEC filings.
b.       There have been no significant changes in the Company's internal controls or in other factors that could significantly affect internal controls subsequent to the date of the above evaluation.
16
PART II - OTHER INFORMATION
ITEM 1.     LEGAL PROCEEDINGS
None
ITEM 2.      CHANGES IN SECURITIES
In May 2004, the Company completed the placement of a $16 million equity offering with accredited private investors. Included were 4,266,668 shares of common stock issued at a price of $3.75, along with warrants to purchase an additional 1,280,000 common shares. The warrants are exercisable at $4.25 per share and within a window, from six-months to 3.5 years after closing of the transaction. Net proceeds from the private placement of $15.0 million will be used to expand the Company's capital expenditure program, restore balance sheet liquidity, complement on-going operations and provide for general corporate purposes.
In June 2004, the Company filed a registration statement on Form S-3 that registers a total of 9,229,347 common shares. The shares registered were issued in conjunction with private placements in May 2004 and August 2003, warrants exercised during the first quarter of 2004, and for seismic options and producing property and leasehold acquisitions.
ITEM 3.      DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4.      SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On May 14, 2004, the Company held its Annual Meeting of Shareholders at the Petroleum Club of San Antonio, pursuant to the notice mailed to shareholders of record on April 23, 2004. The following matters were submitted for approval by vote at the meeting. All matters were approved by the shareholders vote and the results of the voting is shown below for each matter.
1.	Election of two Class C Directors to serve for three-year terms expiring in 2007:
	Nominee	For				Against
	Michael J. Pint	19,742,528				138,271
	James E. Sigmon	19,742,528				138,271
There were no changes in Directors of the Company.
2.	Proposal to ratify the appointment of Akin, Doherty, Klein & Feuge, P.C., certified public accountants, as independent auditors of the Company and its subsidiaries for the calendar year ending December 31, 2004:
	For	Against				Abstain
	19,799,502	51,870				29,427
ITEM 5.      OTHER INFORMATION
None
17
ITEM 6.      EXHIBITS AND REPORTS ON FORM 8-K
a)     Exhibit 4   Credit Agreement between The Exploration Company of Delaware, Inc. and Guaranty Bank, FSB, dated June 30, 2004, filed herewith.
b)     Exhibit 31.1   Certification of Chief Executive Officer required pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended filed herewith.
c)     Exhibit 31.2   Certification of Chief Financial Officer required pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended filed herewith.
d)     Exhibit 32.1   Certification of Chief Executive Officer required pursuant to 18 U.S.C. Section 1350 as required by the Sarbanes-Oxley Act of 2002 filed herewith.
e)     Exhibit 32.2   Certification of Chief Financial Officer required pursuant to 18 U.S.C. Section 1350 as required by the Sarbanes-Oxley Act of 2002 filed herewith.
f)     Form 8-K dated April 5, 2004; regarding the press release dated April 2, 2004 with respect to the Registrant's first quarter 2004 operations update.
g)      Form 8-K dated April 23, 2004; regarding the press release dated April 19, 2004 with respect to the Registrant's presentation at the IPAA Oil & Gas Investment Symposium.
h)    Form 8-K dated May 6, 2004; regarding the press release dated May 5, 2004 with respect to the Registrant's first quarter 2004 earnings.
i)    Form 8-K dated May 20, 2004; regarding the presentation at its shareholders meeting held May 14, 2004, and the press release dated May 18, 2004 announcing a private placement of common stock.
j)    Form 8-K dated June 10, 2004; regarding the press release dated June 7, 2004, announcing the Registrants webcast at the RBC Capital Markets' North American Energy and Power Conference, and an outline of slides used in that presentation.
k)    Form 8-K dated June 18, 2004; regarding the press release of the same date entitled "The Exploration Company Updates Maverick Basin Operations."
l)    Form 8-K dated July 28, 2004; regarding the press release dated July 27, 2004, entitled "The Exploration Company Updates First-Half 2004 Operations; Signs New $50 Million Credit Facility; Adds to Maverick Basin Rig Count and Acreage Position."
m)    Form 8-K dated August 3, 2004; regarding the press release dated July 30, 2004, entitled "The Exploration Company to Webcast 9th Oil & Gas Conference Presentation" and providing an outline of the slides used in said presentation on August 2, 2004.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
				THE EXPLORATION COMPANY
				(Registrant)
				/s/ P. Mark Stark
				P. Mark Stark,
				Chief Financial Officer
Date:  August 9, 2004
18

EX-4

Exhibit 4
CREDIT AGREEMENT BETWEEN THE EXPLORATION COMPANY OF DELAWARE, INC. AND GUARANTY BANK, FSB
June 30, 2004
_____________________________________
REDUCING REVOLVING LINE OF CREDIT OF UP TO $50,000,000.00 _____________________________________
TABLE OF CONTENTS
		Page
ARTICLE I     DEFINITIONS AND INTERPRETATION		1
1.1       Terms Defined Above		1
1.2       Additional Defined Terms		1
1.3       Undefined Financial Accounting Terms		13
1.4       References		13
1.5       Articles and Sections		13
1.6       Number and Gender		13
1.7       Incorporation of Exhibits		13
ARTICLE II      TERMS OF FACILITY		13
2.1       Revolving Line of Credit		13
2.2       Letter of Credit Facility		14
2.3       Limitations on Interest Periods		14
2.4       Limitation on Types of Loans		14
2.5       Use of Loan Proceeds and Letters of Credit		15
2.6       Interest		15
2.7       Repayment of Loans and Interest		16
2.8       Outstanding Amounts		16
2.9       Time, Place, and Method of Payments		16
2.10     Borrowing Base Determinations		16
2.11     Mandatory Prepayments		17
2.12     Voluntary Prepayments of Loans		17
2.13     Commitment Fee		18
2.14     Facility Fee		18
2.15     Engineering Fee		18
2.16     Letter of Credit Fee		18
2.17     Loans to Satisfy Obligations of Borrower		19
2.18     Security Interest in Accounts; Right of Offset		19
2.19     General Provisions Relating to Interest		19
2.20     Yield Protection		20
2.21     Illegality		21
2.22     Regulatory Change		21
2.23     Limitations on Interest Periods		21
2.24     Letters in Lieu of Transfer Orders		21
2.25     Power of Attorney		22
ARTICLE III      CONDITION		22
3.1       Receipt of Loan Documents and Other Items		22
3.2       Each Loan and Letter of Credit		24
ARTICLE IV      REPRESENTATIONS AND WARRANTIES		26
4.1       Due Authorization		26
4.2       Corporate Existence		26
4.3       Valid and Binding Obligations		26
- i -
4.4       Security Instruments		26
4.5       Title to Assets		26
4.6       Scope and Accuracy of Financial Statements		26
4.7       No Material Misstatements		27
4.8       Liabilities, Litigation, and Restrictions		27
4.9       Authorizations; Consents		27
4.10     Compliance with Laws		27
4.11     ERISA		27
4.12     Environmental Laws		28
4.13     Compliance with Federal Reserve Regulations		28
4.14     Investment Company Act Compliance		28
4.15     Public Utility Holding Company Act Compliance		28
4.16     Proper Filing of Tax Returns; Payment of Taxes Due		28
4.17     Refunds		29
4.18     Gas Contracts		29
4.19     Intellectual Property		29
4.20     Casualties or Taking of Property		29
4.21     Locations of Borrower		29
4.22     Subsidiaries		29
4.23     Existing Indebtedness; No Defenses		30
ARTICLE V      AFFIRMATIVE COVENANTS		30
5.1       Maintenance and Access to Records		30
5.2       Quarterly Financial Statements; Compliance Certificates		30
5.3       Quarterly Financial Projections		30
5.4       Annual Financial Statements		30
5.5       Oil and Gas Reserve Reports		30
5.6       Title Opinions; Title Defects		31
5.7       Notices of Certain Events		31
5.8       Letters in Lieu of Transfer Orders; Division Orders		32
5.9       Additional Information		32
5.10     Compliance with Laws		32
5.11     Payment of Assessments and Charges		33
5.12     Maintenance of Corporate Existence and Good Standing		33
5.13     Payment of Note; Performance of Obligations		33
5.14     Further Assurances		33
5.15     Initial Fees and Expenses of Counsel to Lender		33
5.16     Subsequent Fees and Expenses of Lender		33
5.17     Operation of Oil and Gas Properties		34
5.18     Maintenance and Inspection of Properties		34
5.19     Maintenance of Insurance		34
5.20     INDEMNIFICATION		34
5.21     Hedging		35
ARTICLE VI      NEGATIVE COVENANTS		35
6.1       Indebtedness		36
6.2       Contingent Obligations		36
- ii -
6.3       Liens		36
6.4       Sales of Assets		36
6.5       Leasebacks		36
6.6       Sale or Discount of Receivables		36
6.7       Loans or Advances		36
6.8       Investments		36
6.9       Dividends and Distributions		37
6.10     Issuance of Stock; Changes in Corporate Structure		37
6.11     Transactions with Affiliates		37
6.12     Lines of Business		37
6.13     ERISA Compliance		37
6.14     Current Ratio		37
6.15     Maximum Debt to EBITDAX Ratio		38
6.16     Tangible Net Worth		38
6.17     Interest Coverage Ratio		38
ARTICLE VII      EVENTS OF DEFAULT		38
7.1       Enumeration of Events of Default		38
7.2       Remedies		39
ARTICLE VIII     MISCELLANEOUS		40
8.1       Transfers; Participations		40
8.2       Survival of Representations, Warranties, and Covenants		40
8.3       Notices and Other Communications		40
8.4       Parties in Interest		41
8.5       Rights of Third Parties		41
8.6       Renewals; Extensions		41
8.7       No Waiver; Rights Cumulative		41
8.8       Survival Upon Unenforceability		42
8.9       Amendments; Waivers		42
8.10     Controlling Agreement		42
8.11     Disposition of Collateral		42
8.12     GOVERNING LAW		42
8.13     JURISDICTION AND VENUE		42
8.14     WAIVER OF RIGHTS TO JURY TRIAL		43
8.15     ENTIRE AGREEMENT		43
8.16     Counterparts		43
8.17     Release by Borrower		43
LIST OF EXHIBITS
Exhibit I	-     Form of Note
Exhibit II	-     Form of Borrowing Request
Exhibit III	-     Form of Compliance Certificate
Exhibit IV	-     Form of Opinion of Counsel
Exhibit V	-     Disclosures
- iii -

CREDIT AGREEMENT
THIS CREDIT AGREEMENT is made and entered into effective the 30th day of June, 2004, by and between THE EXPLORATION COMPANY OF DELAWARE, INC., a Delaware corporation (the "Borrower"), and GUARANTY BANK, FSB, a federal savings bank (the "Lender").
W I T N E S S E T H:
In consideration of the mutual covenants and agreements herein contained, the Borrower and the Lender hereby agree as follows, amending and restating in its entirety the Credit Agreement dated as of March 4, 2002, by and between the Borrower and Hibernia National Bank (the "Existing Lender"), as heretofore amended, restated, or supplemented (the "Existing Credit Agreement").
ARTICLE I DEFINITIONS AND INTERPRETATION
1.1      Terms Defined Above. As used in this Credit Agreement, the terms "Borrower", "Existing Credit Agreement", "Existing Lenders" and "Lender" shall have the meaning assigned to them hereinabove.
1.2      Additional Defined Terms. As used in this Credit Agreement, each of the following terms shall have the meaning assigned thereto in this Section, unless the context otherwise requires:
	"Additional Costs" shall mean costs which the Lender determines are attributable to its obligation to make or its making or maintaining any LIBO Rate Loan, or any reduction in any amount receivable by the Lender in respect of any such obligation or any LIBO Rate Loan, resulting from any Regulatory Change which (a) changes the basis of taxation of any amounts payable to the Lender under this Agreement or the Note in respect of any LIBO Rate Loan (other than taxes imposed on the overall net income of the Lender), (b) imposes or modifies any reserve, special deposit, minimum capital, capital rates, or similar requirements relating to any extensions of credit or other assets of, or any deposits with or other liabilities of, the Lender (including LIBO Rate Loans and Dollar deposits in the London interbank market in connection with LIBO Rate Loans), or any commitments of the Lender hereunder, (c) increases the Assessment Rate, or (d) imposes any other condition affecting this Agreement or any of such extensions of credit, liabilities, or commitments.
	"Adjusted LIBO Rate" shall mean, for any LIBO Rate Loan, an interest rate per annum (rounded upwards, if necessary, to the nearest 1/100 of 1%) determined by the Lender to be equal to the sum of the LIBO Rate for such Loan plus the Applicable Margin, but in no event exceeding the Highest Lawful Rate.
1
	"Affiliate" shall mean any Person directly or indirectly controlling, or under common control with, the Borrower and includes any Subsidiary of the Borrower and any "affiliate" of the Borrower within the meaning of Reg. Section 240.12b-2 of the Securities Exchange Act of 1934, as amended, with "control," as used in this definition, meaning possession, directly or indirectly, of the power to direct or cause the direction of management, policies or action through ownership of voting securities, contract, voting trust, or membership in management or in the group appointing or electing management or otherwise through formal or informal arrangements or business relationships.
	"Agreement" shall mean this Credit Agreement, as it may be amended, supplemented, or restated from time to time.
	"Applicable Lending Office" shall mean, for each type of Loan, the lending office of the Lender (or an affiliate of the Lender) designated for such type of Loan on the signature pages hereof or such other office of the Lender (or an affiliate of the Lender) as the Lender may from time to time specify to the Borrower as the office by which Loans of such type are to be made and maintained.
	"Applicable Margin" shall mean as to each LIBO Rate Loan, the LIBO Rate as reflected on Exhibit VI.
	"Assignment" shall mean the Assignment of Notes, Liens, Security Interests, and Other Rights, in form and substance satisfactory to the Lender, executed by the Existing Lender, assigning to the Lender the Existing Note, the indebtedness evidenced thereby, the Liens securing the Existing Note, and the rights of the Existing Lender under the Existing Loan Documents, and financing statement changes constituent thereto.
	"Available Commitment" shall mean, at any time, an amount equal to the remainder, if any, of (a) the Borrowing Base in effect at such time minus (b) the sum of the outstanding balance (principal and interest) on the Note at such time plus the L/C Exposure at such time.
	"Base Rate" shall mean, at any time, the rate of interest per annum then most recently established by the Lender as its base rate, which rate may not be the lowest rate of interest charged by the Lender to its borrowers. Each change in any interest rate provided for herein based upon the Base Rate resulting from a change in the Base Rate shall take effect without notice to the Borrower at the time of such change in the Base Rate.
	"Borrowing Base" shall mean, at any time, the amount determined by the Lender in accordance with Section 2.7 and then in effect.
	"Borrowing Request" shall mean each written request, in substantially the form attached hereto as Exhibit II, by the Borrower to the Lender for a borrowing or prepayment pursuant to Sections 2.1 or 2.12, each of which shall:
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	(a)     be signed by a Responsible Officer of the Borrower;
	(b)     specify the amount and type of Loan requested or to be converted and the date of the borrowing or conversion (which shall be a Business Day);
	(c)     when requesting a Floating Rate Loan, be delivered to the Lender no later than 1:00 p.m., Central Standard or Daylight Savings Time, as the case may be, on the Business Day of the requested borrowing or conversion; and
	(d)     when requesting a LIBO Rate Loan, be delivered to the Lender no later than 10:00 a.m., Central Standard or Daylight Savings Time, as the case may be, three Business Days preceding the requested borrowing or conversion and designate the Interest Period requested with respect to such Loan.
	"Business Day" shall mean (a) for all purposes other than as covered by clause (b) of this definition, a day other than a Saturday, Sunday, legal holiday for commercial banks under the laws of the State of Texas, or any other day when banking is suspended in the State of Texas, and (b) with respect to all requests, notices, and determinations in connection with, and payments of principal and interest on, LIBO Rate Loans, a day which is a Business Day described in clause (a) of this definition and which is a day for trading by and between banks for Dollar deposits in the London interbank market.
