Cadogan Regulatory News (CAD)

CADOGAN PETROLEUM PLC

Preliminary Results for the Year Ended 31 December 2010

Cadogan Petroleum plc an independent oil and gas exploration, development and production company with onshore gas, condensate and oil assets in Ukraine, announces its preliminary results for the year ended 31 December 2010.

Principal Developments

Developments in 2010

·; Extension received on the Pirkovskoe licence to 2015

·; Farm-out campaign being pursued to conserve existing cash and spread the risks associated with further exploration and development

·; Resolution of Pirkovskoe and Zagoryanksa licences issues

·; Total capital expenditure of £7.8 million (2009: £23.5 million) during the year

·; Net cash and cash equivalents at year end of £23.5 million (2009: £30.5 million)

Enquiries

Chairman's Statement

Introduction and strategic alliance with Eni

I am delighted to be able to report that, since shareholders approved the resolutions at the 2010 Annual General Meeting giving the Board a clear mandate to pursue its operational strategy in Ukraine, significant progress has been made. The Group has completed the rationalisation of its operations in Ukraine and is now in a position to develop its assets more aggressively. Licence issues, one of the factors that have hindered the Group's potential since the IPO in June 2008, have now been resolved.

In addition, on 13 April 2011, the Company announced a very significant agreement, conditional on the approval of shareholders and the relevant Ukrainian authorities, with Eni S.p.A ("Eni") the major Italian integrated energy company. Eni will initially acquire a 30 per cent interest in our Pokrovskoe licence, with the option to acquire a further 30 per cent interest in the future. Eni will also acquire a 60 per cent interest in our Zagoryanska licence. Both licences are in eastern Ukraine. The initial consideration will comprise 100 per cent funding of a work programme of approximately USD30 million (excluding VAT), including drilling and seismic re-processing, plus a USD38 million payment. Subject to successful results from the above programmes and award of production licences, Eni will pay the Group further amounts of up to USD90 million.

The announcement of this major transaction signifies a turning point for Cadogan. With Eni as a strategic partner, the Group can more rapidly develop the potential in these two licences and can embark on other significant oil and gas opportunities in Ukraine.

The transaction, which is a class one transaction under the UKLA Listing Rules, is subject to Cadogan shareholder and Ukrainian Anti-Monopoly Commission approval. The Company plans to issue a circular to shareholders in May 2011, giving full details of the proposed transaction and convening a general meeting of the Company prior to mid-June 2011. It is planned that the transaction will complete on or around 30 June 2011.

Operations summary

During the first half of 2010 the Board kept operations to a minimum, whilst the future of the Group was determined. Once it was clear that shareholders had mandated the Board to pursue its operational strategy in Ukraine, a number of relatively low-cost work programmes were initiated. At Zagoryansaka 3, a successful well-testing programme was completed in joint venture with a local contractor and the well tied-in to nearby production facilities. Commercial production commenced in August. At Pokrovskoe 1, a deepening of the well commenced in October and was suspended in December at 5,450 metres. We encountered strong indications of gas on the LWD logs over significant sections in the Lower Visean. Completion of this well is expected within the current year as part of the Eni work programme.

 At Bitlyanska, our exploration asset in the west of Ukraine, a 2D seismic survey of the licence area was successfully undertaken in the later part of the year and the data acquired is currently being interpreted.

Licence developments

In September 2010 the Higher Administrative Court of Ukraine formally approved the terms of a settlement agreement between Cadogan and NSJC Nadra Ukraine ("Nadra"), a state-owned company, whereby Nadra and its subsidiary Poltavanaftogazgeology withdrew the case between them over the licences currently owned by Cadogan for the Pirkrovskoe and Zagoryanska fields. As part of the settlement the Group purchased five deep wells on the Zagoryanska field and the development of this field forms part of the agreed work plan with Eni. The Board now views the previous challenge to the Pirkrovskoe and Zagoryanska licences as fully concluded. Nadra is a significant presence in Ukraine and Cadogan looks forward to cooperating with them in the future.

Overview of financial position

At 21 April 2011 the Group had current cash and cash equivalents of approximately £23.1 million. This is more than adequate to fulfil the Group's current work programmes and the proceeds from the Eni transaction will enable the Group to grow its position in Ukraine.

Litigation

In June 2009, the Group commenced litigation in the High Court in London against the former Chief Executive Officer, Chief Operating Officer and certain third parties, including individuals and suppliers. The action was initiated to seek a return of funds to the Group associated with the procurement of and payment for certain assets and services. For the year to 31 December 2010 the Group has incurred costs of £1.4 million (2009: £6.1 million). The litigation has yet to come to trial, but the Group has secured a number of settlements with the various parties in the case. The resultant settlements have in 2010 generated £6.0 million which has been disclosed in Other Operating Income. The litigation continues against the former Chief Operating Officer.

In addition under the settlement with Global Process Systems LLC ("GPS") entered into in October 2009, GPS took two gas plants back into stock and undertook to pay the Group USD37.5 million. The Group received USD1 million on execution in 2009, USD3.5million in 2010 and an additional USD3.0 million in January this year. All three payments have been recorded as a settlement of a receivable. The balance is due in three equal tranches, each of USD10 million, during 2011. The first payment of USD10 million of the remaining USD30 million was due to be paid to the Group on 14 February 2011 but was not received. A cure period expired on 18 April 2011. In April 2011 the Board commissioned a desktop study of the plants by an independent third party, which included an estimate of value subject to certain assumptions and caveats. Having taken the foregoing into account, the Board considers that the plants are likely to be worth close to the USD30 million (approximately £19.4 million) receivable that remains outstanding under the agreement. The Group retains legal title to the plants until the final payment has been received from GPS, with whom negotiations continue.

Employees

2010 was a challenging year for Cadogan's employees, especially with the uncertainty over Group's future undecided until mid-year. As always the staff has responded positively to events and continue to remain committed to building a business in Ukraine. The Board would like to thank them for their dedication and hard work.

