China North East Petroleum Provides Response to Report Allegations

HARBIN, China and NEW YORK, April 19, 2011 /PRNewswire-Asia-FirstCall/ --China North East Petroleum Holdings Ltd. (NYSE Amex: NEP), a leading independent oil producing and oilfield services company in Northern China, responded today to the research report published online on April 13, 2011 by a short seller operating under the pseudonym "Bigfish Research."

As we stated in our press release issued on April 14, 2011, China North East Petroleum (the "Company") provides the following detailed response to the allegations of Bigfish Research contained in its report published on April 14, 2011.

Allegation 1:  Our acquisition of Tiancheng is too good to be true.

Company Comment:  Actual Results Cannot Be Extrapolated From Pro Forma Numbers.  The Bigfish Report is a good example of how numbers can be misconstrued and manipulated.  Bigfish has a fundamental misunderstanding of the nature and purpose of pro forma financial information.  In accordance with Accounting Standards Codification 805-10-50-2h, the pro forma information presented in the Company's financial statements in connection with its acquisition of Song Yuan Tiancheng Drilling Engineering Co., Ltd. ("Tiancheng") represents the revenue and earnings of the combined entity for the reporting period as though the acquisition date for all business combinations that occurred during the year had been as of the beginning of the annual reporting period.  Thus, the pro forma numbers were estimates drawn reasonably from assumptions at the time (January 2009) and were not actual numbers.  They do not represent the actual results of either the Company or of Tiancheng, which the Company eventually acquired in September 2009.

Nevertheless, Bigfish uses the pro forma numbers to extrapolate what he claims to be the "actual earnings" of Tiancheng and then calls into question the Company's reported results.   Bigfish alleges that the actual revenues of Tiancheng can be determined by merely subtracting the Company's earnings for the three and nine month periods ended September 30, 2009 from the pro forma numbers for the same periods.  This is wrong.  The actual financial results of Tiancheng as a standalone entity for the three and nine months ended September 30, 2009 are irrelevant to the pro forma numbers.  The actual Tiancheng revenues and earnings cannot be extrapolated from the pro forma numbers.  

Significant Oil Price Drops in 2008 and 2009 and Other Internal Factors of the Target Affected Value of Tiancheng and Drilling Activity.  Bigfish cannot believe the Company acquired Tiancheng for only $13 million given the reported financial results of this business segment in the last quarter of 2009 and in 2010.  Bigfish has, however, overlooked two very significant factors affecting the acquisition:  the price of oil and the challenges that the prior owners of Tiancheng faced at the time.  

Beginning in the second half of 2008, oil prices dropped significantly from $145.29 a barrel on July 4, 2008 to $44.60 a barrel on December 31, 2008(1) and only began to recover slowly in the second quarter of 2009.  Tiancheng was founded in December 2007 when oil prices were very high.  When oil prices plummeted in 2008-2009, oil and gas producers slowed or even stopped drilling, which in turn substantially reduced Tiancheng's drilling activity in 2009.  As a result, even though Tiancheng entered into contracts to drill 145 wells between January and June of 2009, only 80 wells were drilled prior to the Company's acquisition of Tiancheng in September 2009.

Oil prices began to increase in the second half of 2009, and as oil prices rose, drilling activity increased and by the time the Company acquired Tiancheng in September 2009, drilling activity in the region had increased significantly and in the last three months of 2009, the Company drilled 60 wells, 6 wells for Daqing Shunwei and 54 wells for PetroChina.

Due to financial issues affecting the former owners of Tiancheng, caused in part by the significant drop in oil prices, that threatened the stability of Tiancheng, the former owners were anxious to sell the business.  This in turn affected the selling price the Company was able to negotiate.

As a result, NEP was able to acquire Tiancheng for the price of its asset value, and the goodwill from the acquisition is properly reflected in the financial statements.

Allegation 2: Bigfish complains that contract drilling services contributed 0% of revenue and income in 2008 but contributed 50% of the adjusted net income in 2010.

Company Comment:  First, the Company did not own Tiancheng in 2008 and thus could not have earned any revenue from the operation of this drilling subsidiary.  

Second, the "Adjusted Net Income" number calculated by Bigfish is misleading and inappropriate.  The Company does not report net income on a segment by segment basis and U.S. generally accepted accounting principles (GAAP) do not require the Company to do so. Management's discussion regarding net income of the contract drilling services is before allocation of certain overhead expenses. Normal accounting practices dictate that a company with different business segments will often compare revenue and gross profit to evaluate the performance of different segments and not net income.      

Third, average gross margins in the drilling industry are 55.58%.(2)  The gross margin of the Company's contract drilling segment in 2010 was 56.5% which is in line with industry averages.

Finally, Tiancheng contributed more significantly to NEP's overall performance in recent quarters because total oil production declined in 2010 due to weather-related events, which impacted the Company's oil production segment thereby increasing the impact of the contract drilling segment. 

Allegation 3:  Our Drilling Contracts Do Not Exist.