	"Change in Control" shall mean the acquisition by any Person, or two or more Persons acting in concert, in each case not at the time of acquisition, an Affiliate of the Borrower of beneficial ownership (within the meaning of Rule 13d-3 of the Securities and Exchange Commission under the Securities Exchange Act of 1934) of 51% or more of the outstanding common stock of the Borrower.
	"Closing Date" shall mean the effective date of this Agreement.
	"Collateral" shall mean the Mortgaged Properties and any other Property now or at any time used or intended as security for the payment or performance of all or any portion of the Obligations.
	"Commitment" shall mean the obligation of the Lender, subject to applicable provisions of this Agreement, to make Loans to or for the benefit of the Borrower pursuant to Section 2.1 and to issue Letters of Credit pursuant to Section 2.2.
	"Commitment Fee" shall mean each fee payable to the Lender by the Borrower pursuant to Section 2.13.
	"Commitment Period" shall mean the period from and including the Closing Date to but not including the Commitment Termination Date.
	"Commitment Termination Date" shall mean June 30, 2007.
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	"Commodity Hedge Agreement" shall mean any crude oil, natural gas, or other hydrocarbon floor, collar, cap, price protection, or swap agreement, in form and substance with a Person acceptable to the Lender.
	"Commonly Controlled Entity" shall mean any Person which is under common control with the Borrower within the meaning of Section 4001 of ERISA.
	"Compliance Certificate" shall mean each certificate, substantially in the form attached hereto as Exhibit III, executed by a Responsible Officer of the Borrower and furnished to the Lender from time to time in accordance with Sections 5.2 and 5.3.
	"Contingent Obligation" shall mean, as to any Person, any obligation of such Person guaranteeing or in effect guaranteeing any Indebtedness, leases, dividends, or other obligations of any other Person (for purposes of this definition, a "primary obligation") in any manner, whether directly or indirectly, including, without limitation, any obligation of such Person, regardless of whether such obligation is contingent, (a) to purchase any primary obligation or any Property constituting direct or indirect security therefor, (b) to advance or supply funds (i) for the purchase or payment of any primary obligation, or (ii) to maintain working or equity capital of any other Person in respect of any primary obligation, or otherwise to maintain the net worth or solvency of any other Person, (c) to purchase Property, securities or services primarily for the purpose of assuring the owner of any primary obligation of the ability of the Person primarily liable for such primary obligation to make payment thereof, or (d) otherwise to assure or hold harmless the owner of any such primary obligation against loss in respect thereof, with the amount of any Contingent Obligation being deemed to be equal to the stated or determinable amount of the primary obligation in respect of which such Contingent Obligation is made or, if not stated or determinable, the maximum reasonably anticipated liability in respect thereof as determined by such Person in good faith.
	"Current Assets" shall mean all assets which would, in accordance with GAAP, be included as current assets on a balance sheet of the Borrowers on a consolidated basis, as of the date of calculation, plus unused loan availability under this facility.
	"Current Liabilities" shall mean all liabilities which would, in accordance with GAAP, be included as current liabilities on a balance sheet of the Borrowers on a consolidated basis, as of the date of calculation, but excluding the current maturities under this facility, both principal and interest.
	"Default" shall mean any event or occurrence which with the lapse of applicable grace period or the giving of notice or both would become an Event of Default.
	"Default Rate" shall mean a per annum interest rate equal to the Base Rate plus five percent (5%), but in no event exceeding the Highest Lawful Rate.
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	"Dollars" and "$" shall mean dollars in lawful currency of the United States of America.
	"EBITDAX" shall mean, for any period, operating earnings determined in accordance with GAAP, excluding for such period, depreciation, amortization, and other non-cash expenses or non-cash gains and exploration expenses.
	"Engineering Fee" shall mean each fee payable to the Lender by the Borrower pursuant to Section 2.15.
	"Environmental Complaint" shall mean any written complaint, order, directive, claim, citation, notice of environmental report or investigation, or other notice by any Governmental Authority or any other Person with respect to (a) air emissions, (b) spills, releases, or discharges to soils, any improvements located thereon, surface water, groundwater, or the sewer, septic, waste treatment, storage, or disposal systems servicing any Property of the Borrower, (c) solid or liquid waste disposal, (d) the use, generation, storage, transportation, or disposal of any Hazardous Substance, or (e) other environmental, health, or safety matters affecting any Property of the Borrower or the business conducted thereon.
	"Environmental Laws" shall mean (a) the following federal laws as they may be cited, referenced, and amended from time to time: the Clean Air Act, the Clean Water Act, the Safe Drinking Water Act, the Comprehensive Environmental Response, Compensation and Liability Act, the Endangered Species Act, the Resource Conservation and Recovery Act, the Occupational Safety and Health Act, the Hazardous Materials Transportation Act, the Superfund Amendments and Reauthorization Act, and the Toxic Substances Control Act; (b) any and all equivalent environmental statutes of any state in which Property of the Borrower is situated, as they may be cited, referenced and amended from time to time; (c) any rules or regulations promulgated under or adopted pursuant to the above federal and state laws; and (d) any other equivalent federal, state, or local statute or any requirement, rule, regulation, code, ordinance, or order adopted pursuant thereto, including, without limitation, those relating to the generation, transportation, treatment, storage, recycling, disposal, handling, or release of Hazardous Substances.
	"ERISA" shall mean the Employee Retirement Income Security Act of 1974, as amended from time to time, and the regulations thereunder and interpretations thereof.
	"Event of Default" shall mean any of the events specified in Section 7.1.
	"Existing Loan Documents" shall mean the Loan Documents, as such term is defined in the Existing Credit Agreement, in existence on the Closing Date immediately prior to the Assignment.
	"Existing Note" shall mean the Note, as such term is defined in the Existing Credit Agreement, in existence on the Closing Date immediately prior to the Assignment.
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	"Existing Security Instruments" shall mean the Security Instruments, as such term is defined in the Existing Credit Agreement, in existence on the Closing Date immediately prior to the Assignment.
	"Final Maturity" shall mean June 30, 2007.
	"Financial Statements" shall mean statements of the financial condition of the Borrower as at the point in time and for the period indicated and consisting of at least a balance sheet and related statements of operations, common stock and other stockholders' equity, and cash flows for the Borrower and, when required by applicable provisions of this Agreement to be audited, accompanied by the unqualified certification of a nationally-recognized firm of independent certified public accountants or other independent certified public accountants acceptable to the Lender and footnotes to any of the foregoing, all of which shall be prepared in accordance with GAAP consistently applied and in comparative form with respect to the corresponding period of the preceding fiscal period.
	"Fixed Rate Loan" shall mean any LIBO Rate Loan.
	"Floating Rate" shall mean an interest rate per annum equal to the rate reflected on Exhibit VI, but in no event exceeding the Highest Lawful Rate.
	"Floating Rate Loan" shall mean any Loan and any portion of the Loan Balance which the Borrower has requested, in the initial Borrowing Request for such Loan or a subsequent Borrowing Request for such portion of the Loan Balance, bear interest at the Floating Rate, or which pursuant to the terms hereof is otherwise required to bear interest at the Floating Rate.
	"GAAP" shall mean generally accepted accounting principles established by, or accepted by, the Financial Accounting Standards Board or the American Institute of Certified Public Accountants and in effect in the United States from time to time.
	"Governmental Authority" shall mean any nation, country, commonwealth, territory, government, state, county, parish, municipality, or other political subdivision and any entity exercising executive, legislative, judicial, regulatory, or administrative functions of or pertaining to government.
	"Hazardous Substances" shall mean flammables, explosives, radioactive materials, hazardous wastes, asbestos, or any material containing asbestos, polychlorinated biphenyls (PCBs), toxic substances or related materials, petroleum, petroleum products, associated oil or natural gas exploration, production, and development wastes, or any substances defined as "hazardous substances," "hazardous materials," "hazardous wastes," or "toxic substances" under the Comprehensive Environmental Response, Compensation and Liability Act, as amended, the Superfund Amendments and Reauthorization Act, as amended, the Hazardous Materials Transportation Act, as amended, the Resource Conservation and Recovery Act, as amended, the Toxic Substances Control Act, as amended, or any other law or regulation now or hereafter enacted or promulgated by any Governmental Authority.
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	"Highest Lawful Rate" shall mean the maximum non-usurious interest rate, if any (or, if the context so requires, an amount calculated at such rate), that at any time or from time to time may be contracted for, taken, reserved, charged, or received under applicable laws of the State of Texas or the United States of America, whichever authorizes the greater rate, as such laws are presently in effect or, to the extent allowed by applicable law, as such laws may hereafter be in effect and which allow a higher maximum non-usurious interest rate than such laws now allow.
	"Indebtedness" shall mean, as to any Person, without duplication, (a) all liabilities (excluding reserves for deferred income taxes, deferred compensation liabilities, and other deferred liabilities and credits) which in accordance with GAAP would be included in determining total liabilities as shown on the liability side of a balance sheet, (b) all obligations of such Person evidenced by bonds, debentures, promissory notes, or similar evidences of indebtedness, (c) all other indebtedness of such Person for borrowed money, and (d) all obligations of others, to the extent any such obligation is secured by a Lien on the assets of such Person (whether or not such Person has assumed or become liable for the obligation secured by such Lien).
	"Insolvency Proceeding" shall mean application (whether voluntary or instituted by another Person) for or the consent to the appointment of a receiver, trustee, conservator, custodian, or liquidator of any Person or of all or a substantial part of the Property of such Person, or the filing of a petition (whether voluntary or instituted by another Person) commencing a case under Title 11 of the United States Code, seeking liquidation, reorganization, or rearrangement or taking advantage of any bankruptcy, insolvency, debtor's relief, or other similar law of the United States, the State of Texas, or any other jurisdiction.
	"Intellectual Property" shall mean patents, patent applications, trademarks, tradenames, copyrights, technology, know-how, and processes.
	"Interest Expense" shall mean, for any period, the total interest expense (including, without limitation, interest expense attributable to capitalized leases) of the Borrower for such period, determined in accordance with GAAP, plus dividends paid on preferred stock. However, Interest Expense, as defined herein, is not to include "non-cash" amounts of interest expenses that is recorded on the books and records of the Borrower that relates to the accretion of the preferred stock that is presently outstanding.
	"Interest Period" shall mean, subject to the limitations set forth in Section 2.3, with respect to any LIBO Rate Loan, a period commencing on the date such Loan is made or converted from a Loan of another type pursuant to this Agreement or the last day of the next preceding Interest Period with respect to such Loan and ending on the numerically corresponding day in the calendar month that is one, two, three, or, subject to availability, six months thereafter, as the Borrower may request in the Borrowing Request for such Loan.
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	"Investment" in any Person shall mean any stock, bond, note, or other evidence of Indebtedness, or any other security (other than current trade and customer accounts) of, investment or partnership interest in or loan to, such Person.
	"L/C Exposure" shall mean, at any time, the aggregate maximum amount available to be drawn under outstanding Letters of Credit at such time, but shall not include LC's issued for Commodity Hedge Agreements or Rate Management Transactions.
	"Letter of Credit" shall mean any standby letter of credit issued by the Lender for the account of the Borrower pursuant to Section 2.2.
	"Letter of Credit Application" shall mean the standard letter of credit application employed by the Lender from time to time in connection with letters of credit.
	"Letter of Credit Fee" shall mean each fee payable to the Lender by the Borrower pursuant to Section 2.16 upon or in connection with the issuance of a Letter of Credit.
	"LIBO Rate" shall mean, with respect to any Interest Period for any LIBO Rate Loan, the lesser of (a) the rate per annum equal to the average of the offered quotations appearing on Telerate Page 3750 (or if such Telerate Page shall not be available, any successor or similar service selected by the Lender and the Borrower) as of approximately 10:00 a.m., Central Standard or Daylight Savings Time, as the case may be, on the day two Business Days prior to the first day of such Interest Period for Dollar deposits in an amount comparable to the principal amount of such LIBO Rate Loan and having a term comparable to the Interest Period for such LIBO Rate Loan, or (b) the Highest Lawful Rate. If neither such Telerate Page 3750 nor any successor or similar service is available, the term "LIBO Rate" shall mean, with respect to any Interest Period for any LIBO Rate Loan, the lesser of (a) the rate per annum quoted by the Lender at a pproximately 11:00 a.m., London time (or as soon thereafter as practicable) two Business Days prior to the first day of the Interest Period for such LIBO Rate Loan for the offering by the Lender to leading banks in the London interbank market of Dollar deposits in an amount comparable to the principal amount of such LIBO Rate Loan and having a term comparable to the Interest Period for such LIBO Rate Loan, or (b) the Highest Lawful Rate.
	"LIBO Rate Loan" shall mean any Loan and any portion of the Loan Balance which the Borrower has requested, in the initial Borrowing Request for such Loan or a subsequent Borrowing Request for such portion of the Loan Balance, bear interest at the Adjusted LIBO Rate and which is permitted by the terms hereof to bear interest at the Adjusted LIBO Rate.
	"Lien" shall mean any interest in Property securing an obligation owed to, or a claim by, a Person other than the owner of such Property, whether such interest is based on common law, statute, or contract, and including, but not limited to, the lien or security interest arising from a mortgage, encumbrance, pledge, security agreement, conditional
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	sale or trust receipt, or a lease, consignment, or bailment for security purposes (other than true leases or true consignments), liens of mechanics, materialmen, and artisans, maritime liens and reservations, exceptions, encroachments, easements, rights of way, covenants, conditions, restrictions, leases, and other title exceptions and encumbrances affecting Property which secure an obligation owed to, or a claim by, a Person other than the owner of such Property (for the purpose of this Agreement, the Borrower shall be deemed to be the owner of any Property which it has acquired or holds subject to a conditional sale agreement, financing lease, or other arrangement pursuant to which title to the Property has been retained by or vested in some other Person for security purposes), and the filing or recording of any financing statement or other security instrument in any public office.
	"Limitation Period" shall mean any period while any amount remains owing on the Note and interest on such amount, calculated at the applicable interest rate, plus any fees or other sums payable under any Loan Document and deemed to be interest under applicable law, would exceed the amount of interest which would accrue at the Highest Lawful Rate.
	"Loan" shall mean any loan made by the Lender to or for the benefit of the Borrower pursuant to this Agreement and any payment made by the Lender under a Letter of Credit.
	"Loan Balance" shall mean, at any time, the outstanding principal balance of the Note at such time, plus the L/C Exposure at such time.
	"Loan Documents" shall mean this Agreement, the Note, the Letters of Credit Applications, the Letters of Credit, the Security Instruments, and all other documents and instruments now or hereafter delivered pursuant to the terms of or in connection with this Agreement, the Note, the Letters of Credit Applications, the Letters of Credit, or the Security Instruments, and all renewals and extensions of, amendments and supplements to, and restatements of, any or all of the foregoing from time to time in effect.
	"Material Adverse Effect" shall mean (a) any Material adverse effect on the business, operations, properties, conditions (financial or otherwise), or prospects of the Borrower, which increases the risk that any of the Obligations will not be repaid as and when due, or (b) any adverse effect upon the Collateral.
	"Mortgaged Properties" shall mean all proven Oil and Gas Properties of the Borrower, subject to a perfected first-priority Lien in favor of the Lender, subject only to Permitted Liens, as security for the Obligations.
	"Note" shall mean the promissory note of the Borrower, in the form attached hereto as Exhibit I, together with all renewals, extensions for any period, increases, and rearrangements thereof.