Board and governance

Since the 2010 Annual General Meeting the Board has been restructured with the addition of three new directors - Alessandro Benedetti and Bertrand des Pallieres, who represent SPQR Capital Holdings S.A. which purchased a significant shareholding in the company and is supportive of management's plans, and Gordon Stein as Chief Financial Officer. All three directors will seek re-appointment at the forthcoming annual general meeting.

Alan Cole and I have decided not to seek re-election at the forthcoming annual general meeting. As a result our Senior Independent Director Philip Dayer will act as interim chairman and lead the search for a new chairman and an additional independent non-executive director. As is best practice, all the remaining directors will be putting themselves forward for re-election at the annual general meeting.

Prospects

The Board remain committed to building a successful oil and gas business in Ukraine. Over the past year management have successfully rebased the Company commensurate with its financial resources, whilst completing the total overhaul of its operating procedures, and improved the technical analysis and management of its resource base. The transaction with Eni will, if approved by shareholders, prove transformational to the prospects of the Group, facilitating the exploitation of the Pokrovskoe and Zagoryanska licences and aligning the interests of a major integrated energy company with Cadogan in Ukraine, a country where the opportunities in oil and gas remain abundant. The Board looks forward to the future with confidence.

Operations Review

At the beginning of 2011 the Group held working interests in nine (2009: eleven) gas, condensate and oil exploration and production licences in the east and west of Ukraine. All these assets are operated by the Group and are located in either the Carpathian basin or the Dnieper-Donets basin, in close proximity to the Ukrainian gas distribution infrastructure. The Group's primary focus is on the Bitlyanska licence, (Carpathian Basin, west Ukraine), Pokrovskoe, Zagoryanska and Pirkovskoe licences (Dnieper-Donets basin, east Ukraine) where the Group's main reserve and resource potential is located.

(1) E&D = Exploration and Development.

(2) The working interest on the Bitlyanska licence declines on a stepped basis, every five years after the commencement of production on each well. The Joint Activity Agreement ('JAA') also distinguishes working interests on new wells and work over wells with the former offering a higher share to the Group. Effective working interests are shown above.

(3) Discussions are currently underway with the Ministry of Environmental Protection in Ukraine to renew the licence for a further five years in August 2011.

(4) Although this licence expired in December 2009, it was reacquired by the Group in September 2010 at commercially advantageous terms.

Bitlyanska licence area

The Bitlyanska exploration and development licence covers an area of 390 square kilometres and the Group has a 96.5 per cent to 97.1 per cent working interest, varying with production. There are three hydrocarbon discoveries in this licence area: Bitlya, Borynya and Vovchenska. The Borynya and Bitlya fields hold 211.5 mmboe (2009: 211.5 mmboe) and 113.92 mmboe (2009: 113.9 mmboe) of Contingent Resources respectively, while no Reserves and Resources have been attributed to the Vovchenska field.

The required work programme for this licence includes: (a) seismic surveying; (b) drilling of Bitlya 2, re-entering of Borynya 3 (testing and possible completion for production) and drilling of two additional wells; (c) commencement of a pilot commercial exploitation of Vovchenska 11 well; and (d) conducting geological and economic estimation work on the Vovchenska field.

The Borynya 3 well was terminated at a drilled depth of 5,325 metres in 2009 and the well was suspended for future evaluation. Several discrete gas bearing pressure regimes were penetrated and good quality data were obtained from the well. In June 2009, Borynya 3 tested gas from a secondary reservoir at a maximum flow rate of 128,000 cubic metres per day during a limited duration drill stem test.

Bitlya is a 3,000 metre normally pressured gas field which has already been drilled by the Bitlya 1 well. This well established the presence of hydrocarbons in a structure identified by Soviet era 2D seismic. This has been reprocessed and reinterpreted using modern geophysical techniques, including generation of a structurally balanced section to verify the tectonic activity in the area. A targeted seismic 2D survey of the licence area was successfully undertaken in September 2010 and the data acquired is currently being interpreted. Although the structure is confirmed by earlier analysis the seismic survey undertaken in 2010 will indicate the geometry and extent of the closure. 

Pokrovskoe licence

The Group has a 100 per cent working interest in the Pokrovskoe licence which holds 51.1 mmboe (2009: 51.1 mmboe) of Prospective Resources. The exploration licence covers 49.5 square kilometres and runs until August 2011. Discussions are currently underway with the Ministry of Environmental Protection in Ukraine to renew the licence for a further five years. There is a two well drilling commitment (the wells have been partially drilled), 3D seismic work commitment as well as the construction of a gas treatment plant if required. Interpretation of the 3D seismic was completed in early 2010 and confirmed the presence of a prospect with four-way closure at the Lower Visean level and potentially in the deeper Tournasian sediments beneath both the Pokrovskoe 1 and Pokrovskoe 2 well locations, separated by a geological fault.

Deepening of the Pokrovskoe 1 well commenced in October 2010 and supported management's revised structural interpretation. The well encountered strong indications of gas during drilling and on the LWD logs over significant sections in the Lower Visean. Due to the onset of winter weather and the complexity of the drilling operations, it was decided to suspend drilling operations at 5,450 metres. An alternative all weather rig has been sourced and commercial negotiations are underway with a view to recommencing drilling operations in the second quarter of 2011.

Pokrovskoe 2 was the first exploration well drilled on the Pokrovskoe structure and was terminated at a drilling depth of 5,185 metres, where the well suspended for future evaluation and possible deepening. During drilling and coring operations across the Visean (V17 to V22) formations, there was strong gas influx into the well bore.

Since the year end, the Group has announced that it has reached agreement with Eni S.p.A ("Eni"), the major Italian integrated energy company, for the acquisition of an interest in the Group's Pokrovskoe licence. Subject to approval by shareholders, Eni will initially acquire a 30 per cent interest in the licence, with the option to acquire a further 30 per cent interest in the future. The consideration will comprise 100 per cent funding of a work programme of approximately USD30 million (excluding VAT), which will be used to fulfil the work obligations on the licence through the deepening of Pokrovskoe 1 and the deepening or re-drilling of Pokrovskoe 2 in order to will test the potential of the Upper and Lower Visean intervals.