Company Comment:  All of our drilling contracts exist.   We enter into drilling contracts in the ordinary course of business and as such are not required to file these drilling contracts with our periodic filings under the Securities Exchange Act of 1934.(3)  They are summarized below:

In the fourth quarter of 2009, Tiancheng completed contracts to drill 60 shallow wells, which included 54 wells for state-owned PetroChina -- Jilin Branch and six wells for non-state-owned Daqing Shunwei Energy Development Co. Ltd. The total drilling depth accomplished was 99,161 meters (approximately 325,331 feet), representing revenue of $13,577,310.

In 2010, Tiancheng completed contracts to drill 146 wells for state-owned PetroChina -- Jilin Branch and 45 wells for non-state-owned Daqing Shunwei Energy Development Co. Ltd.  In addition, the Company completed 22 wells for Beijing Junlun Runzhong Technology Co. Ltd. The total drilling depth accomplished in 2010 was 317,885 meters (approximately 1,042,930 feet).

Allegation 4:  Drilling Depth

Company Comment:  In 2010, the Company's contract drilling segment drilled a total of 317,885 meters, which represents revenues of $44,875,757, the number contained in our financial statements.  In reviewing the actual meters drilled, we discovered an error in the formula resulting in a double counting of drilling depth for two months.  The error, however, is not material because it had no impact on the Company's 2010 financial statements, which are accurate

Allegation 5: We overpaid for our 8th drilling rig.

Company Comment:  Bigfish alleges that in December 2009 we paid $3.4 million for a single rig, which Bigfish alleges is suspicious since we paid approximately $1.7 million per rig in connection with the acquisition of Tiancheng.  Bigfish supports this allegation by pointing to the approximately $3.4 million we spent for segment assets.  Once again, Bigfish is wrong.   In December 2009, we purchased a new 4,000 meter rig for the price of approximately $1.8 million and also upgraded an existing rig at the cost of approximately $1.6 million.  The purpose of this upgrade was to convert a rig with a drilling depth of 2,000 meters to a rig with a drilling depth of 3,500 meters.  Therefore, the $3.4 million spent for segment assets reflects not only the new 4,000 meter rig, but the upgrade of an existing rig.  

Allegation 6:  We are overestimating our drilling capacity.

Company Comment:  The Bigfish report, extrapolating from a statement in the annual report of Eurasia Drilling regarding its drilling capacity, and without any analysis with respect to the depth of the wells drilled by Eurasia or the geological formations within its oil fields, accuses the Company of overstating its drilling capacity.  They are wrong again.

We are unable to comment on the drilling capacity of Eurasia Drilling or on any other drilling company.  We can only speak to our capacity.  The wells we drill typically range from between 900 and 2,500 meters deep(4).  In 2010 we averaged a drilling depth of 1,614 meters.  The average number of days it takes to drill a typical well is between 7 and 9 days(5).  In 2010, we drilled a total of 213 wells utilizing 8 drilling rigs.  Assuming an average of 9 days per well, 8 rigs can drill significantly more than 213 wells.

Allegation 7: Tiancheng has a 41.7% margin

Company Comment:  As noted above the Bigfish methodology in calculating adjusted net income and net margins attributable to our contract drilling segment is inaccurate and inappropriate.  We report net income on a consolidated basis only.  We only report gross margins on a segment basis and as stated above, our gross margins are well within industry standards

Additionally, the Company is aware that since Bigfish issued its bogus April 14, 2011 report, Bigfish has issued two additional reports.  These, too, suffer from the same ignorance, misleading statements, falsity and misunderstandings that plague the April 14, 2011 report.  We are hopeful that this press release conclusively debunks not only the credibility and veracity of the April 14, 2011 report, but the general credibility of the persons hiding behind the Bigfish site.  The Company does not intend to engage Bigfish in a daily back and forth dialogue.  Rather, we trust that all concerned, including investors, will see the people hiding behind the Bigfish site for whom they are and not pay heed to anything they have to say.

Finally, the Company invites any of its investors to visit its drilling services and oil production operations in China any time in the future.  The Company has hosted many investor visits as a public entity and we would welcome any future visits.  

ABOUT CHINA NORTH EAST PETROLEUM

China North East Petroleum Holdings Limited is an independent oil company that engages in the production of crude oil and in providing drilling and production services in Northern China. The Company is a pioneer in China's private oil exploration and production industry, and the first Chinese non-state-owned oil company trading on the NYSE Amex.

The Company has a guaranteed arrangement with the PetroChina to sell 100% of its produced crude oil for use in the China marketplace. The Company currently operates four oilfields in Northern China. The Company also has an oil service subsidiary, Song Yuan Tiancheng Drilling Engineering Co. Ltd. ("Tiancheng") that provides drilling and oilfield services to both state-owned and private oil operators. For more information about the Company, please visit http://www.cnepetroleum.com.

SOURCE China North East Petroleum Holdings Ltd.

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