	"Obligations" shall mean, without duplication, (a) all Indebtedness evidenced by
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	the Note, (b) the Reimbursement Obligations, (c) the undrawn, unexpired amount of all outstanding Letters of Credit, (d) the obligation of the Borrower for the payment of Commitment Fees, Letter of Credit Fees, and Engineering Fees, (e) all obligations and liabilities whether now existing or hereafter arising of the Borrower to the Lender in connection with any Commodity Hedge Agreement or Rate Management Transaction, including Letters of Credit issued outside of this facility for Commodity Hedge Agreements or Rate Management Transactions, and (f) all other obligations and liabilities of the Borrower to the Lender, now existing or hereafter incurred, under, arising out of or in connection with any Loan Document, and to the extent that any of the foregoing includes or refers to the payment of amounts deemed or constituting interest, only so much thereof as shall have accrued, been earned and which remains unpaid at each relevant time of determination.
	"Oil and Gas Properties" shall mean fee, leasehold, or other interests in or under mineral estates or oil, gas, and other liquid or gaseous hydrocarbon leases with respect to Properties situated in the United States or offshore from any State of the United States, including, without limitation, overriding royalty and royalty interests, leasehold estate interests, net profits interests, production payment interests, and mineral fee interests, together with contracts executed in connection therewith and all tenements, hereditaments, appurtenances and Properties appertaining, belonging, affixed, or incidental thereto.
	"Permitted Liens" shall mean (a) Liens for taxes, assessments, or other governmental charges or levies not yet due or which (if foreclosure, distraint, sale, or other similar proceedings shall not have been initiated) are being contested in good faith by appropriate proceedings, and such reserve as may be required by GAAP shall have been made therefore, (b) Liens (including, but not limited to, pledges or deposits) in connection with workers' compensation, unemployment insurance or other social security (other than Liens created by Section 4068 of ERISA), old-age pension, or public liability obligations which are not yet due or which are being contested in good faith by appropriate proceedings, if such reserve as may be required by GAAP shall have been made therefore, (c) Liens in favor of vendors, carriers, warehousemen, repairmen, mechanics, workmen, materialmen, construction, or similar Liens arising by op eration of law in the ordinary course of business in respect of obligations which are not yet due or which are being contested in good faith by appropriate proceedings, if such reserve as may be required by GAAP shall have been made therefore, (d) Liens in favor of operators and non-operators under joint operating agreements or similar contractual arrangements arising in the ordinary course of the business of the Borrower to secure amounts owing, which amounts are not yet due or are being contested in good faith by appropriate proceedings, if such reserve as may be required by GAAP shall have been made therefore, (e) Liens under production sales agreements, division orders, operating agreements, and other agreements customary in the oil and gas business for processing, producing, and selling hydrocarbons securing obligations not constituting Indebtedness and provided that such Liens do not secure obligations to deliver hydrocarbons at some future date without receiving full payment therefore within 90 days of delivery, (f) easements, rights of way, restrictions, and other similar encumbrances, and minor defects in the chain of title which
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	are customarily accepted in the oil and gas financing industry, none of which interfere with the ordinary conduct of the business of the Borrower or materially detract from the value or use of the Property to which they apply and (g) Liens in favor of the Lender and other Liens expressly permitted under the Security Instruments.
	"Person" shall mean an individual, corporation, partnership, trust, unincorporated organization, government, any agency or political subdivision of any government, or any other form of entity.
	"Plan" shall mean, at any time, any employee benefit plan which is covered by ERISA and in respect of which the Borrower, or any Commonly Controlled Entity is (or, if such plan were terminated at such time, would under Section 4069 of ERISA be deemed to be) an "employer" as defined in Section 3(5) of ERISA.
	"Principal Office" shall mean the principal office of the Lender in Houston, Texas, presently located at 333 Clay Street, Suite 4400, Houston, Texas 77002.
	"Property" shall mean any interest in any kind of property or asset, whether real, personal or mixed, tangible or intangible.
	"Rate Management Transaction" shall mean any transaction (including an agreement with respect thereto) now existing or hereafter entered into between Borrower and Lender or a Person acceptable to the Lender which is a rate swap, basis swap, forward rate transaction, commodity swap, commodity option, equity or equity index swap, equity or equity index option, bond option, interest rate option, foreign exchange transaction, cap transaction, floor transaction, collar transaction, forward transaction, currency swap transaction, cross-currency rate swap transaction, currency option or any other similar transaction (including any option with respect to any of these transactions) or any combination thereof, whether linked to on or more interest rates, foreign currencies, commodity prices, equity prices or other financial measures.
	"Regulation D" shall mean Regulation D of the Board of Governors of the Federal Reserve System, as the same may be amended or supplemented from time to time.
	"Regulatory Change" shall mean the passage, adoption, institution, or amendment of any federal, state, local, or foreign Requirement of Law (including, without limitation, Regulation D), or any interpretation, directive, or request (whether or not having the force of law) of any Governmental Authority or monetary authority charged with the enforcement, interpretation, or administration thereof, occurring after the Closing Date and applying to a class of banks including the Lender.
	"Reimbursement Obligation" shall mean the obligation of the Borrower to provide to the Lender or reimburse the Lender for any amounts payable, paid, or incurred by the Lender with respect to Letters of Credit.
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	"Release of Hazardous Substances" shall mean any emission, spill, release, disposal, or discharge, except in accordance with a valid permit, license, certificate, or approval of the relevant Governmental Authority, of any Hazardous Substance into or upon (a) the air, (b) soils or any improvements located thereon, (c) surface water or groundwater, or (d) the sewer or septic system, or the waste treatment, storage, or disposal system servicing any Property of the Borrower.
	"Requirement of Law" shall mean, as to any Person, the certificate or articles of incorporation and by-laws, partnership agreements or other organizational or governing documents of such Person, and any applicable law, treaty, ordinance, order, judgment, rule, decree, regulation, or determination of an arbitrator, court, or other Governmental Authority, including, without limitation, rules, regulations, orders, and requirements for permits, licenses, registrations, approvals, or authorizations, in each case as such now exist or may be hereafter amended and are applicable to or binding upon such Person or any of its Property or to which such Person or any of its Property is subject.
	"Reserve Report" shall mean each report delivered to the Lender pursuant to Section 5.4.
	"Responsible Officer" shall mean, as to any Person, its President, Chief Executive Officer, Chief Financial Officer, Controller or any Vice President.
	"Security Instruments" shall mean the Existing Security Instruments and the security instruments executed and delivered in satisfaction of the condition set forth in Section 3.1(f), and all other documents and instruments at any time executed as security for all or any portion of the Obligations, as such instruments may be amended, restated, or supplemented from time to time.
	"Subsidiary" shall mean, as to any Person, a corporation of which shares of stock having ordinary voting power (other than stock having such power only by reason of the happening of a contingency) to elect a majority of the board of directors or other managers of such corporation are at the time owned, or the management of which is otherwise controlled, directly or indirectly through one or more intermediaries, or both, by such Person.
	"Superfund Site" shall mean those sites listed on the Environmental Protection Agency National Priority List and eligible for remedial action or any comparable state registries or list in any state of the United States.
	"Tangible Net Worth" shall mean (a) total assets, as would be reflected on a balance sheet of the Borrower prepared in accordance with GAAP, exclusive of Intellectual Property, experimental or organization expenses, franchises, licenses, permits, and other intangible assets, and unamortized goodwill adjusted for the non-cash items of impairment and dry-hole costs incurred subsequent to March 31, 2004, minus (b) total liabilities, as
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	would be reflected on a balance sheet of the Borrower prepared in accordance with GAAP.
	"UCC" shall mean the Uniform Commercial Code as from time to time in effect in the State of Texas.
1.3      Undefined Financial Accounting Terms. Undefined financial accounting terms used in this Agreement shall be defined according to GAAP or the Securities Exchange Commission at the time in effect.
1.4      References. References in this Agreement to Exhibit, Article, or Section numbers shall be to Exhibits, Articles, or Sections of this Agreement, unless expressly stated to the contrary. References in this Agreement to "hereby," "herein," "hereinafter," "hereinabove," "hereinbelow," "hereof," "hereunder" and words of similar import shall be to this Agreement in its entirety and not only to the particular Exhibit, Article, or Section in which such reference appears.
1.5      Articles and Sections. This Agreement, for convenience only, has been divided into Articles and Sections; and it is understood that the rights and other legal relations of the parties hereto shall be determined from this instrument as an entirety and without regard to the aforesaid division into Articles and Sections and without regard to headings prefixed to such Articles or Sections.
1.6     Number and Gender. Whenever the context requires, reference herein made to the single number shall be understood to include the plural; and likewise, the plural shall be understood to include the singular. Definitions of terms defined in the singular or plural shall be equally applicable to the plural or singular, as the case may be, unless otherwise indicated. Words denoting sex shall be construed to include the masculine, feminine and neuter, when such construction is appropriate; and specific enumeration shall not exclude t he general but shall be construed as cumulative.
1.7      Incorporation of Exhibits. The Exhibits attached to this Agreement are incorporated herein and shall be considered a part of this Agreement for all purposes.
ARTICLE II TERMS OF FACILITY
2.1      Revolving Line of Credit.  (a)  Upon the terms and conditions (including, without limitation, the right of the Lender to decline to make any Loan so long as any Default or Event of Default exists) and relying on the representations and warranties contained in this Agreement, the Lender agrees, during the Commitment Period, to make Loans, in immediately available funds at the Principal Office, to or for the benefit of the Borrower, from time to time on any Business Day designated by the Borrower following receipt by the Lender of a Borrowing Request; provided, however, that the Loan Balance shall not exceed at any time the Borrowing Base then in effect. Loans shall be made from time to time on any Business Day designated by the Borrower in its Borrowing Request.
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(b)     Subject to the terms of this Agreement, during the Commitment Period, the Borrower may borrow, repay, and reborrow and convert Loans of one type or with one Interest Period into Loans of another type or with a different Interest Period. Except for prepayments made pursuant to Section 2.11, each borrowing, conversion, and prepayment of principal of Loans shall be in an amount at least equal to $100,000. Each borrowing, prepayment, or conversion of or into a Loan of a different type or, in the case of a LIBO Rate Loan, having a different Interest Period, shall be deemed a separate borrowing, conversion, and prepayment for purposes of the foregoing, one for each type of Loan or Interest Period. Anything in this Agreement to the contrary notwithstanding, the aggregate principal amount of LIBO Rate Loans having the same Interest Period shall be at least equal to $200,000 with multiples of $100,000; and if any LIBO Rate Loan would otherwise be in a lesser principal amount for any period, such Loan shall be a Floating Rate Loan during such period.
(c)     The Loans made under this Section 2.1 shall be made and maintained at the Principal Office and shall be evidenced by the Note.
2.2      Letter of Credit Facility. Upon the terms and conditions and relying on the representations and warranties contained in this Agreement, the Lender agrees, from the date of this Agreement until the date which is 30 days prior to the Commitment Termination Date, to issue Letters of Credit for the account of the Borrower and to renew and extend such Letters of Credit. Letters of Credit shall be issued, renewed, or extended from time to time on any Business Day designated by the Borrower following the receipt in accordance with the terms hereof by the Lender of the written (or oral, confirmed prompt ly in writing) request by a Responsible Officer of the Borrower therefor and a Letter of Credit Application. Letters of Credit shall be issued in such amounts as the Borrower may request; provided, however, that (i) no Letter of Credit shall have an expiration date which is more than 365 days after the issuance thereof or subsequent to five days prior to the Commitment Termination Date, (ii) the Loan Balance shall not exceed at any time the amount of the Borrowing Base, and (iii) the L/C Exposure shall not exceed at any time $3,000,000.
2.3      Limitations on Interest Periods. Each Interest Period selected by the Borrower (a) which commences on the last Business Day of a calendar month (or any day for which there is no numerically corresponding day in the appropriate subsequent calendar month) shall end on the last Business Day of the appropriate subsequent calendar month, (b) which would otherwise end on a day which is not a Business Day shall end on the next succeeding Business Day (or, if such next succeeding Business Day falls in the next succeeding calendar month, on the next preceding Business Day), (c) which would otherwise end a fter Final Maturity shall end on Final Maturity, and (d) shall have a duration of not less than one month and, if any Interest Period would otherwise be a shorter period, the relevant Loan shall be a Floating Rate Loan during such period.
2.4      Limitation on Types of Loans. Anything herein to the contrary notwithstanding, no more than six separate Loans, including LIBO Rate Loans, shall be outstanding at any one time, with, for purposes of this Section, all Floating Rate Loans constituting one Loan, and all LIBO Rate Loans for the same Interest Period constituting one Loan. Anything herein to the contrary notwithstanding, if, on or prior to the determination of any interest rate for any LIBO Rate Loan for any Interest Period therefor:
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	(a)      the Lender determines (which determination shall be conclusive, absent manifest error) that quotations of interest rates for the deposits referred to in the definition of "LIBO Rate" in Section 1.2 are not being provided in the relevant amounts or for the relevant maturities for purposes of determining the rate of interest for such Loan as provided in this Agreement; or
	(b)      the Lender determines (which determination shall be conclusive, absent manifest error) that the rates of interest referred to in the definition of "LIBO Rate" in Section 1.2 upon the basis of which the rate of interest for such Loan for such Interest Period is to be determined do not adequately cover the cost to the Lender of making or maintaining such Loan for such Interest Period,
then the Lender shall give the Borrower prompt notice thereof; and so long as such condition remains in effect, the Lender shall be under no obligation to make LIBO Rate Loans or to convert Floating Rate Loans into LIBO Rate Loans, and the Borrower shall, on the last day of the then current Interest Period for each outstanding LIBO Rate Loan, either prepay such LIBO Rate Loan or convert such Loan into a Floating Rate Loan in accordance with Section 2.12.
2.5     Use of Loan Proceeds and Letters of Credit.  (a)  As of the date hereof, indebtedness in the amount of $6,099,236.79 is outstanding under the Existing Note. The Lender shall use proceeds of the initial Loan to purchase such indebtedness. Such indebtedness shall be renewed, extended, and rearranged pursuant to the terms of this Agreement, the Note, and the relevant Borrowing Request and shall for all purposes be deemed a borrowing hereunder. Proceeds of all subs equent Loans shall be used solely for acquisitions and development of Oil and Gas Properties and for general corporate purposes.
(b)     Letters of Credit shall be used solely for general corporate purposes provided, however, no Letter of Credit may be used in lieu or in support of stay or appeal bonds without Lender's written consent.
2.6      Interest. Subject to the terms of this Agreement (including, without limitation, Section 2.19), interest on the Loans shall accrue and be payable at a rate per annum equal to the Floating Rate for each Floating Rate Loan and the Adjusted LIBO Rate for each LIBO Rate Loan. Interest on all Floating Rate Loans shall be computed on the basis of a year of 365 or 366 days, as the case may be, and actual days elapsed (including the first day but excluding the last day) during the period for which payable. Interest on all LIBO Rate Loans shall be computed on the basis of a year of 360 days, and actual days elapsed (including the first day but excluding the last day) during the peri od for which payable. Notwithstanding the foregoing, interest on past-due principal and, to the extent permitted by applicable law, past-due interest, shall accrue at the Default Rate, computed on the basis of a year of 365 or 366 days, as the case may be, and actual days elapsed (including the first day but excluding the last day) during the period for which payable, and shall be payable upon demand by the Lender at any time as to all or any portion of such interest. In the event that the Borrower fails to select the duration of any Interest Period for any Fixed Rate Loan within the time period and otherwise as provided herein, such Loan (if outstanding as a Fixed Rate Loan) will be automatically converted into a Floating Rate Loan on the last day of the then current Interest Period for such Loan or (if outstanding as a Floating Rate Loan) will remain as, or (if not then outstanding) will be made as, a Floating Rate Loan.
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Interest provided for herein shall be calculated on unpaid sums actually advanced and outstanding pursuant to the terms of this Agreement and only for the period from the date or dates of such advances until repayment. Notwithstanding anything in this Agreement to the contrary if an Event of Default shall have occurred and be continuing each LIBO Rate Loan shall be converted to a Floating Rate Loan on the last day of the interest period applicable thereto.