Zagoryanska licence

The Group has a 90 per cent working interest in the Zagoryanksa licence area. The Zagoryanska licences hold 96.4 mmboe of Contingent Resources (2009: 96.4 mmboe of Contingent Resources). The exploration and development licence covers 49.6 square kilometres and the licence was extended in 2009 until April 2014.

The required work programme includes: a 3D seismic survey (completed); testing of well Zagoryanska 3 (underway); workover of well Zagoryanska 2; the drilling of an appraisal well; and conducting geological and economic estimation of hydrocarbon Reserves, which are to be verified by the State of Reserves Commission.

The Zagoryanska 3 well had been drilled in 2008, to a TD of 5,110 metres in the Lower Visean (V26) and was suspended in order to evaluate the data obtained from testing. In late 2009, additional testing of the well was farmed-out to a local company to test the well at their own expense in return for a share of any future production from the well. The test indicated sufficient gas in the Upper Visean (V18) for commercial production to commence and the well was tied into the Group's Zagoryanska gas treatment plant. Production commenced in August 2010 at a flow rate of 55 mcm/day (2 million scf/day) of gas and 15 t/day (120 bpd) of condensate. Average monthly production rates during 2010 were 51 mcm/day gas and 10 t/day condensate.

As a result of the settlement agreement entered into with NSJC Nadra Ukraine in September 2010 (refer to note 3(f)), the Group has purchased the Zagoryanska 3 well, which it was previously renting, together with four additional wells on the field. The Group intends to work- over some of these wells in 2011 and if successful put them into production.

As part of the transaction with Eni, announced since the year end and subject to shareholders approval, Eni will acquire a 60 per cent interest in the Zagoryanska licence for a payment of USD38 million, should the transaction complete later in the year.

Pirkovskoe licence

The Group has a 97 per cent working interest in the Pirkovskoe licence which holds 2.4 mmboe (2009: 2.4 mmboe) of proved and probable Reserves, 5.0 mmboe (2009: 5.0 mmboe) of possible Reserves, 134.0 mmboe of Contingent Resources (2009: 134.0 mmboe of Contingent Resources). The exploration and appraisal licence covers 71.6 square kilometres and has been renewed until October 2015.

The required work programme includes work-over of the Pirkovskoe 460 well (completed), and the testing of Pirkovskoe 1 and deepening followed by testing of the suspended Pirkovskoe 2 wells, the drilling of a new well scheduled for 2013 and calculation of the potential hydrocarbon reserves.

Pirkovskoe 1 was the first appraisal well drilled in the northern part of the Pirkovskoe licence. The well was terminated at a TD of 5,723 metres in the Devonian D3 and after testing the Devonian and lower Carboniferous, the well was temporarily suspended. The testing and subsequent completion of several shallower Carboniferous oil and gas bearing zones was farmed out to a local company at no cost to Cadogan, in return for a share of any future production. This interval produced small volumes of oil and gas and is currently shut-in.

The Pirkovskoe 2 well was drilled to a depth of 4,580 metres, and has been suspended until the results of Pirkovskoe 1 have been reviewed. However there is an obligation to deepen to TD of 5450m.

The Group owns the Kraznozayarska gas treatment plant, on the Pirkovskoe licence area, which is connected to the UkrTransGas system. Its capacity was upgraded in July 2007 to 300,000 cubic metres per day of gas and 150 tonnes per day of condensate in anticipation of future production.

Minor fields

The Group has a number of minor fields located in western Ukraine. These include the following:

§ Debeslavtska licence area

An exploration and development licence and production licence, containing 0.2 mmboe of proved, probable and possible Reserves (2009: 0.3 mmboe). This licence is currently producing 100.7 boepd (2009: 132.0 boepd). The Group drilled a series of three shallow wells on the field using its own drilling rig. Results of this program are under evaluation.

§ Cheremkhivska licence area

A production licence containing 0.1 mmboe of proved, probable and possible Reserves (2009: 0.1 mmboe). This licence is currently producing 33.2 boepd (2009: 56.2 boepd).

·; Slobodo-Rungerska licence area

An exploration and development licence, with no booked Reserves and Resources (2009: nil). During 2010 the six producing wells on this licence were abandoned as they were no longer commercially viable. In 2009 only 7.6 bopd were produced from the shallow wells in difficult mountainous forest terrain. Reprocessing of seismic data is currently underway to assess the deeper potential of this licence.

·; Monastreyetska licence area

An exploration and development licence, with no booked Reserves or Resources (2009: nil). Re-entry of the Blazhiv 1 well was undertaken and minor oil production re-established at the rate of 10 bopd.

Financial Review

Overview

In 2010, the activities of the Group continued to be mainly in the exploration and development stage. However the commencement of production at the Zagoryanska 3 well and the expansion of activities at the Debeslavetske field enabled revenue to increase from £2.3 million in 2009 to £3.3 million in 2010. This increase, together with the continuation of the cost reduction programme initiated in 2009 and the recoveries achieved during the year, enabled the Group to achieve a small profit after tax of £0.9 million for 2010 (2009: loss of £107.3 million of which £87.3 million related to one-off impairments booked in that year). This profit was reflected by a corresponding small increase in the net asset position as at 31 December 2010 to £84.8 million from £83.6 million as at 31 December 2009. The curtailment of cash outflows initiated on the change of management was reflected by the net outflow for the year being reduced to £7.0 million (2009: £41.5 million)

Income statement

Profit before tax was £0.5 million (2009: loss of £107.2 million after impairments of £87.3 million). Revenues comprised sales of gas from the Debeslavetske and Cheremkivske fields and, additionally in 2010, of gas and condensate from the Zagoryanska 3 well. Cost of sales, which represents production royalties and taxes, depreciation and depletion of producing wells and direct staff costs increased to £2.7 million in 2010 from £2.0 million in 2009 to give a gross profit of £0.6 million (2009: £0.3 million).