2.7      Repayment of Loans and Interest. Accrued and unpaid interest on each outstanding Floating Rate Loan shall be due and payable monthly commencing on the first day of August, 2004, and continuing on the first day of each calendar month thereafter while any Floating Rate Loan remains outstanding, the payment in each instance to be the amount of interest which has accrued and remains unpaid in respect of the relevant Loan. Accrued and unpaid interest on each outstanding LIBO Rate Loan shall be due a nd payable on the last day of the Interest Period for such LIBO Rate Loan and, in the case of any Interest Period in excess of three months, on the day of the third calendar month following the commencement of such Interest Period corresponding to the day of the calendar month on which such Interest Period commenced, the payment in each instance to be the amount of interest which has accrued and remains unpaid in respect of the relevant Loan. The Loan Balance, together with all accrued and unpaid interest thereon, shall be due and payable at Final Maturity. At the time of making each payment hereunder or under the Note, the Borrower shall specify to the Lender the Loans or other amounts payable by the Borrower hereunder to which such payment is to be applied. In the event the Borrower fails to so specify, or if an Event of Default has occurred and is continuing, the Lender may apply such payment as it may elect in its sole discretion.
2.8      Outstanding Amounts. The outstanding principal balance of the Note reflected by the notations by the Lender on its records shall be deemed rebuttably presumptive evidence of the principal amount owing on the Note. The liability for payment of principal and interest evidenced by the Note shall be limited to principal amounts actually advanced and outstanding pursuant to this Agreement and interest on such amounts calculated in accordance with this Agreement.
2.9      Time, Place, and Method of Payments. All payments required pursuant to this Agreement or the Note shall be made in lawful money of the United States of America and in immediately available funds (which funds may be paid to the Lender by wire transfer or check executed by an authorized officer of the Borrower and made payable to the Lender), shall be deemed received by the Lender on the next Business Day following receipt if such receipt is after 2:00 p.m., Central Standard or Daylight Savings Time, as the case may be, on a ny Business Day, and shall be made at the Principal Office. Except as provided to the contrary herein, if the due date of any payment hereunder or under the Note would otherwise fall on a day which is not a Business Day, such date shall be extended to the next succeeding Business Day, and interest shall be payable for any principal so extended for the period of such extension.
2.10    Borrowing Base Determinations.  (a)  The Borrowing Base as of July 1, 2004, is acknowledged by the Borrower and the Lender to be $14,600,000 until the next Borrowing Base review scheduled for September 1, 2004. Should the Borrower not execute hedges as detailed in Section 3.1(f)(i)(ii) within five (5) Business Days of Closing Date, the Borrowing Base shall be $12,300,000.
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(b)    The Borrowing Base shall be redetermined semi-annually on the basis of information supplied by the Borrower in compliance with the provisions of this Agreement, including, without limitation, Reserve Reports, and all other information available to the Lender. In addition, the Lender shall, in the normal course of business following a request of the Borrower, redetermine the Borrowing Base; provided, however, the Lender shall not be obligated to respond to more than three such requests during any calendar year. Notwithstanding the foregoing, the Lender may at its discretion redetermine the Borrowing Base and the amount by which the Borrowing Base shall be reduced each calendar month as set forth in Section 2.10(a) at any time and from time to time.
(c)     Upon each determination of the Borrowing Base by the Lender, the Lender shall notify the Borrower orally (confirming such notice promptly in writing) of such determination, and the Borrowing Base and the amount by which the Borrowing Base shall be reduced so communicated to the Borrower shall become effective upon receipt of such written notification by the Borrower and shall remain in effect until the next subsequent determination of the Borrowing Base and the amount by which the Borrowing Base shall be reduced.
(d)     The Borrowing Base shall reasonably represent the determination by the Lender, in accordance with the applicable definitions and provisions herein contained and its customary lending practices for loans of this nature, of the value, for loan purposes, of the Mortgaged Properties, subject, in the case of any increase in the Borrowing Base, to the credit approval process of the Lender. Furthermore, the Borrower acknowledges that the determination of the Borrowing Base contains an equity cushion (market value in excess of loan value), which is acknowledged by the Borrower to be essential for the adequate protection of the Lender.
2.11    Mandatory Prepayments. If at any time the sum of the Loan Balance and the L/C Exposure exceeds the Borrowing Base then in effect, the Borrower shall, within 30 days of notice from the Lender of such occurrence, (a) prepay, or make arrangements acceptable to the Lender for the prepayment of, the amount of such excess for application on the Loan Balance, (b) provide additional collateral, of character and value satisfactory to the Lender in its reasonable discretion, to secure the Obligations by the execution and delivery to the Lender of security instruments in form and substance satisfactory to the Lender, or (c) effect any combination of the alternatives described in clauses (a) and (b) of this Section and acceptable to the Lender in its reasonable discretion. In t he event that a mandatory prepayment is required under this Section and the Loan Balance is less than the amount required to be prepaid, the Borrower shall repay the entire Loan Balance and, in accordance with the provisions of the relevant Letter of Credit Applications executed by the Borrower or otherwise to the reasonable satisfaction of the Lender, deposit with the Lender, as additional collateral securing the Obligations, an amount of cash, in immediately available funds, equal to the L/C Exposure minus the Borrowing Base. The cash deposited with the Lender in satisfaction of the requirement provided in this Section may be invested, at the sole discretion of the Lender and then only at the express direction of the Borrower as to investment vehicle and maturity (which shall be no later than the latest expiry date of any then outstanding Letter of Credit), for the account of the Borrower in cash or cash equivalent investments offered by or through the Lender.
2.12    Voluntary Prepayments of Loans. Subject to applicable provisions of this Agreement, the Borrower shall have the right at any time or from time to time to prepay Loans without prepayment
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penalty provided, however, no such prepayment shall serve to postpone the repayment when due of any Obligation.
2.13    Commitment Fee. In addition to interest on the Note as provided herein and all other fees payable hereunder and to compensate the Lender for maintaining funds available, the Borrower shall pay to the Lender, in immediately available funds (which funds may be paid to the Lender by wire transfer or check executed by an authorized officer of the Borrower and made payable to the Lender), on the first day of September, 2004, and on the first day of each third calendar month thereafter during the Commitment Per iod, a fee in the amount of one-half percent (1/2%) per annum, calculated on the basis of a year of 365 or 366 days, as the case may be, and actual days elapsed (including the first day but excluding the last day), on the average daily amount of the Available Commitment during the preceding quarterly period.
2.14    Facility Fee. In addition to interest on the Note as provided herein and all other fees payable hereunder and to compensate the Lender for the costs of the extension of credit hereunder, the Borrower shall pay to the Lender on the Closing Date, in immediately available funds (which funds may be paid to the Lender by wire transfer or check executed by an authorized officer of the Borrower and made payable to the Lender), a facility fee in the amount of 0.75% of the initial Borrowing Base (of which 50% of such fee has previously been paid and the Lender will credit, with the balance due on the Closing Date and the Lender will credit $29,062.50 towards the initial Facility Fee ) and 0.75% on any future increase of the Borrowing Base then in effect.
2.15    Engineering Fee. In addition to interest on the Note as provided herein and all other fees payable hereunder and to compensate the Lender for the costs of evaluating the Mortgaged Properties and reviewing the Reserve Reports, the Borrower shall pay to the Lender, in immediately available funds (which funds may be paid to the Lender by wire transfer or check executed by an authorized officer of the Borrower and made payable to the Lender), $10,000 for the initial engineering review and $5,000 for each subsequent engineering review.
2.16    Letter of Credit Fee. In addition to interest on the Note as provided herein and Commitment Fees and Facility Fees payable hereunder, the Borrower agrees to pay to the Lender on the date of issuance of each Letter of Credit, whether under the terms of this Agreement or outside of the Agreement, a fee equal to that reflected on Exhibit VI calculated on the basis of a year of 365 or 366 days, as the case may be, and actual days elapsed (including the first day but excluding the last day), on the face amount of such Letter of Credit beginning on the date of the issuance of each Letter of Credit until the Lender has received the cancelled Letter of Credit or a written cancellation of the Letter of Credit from the beneficiary of such Letter of Credit in form and substance reasonably satisfactory to the Lender. One-half of such Letter of Credit Fees shall be paid to the Lender on t he date of issuance of each Letter of Credit, the remainder payable to the Lender on the first day of each third calendar month following the issuance of a Letter of Credit in immediately available funds (which funds may be paid to the Lender by wire transfer or check executed by an authorized officer of the Borrower and made payable to the Lender provided, however, in the event such Letter of Credit is canceled prior to its original expiry date or a payment is made by the Lender with respect to such Letter of Credit, the Lender shall, within ten days after such cancellation or the making of such payment, rebate to the Borrower the unearned portion of such fee. The Borrower also agrees to pay
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to the Lender on demand its then-current letter of credit transactional fees, including, without limitation, amendment fees, payable with respect to each Letter of Credit. Upon the Borrower's request, a then-current schedule of fees will be provided which fees are subject to change.
2.17    Loans to Satisfy Obligations of Borrower. The Lender may, but shall not be obligated to, make Loans for the benefit of the Borrower and apply proceeds thereof to the extent reasonably required to satisfy of any condition, warranty, representation, or covenant of the Borrower contained in this Agreement or any other Loan Document. Any such Loan shall be evidenced by the Note and shall be made at the Floating Rate.
2.18    Security Interest in Accounts; Right of Offset. As security for the payment and performance of the Obligations, the Borrower hereby transfers, assigns, and pledges to the Lender and grants to the Lender a security interest in all funds of the Borrower now or hereafter or from time to time on deposit with the Lender, with such interest of the Lender to be retransferred, reassigned, and/or released by the Lender, as the case may be, at the expense of the Borrower upon payment in full and complete performance by the Borrower of all Obligations. All remedies as secured party or assignee of such funds shall be exercisable by the Lender upon the occurrence of any Event of Default, regardless of whether the exercise of any such remedy would result in any penalty or loss of interest or profit with respect to any withdrawal of funds deposited in a time deposit account prior to the mat urity thereof. Furthermore, the Borrower hereby grants to the Lender the right, exercisable at such time as any Obligation shall mature, whether by acceleration of maturity or otherwise, of offset or banker's lien against all funds of the Borrower now or hereafter or from time to time on deposit with the Lender, regardless of whether the exercise of any such remedy would result in any penalty or loss of interest or profit with respect to any withdrawal of funds deposited in a time deposit account prior to the maturity thereof. The Lender agrees to promptly notify the Borrower in writing of Lender's i ntent to exercise its rights pursuant to Section 2.18. The rights of Lender granted herein shall not include the accounts listed on Exhibit VI.
2.19    General Provisions Relating to Interest.  (a)  It is the intention of the parties hereto to comply strictly with the usury laws of the State of Texas and the United States of America. In this connection, there shall never be collected, charged, or received on the sums advanced hereunder interest in excess of that which would accrue at the Highest Lawful Rate. For purposes of Chapter 303 of the Texas Finance Code (Vernon's 1999), the Borrower agrees that the Highest Lawful Rate shall be the "weekly ceiling" as defined in such Section, provided that the Lender may also rely, to the extent permitted by applicable laws of the State of Texas or the United States of America, on alternative maximum rates of interest under other laws of the State of Texas or the United States of America applicable to the Lender, if greater.
(b)    Notwithstanding anything herein or in the Note to the contrary, during any Limitation Period, the interest rate to be charged on amounts evidenced by the Note shall be the Highest Lawful Rate, and the obligation, if any, of the Borrower for the payment of fees or other charges deemed to be interest under applicable law shall be suspended. During any period or periods of time following a Limitation Period, to the extent permitted by applicable laws of the State of Texas or the United States of America, the interest rate to be charged hereunder shall remain at the Highest Lawful Rate until such time as there has been paid to the Lender (i) the amount of interest in excess
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of that accruing at the Highest Lawful Rate that the Lender would have received during the Limitation Period had the interest rate remained at the otherwise applicable rate, and (ii) all interest and fees otherwise payable to the Lender but for the effect of such Limitation Period.
(c)     If, under any circumstances, the aggregate amounts paid on the Note or under this Agreement or any other Loan Document include amounts which by law are deemed interest and which would exceed the amount permitted if the Highest Lawful Rate were in effect, the Borrower stipulates that such payment and collection will have been and will be deemed to have been, to the extent permitted by applicable laws of the State of Texas or the United States of America, the result of mathematical error on the part of the Borrower and the Lender; and the Lender shall promptly refund the amount of such excess (to the extent only of such interest payments in excess of that which would have accrued and been payable on the basis of the Highest Lawful Rate) upon discovery of such error by the Lender or notice thereof from the Borrower. In the event that the ma turity of any Obligation is accelerated, by reason of an election by the Lender or otherwise, or in the event of any required or permitted prepayment, then the consideration constituting interest under applicable laws may never exceed the Highest Lawful Rate; and excess amounts paid which by law are deemed interest, if any, shall be credited by the Lender on the principal amount of the Obligations, or if the principal amount of the Obligations shall have been paid in full, refunded to the Borrower.
(d)    All sums paid, or agreed to be paid, to the Lender for the use, forbearance and detention of the proceeds of any advance hereunder shall, to the extent permitted by applicable law, be amortized, prorated, allocated, and spread throughout the full term hereof until paid in full so that the actual rate of interest is uniform but does not exceed the Highest Lawful Rate throughout the full term hereof.
2.20    Yield Protection. The Borrower shall pay to the Lender within 30 days of receipt of written request of Lender (which shall set forth in reasonable detail, the basis for requesting such amounts) such amounts as shall be sufficient in the reasonable opinion of the Lender to compensate it for any loss, cost, or expense incurred by and as a result of:
			(i)      any payment, prepayment, or conversion by the Borrower of a Fixed Rate Loan on a date other than the last day of an Interest Period for such Loan; or
			(ii)    any failure by the Borrower to borrow a Fixed Rate Loan from the Lender on the date for such borrowing specified in the relevant Borrowing Request;
such compensation to include, without limitation, with respect to any LIBO Rate Loan, an amount equal to the excess, if any, of (A) the amount of interest which would have accrued on the principal amount so paid, prepaid, converted, or not borrowed for the period from the date of such payment, prepayment, conversion, or failure to borrow to the last day of the then current Interest Period for such Loan (or, in the case of a failure to borrow, the Interest Period for such Loan which would have commenced on the date of such failure to borrow) at the applicable rate of interest for such Loan provided for herein over (B) the interest component (as reasonably determined by the Lender) of the
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amount (as reasonably determined by the Lender) the Lender would have bid in the London interbank market for Dollar deposits of amounts comparable to such principal amount and maturities comparable to such period.
2.21    Illegality. Notwithstanding any other provision of this Agreement, in the event that it becomes unlawful for the Lender or its Applicable Lending Office to (a) honor its obligation to make any type of Fixed Rate Loans hereunder, or (b) maintain any type of Fixed Rate Loans hereunder, then the Lender shall promptly notify the Borrower thereof; and the obligation of the Lender hereunder to make such type of Fixed Rate Loans and to convert other types of Loans into Fixed Rate Loans of such type shall be suspended until such time as the Lender may again make and maintain Fixed Rate Loans of such type, and the outstanding Fixed Rate Loans of such type shall be converted into Floating Rate Loans in acc ordance with Section 2.13. Before giving such notice pursuant to this Section, the Lender will designate a different available Applicable Lending Office for Fixed Rate Loans or take such other action as the Borrower may request if such designation or action will avoid the need to suspend the obligation of the Lender to make Fixed Rate Loans and will not, in the opinion of the Lender, be disadvantageous to the Lender.