·; Other administrative expenses of £8.4 million (2009: £25.3 million) comprise other staff costs, professional fees, Directors' remuneration, depreciation charges on non-producing property, plant and equipment. In addition to recurring administrative expenses, £1.4 million (2009: £6.1 million) of professional costs were incurred in relation to litigation, £0.1 million (2009: £5.0 million) loss on disposal of property, plant and equipment, £nil (2009: £1.1 million) provision for bad and doubtful debts, and £nil (2009: £0.8 million) of consultancy fees were incurred to defend the legal challenges indirectly associated with the Pirkovskoe and Zagoryanska licences and also to extend the Zagoryanska licence.

·; Other operating income has been disclosed separately in the income statement so as not to distort the comparison of administrative expenses by netting recoveries against them. Of the total of £7.6 million shown in this category for 2010, £6.0 million (2009: £nil) is represented by recoveries from former members of management, suppliers and related parties through out of court settlements and the remainder of £1.6 million (2009: £4.6 million) relates to net foreign exchange gains.

·; Reversal of impairment charges in 2010 comprised of £1.5 million (2009: £13.2 million impairment) representing net recoveries of Ukrainian VAT. Net losses of £0.9 million (2009: £6.6 million) were incurred on sales of surplus inventories and provision for inventory. The income statement for 2009 shows impairment charges of £87.3 million which were made to reduce the carrying values of goodwill, E&E assets, PP&E assets, prepayments, inventories and other receivables as at 31 December 2009 (see below). No further impairment charges were made in 2010.

Investment revenue decreased during the year to £0.1 million (2009: £0.4 million) due mainly to a reduction of interest rates and to the level of funds held.

Cash flow statement

The Condensed Consolidated Cash Flow Statement shows expenditure of £4.0 million (2009: £15.9 million) on intangible E&E assets and £3.8 million (2009: £7.6 million) on PP&E.

Balance sheet

As at 31 December 2010, the Group had net cash and cash equivalents of £23.5 million (2009: £30.5 million). Intangible E&E assets of £4.0 million (2009: £nil) represent the carrying value of the Group's investment of exploration and appraisal assets during the year to 31 December 2010 following the impairment as at 31 December 2009 noted above. The PP&E balance of £34.9 million at 31 December 2010 (2009: £32.0 million), mainly comprised of the cost of developing fields with commercial reserves and bringing them into production. Trade and other receivables of £25.0 million include £21.3 million (2009: £18.8 million as non-current other receivable; £4.1 million as current other receivable) receivable in respect of the settlement with GPS (refer to note 3(a)).

Key performance indicators

The Group monitors its performance in implementing its strategy with reference to clear targets set out for five key financial and one key non-financial performance indicators ('KPIs'):

·; to increase oil, gas and condensate production measured on number of barrels of oil equivalent produced per day ('boepd');

·; to increase the Group's oil and gas reserves by de-risking possible resources and contingent reserves into proved plus probable reserves ('2P'). This is measured in million barrels of oil equivalent ('mmboe');

·; to increase the realised price per 1,000 cubic metres;

·; to decrease the cost per barrel for exploration and acquisition related expenditure;

·; to increase the Group's basic and diluted earnings per share; and

·; to reduce the number of lost time incidents.

In 2009 the Group focused on reducing costs and headcount and therefore used reduction in monthly cash outflows from operating and investing activities together with the reduction in the numbers employed to monitor its performance. In 2010 the Group has resumed using KPIs which it used prior to 2009.

These KPIs are applied across the Group. The Group's performance in 2010 against these targets is set out in the table below, together with the prior year performance data. No changes have been made to the source of data or calculation used in the year.

(1) Average production is calculated as the average daily monthly production during the year.

(2) Quantity of 2P reserves as at 31 December 2009 is based on Gaffney, Clines & Associates' independent reserves report dated 16 March 2010. Reserves at 31 December 2010 are updated for the actual production during 2010.

(3) This represents the average price received for gas sold during the year (including VAT).

(4) Basic profit/(loss) per Ordinary share is calculated by dividing the net profit/(loss) for the year attributable to Ordinary equity holder of the parent by the weighted average number of Ordinary shares during the year.

(5) Lost time incidents relate to injuries where an employee/contractor is injured and has time off work.

Related party transactions

Related party transactions are set out in note 30 to the Consolidated Financial Statements of the 2010 Annual Report.

Treasury

The Group continually monitors its exposure to currency risk. It maintains a portfolio of cash and cash equivalent balances in both USD and GBP held primarily in the UK and holds these mostly in term deposits depending on the Group's operational requirements. Production revenues from the sale of hydrocarbons are received in the local currency in Ukraine ('UAH') and to date funds from such revenues have been held in Ukraine for further use in operations rather than being remitted to the UK. Funds are primarily converted to USD and transferred to the Company's subsidiaries to fund operations at which time the funds are converted to UAH. Some payments are made on behalf of the subsidiaries from the UK.

Statement of Reserves and Resources

The Group did not commission an independent Reserves and Resources Evaluation of the Group's oil and gas assets in Ukraine, as at 31 December 2010 due to the limited level of drilling and operational activity undertaken during 2010. The summary of the Reserves and Resources below are based on the Independent Reserves and Resources Evaluation performed by Gaffney Cline and Associates as at 31 December 2009 adjusted for 2010 actual production.

Summary of Reserves

As of 31 December 2010

*During 2010 the Group produced additional 0.3bcf of natural gas and 0.01mmbl of condensate from Zagoryanska field which were not included by Gaffney Cline and Associates in the reserves balances at 31 December 2009 provided in the Reserves and Resources Evaluation Report as at that date.