2.22    Regulatory Change. In the event that by reason of any Regulatory Change, the Lender (a) incur Additional Costs based on or measured by the excess above a specified level of the amount of a category of deposits or other liabilities of the Lender which includes deposits by reference to which the interest rate on any Fixed Rate Loan is determined as provided in this Agreement or a category of extensions of credit or other assets of such Lender which includes any Fixed Rate Loan, or (b) becomes subject to restrictions on the amount of such a category of liabilities or assets which it may hold, then, at the election of the Lender with notice to the Borrower, the obligation of the Lender to make such F ixed Rate Loans and to convert Floating Rate Loans into such Fixed Rate Loans shall be suspended until such time as such Regulatory Change ceases to be in effect, and all such outstanding Fixed Rate Loans shall be converted into Floating Rate Loans in accordance with Section 2.13.
2.23    Limitations on Interest Periods. Each Interest Period selected by the Borrower (a) which commences on the last Business Day of a calendar month (or, with respect to any LIBO Rate Loan, any day for which there is no numerically corresponding day in the appropriate subsequent calendar month) shall end on the last Business Day of the appropriate subsequent calendar month, (b) which would otherwise end on a day which is not a Business Day shall end on the next succeeding Business Day (or, if such next succeeding Business Day falls in the next succeeding calendar month, on the next preceding Business Day), (c) which would otherwise commence before and end after Final Maturity shall end on Final Maturity, and (d) shall have a duration of not less than thirty, sixty or ninety days, as to any LIBO Rate Loan, and, if any Interest Period would otherwise be a shorter period, the relevant Loan shall be a Floating Rate Loan during such period.
2.24    Letters in Lieu of Transfer Orders. The Lender agrees that none of the letters in lieu of transfer or division orders provided by the Borrower pursuant to Section 3.1(g)(v) or Section 5.7 will be sent to the addressees thereof prior to the occurrence and continuance of an Event of Default, at which time the Lender may, at its option and in addition to the exercise of any of its other rights and remedies, send any or all of such letters.
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2.25    Power of Attorney. The Borrower hereby designates the Lender as its agent and attorney-in-fact, to act in its name, place, and stead for the purpose of completing and, upon the occurrence and continuance of an Event of Default, delivering any and all of the letters in lieu of transfer orders delivered by the Borrower to the Lender pursuant to Section 3.1(g)(v) or Section 5.7, including, without limitation, completing any blanks contained in such letters and attaching exhibits thereto describing the relevant Collateral. The Borrower hereby ratifies and confirms all that the Lender shall lawfully do or cause to be done by virtue of this power of attorney and the rights granted with respect to such power of attorney. This power of attorney is coupled with the interests of the Lender in the Collateral, shall commence and be in full force and effect as of the Closing Date and shall remain in full force and effect and shall be irrevocable so long as any Obligation remains outstanding or unpaid or any Commitment exists. The powers conferred on the Lender by this appointment are solely to protect the interests of the Lender under the Loan Documents and shall not impose any duty upon the Lender to exercise any such powers. The Lender shall be accountable only for amounts that it actually receives as a result of the exercise of such powers and shall not be responsible to the Borrower or any other Person for any act or failure to act with respect to such powers, except for gross negligence or willful misconduct.
ARTICLE III CONDITIONS
The obligations of the Lender to enter into this Agreement and to make Loans and issue Letters of Credit are subject to the satisfaction of the following conditions precedent:
3.1      Receipt of Loan Documents and Other Items. The Lender shall have no obligation under this Agreement unless and until all matters incident to the consummation of the transactions contemplated herein, including, without limitation, the review by the Lender or its counsel of the title of the Borrower to its Oil and Gas Properties, shall be satisfactory to the Lender, and the Lender shall have received, reviewed, and approved the following documents and other items, appropriately executed when necessary and, where applicable, acknowledged by the Borrower, all in form and substance reasonably satisfactory to the Lender and dated, where applicable, of even date herewith or a date prior thereto and acceptable to the Lender:
	(a)     multiple counterparts of this Agreement and the Assignment, as requested by the Lender;
	(b)     the Existing Notes, endorsed payable to the Lender;
	(c)     the Note;
	(d)     copies of the Articles of Incorporation, the bylaws, and all amendments to each of the foregoing of the Borrower accompanied by a certificates issued by the secretary or assistant secretary of the Borrower to the effect that each such copy is correct and complete;
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	(e)     certificates of incumbency dated the Closing Date and signatures of all of the respective officers of the Borrower who are authorized to execute Loan Documents on behalf of the Borrower, each such certificate being executed by the respective secretary or assistant secretary of the Borrower;
	(f)     copies of resolutions of the Borrower approving the Loan Documents and authorizing the transactions contemplated herein and therein, duly adopted by the board of directors of the Borrower accompanied by a certificate of the secretary or assistant secretary of the Borrower to the effect that such copies are true and correct copies of the resolutions duly adopted at a meeting or by unanimous consent of the board of directors of the Borrower and that such resolutions constitute all the resolutions adopted with respect to such transactions, have not been amended, modified, or revoked in any respect, and are in full force and effect as of the date of such certificate;
	(g)     certificates dated as of a recent date from the Secretary of State or other appropriate Governmental Authority for the State of Delaware evidencing the existence or qualification and good standing of the Borrower in such jurisdiction;
	(h)     the following documents ratifying, amending and/or restating the Existing Security Instruments and otherwise establishing Liens in favor of the Lender in and to the Collateral:
		(i)     Amended and Restated Mortgage, Deed of Trust, Indenture, Security Agreement, Assignment of Production, and Financing Statement from the Borrower covering all Oil and Gas Properties of the Borrower and all improvements, personal property, and fixtures related thereto;
		(ii)    Financing Statements from the Borrower, as debtor, constituent to the instrument described in clause (i) above;
		(iii)   Security Agreement from the Borrower pledging accounts, contract rights, etc.;
		(iv)   Financing Statement from the Borrower, as debtor, constituent to the instrument described in clause (iii) above;
		(v)    undated letters, in form and substance satisfactory to the Lender, from the Borrower to each purchaser of production and disburser of the proceeds of production from or attributable to the Mortgaged Properties, together with additional letters with the addressees left blank, authorizing and directing the addressees to make future payments attributable to production from the Mortgaged Properties directly to the Lender;
	(i)     unaudited Financial Statements of the Borrower as of March 31, 2004;
	(j)     quarterly financial projections as of May 31, 2004;
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	(k)    results of searches of the UCC Records of the Secretary of State of the State(s) of Delaware and Texas, from a source acceptable to the Lender and reflecting no Liens against any of the Collateral as to which perfection of a Lien is accomplished by the filing of a financing statement other than existing security instruments in favor of the Lender;
	(l)      confirmation, acceptable to the Lender, of the title of the Borrower to the Mortgaged Properties, free and clear of Liens other than Permitted Liens;
	(m)   copies of all material operating, lease, sublease, royalty, sales, exchange, processing, farmout, bidding, pooling, unitization, communitization, and other agreements relating to the Mortgaged Properties requested by the Lender;
	(n)   reservoir engineering reports covering the Mortgaged Properties;
	(o)   the opinion of Barton, Schneider & Russell, LLP, counsel to the Borrower, in substantially the form attached hereto as Exhibit IV, with such changes thereto as may be approved by the Lender;
	(p)   certificates evidencing the insurance coverage required pursuant to Section 5.18;
	(q)   payment of the balance owed on the Facility Fee;
	(r)    payment of the fees described in Section 5.14;
	(s)    as consideration for a higher initial Borrowing Base, Borrower will furnish proof satisfactory to the Lender that it has entered into Commodity Hedge Agreements with a Person acceptable to the Lender with the volumes prices and dates as follows:
		(i)      from September 1 to December 31, 2004, at least 135,000 mcf of gas per month at $5.25 per mmbtu and 15,000 barrels of oil per month at $28.00 per barrel; and
		(ii)     for the year 2005 at least 95,000 mcf of gas per month at $4.75 per mmbtu and 10,000 barrels of oil per month at $26.00 per barrel; and
	(t)     such other agreements, documents, instruments, opinions, certificates, waivers, consents, and evidence as the Lender may reasonably request.
3.2      Each Loan and Letter of Credit. In addition to the conditions precedent stated elsewhere herein, the Lender shall not be obligated to make any Loan or issue any Letter of Credit unless:
	(a)    the Borrower shall have delivered to the Lender a Borrowing Request at least one Business Day prior to the requested date for the relevant Loan, or a Letter of Credit Application at least two Business Days prior to the requested issuance date for the relevant Letter of Credit (including,  without  limitation,  renewals and  extensions  thereof)  and  each  statement  or
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	certification made in such Borrowing Request or Letter of Credit Application, as the case may be, shall be true and correct in all material respects on the requested date for such Loan or the issuance of such Letter of Credit or renewals or extensions thereof;
	(b)    no Event of Default or Default shall exist or will occur as a result of the making of the requested Loan or the issuance of the requested Letter of Credit or renewals or extensions thereof;
	(c)     if requested by the Lender, the Borrower shall have delivered evidence reasonably satisfactory to the Lender substantiating any of the matters contained in this Agreement which are reasonably necessary to enable the Borrower to qualify for such Loan or the issuance of such Letter of Credit or renewals or extensions thereof;
	(d)     the Lender shall have received, reviewed, and approved such additional documents and items as described in Section 3.1 as may be reasonably requested by the Lender with respect to such Loan or Letter of Credit or renewals or extensions thereof;
	(e)     no event shall have occurred which, in the reasonable opinion of the Lender, could reasonably be expected to result in a Material Adverse Effect;
	(f)     each of the representations and warranties contained in this Agreement shall be true and correct (unless they speak to a specific date or are based on facts which have changed by transactions contemplated or expressly permitted by this Agreement) and shall be deemed to be repeated by the Borrower as if made on the requested date for such Loan or the issuance of such Letter of Credit or renewals or extensions thereof;
	(g)    the Security Instruments shall be in full force and effect and provide to the Lender the security intended thereby;
	(h)    neither the consummation of the transactions contemplated hereby nor the making of such Loan nor the issuance of such Letter of Credit shall contravene, violate, or conflict with any Requirement of Law;
	(i)     the Borrower shall hold full legal title to the Collateral and be the sole beneficial owner thereof;
	(j)     the Lender shall have received the payment of all Engineering Fees, and other fees payable to the Lender hereunder and reimbursement from the Borrower, or special legal counsel for the Lender shall have received payment from the Borrower, for (i) all reasonable fees and expenses of counsel to the Lender for which the Borrower is responsible pursuant to applicable provisions of this Agreement and for which invoices have been presented as of or prior to the date of the relevant Loan or Letter of Credit Application, and (ii) estimated fees charged by filing officers and other public officials incurred or to be incurred in connection with the filing and recordation of any Security Instruments, for which invoices have been presented as of or prior to the date of the requested Loan or Letter of Credit Application; and
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	(k)    all matters incident to the consummation of the transactions hereby contemplated shall be satisfactory to the Lender.
ARTICLE IV REPRESENTATIONS AND WARRANTIES
To induce the Lender to enter into this Agreement and to make the Loans and issue Letters of Credit, the Borrower represents and warrants to the Lender (which representations and warranties shall survive the delivery of the Note) that:
4.1      Due Authorization. The execution and delivery by the Borrower of this Agreement and the borrowings hereunder, the execution and delivery by the Borrower of the Note, the repayment of the Note and interest and fees provided for in the Note and this Agreement, the execution and delivery of the Security Instruments by the Borrower and the performance of all obligations of the Borrower under the Loan Documents are within the power of the Borrower, have been duly authorized by all necessary corporate action by the Borrower, and do not and will not (a) require the consent of any Governmental Authority, (b) contravene or conflict with any Requirement of Law, (c) contravene or conflict with any indenture, instrument, or other agreement to which the Borrower is a party or by which any Property of the Borrower may be presently bound or encumbered, or (d) result in or require the creation or imposition of any Lien in, upon or of any Property of the Borrower under any such indenture, instrument, or other agreement, other than the Loan Documents.
4.2      Corporate Existence. The Borrower is a corporation duly organized, legally existing under the laws of its state of incorporation and is duly qualified as a corporation and in good standing in all jurisdictions wherein the ownership of Property or the operation of its business necessitates same, other than those jurisdictions wherein the failure to so qualify will not have a Material Adverse Effect.
4.3      Valid and Binding Obligations. All Loan Documents to which the Borrower is a party, when duly executed and delivered by the Borrower, will be the legal, valid, and binding obligations of the Borrower, enforceable against the Borrower in accordance with their respective terms.
4.4      Security Instruments. The provisions of each Security Instrument executed by the Borrower are effective to create in favor of the Lender, a legal, valid, and enforceable Lien in all right, title, and interest of the Borrower in the Collateral described therein, which Liens, assuming the accomplishment of recording and filing in accordance with applicable laws prior to the intervention of rights of other Persons, shall constitute fully perfected first-priority Liens on all right, title, and interest of the Borrower in the C ollateral described therein.
4.5      Title to Assets. The Borrower has good and defensible title to its Oil and Gas Properties, free and clear of all Liens except Permitted Liens.
4.6      Scope and Accuracy of Financial Statements. The Financial Statements of the Borrower as of March 31, 2004, present fairly the financial position and results of operations and cash flows of
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the Borrower as at the relevant point in time or for the period indicated, as applicable. No event or circumstance has occurred since March 31, 2004, which could reasonably be expected to have a Material Adverse Effect.
4.7      No Material Misstatements. No information, exhibit, statement, or report furnished to the Lender by or at the direction of the Borrower in connection with this Agreement contains any material misstatement of fact or omits to state a material fact or any fact necessary to make the statements contained therein not misleading as of the date made or deemed made.
4.8      Liabilities, Litigation, and Restrictions. Other than as listed under the heading "Liabilities" on Exhibit V attached hereto, the Borrower has no liabilities, direct, or contingent, which may materially and adversely affect its business or operations or its ownership of the Collateral. Except as set forth under the heading "Litigation" on Exhibit V hereto, no litigation or other action of any nature affecting the Borrower are pending before any Governmental Authority or, to the best knowledge of the Borrower, threatened a gainst or affecting the Borrower which might reasonably be expected to result in any impairment of its ownership of any Collateral or have a Material Adverse Effect. To the best knowledge of the Borrower, after due inquiry, no unusual or unduly burdensome restriction, restraint or hazard exists by contract, Requirement of Law, or otherwise relative to the business or operations of the Borrower or the ownership and operation of the Collateral other than such as relate generally to Persons engaged in business activities similar to those conducted by the Borrower.
4.9      Authorizations; Consents. Except as expressly contemplated by this Agreement, no authorization, consent, approval, exemption, franchise, permit, or license of, or filing with, any Governmental Authority or any other Person is required to authorize or is otherwise required in connection with the valid execution and delivery by the Borrower of the Loan Documents or any instrument contemplated hereby, the repayment by the Borrower of the Note and interest and fees provided in the Note and this Agreement, or the performance by the Borrower of the Obligations.
4.10    Compliance with Laws. The Borrower and its Property, including, without limitation, the Mortgaged Property, are in compliance with all applicable Requirements of Law, including, without limitation, Environmental Laws, the Natural Gas Policy Act of 1978, as amended, and ERISA, except to the extent non-compliance with any such Requirements of Law could not reasonably be expected to have a Material Adverse Effect.
4.11    ERISA. No Reportable Event has occurred with respect to any Single Employer Plan, and each Single Employer Plan has complied with and been administered in all material respects in accordance with applicable provisions of ERISA and the Code. To the best knowledge of the Borrower, (a) no Reportable Event has occurred with respect to any Multiemployer Plan, and (b) each Multiemployer Plan has complied with and been administered in all material respects with applicable provisions of ERISA and the Code. The present value of all benefits vested under each Single Employer Plan maintained by the Borrower or any Commonly Controlled Entity (based on the assumptions used to fund such Plan) did not, as of the last annual valuation date applicable thereto, exceed the value of the assets of such Plan allocable to such vested benefits. Neither the Borrower nor any Commonly Controlled Enti ty has had a complete or partial withdrawal from any Multiemployer
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Plan for which there is any withdrawal liability. As of the most recent valuation date applicable to any Multiemployer Plan, neither the Borrower nor any Commonly Controlled Entity would become subject to any liability under ERISA if the Borrower or such Commonly Controlled Entity were to withdraw completely from such Multiemployer Plan. Neither the Borrower nor any Commonly Controlled Entity has received notice that any Multiemployer Plan is Insolvent or in Reorganization. To the knowledge of the Borrower, no such Insolvency or Reorganization is reasonably likely to occur. Based upon GAAP existing as of the date of this Agreement and current factual circumstances, the Borrower has no reason to believe that the annual cost during the term of this Agreement to the Borrower and all Commonly Controlled Entities for post-retirement benefits to be provided to the current and former employees of the Borrower and all Commonly Controlled Entities under Plans which are welfare benefit plans (as defined in Section 3(1) of ERISA) will, in the aggregate, have a Material Adverse Effect.
4.12    Environmental Laws. To the best knowledge and belief of the Borrower, except as would not have a Material Adverse Effect, or as described on Exhibit V under the heading "Environmental Matters:"
	(a)     no Property of the Borrower is currently on or has ever been on any Property which is on or has ever been on, any federal or state list of Superfund Sites;
	(b)    no Hazardous Substances have been generated, transported, and/or disposed of by the Borrower at a site which was, at the time of such generation, transportation, and/or disposal, or has since become, a Superfund Site;
	(c)    except in accordance with applicable Requirements of Law or the terms of a valid permit, license, certificate, or approval of the relevant Governmental Authority, no Release of Hazardous Substances by the Borrower or from, affecting, or related to any Property of the Borrower or adjacent to any Property of the Borrower has occurred; and
	(d)    no Environmental Complaint has been received by the Borrower.
4.13    Compliance with Federal Reserve Regulations. No transaction contemplated by the Loan Documents is in violation of any regulations promulgated by the Board of Governors of the Federal Reserve System, including, without limitation, Regulations T, U, or X.
4.14    Investment Company Act Compliance. The Borrower is not, nor is the Borrower directly or indirectly controlled by or acting on behalf of any Person which is, an "investment company" or an "affiliated person" of an "investment company" within the meaning of the Investment Company Act of 1940, as amended.
4.15    Public Utility Holding Company Act Compliance. The Borrower is not a "holding company," or an "affiliate" of a "holding company" or of a "subsidiary company" of a "holding company," within the meaning of the Public Utility Holding Company Act of 1935, as amended.
4.16    Proper Filing  of  Tax Returns;  Payment  of  Taxes Due.  The Borrower has duly and
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properly filed its United States income tax return and all other tax returns which are required to be filed and has paid all taxes due except such as are being contested in good faith and as to which adequate provisions and disclosures have been made. The respective charges and reserves on the books of the Borrower with respect to taxes and other governmental charges are adequate.
4.17    Refunds. Except as described on Exhibit V under the heading "Refunds," no orders of, proceedings pending before, or other requirements of, the Federal Energy Regulatory Commission, the Texas Railroad Commission, or any Governmental Authority exist which could result in the Borrower being required to refund any material portion of the proceeds received or to be received from the sale of hydrocarbons constituting part of the Mortgaged Property.
4.18    Gas Contracts. Except as described on Exhibit V under the heading "Gas Contracts," the Borrower (a) are not obligated in any material respect by virtue of any prepayment made under any contract containing a "take-or-pay" or "prepayment" provision or under any similar agreement to deliver hydrocarbons produced from or allocated to any of the Mortgaged Property at some future date without receiving full payment therefor within 90 days of delivery, and (b) has not produced gas, in any material amount, subject to, and neither the Borrow er nor any of the Mortgaged Properties is subject to, balancing rights of third parties or subject to balancing duties under governmental requirements, except as to such matters for which the Borrower has established monetary reserves adequate in amount to satisfy such obligations and has segregated such reserves from other accounts.
4.19    Intellectual Property. The Borrower owns or is licensed to use all Intellectual Property necessary to conduct all business material to its condition (financial or otherwise), business, or operations as such business is currently conducted. No claim has been asserted or is pending by any Person with the respect to the use of any such Intellectual Property or challenging or questioning the validity or effectiveness of any such Intellectual Property; and the Borrower knows of no valid basis for any such claim. The use of such Intelle ctual Property by the Borrower does not infringe on the rights of any Person, except for such claims and infringements as do not, in the aggregate, give rise to any material liability on the part of the Borrower.
4.20    Casualties or Taking of Property. Except as disclosed on Exhibit V under the heading "Casualties," since March 31, 2004, neither the business nor any Property of the Borrower has been materially adversely affected as a result of any fire, explosion, earthquake, flood, drought, windstorm, accident, strike or other labor disturbance, embargo, requisition or taking of Property, or cancellation of contracts, permits, or concessions by any Governmental Authority, riot, activities of armed forces, or acts of God.
4.21    Locations of Borrower. The principal place of business and chief executive office of the Borrower is located at the address of the Borrower set forth in Section 8.3 or at such other location as the Borrower may have, by proper written notice hereunder, advised the Lender, provided that such other location is within a state in which appropriate financing statements from the Borrower in favor of the Lender have been filed.
4.22    Subsidiaries. The Borrower has no Subsidiaries except those described on Exhibit V under the heading "Subsidiaries".
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4.23    Existing Indebtedness; No Defenses. As of the date hereof, (a) the Borrower is indebted to the Existing Lender under the Existing Note in the aggregate principal amount of $6,099,236.79, and (b) the Borrower has no defenses to, rights of setoff against, claims or counterclaims with respect to, and no default exists under or with respect to, any of the Existing Loan Documents or any Indebtedness or obligation of the Borrower to the Existing Lender.
ARTICLE V AFFIRMATIVE COVENANTS
So long as any Obligation remains outstanding or unpaid or any Commitment exists, the Borrower, where applicable, shall:
5.1      Maintenance and Access to Records. Keep adequate records, in accordance with GAAP, of all its transactions so that at any time, and from time to time, its true and complete financial condition may be readily determined, and promptly following the reasonable request of the Lender, make such records available for inspection by the Lender and, at the expense of the Borrower, allow the Lender to make and take away copies thereof.
5.2      Quarterly Financial Statements; Compliance Certificates. Deliver to the Lender, (a) on or before the 45th day after the close of each of the first three quarterly periods of each fiscal year of the Borrower, a copy of the respective unaudited consolidated Financial Statements of the Borrower as at the close of such quarterly period and from the beginning of such fiscal year to the end of such period, such Financial Statements to be certified by a Responsible Officer of the Borrower as a fair presentation of the condition of the Borrower, subject to changes resulting from normal year-end audit adjustments, and (b) on or before the 45th day after the close of each fiscal quarter, with the exception of the last fiscal quarter, a Compliance Certificate.
5.3      Quarterly Financial Projections. Deliver at the same time as quarterly Financial Statements financial projections which include projected capital expenditures.
5.4      Annual Financial Statements. Deliver to the Lender, on or before the 90th day after the close of each fiscal year of the Borrower, respectively, a copy of its annual audited Financial Statements and a Compliance Certificate and an annual Borrower forecast updated quarterly which includes projected capital expenditures.
5.5      Oil and Gas Reserve Reports.  (a)  Deliver to the Lender no later than February 15 of each year during the term of this Agreement, engineering reports in form and substance satisfactory to the Lender, and upon Lender's request, certified by any nationally- or regionally-recognized independent consulting petroleum engineers acceptable to the Lender as fairly and accurately setting forth (i) the proven and producing, shut-in, behind-pipe, and undeveloped oil and gas reserves (separately classified as suc h) attributable to the Mortgaged Properties as of January 1 of the year for which such reserve reports are furnished, (ii) the aggregate present value of the future net income with respect to such Mortgaged Properties, discounted at a stated per annum discount rate of
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proven and producing reserves, (iii) projections of the annual rate of production, gross income, and net income with respect to such proven and producing reserves, and (iv) information with respect to the "take-or-pay," "prepayment," and gas-balancing liabilities of the Borrower.
(b)     Deliver to the Lender no later than August 15 of each year during the term of this Agreement, engineering reports in form and substance satisfactory to the Lender prepared by or under the supervision of the chief petroleum engineer of the Borrower evaluating the Mortgaged Properties as of July 1 of the year for which such reserve reports are furnished and updating the information provided in the reports pursuant to Section 5.4(a).
(c)     Each of the reports provided pursuant to this Section shall be submitted to the Lender together with additional data concerning pricing, quantities of production from the Mortgaged Properties, volumes of production sold, purchasers of production, gross revenues, expenses, and such other information and engineering and geological data with respect thereto as the Lender may reasonably request.
5.6      Title Opinions; Title Defects. Promptly upon the request of the Lender, furnish to the Lender title opinions or other title information, in form and substance and by counsel reasonably satisfactory to the Lender, or other confirmation of title reasonably acceptable to the Lender, covering Oil and Gas Properties constituting not less than 81% of the value, determined by the Lender in its sole discretion, of the Mortgaged Properties; and promptly, but in any event within 45 days after notice by the Lender of any defect, mate rial in the opinion of the Lender in value, in the title of the Borrower to any of its Oil and Gas Properties, clear such title defects, and, in the event any such title defects are not cured in a timely manner, pay all related costs and fees incurred by the Lender to do so.
5.7      Notices of Certain Events. Deliver to the Lender, immediately upon having knowledge of the occurrence of any of the following events or circumstances, a written statement with respect thereto, signed by a Responsible Officer of the Borrower and setting forth the relevant event or circumstance and the steps being taken by the Borrower with respect to such event or circumstance:
	(a)    any Default or Event of Default;
	(b)    any default or event of default under any contractual obligation of the Borrower, or any litigation, investigation, or proceeding between the Borrower and any Governmental Authority which, in either case, if not cured or if adversely determined, as the case may be, could reasonably be expected to have a Material Adverse Effect;
	(c)    any litigation or proceeding involving the Borrower as a defendant or in which any Property of the Borrower is subject to a claim and in which the amount involved is $100,000.00 or more in the aggregate and which is not covered by insurance or in which injunctive or similar relief is sought;
	(d)    the receipt by the Borrower of any written Environmental Complaint having a Material Adverse Effect;
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	(e)    any actual, proposed, or threatened testing or other investigation by any Governmental Authority or other Person concerning the environmental condition of, or relating to, any Property of the Borrower or adjacent to any Property of the Borrower following any allegation of a violation of an Environmental Complaint which could reasonably be expected to result in a Material Adverse Effect;
	(f)     any Release of Hazardous Substances by the Borrower or from, affecting, or related to any Property of the Borrower or adjacent to any Property of the Borrower except in accordance with applicable Requirements of Law or the terms of a valid permit, license, certificate, or approval of the relevant Governmental Authority, or the violation of any Environmental Law, or the revocation, suspension, or forfeiture of or failure to renew, any permit, license, registration, approval, or authorization in each such case which could reasonably be expected to have a Material Adverse Effect;
	(g)    the change in identity or address of any Person remitting to the Borrower proceeds from the sale of hydrocarbon production from or attributable to any Mortgaged Property; and
	(h)     any other event or condition which could reasonably be expected to have a Material Adverse Effect.
5.8      Letters in Lieu of Transfer Orders; Division Orders. Promptly upon request by the Lender at any time and from time to time, and without limitation on the rights of the Lender pursuant to Section 2.17, execute such letters in lieu of transfer orders, in addition to the letters signed by the Borrower and delivered to the Lender in satisfaction of the condition set forth in Section 3.1(g)(v) and/or division and/or transfer orders as are necessary or appropriate to transfer and deliver to the Lender proceeds from or attributable to any Mortgaged Property.
5.9      Additional Information. Furnish to the Lender, promptly upon the request of the Lender, such additional financial or other information concerning the assets, liabilities, operations, and transactions of the Borrower as the Lender may reasonably request from time to time; and notify the Lender not less than ten Business Days prior to the occurrence of any condition or event that may change the proper location for the filing of any financing statement or other public notice or recording for the purpose of perfecting a Lien i n any Collateral, including, without limitation, any change in its name or the location of its principal place of business or chief executive office; and upon the request of the Lender, execute such additional Security Instruments as may be necessary or appropriate in connection therewith.
5.10    Compliance with Laws. Except to the extent the failure to comply or cause compliance would not have a Material Adverse Effect, comply with all applicable Requirements of Law, including, without limitation, (a) the Natural Gas Policy Act of 1978, as amended, (b) ERISA, (c) Environmental Laws, and (d) all permits, licenses, registrations, approvals, and authorizations (i) related to any natural or environmental resource or media located on, above, within, in the vicinity of, related to or affected by any Property of the Borrower, (ii) required for the performance of the operations of the Borrower, or (iii) applicable to the use, generation, handling, storage, treatment, transport, or disposal of any Hazardous Substances; and cause all employees, crew members, agents, contractors, subcontractors,
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and future lessees (pursuant to appropriate lease provisions) of the Borrower, while such Persons are acting within the scope of their relationship with the Borrower, to comply with all such Requirements of Law as may be necessary or appropriate to enable the Borrower to so comply.
5.11    Payment of Assessments and Charges. Pay all taxes, assessments, governmental charges, rent, and other Indebtedness which, if unpaid, might become a Lien against the Property of the Borrower, except any of the foregoing being contested in good faith and as to which adequate reserve in accordance with GAAP has been established or unless failure to pay would not have a Material Adverse Effect.
5.12    Maintenance of Corporate Existence and Good Standing. Maintain its corporate existence or qualification and good standing in its jurisdiction of incorporation and in all jurisdictions wherein the Property now owned or hereafter acquired or business now or hereafter conducted necessitates same.
5.13    Payment of Note; Performance of Obligations. Pay the Note according to its terms and do and perform every act and discharge all of its other Obligations.
5.14    Further Assurances. Promptly cure any defects in the execution and delivery of any of the Loan Documents and all agreements contemplated thereby, and execute, acknowledge, and deliver such other assurances and instruments as shall, in the opinion of the Lender, be reasonably necessary to fulfill the terms of the Loan Documents.
5.15    Initial Fees and Expenses of Counsel to Lender. On the Closing Date, promptly reimburse the Lender for all reasonable fees and expenses, including estimated recording fees, of Jackson Walker L.L.P., special counsel to the Lender and in connection with the preparation of this Agreement and all documentation contemplated hereby, the satisfaction of the conditions precedent set forth herein, the filing and recordation of Security Instruments, and the consummation of the transactions contemplated in this Agreement.
5.16    Subsequent Fees and Expenses of Lender. Upon request by the Lender, promptly reimburse the Lender (to the fullest extent permitted by law) for all amounts reasonably expended, advanced, or incurred by or on behalf of the Lender to satisfy any obligation of the Borrower under any of the Loan Documents; to collect the Obligations; to ratify, amend, restate, or prepare additional Loan Documents, as the case may be; for the filing and recordation of Security Instruments; to enforce the rights of the Lender under any of the Loan Documents; and to protect the Properties or business of the Borrower, including, without limitation, the Collateral, which amounts shall be deemed compensatory in nature and liquidated as to amount upon notice to the Borrower by the Lender and which amounts shall include, but not be limited to (a) all court costs, (b) reasonable attorneys' fees, (c) reasona ble fees and expenses of auditors and accountants incurred to protect the interests of the Lender, (d) fees and expenses incurred in connection with the participation by the Lender as a member of the creditors' committee in a case commenced under any Insolvency Proceeding, (e) fees and expenses incurred in connection with lifting the automatic stay prescribed in Section362 Title 11 of the United States Code, and (f) fees and expenses incurred in connection with any action pursuant to Section 1129 Title 11 of the United States Code all reasonably incurred by the Lender in connection
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with the collection of any sums due under the Loan Documents, together with interest at the per annum interest rate equal to the Floating Rate, calculated on a basis of a calendar year of 365 or 366 days, as the case may be, counting the actual number of days elapsed, on each such amount from the date of notification that the same was expended, advanced, or incurred by the Lender until the date it is repaid to the Lender, with the obligations under this Section surviving the non-assumption of this Agreement in a case commenced under any Insolvency Proceeding and being binding upon the Borrower and/or a trustee, receiver, custodian, or liq uidator of the Borrower appointed in any such case.