Summary of Contingent Resources

As of 31 December 2010

Reserves are only assigned to Pirkovskoe, Debeslavetska and Cheremkhivska fields.

Although commercial production has been achieved at Zagoryanska field no 2P reserves have been booked as of 31 December 2010 as the Group did not receive an update CPR to independently confirm the Reserves quantities.

Contingent Resources are assigned to Pirkovskoe, Zagoryanska, Borynya and Bitlya fields, where development is contingent on further appraisal.

Prospective Resources of 237 bcf gas and 8.4mmbl condensate are attributed to Pokrovskoe field, where there has not yet been a production test.

Condensed Consolidated Income Statement

For the year ended 31 December 2010

Condensed Consolidated Statement of Comprehensive Income

For the year ended 31 December 2010

Condensed Consolidated Balance Sheet

As at 31 December 2010

Condensed Consolidated Cash Flow Statement

For the year ended 31 December 2010

Condensed Consolidated Statement of Changes in Equity

For the year ended 31 December 2010

Notes to the Condensed Consolidated Financial Information

For the year ended 31 December 2010

1. General information

Cadogan Petroleum plc (the 'Company', together with its subsidiaries the 'Group'), is incorporated in England and Wales under the Companies Act, who began trading on the London Stock Exchange on 23 June 2008.

The financial information set out above does not constitute the Company's statutory accounts for the years ended 31 December 2010 or 2009, but is derived from those accounts. Statutory accounts for 2009 have been delivered to the Registrar of Companies and those for 2010 will be delivered following the Company's Annual General Meeting. The auditors have reported on both sets of accounts. Both reports were qualified in respect of a limitation in scope resulting from an inability to obtain sufficient appropriate audit evidence regarding (a) the carrying values of assets as at 31 December 2008 and (b) the completeness and accuracy of the disclosures of related party transactions and directors' remuneration and contained a statement under sections 498(2)(unable to determine whether adequate accounting records had been kept) and (3)(failure to obtain necessary information and explanations) of the Companies Act 2006 in respect of this limitation. The 2010 audit report contained an emphasis of matter in relation to the uncertainty over recoverability of an amount of £21.3 million included within current other receivables in respect of two gas plants being sold by Global Process Systems LLC as set out in note 3(a). The 2009 audit report drew attention by way of emphases of matter in relation to the status of legal proceedings surrounding the validity of certain of the Group's licences in Ukraine and to proposed Annual General Meeting resolutions and potential impact on going concern if passed. The Ukrainian licence issue has been resolved as set out in note 3(f) and the resolutions were never put to the meeting.

2. Significant accounting policies

(a) Basis of accounting

The financial information has been prepared in accordance with IFRSs as adopted by the European Union and has been prepared on the basis of the accounting policies set out in the Group's 2010 Annual Report.

Whilst the financial information in this preliminary announcement has been prepared in accordance with IFRS, this announcement does not itself contain sufficient information to comply with IFRS. A copy of the full financial statements prepared in accordance with IFRS has been published and is available on the Company's website.

The prior year consolidated income statement reflects a reclassification of £4.6 million of foreign exchange gain from other administrative expenses to other operating income so as not to distort the comparison of the administrative expenses by netting recoveries against them.

The preliminary announcement was approved by the Board on 21 April 2010.

(b) Fundamental uncertainty associated with opening balances for 2009 and previous restatement

In March 2009, the former Chief Executive Officer resigned as Director of the Company and, subsequent to the departure of the former Chief Executive Officer, the Board commenced an internal investigation into potential procurement irregularities within the Group. In June 2009 the former Chief Financial Officer, Chief Operating Officer, and Asset Development Director also resigned.

During the Board's investigation, certain payments were identified that were inappropriately capitalised in the Company's consolidated financial statements for the years ended 31 December 2006, 2007 and 2008. As a result of this investigation, the original Annual Financial Report for 2008, issued on 26 June 2009, was reissued on 8 October 2009 (the Revised Annual Financial Report), to adjust for those items known at the date of the Revised Annual Financial Report. The effect of these adjustments was to reduce exploration and evaluation ('E&E') assets by £4.3 million, and property, plant and equipment ('PP&E') by £0.6 million as at 31 December 2008, with a corresponding decrease in equity £4.9 million at the same date. These balances enter into the calculation of the comparative amounts for the consolidated income statement, consolidated statement of comprehensive income, consolidated and parent company cash flow statements, and consolidated and parent company statement of changes in equity for the year ended 31 December 2009.

In view of the events and circumstances which occurred in the Group during 2009, which indicated that there could be doubts concerning the recoverability of the Group's goodwill, E&E and PP&E assets, the Board took the following action during 2009:

·; Internal investigation into procurement irregularities with adjustments made for all known payments inappropriately capitalised in the Group's consolidated financial statements for the years ended 31 December 2006, 2007 and 2008 (refer to Revised Annual Financial Report 2008);

·; Ongoing litigation at the High Court in London;

·; Review of inventories held by the Group with a provision provided to reduce the carrying value of the inventory to net realisable value (see note 13); and

·; Receipt of a Reserves and Resources Evaluation to support the carrying value of E&E, PP&E and goodwill assets as at 31 December 2009, resulting in an impairment charge for that year (see note 7).

The investigation concluded in respect of the capitalisation and recoverability of assets as at 31 December 2009, but not in respect of the values of assets as at 31 December 2008 which enter into the calculation of the consolidated income statement, consolidated statement of comprehensive income, consolidated and parent company cash flow statements, and consolidated and parent company statement of changes in equity for the year to 31 December 2009. The Board is of the opinion that uncertainties regarding the recognition, measurement and presentation of the Group's assets and liabilities as at 31 December 2009 have been eliminated and that the assets and liabilities are appropriately presented within the Group's Balance Sheets at 31 December 2009 and subsequently.

(c) Going concern

The Group's business activities, together with the factors likely to affect future development, performance and position are set out in the Business Review. The financial position of the Group, its cash flow and liquidity position are described in the Financial Review.

The Group's cash balance at 31 December 2010 was £23.5 million (2009: £30.5 million) with no material external debt and the Directors believe that the capital available at the date of the issue of these financial statements is sufficient for the Group to manage its business risks successfully.

The Group's forecasts and projections, taking into account reasonably possible changes in operational performance, start dates and flow rates for commercial production and the price of hydrocarbons sold to Ukrainian customers, show that there are reasonable expectations that the Group will be able to operate on funds currently held and those generated internally, for the foreseeable future, without taking into account receivables from litigation and without the requirement to seek external financing.

As the Group engages in oil and gas exploration and development activities, the most significant risk faced by the Group is delays encountered in achieving commercial production from the Group's major fields. The Group also continues to pursue its farm-out campaign, which, if successful, will enable it to farm-out a portion of its interests in its oil and gas licences to spread the risks associated with further exploration and development.

After making enquiries and considering the uncertainties described above, the Directors have a reasonable expectation that the Company and the Group have adequate resources to continue in operational existence for the foreseeable future and consider the going concern basis of accounting to be appropriate. Thus they continue to adopt the going concern basis of accounting in preparing the annual financial statements.

3. Critical accounting judgements

In the application of the Group's accounting policies, which are described in note 2, the Directors are required to make judgements, estimates and assumptions about the carrying amounts of the assets and liabilities that are not readily apparent from other sources. The estimates and associated assumptions are based on historical experience and other factors that are considered to be relevant. Actual results may differ from these estimates.

The estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognised in the period in which the estimate is revised if the revision affects only that period or in the period of the revision and future periods if the revision affects both the current and future periods.

The following are the critical judgements and estimates that the Directors have made in the process of applying the Group's accounting policies and that have the most significant effect on the amounts recognised in the financial statements:

(a) Other receivable recognised in relation to settlement with Global Process Systems LLC ('GPS')

An amount of £21.3 million has been recognised in current other receivables as at 31 December 2010, representing receivables from a settlement agreement reached with GPS (2009: £18.8 million as non-current other receivable; £4.1 million as current other receivable, see note 14).

During October 2009, a settlement was reached with GPS resolving previous disputes which existed between the Group and GPS concerning the manufacture and delivery of two gas treatment plants for a total purchase price of USD54.5 million.

The key commercial terms of the settlement provide for GPS exclusively to market the two gas plants for a 10 month period and, if a sale is achieved, for the Group to receive in stage payments an aggregate cash consideration of USD38.5 million. If the plants are not sold within this period, then GPS agreed to take the plants to stock and the Group will receive stage payments for an aggregate cash consideration of USD37.5 million. The settlement also provides for the release by GPS of a potential USD10.9 million contractual claim against the Group for the unpaid balance of the consideration for the plants. The amounts of USD43.5 million paid to GPS in respect of the gas plants had previously been recognised as prepayments, as title to the gas plants was to pass on delivery. As a result of the settlement, these prepayments were then reclassified as receivables included within other receivables at 31 December 2009.

GPS were not able to sell the plants within the stipulated period, and so the stage payments terms apply. During the years to 31 December 2009 and 2010, USD1 million and USD3.5 million were received from GPS respectively. A further USD3 million was received on 4 January 2011.

The first payment of USD10 million of the remaining USD30 million was due to be paid to the Group on 14 February 2011 but was not received. A cure period expired on 18 April 2011. In April 2011 the Board commissioned a desktop study of the plants by an independent third party, which included an estimate of value subject to certain assumptions and caveats. Having taken the foregoing into account, the Board considers that the plants are likely to be worth close to the USD30 million (approximately £19.4 million) receivable that remains outstanding under the agreement. The Group retains legal title to the plants until the final payment has been received from GPS, with whom negotiations continue.

An impairment charge of £3.9 million has been provided in the year ended to 31 December 2009 to reduce the carrying value of the original prepayments to their fair value, being the expected proceeds from the settlement.

No such charge has been made in the year to 31 December 2010 as the Directors consider that the remaining amounts are likely to be recovered. However, given the difficulties experienced to date in collecting the amounts due from GPS, and inherent uncertainty involved in estimating the value of the plants, this is judgemental.

(b) Impairment of E&E and PP&E

At 31 December 2010 the Group reviewed the carrying amounts of its PP&E and E&E assets to determine whether there is any indication that those assets have suffered an impairment loss. No indicators of non-recoverability of the carrying amounts of the above mentioned assets existed at the balance sheet date. The Directors believe that the Pokrovskoe exploration license which expires in August 2011 will be renewed for further 5 years.

Impairments of £63.5 million were charged in 2009 to reduce the carrying values of the Group's goodwill, E&E assets and PP&E assets as required by IAS 36 Impairment of Assets and IFRS 6 Exploration for and Evaluation of Mineral Resources as a result of the significant downward revisions to the Group's Reserves and Resources estimates in the independent Reserves and Resources Evaluation received in early 2010 and poor test results on wells drilled to that date.

In addition to the impairment provided in 2009 against the Group's goodwill, E&E and PPE assets, further impairment charges of £23.8 million against the carrying value of certain assets were provided for in 2009 (see note 7). Refer to the 2009 Annual Financial Report for a detailed discussion of the assumptions made to calculate the various impairments in 2009. Also refer to notes 11 and 12 for details of the carrying value of these assets.

(c) Reserves

Commercial Reserves are proven and probable ('2P') oil and gas reserves, which are defined as the estimated quantities of crude oil, natural gas and natural gas liquids which geological, geophysical and engineering data demonstrate with a specified degree of certainty to be recoverable in future years from known reservoirs and which are considered commercially producible. There should be a 50 per cent statistical probability that the actual quantity of recoverable Reserves will be more than the amount estimated as proven and probable Reserves and a 50 per cent statistical probability that it will be less.