5.17    Operation of Oil and Gas Properties. The Borrower shall develop, maintain, and operate its Oil and Gas Properties in a prudent and workmanlike manner in accordance with industry standards.
5.18    Maintenance and Inspection of Properties. The Borrower shall maintain all of its tangible Properties in good repair and condition, ordinary wear and tear excepted; make all necessary replacements thereof and operate such Properties in a good and workmanlike manner; and permit any authorized representative of the Lender to visit and inspect, at the expense of the Borrower, any tangible Property of the Borrower.
5.19    Maintenance of Insurance. The Borrower shall maintain insurance with respect to its Properties and businesses against such liabilities, casualties, risks, and contingencies as is customary in the relevant industry and sufficient to prevent a Material Adverse Effect, all such insurance to be in amounts and from insurers reasonably acceptable to the Lender, maintained by Borrower, naming the Lender as loss payee, only as to coverage on physical damage and only as it relates to Borrower's' specific interest in such property and, upon a ny renewal of any such insurance and at other times upon request by the Lender, furnish to the Lender evidence, satisfactory to the Lender, on the Closing Date of the maintenance of such insurance.
5.20    INDEMNIFICATION. INDEMNIFY AND HOLD THE LENDER AND ITS SHAREHOLDERS, OFFICERS, DIRECTORS, EMPLOYEES, AGENTS, ATTORNEYS-IN-FACT, AND AFFILIATES AND EACH TRUSTEE FOR THE BENEFIT OF THE LENDER (COLLECTIVELY  THE  "LENDER  PARTIES")  UNDER  ANY  SECURITY  INSTRUMENT HARMLESS FROM AND AGAINST ANY AND ALL CLAIMS, LOSSES, DAMAGES, LIABILITIES, FINES, PENALTIES, CHARGES, ADMINISTRATIVE AND JUDICIAL PROCEEDINGS AND ORDERS, JUDGMENTS, REMEDIAL ACTIONS, REQUIREMENTS AND ENFORCEMENT ACTIONS OF ANY KIND, AND ALL REASONABLE COSTS AND EXPENSES INCURRED IN CONNECTION THEREWITH (INCLUDING, WITHOUT LIMITATION, ATTORNEYS' FEES AND EXPENSES), ARISING DIRECTLY OR INDIRECTLY, IN WHOLE OR IN PART, FROM (A) THE PRESENCE OF ANY HAZARDOUS SUBSTANCES ON, UNDER, OR FROM ANY MORTGAGED PROPERTY OF THE BORROWER, WHETHER PRIOR TO OR DURING THE TERM HEREOF, (B) ANY ACTIVITY CARRIED ON OR UNDERTAKEN ON OR OFF ANY MORTGAGED PROPERTY OF THE BORROWER, WHETHER PRIOR TO OR DURING THE TERM HEREOF, AND WHETHER BY THE BORROWER OR ANY PREDECESSOR IN TITLE, EMPLOYEE, AGENT, CONTRACTOR, OR SUBCONTRACTOR OF THE BORROWER OR ANY OTHER PERSON AT ANY TIME OCCUPYING OR PRESENT ON SUCH PROPERTY, IN CONNECTION WITH THE HANDLING, TREATMENT, REMOVAL, STORAGE, DECONTAMINATION, CLEANUP, TRANSPORTATION, OR DISPOSAL OF ANY
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HAZARDOUS SUBSTANCES AT ANY TIME LOCATED OR PRESENT ON OR UNDER SUCH PROPERTY, (C) ANY RESIDUAL CONTAMINATION ON OR UNDER ANY PROPERTY OF THE BORROWER, (D) ANY CONTAMINATION OF ANY MORTGAGED PROPERTY OR NATURAL RESOURCES ARISING IN CONNECTION WITH THE GENERATION, USE, HANDLING, STORAGE, TRANSPORTATION OR DISPOSAL OF ANY HAZARDOUS SUBSTANCES BY  THE BORROWER OR  ANY EMPLOYEE,  AGENT, CONTRACTOR,  OR SUBCONTRACTOR OF THE BORROWER WHILE SUCH PERSONS ARE ACTING WITHIN THE SCOPE OF THEIR RELATIONSHIP WITH THE BORROWER, IRRESPECTIVE OF WHETHER ANY OF SUCH ACTIVITIES WERE OR WILL BE UNDERTAKEN I N ACCORDANCE WITH APPLICABLE REQUIREMENTS OF LAW, OR (E) THE PERFORMANCE AND ENFORCEMENT OF ANY LOAN DOCUMENT, ANY ALLEGATION BY ANY BENEFICIARY OF A LETTER OF CREDIT OF A WRONGFUL DISHONOR BY THE LENDER OF A CLAIM OR DRAFT PRESENTED THEREUNDER, OR ANY OTHER ACT OR OMISSION IN CONNECTION WITH OR RELATED TO ANY LOAN DOCUMENT OR THE TRANSACTIONS CONTEMPLATED THEREBY, INCLUDING, WITHOUT LIMITATION, ANY OF THE FOREGOING IN THIS SECTION ARISING FROM NEGLIGENCE, WHETHER SOLE OR CONCURRENT, ON THE PART OF THE LENDER PARTIES OR ANY OF ITS SHAREHOLDERS, OFFICERS, DIRECTORS, EMPLOYEES, AGENTS, ATTORNEYS-IN-FACT, OR AFFILIATES OR ANY TRUSTEE FOR THE BENEFIT OF THE LENDER UNDER ANY SECURITY INSTRUMENT BUT NOT INCLUDING ANY OF THE FOREGOING ARISING FROM THE GROSS NEGLIGENCE OR WILLFUL MISCONDUCT OF THE LENDER PARTIES; WITH THE FOREGOING INDEMNITY SURVIVING SATISFACTION OF ALL OBLIGATIONS AND THE TERMINATION OF THIS AGREEMENT, UNLESS ALL SUCH OBLIGATIONS HAVE BEEN SATISFIED WHOLLY IN CASH FROM THE BORROWER AND NOT BY WAY OF REALIZATION AGAINST ANY COLLATERAL OR THE CONVEYANCE OF ANY PROPERTY IN LIEU THEREOF, PROVIDED THAT SUCH INDEMNITY SHALL NOT EXTEND TO ANY ACT OR OMISSION BY THE LENDER WITH RESPECT TO ANY PROPERTY SUBSEQUENT TO THE LENDER BECOMING THE OWNER OF SUCH PROPERTY AND WITH RESPECT TO WHICH PROPERTY SUCH CLAIM, LOSS, DAMAGE, LIABILITY, FINE, PENALTY, CHARGE, PROCEEDING, ORDER, JUDGMENT, ACTION, OR REQUIREMENT ARISES SUBSEQUENT TO THE ACQUISITION OF TITLE THERETO BY THE LENDER.
5.21    Hedging. If at any time the Borrower's usage under this facility exceeds 50% of the Borrowing Base, the borrower will be required to maintain on a rolling 12 month basis hedges, in a form acceptable to the Lender, on 50% of Borrower's proved producing oil and gas reserves. In the event Borrower's usage under this facility remains below 50% for two consecutive quarters, the Borrower may request that this hedge requirement be reduced or eliminated. Such a request is subject to the Lender's credit approval process.
ARTICLE VI NEGATIVE COVENANTS
So long as any Obligation remains outstanding or unpaid or any Commitment exists, the Borrower will not:
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6.1      Indebtedness. Create, incur, assume, or suffer to exist any Indebtedness, whether by way of loan or otherwise; provided, however, the foregoing restriction shall not apply to (a) the Obligations, (b) unsecured accounts payable incurred in the ordinary course of business, which are not unpaid in excess of 90 days beyond invoice due date or are being contested in good faith and as to which such reserve as is required by GAAP has been made, accrued or deferred taxes and other liabilities not constituting borrowed money, (c) crude oil, natural gas, or other hydrocarbon floor, collar, cap, price protection, or swap agreements, in form and substance and with a Person acceptable to the Lender, provided that (i) except as provided in Schedule 6.1, such agreements shall not be entered into with respect to Mortgaged Properties constituting more than 80% of the volume of all proved developed producing reserves as determined by Lender, and (ii) that the floor prices in such agreements are not less than the minimum prices used by the Lender in its most recent Borrowing Base determination, (d) Rate Management Transactions, in form and substance and with a Person reasonably acceptable to the Lender, and (e)  Indebtedness secured by Permitted Liens.
6.2      Contingent Obligations. Create, incur, assume, or suffer to exist any Contingent Obligation; provided, however, the foregoing restriction shall not apply to (a) performance guarantees and performance surety or other bonds provided in the ordinary course of business, or (b) trade credit incurred or operating leases entered into in the ordinary course of business.
6.3      Liens. Create, incur, assume, or suffer to exist any Lien on any of its Oil and Gas Properties or any other Property, whether now owned or hereafter acquired; provided, however, the foregoing restrictions shall not apply to Permitted Liens or the non-recourse Indebtedness described in Section 6.1(h) hereof.
6.4      Sales of Assets. Without the prior written consent of the Lender, sell, transfer, or otherwise dispose of, in one or any series of transactions, assets, whether now owned or hereafter acquired; provided, however, Borrower shall be permitted to sell, transfer or otherwise dispose of excess and obsolete equipment and vehicles and other excess and obsolete assets in the ordinary course of business and may sell non-Mortgage Properties.
6.5      Leasebacks.  Enter into any agreement to sell or transfer any Mortgaged Property and thereafter rent or lease as lessee such Property or other Property intended for the same use or purpose as the Property sold or transferred.
6.6      Sale or Discount of Receivables. Except to minimize losses on bona fide debts previously contracted, discount or sell with recourse, or sell for less than the greater of the face or market value thereof, any of its Note receivable or accounts receivable.
6.7      Loans or Advances. Make or agree to make or allow to remain outstanding any loans or advances to any Person; provided, however, the foregoing restrictions shall not apply to (a) advances or extensions of credit in the form of accounts receivable incurred in the ordinary course of business and upon terms common in the industry for such accounts receivable, or (b) advances to employees of the Borrower for the payment of expenses in the ordinary course of business.
6.8      Investments. Acquire Investments in, or purchase or otherwise acquire all or substantially
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all of the assets of, any Person; provided, however, the foregoing restriction shall not apply to the purchase or acquisition of (a) Oil and Gas Properties, or assets related to their operation, (b) Investments in the form of (i) debt securities issued or directly and fully guaranteed or insured by the United States Government or any agency or instrumentality thereof, with maturities of no more than one year, (ii) commercial paper of a domestic issuer rated at the date of acquisition at least P-2 by Moody's Investor Service, Inc. or A-2 by Standard & Poor's Corporation and with maturities of no more than one year from the date of acquisition, or (iii) repurchase agreements covering debt securities or commercial paper of the type permitted in this Section, certificates of deposit, demand deposits, eurodollar time deposits, overnight bank deposits and bankers' acceptances, with maturities of no more than one year from the date of acquisition, issued by or acquired from or through the Lender or any bank or trust company organized under the laws of the United States or any state thereof and having capital surplus and undivided profits aggregating at least $100,000,000.00, (c) other short-term Investments similar in nature and degree of risk to those described in clause (b) of this Section, or (d) money-market funds.
6.9      Dividends and Distributions. Declare, pay, or make, whether in cash or other Property of the Borrower, any dividend or distribution to any Person except that dividends on preferred stock will be allowed so long as there is no Default or an Event of Default and the payment of such will not result in a Default or an Event of Default.
6.10    Issuance of Stock; Changes in Corporate Structure. Issue or agree to issue additional shares of capital stock, in one or any series of transactions if it results in a Change of Control; enter into any transaction of consolidation, merger, or amalgamation unless no Default exists or would result therefrom and Borrower is the surviving entity; liquidate, wind-up, or dissolve (or suffer any liquidation or dissolution).
6.11    Transactions with Affiliates. Directly or indirectly, enter into any transaction (including the sale, lease, or exchange of Property or the rendering of service) with any of its Affiliates, other than upon fair and reasonable terms no less favorable than could be obtained in an arm's length transaction with a Person which was not an Affiliate.
6.12    Lines of Business. Expand, on its own or through any Subsidiary, into any line of business which would allow a material change in the character of the business in which the Borrower is engaged as of the date hereof.
6.13    ERISA Compliance. Permit any Plan maintained by it or any Commonly Controlled Entity to (a) engage in any Prohibited Transaction, (b) incur any "accumulated funding deficiency," as such term is defined in Section 302 of ERISA, or (c) terminate in a manner which could result in the imposition of a Lien on any Property of the Borrower pursuant to Section 4068 of ERISA; or assume an obligation to contribute to any Multiemployer Plan; or acquire any Person or the assets of any Person which has now or has had at any time an obligation to contribute to any Multiemployer Plan.
6.14    Current Ratio. Permit, as of the close of any fiscal quarter, the ratio of Current Assets to Current Liabilities to be less than 1.00 to 1.00.
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6.15    Maximum Debt to EBITDAX Ratio. Permit, as of the close of any fiscal quarter, the ratio of (a) all debt, including, but not limited to, debt under this facility and $16,000,000 of preferred stock to (b) EBITDAX to be greater than 3.00 to 1.00, measured on a rolling four-quarter basis.
6.16    Tangible Net Worth. Permit tangible net worth of the Borrowers on a consolidated basis, as of the close of any fiscal quarter, to be less than 75% of Tangible Net Worth as of March 31, 2004, plus 50% of positive quarterly net income thereafter.
6.17    Interest Coverage Ratio. Permit, as of the close of any fiscal quarter, the ratio of (a) annualized quarterly EBITDAX to (b) Interest Expense to be less than 2.50 to 1.00 measured on a rolling four quarter basis.
ARTICLE VII EVENTS OF DEFAULT
7.1       Enumeration of Events of Default. Any of the following events shall constitute an Event of Default:
	(a)    default shall be made in the payment when due of any installment of principal or interest under this Agreement or the Note or in the payment when due of any fee or other sum payable under any Loan Document and such default as to interest or fees only shall have continued for three business days and such default as to Fees or other amounts payable shall have continued for ten business days.