Commercial Reserves used in the calculation of depreciation and for impairment test purposes are determined using estimates of oil and gas in place, recovery factors and future oil and gas prices. Management base their estimate of oil and gas Reserves and Resources upon the Report provided by independent advisers.

Although as at 31 December 2009 no 2P reserves were identified at Zagoryanska, subsequent to the issue of the 2009 Annual Financial Report, commercially recoverable gas was identified in that field.

The extension of the Pirkovskoe licence to 2015 was approved on 23 September 2010 by the Ministry of Ecology and Cadogan and the license was extended to November 2015.

(d) Recoverability of VAT

The Group has significant receivables from the State Budget of Ukraine relating to reimbursement of VAT arising on purchases of goods and services from external service and product providers. Although £1.8 million of Ukrainian VAT was recovered in the year to 31 December 2010, largely through a bond scheme initiated by the Government of Ukraine, the Directors consider that this scheme was one-off in nature. Management anticipates no significant cash settlements of receivables from the State Budget.

The Group therefore recognises recoverable VAT only to the extent that it is probable that VAT payable arising on the sales of gas production will be sufficient to offset the VAT due from the State within a reasonable period. Estimating the recoverability of VAT requires management to make an estimate of the future revenues in order to calculate amounts and timing of the VAT payable available for offset. At 31 December 2009, the Directors were uncertain as to the commercial viability of the Group's major fields and therefore believed it inappropriate to present these amounts as assets given the uncertainties surrounding the expectation for recovery, and impaired the Ukrainian VAT receivable of the Group in full. A provision of £12.2 million (2009: £14.0 million) against Ukrainian VAT receivable has thus been recognised as at 31 December 2010.

(e) Going concern

The Group's business activities, together with the factors likely to affect future development, performance and position are set out in the Business Review on pages. The financial position of the Group, its cash flow and liquidity position are described in the Financial Review. In addition, note 2(c) provides details as to the basis on which the Directors have adopted the going concern basis of accounting in preparing the annual financial statements.

The following matter was previously disclosed as a critical accounting judgement but has now been resolved.

(f) Legal proceedings surrounding the validity of the Pirkovskoe and Zagoryanska licences

The Group was involved in legal proceedings, surrounding the validity of the Pirkovskoe and Zagoryanska licences challenged by Poltavanaftogasgeology ('PNGG'), a subsidiary of the Group's joint venture partner, NJSC Nadra Ukraine, a state-owned company ('Nadra'), in relation on previous possession of these licences

With regard to these proceedings on 8 September 2010, the Group entered into a mutual settlement agreement with Nadra and PNGG, whereby PNGG and Nadra applied to the Higher Administrative Court ("the Court") of Ukraine to withdraw the cases between them over the previous ownership of the licences for the Pirkovskoe and Zagoryanska fields and the Group also agreed to purchase five wells on the Zagoryanska licence area.

PNGG and Nadra applied to the Court to withdraw the cases on 13 September 2010. The Court approved the agreement and these applications on 14 October 2010 in respect of the Pirkovskoe licence and on 21 December 2010 in respect of the Zagoryanska licence. The sale and purchase agreements with Nadra to acquire the Zagoryanska 3 well and four additional wells, for a total outlay of USD3.2 million (£2.0 million) excluding VAT were executed on 2 December 2010 and on 24 December 2010 respectively. As a consequence the indirect challenges to the Group's licences at Pirkrovskoe and Zagoryanksa have now been withdrawn from the Court by Nadra.

(g) Share-based payments

The Group has equity-settled share option schemes and a performance share plan available to certain Directors and employees. In accordance with IFRS 2 Share-based payment, in determining the fair value of options granted, the Group has applied the Black-Scholes and stochastic models. As a result, the Group makes assumptions for expected volatility, expected life, risk free rate and expected divided yield.

4. Business and geographical segments

The Directors consider there to be only one business segment, the exploration and development of oil and gas revenues and only one geographical segment, being Ukraine.

5. Dividend

The Directors do not recommend the payment of a dividend for the year (2009: £nil).

6. Other operating income

Out of court settlements represent £2.9 million received during the year from Smith Eurasia a former supplier to the Group and £3.1 million from the Group's former executives.

7. Reversal/(impairment) of oil and gas and other assets

Refer to note 3(b) for further details on the various impairments recognised in the prior year.

The carrying value of inventory as at 31 December 2010 and 2009 has been impaired to reduce it to net realisable value (see note 13).

During the year £1.8 million of Ukrainian VAT was recovered through a one-off bond scheme initiated by the Government of Ukraine. The remaining recoverable balance as of 31 December 2010 of £12.2 million (2009: £13.2 million) has been impaired as the Directors are not certain that VAT recoverable in Ukraine previously recognised as an asset will actually be recovered (see note 14).  

8. Profit/(Loss) for the year

The profit/(loss) for the year has been arrived at after charging/(crediting):

Consultancy fees in 2009 relate to consultancy fees paid in order to defend the legal issues over the Pirkovskoe and Zagoryanska licences and with the successful extension of the Zagoryanska licence.

Included within staff costs, is credit of £nil (2009: £0.8 million) relating to the reversal of equity-settled share-based payment transactions previously recognised.

In addition to the depreciation of PP&E of £1.2million (2009: £1.1 million), in the year ended 31 December 2010, depreciation of £0.4 million (2009: £1.6 million) was capitalised to E&E assets being depreciation of tangible assets used in E&E activities.

9. Tax

The Group's operations are conducted primarily outside the UK. The most appropriate tax rate for the Group is therefore considered to be 25% (2009: 25%), the rate of profit tax in Ukraine which is the primary source of revenue for the Group. Taxation for other jurisdictions is calculated at the rates prevailing in the respective jurisdictions.