	(b)    default shall be made by the Borrower in the due observance or performance of any of its respective obligations under the Loan Documents, and such default shall continue for 30 days after the earlier of notice thereof to the Borrower by the Lender or knowledge thereof by the Borrower;
	(c)     any representation or warranty made by the Borrower in any of the Loan Documents proves to have been untrue in any material respect or any representation, statement (including Financial Statements), certificate, or data furnished or made to the Lender in connection herewith proves to have been untrue in any material respect as of the date the facts therein set forth were stated or certified;
	(d)    default shall be made by the Borrower (as principal or other surety) in the payment or performance aggregating $100,000.00 or more of any bond, debenture, note, Commodity Hedge Agreement, Rate Management Transaction, or other Indebtedness or under any credit agreement, loan agreement, indenture, promissory note, or similar agreement or instrument executed in connection with any of the foregoing, and such default shall remain unremedied for in excess of the period of grace, if any, with respect thereto;
	(e)     the Borrower shall (i) apply for or consent to the appointment of a receiver, trustee,
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	or liquidator of it or all or a substantial part of its assets, (ii) file a voluntary petition commencing an Insolvency Proceeding, (iii) make a general assignment for the benefit of creditors, (iv) be unable, or admit in writing its inability, to pay its debts generally as they become due, or (v) file an answer admitting the material allegations of a petition filed against it in any Insolvency Proceeding;
	(f)     an order, judgment, or decree shall be entered against the Borrower by any court of competent jurisdiction or by any other duly authorized authority, on the petition of a creditor or otherwise, granting relief in any Insolvency Proceeding or approving a petition seeking reorganization or an arrangement of its debts or appointing a receiver, trustee, conservator, custodian, or liquidator of it or all or any substantial part of its assets, and such order, judgment, or decree shall not be dismissed or stayed within 60 days;
	(g)    the levy against any significant portion of the Property of the Borrower, or any execution, garnishment, attachment, sequestration, or other writ or similar proceeding which is not permanently dismissed or discharged within 90 days after the levy;
	(h)     a final and non-appealable order, judgment, or decree shall be entered against the Borrower for money damages and/or Indebtedness due in an amount in excess of $250,000, and such order, judgment, or decree shall not be dismissed or stayed within 60 days;
	(i)     the Borrower shall have (i) concealed, removed, or diverted, or permitted to be concealed, removed, or diverted, any material portion of its Property, with intent to hinder, delay, or defraud its creditors or any of them, (ii) made or suffered a transfer of any material portion of its Property which may be fraudulent under any bankruptcy, fraudulent conveyance, or similar law, (iii) made any transfer of its Property to or for the benefit of a creditor at a time when other creditors similarly situated have not been paid, or (iv) suffered or permitted, while insolvent, any creditor to obtain a Lien upon any of its Property through legal proceedings or distraint which is not vacated within 30 days from the date thereof;
	(j)     any  Security  Instrument  shall  for any reason not,  or cease to,  create valid and perfected first-priority Liens subject to Permitted Liens against the Collateral purportedly covered thereby and failure by the Borrower to cure any such defect within 30 days; or
	(k)    the occurrence of a Material Adverse Effect and the same shall remain unremedied for in excess of 30 days after notice given by the Lender.
7.2       Remedies.  (a)  Upon the occurrence of an Event of Default specified in Sections 7.1(f) or 7.1(g), immediately and without notice, (i) all Obligations shall automatically become immediately due and payable, without presentment, demand, protest, notice of protest, default, or dishonor, notice of intent to accelerate maturity, notice of acceleration of maturity, or other notice of any kind, except as may be provided to the contrary elsewhere herein, all of which are hereby expressly waived by the Borrower ; (ii) the Commitment shall immediately cease and terminate unless and until reinstated by the Lender in writing; and (iii) the Lender is hereby authorized at any time and from time to time, without notice to the Borrower (any such notice being expressly waived by the Borrower), to set-off
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and apply any and all deposits of Borrower (general or special, time or demand, provisional or final) held by the Lender and any and all other indebtedness at any time owing by the Lender to or for the credit or account of the Borrower against any and all of the Obligations although such Obligations may be unmatured.
(b)     Upon the occurrence of any Event of Default other than those specified in Sections 7.1(f) or 7.1(g), (i) the Lender may, by notice to the Borrower, declare all Obligations immediately due and payable, without presentment, demand, protest, notice of protest, default, or dishonor, notice of intent to accelerate maturity, notice of acceleration of maturity, or other notice of any kind, except as may be provided to the contrary elsewhere herein, all of which are hereby expressly waived by the Borrower; (ii) the Commitment shall immediately cease and terminate unless and until reinstated by the Lender in writing; and (iii) the Lender is hereby authorized at any time and from time to time, without notice to the Borrower (any such notice being expressly waived by the Borrower), to set-off and apply any and all deposits of Borrower (ge neral or special, time or demand, provisional or final, save and except for the following bank accounts of the Borrower (1) the Revenue Disbursement Account, and (2) the Royalty Account, established with the Lender) held by the Lender and any and all other indebtedness at any time owing by the Lender to or for the credit or account of the Borrower against any and all of the Obligations although such Obligations may be unmatured.
(c)     Upon the occurrence of any Event of Default, the Lender may, in addition to the foregoing in this Section, exercise any or all of its rights and remedies provided by law or pursuant to the Loan Documents.
ARTICLE VIII MISCELLANEOUS
8.1       Transfers; Participations. The Lender with the consent of the Borrower, which consent will not be unreasonably withheld and only if there is no occurrence and continuance of an Event of Default, otherwise Lender may without the consent of the Borrower, at any time, sell, transfer, assign, or grant participations in the Obligations or any portion thereof; and the Lender may forward to each Transferee and prospective Transferee all documents and information relating to such Obligations, whether furnished by the Borrowe r or otherwise obtained, as the Lender determines necessary or desirable. The Borrower agrees that each Transferee, regardless of the nature of any transfer to it, may exercise all rights (including, without limitation, rights of set-off) with respect to the portion of the Obligations held by it as fully as if such Transferee were the direct holder thereof, subject to any agreements between such Transferee and the transferor to such Transferee.
8.2       Survival of Representations, Warranties, and Covenants. All representations and warranties of the Borrower and all covenants and agreements herein made shall survive the execution and delivery of the Note and the Security Instruments and shall remain in force and effect so long as any Obligation is outstanding or any Commitment exists.
8.3       Notices and Other Communications. Except as to verbal notices expressly authorized
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herein, which verbal notices shall be confirmed in writing, all notices, requests, and communications hereunder shall be in writing (including by telecopy). Unless otherwise expressly provided herein, any such notice, request, demand, or other communication shall be deemed to have been duly given or made when delivered by hand, or, in the case of delivery by mail, three days following deposit in the mail, certified mail, return receipt requested, postage prepaid, or, in the case of telecopy notice, when receipt thereof is acknowledged orally or by written confirmation report, addressed as follows:
(a)       if to the Lender, to:
			Guaranty Bank, FSB 333 Clay Street, Suite 4400 Houston, Texas 77002 Attention: Jonathan Gregory Telecopy: (713) 890-8868
(b)       if to the Borrower, to:
			The Exploration Company of Delaware, Inc. 500 North Loop 1604 East Suite 250 San Antonio, Texas 78232 Attention: P. Mark Stark Telecopy: (210) 496-3232
Any party may, by proper written notice hereunder to the others, change the individuals or addresses to which such notices to it shall thereafter be sent.
8.4       Parties in Interest. All covenants and agreements herein contained by or on behalf of the Borrower or the Lender shall be binding upon and inure to the benefit of the Borrower or the Lender, as the case may be, and their respective legal representatives, successors, and assigns.
8.5       Rights of Third Parties. All provisions herein are imposed solely and exclusively for the benefit of the Lender and the Borrower. No other Person shall have any right, benefit, priority, or interest hereunder or as a result hereof or have standing to require satisfaction of provisions hereof in accordance with their terms, and any or all of such provisions may be freely waived in whole or in part by the Lender at any time if in its sole discretion it deems it advisable to do so.
8.6       Renewals; Extensions. All provisions of this Agreement relating to the Note shall apply with equal force and effect to each promissory note hereafter executed which in whole or in part represents a renewal or extension of any part of the Indebtedness of the Borrower under this Agreement, the Note, or any other Loan Document.
8.7       No Waiver; Rights Cumulative. No course of dealing on the part of the Lender, its officers or employees, nor any failure or delay by the Lender with respect to exercising any of its rights under any Loan Document shall operate as a waiver thereof. The rights of the Lender under the Loan
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Documents shall be cumulative and the exercise or partial exercise of any such right shall not preclude the exercise of any other right. Neither the making of any Loan nor the issuance of a Letter of Credit shall constitute a waiver of any of the covenants, warranties, or conditions of the Borrower contained herein. In the event the Borrower is unable to satisfy any such covenant, warranty, or condition, neither the making of any Loan nor the issuance of a Letter of Credit shall have the effect of precluding the Lender from thereafter declaring such inability to be an Event of Default as hereinabove provided.
8.8       Survival Upon Unenforceability. In the event any one or more of the provisions contained in any of the Loan Documents or in any other instrument referred to herein or executed in connection with the Obligations shall, for any reason, be held to be invalid, illegal, or unenforceable in any respect, such invalidity, illegality, or unenforceability shall not affect any other provision of any Loan Document or of any other instrument referred to herein or executed in connection with such Obligations.
8.9       Amendments; Waivers. Neither this Agreement nor any provision hereof may be amended, waived, discharged, or terminated orally, but only by an instrument in writing signed by the party against whom enforcement of the amendment, waiver, discharge, or termination is sought.
8.10     Controlling Agreement. In the event of a conflict between the provisions of this Agreement and those of any other Loan Document, the provisions of this Agreement shall control.
8.11     Disposition of Collateral. Notwithstanding any term or provision, express or implied, in any of the Security Instruments, the realization, liquidation, foreclosure, or any other disposition on or of any or all of the Collateral shall be in the order and manner and determined in the sole discretion of the Lender; provided, however, that in no event shall the Lender violate applicable law or exercise rights and remedies other than those provided in such Security Instruments or otherwise existing at law or in equity.< /A>
8.12     GOVERNING LAW. THIS AGREEMENT AND THE NOTE AND SHALL BE DEEMED TO BE CONTRACTS MADE UNDER AND SHALL BE CONSTRUED IN ACCORDANCE WITH  AND GOVERNED BY THE LAWS OF THE  STATE  OF  TEXAS WITHOUT GIVING EFFECT TO PRINCIPLES THEREOF RELATING TO CONFLICTS OF LAW; PROVIDED, HOWEVER, THAT CHAPTER 345 OF THE TEXAS FINANCE CODE (WHICH REGULATES CERTAIN REVOLVING CREDIT LOAN ACCOUNTS AND REVOLVING TRIPARTY ACCOUNTS) SHALL NOT APPLY.< /A>
8.13     JURISDICTION AND VENUE. ALL ACTIONS OR PROCEEDINGS WITH RESPECT TO, ARISING DIRECTLY OR INDIRECTLY IN CONNECTION WITH, OUT OF, RELATED TO, OR FROM THIS AGREEMENT OR ANY OTHER LOAN DOCUMENT MAY BE LITIGATED, AT THE SOLE DISCRETION AND ELECTION OF THE LENDER, IN COURTS HAVING SITUS IN HOUSTON, HARRIS COUNTY, TEXAS. THE BORROWER HEREBY SUBMITS TO THE JURISDICTION OF ANY LOCAL, STATE, OR FEDERAL COURT LOCATED IN HOUSTON, HARRIS COUNTY, TEXAS, AND HEREBY WAIVES ANY RIGHTS IT MAY HAVE TO TRANSFER OR CHANGE THE JURISDICTION OR VE NUE  OF  ANY  LITIGATION  BROUGHT  AGAINST  IT  BY  THE  LENDER  IN
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ACCORDANCE WITH THIS SECTION.
8.14     WAIVER OF RIGHTS TO JURY TRIAL. THE BORROWER AND THE LENDER HEREBY KNOWINGLY, VOLUNTARILY, INTENTIONALLY, IRREVOCABLY, AND UNCONDITIONALLY WAIVE ALL RIGHTS TO TRIAL BY JURY IN ANY ACTION, SUIT, PROCEEDING, COUNTERCLAIM, OR OTHER LITIGATION THAT RELATES TO OR ARISES OUT OF ANY OF THIS AGREEMENT OR ANY OTHER LOAN DOCUMENT OR THE ACTS OR OMISSIONS OF THE LENDER IN THE ENFORCEMENT OF ANY OF THE TERMS OR PROVISIONS OF THIS AGREEMENT OR ANY OTHER LOAN DOCUMENT OR OTHERWISE WITH RESPECT THERETO. THE PROVISIONS OF THIS SECTION ARE A MATERIAL INDUCEMENT FOR THE LENDER ENTERING INTO THIS AGREEMENT.
8.15     ENTIRE AGREEMENT. THIS AGREEMENT AMENDS, RESTATES AND REPLACES THE EXISTING CREDIT AGREEMENT AND CONSTITUTES THE ENTIRE AGREEMENT BETWEEN THE PARTIES HERETO WITH RESPECT TO THE SUBJECT HEREOF AND SHALL SUPERSEDE ANY PRIOR AGREEMENT BETWEEN THE PARTIES HERETO, WHETHER WRITTEN OR ORAL, RELATING TO THE SUBJECT HEREOF, INCLUDING, WITHOUT LIMITATION, THE EXISTING CREDIT AGREEMENT AND THE DISCUSSION TERM SHEET DATED MAY 1, 2004, FROM THE LENDER TO THE BORROWER. FURTHERMORE, IN THIS REGARD, THIS AGREEMENT AND THE OTHER WRITTEN LO AN DOCUMENTS REPRESENT, COLLECTIVELY, THE FINAL AGREEMENT AMONG THE PARTIES THERETO AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS, OR SUBSEQUENT ORAL AGREEMENTS OF SUCH PARTIES. THERE ARE NO UNWRITTEN ORAL AGREEMENTS AMONG SUCH PARTIES.
8.16     Counterparts. For the convenience of the parties, this Agreement may be executed in multiple counterparts, each of which for all purposes shall be deemed to be an original, and all such counterparts shall together constitute but one and the same Agreement.
8.17     Release by Borrower. Notwithstanding the assignment made and evidenced by the Assignment and the assumption by the Lender of certain obligations and liabilities of the Existing Lender pursuant thereto, the Borrower hereby releases and discharges the Lender from all obligations, claims, losses, causes of action, and liabilities, of whatsoever kind or nature, whether heretofore or hereafter accruing, whether now known or unknown, arising under or in connection with any Existing Loan Document or Existing Letter of Credit or any act or omission by the Existing Lender under or in connection with any Existing Loan Document or Existing Letter of Credit; provided, however, nothing set forth in this Section shall relieve the Lender from its obligations and liabilities under the Loan Documents (other than the Assignment) to which it is a party.
(Remainder of Page Intentionally Left Blank)
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IN WITNESS WHEREOF, this Agreement is deemed executed effective as of the date first above written.
	BORROWER:
	THE EXPLORATION COMPANY OF DELAWARE, INC.
	By:     /s/ P. Mark Stark                               P. Mark Stark           Chief Financial Officer
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	LENDER:
	GUARANTY BANK, FSB
	By:     /s/ Jonathan Gregory                          Jonathan Gregory           Senior Vice President
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EX-31

Exhibit 31.1
Certification
I, James E. Sigmon, certify that:
1.	I have reviewed this Quarterly Report on Form 10-Q of The Exploration Company of Delaware, Inc.;
2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.	The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
	(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
	(b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
	(c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and
5.	The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
	(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
	(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.
Date:	August 9, 2004
	/s/ James E. Sigmon
	James E. Sigmon President and Chief Executive Officer

EX-31

Exhibit 31.2
Certification
I, P. Mark Stark, certify that:
1.	I have reviewed this Quarterly Report on Form 10-Q of The Exploration Company of Delaware, Inc.;
2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.	The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
	(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
	(b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
	(c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and
5.	The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
	(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
	(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.
Date:	August 9, 2004
	/s/ P. Mark Stark
	P. Mark Stark Vice President and Chief Financial Officer

EX-32

Exhibit 32.1
Certification
In connection with the Quarterly Report of The Exploration Company of Delaware, Inc. (the "Company") on Form 10-Q for the period ended June 30, 2004 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, James E. Sigmon, Chief Executive Officer of the Company, hereby certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
1.     The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
2.     The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
	/s/  James E. Sigmon
	Name:  James E. Sigmon
	Title:    Chief Executive Officer
	Date:    August 9, 2004
The foregoing certification is being furnished solely pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and is not being filed as part of the Report or as a separate disclosure document.
A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.

EX-32

Exhibit 32.2
Certification
In connection with the Quarterly Report of The Exploration Company of Delaware, Inc. (the "Company") on Form 10-Q for the period ended June 30, 2004 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, P. Mark Stark, Chief Financial Officer of the Company, hereby certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
1.     The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
2.      The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
	/s/ P. Mark Stark
	Name: P. Mark Stark
	Title:  Chief Financial Officer
	Date:   August 9, 2004
The foregoing certification is being furnished solely pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and is not being filed as part of the Report or as a separate disclosure document.
A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.