The taxation charge for the year can be reconciled to the loss per the income statement as follows:

10. Profit/(Loss) per Ordinary share

Basic profit / (loss) per Ordinary share is calculated by dividing the net profit or loss for the year attributable to owners of the Company by the weighted average number of Ordinary shares outstanding during the year. The calculation of the basic and diluted profit / (loss) per share is based on the following data:

In 2009, diluted loss per Ordinary share equals basic loss per Ordinary share as, due to the losses incurred in 2009, there is no dilutive effect from the subsisting share warrants and share options.

11. Intangible exploration and evaluation assets

Refer to note 3(b) for a discussion of the impairment charge in the prior year.

Additions during the year include £0.4 million (2009: £1.6 million) of capitalised depreciation of development and production assets used in exploration and evaluation activities.

During the year one of the exploration fields of the Group has received a commercial hydrocarbons flow and the net of cost and accumulated impairment of £0.4 million (2009: £nil) of intangible exploration and evaluation costs have transferred to property, plant and equipment.

Within the carrying amount of intangible and exploration assets at 31 December 2010 £2.8 million (2009: £nil) relates to Pokrovskoe licence which expires in August 2011. The Group is taking all the necessary steps to extend this licence and expects the extension in August 2011.

12. Property, plant and equipment

Refer to note 3 (b) for a discussion of the impairment charge in prior year.

13. Inventories

The impairment provision as at 31 December 2010 and 2009 is made so as to reduce the carrying value of the inventories to net realisable value.

14. Other financial assets

Other non-current receivables

Trade and other receivables

All sales are made on a prepayment basis, so there are no trade debtors.

Out of £24.6 million of other receivables £21.3 million as at 31 December 2010 (2009: amounts of £18.8 million and £4.1 million) represent receivables from a settlement agreement with GPS (note 3(a)). This amount is stated after impairment of £3.9 million incurred in 2009 representing the difference between the original prepayment and the amount receivable in accordance with the settlement.

Within the other receivables balance, £2.8 million (2009: £nil) relates to the accrued litigation income from settlement reached in December 2010 with the former Chief Executive of the Group, received in early 2011.

VAT recoverable from the Ukraine tax authorities is only expected to be recovered once significant production commences. As at 31 December 2010, the Directors are uncertain as to the timing of commencement of significant production from the Group's major fields and therefore believe it inappropriate to present these amounts as assets given the uncertainties surrounding the likelihood of recovery. A provision of £12.2 million (2009: £14.0 million) has thus been recognised as at 31 December 2010.

The Directors consider that the carrying amount of the remaining other receivables approximates their fair value and none of which are past due.

15. Notes to the cash flow statement

Cash and cash equivalents (which are presented as a single class of assets on the balance sheet) comprise cash at bank and short-term bank deposits with an original maturity of three months or less. The carrying value of these assets is approximately equal to their fair value.

16. Other related party transactions

The completeness of the disclosure of related party transactions for the year ended 31 December 2010 was affected by the ongoing investigations into alleged irregularities involving certain former Directors.

17. Commitments and contingencies

Joint activity agreements

The Group has interests in nine licences for the conduct of its exploration and development activities within Ukraine. Each licence is held with the obligation to fulfil a minimum set of exploration activities within its term and is summarised on an annual basis, including the agreed minimum amount forecasted expenditure to fulfil those obligations. The activities and proposed expenditure levels are agreed with the government licensing authority Nadra

The minimum required future financing of exploration and development work on fields under the licence obligations are as follow:

A greater level of capital expenditure could however, be incurred in the above period to achieve the Group's corporate targets.

Cypriot court

The Group has put in escrow £0.5 million held by the Group's lawyers in Cyprus to support a bank guarantee provided to the Cypriot Court (the 'Court') in relation to obtaining a freezing order in Cyprus associated with the litigation against one of the former executive Directors. At 31 December 2010 and 2009, this amount is presented as restricted cash included within non-current assets.

The Group has also provided a guarantee to the Court to pay up to £0.3 million in the event that the Court is found liable for damages as a result of erroneously issuing a freezing order associated with the litigation against one of the former executive Directors, in favour of the Group.

18. Events after the balance sheet date

Farm-out of Pokrovskoe and Zagoryanskoe licenses

On 13 April 2011, the Group has announced an agreement with Eni S.p.A ("Eni"), the major Italian integrated energy company, which will initially acquire 30 and 60 per cent interests in Pokrovskoe and Zagoryanskoe licenses respectively. The initial consideration will comprise 100 per cent funding of a Pokrovskoe work programme of approximately USD30 million (excluding VAT), including drilling and seismic re-processing, plus a USD38 million payment for interest in Zagoryanskoe license. Subject to successful results from the above programmes and award of production licences, Eni will pay the Group further amounts of up to USD90 million.

GPS

The first payment of USD10 million of the remaining USD30 million was due to be paid to the Group on 14 February 2011 but was not received. A cure period expired on 18 April 2011. In April 2011 the Board commissioned a desktop study of the plants by an independent third party, which included an estimate of value subject to certain assumptions and caveats. Having taken the foregoing into account, the Board considers that the plants are likely to be worth close to the USD30 million (approximately £19.4 million) receivable that remains outstanding under the agreement. The Group retains legal title to the plants until the final payment has been received from GPS, with whom negotiations continue.

Group restructuring

As part of the ongoing restructuring of the Group the following changes have taken place to the structure of the Group since 31 December 2010:

- on 1 January 2011, Momentum Energy International Inc and Momentum Enterprises Inc, two sub-holding subsidiaries incorporated in Canada, were merged to form Cadogan Momentum Holdings Inc.

- Usenco International Inc (USA), and Colby Petroleum Limited (BVI) were put into liquidation

- Stickle Ltd (Isle of Man) began dissolution proceedings.

- three new Dutch subsidiaries, Pokrovskoe Petroleum BV, Zagoryanska Petroleum BV and Cadogan Pirkovskoe BV were incorporated as sub-holding companies for the licence activities in these respective areas

Litigation

£2.8 million in cash and other assets were received in January and February 2011 under the terms of the settlement agreement with MC Tolley dated 17 December 2010.