Last checked at 28 Apr 2010 07:00
CADOGAN PETROLEUM PLC
Preliminary Results for the Year Ended 31 December 2009
_______________________________________________________________________________________
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 2009.
Principal Developments
Developments in 2009
·; Fundamental management changes, including the appointment of Ian Baron as Chief Executive Officer
·; Full strategic and operational review of the Group's existing assets undertaken
·; Extension received on the Zagoryanska and Bitlyanska licences to 2014
·; Reduced operating expenses through temporarily suspending operations on major fields and lower headcount
·; Farm-out campaign being pursued to conserve existing cash and spread the risks associated with further exploration and development
·; An independent review of the Group's assets was received in March 2010 and resulted in downward reclassification of a large part of the Group's Reserves to the resource category
·; As a consequence of the downgrading of the Group's Reserves and Resources the Group's Ukrainian assets were impaired by £63.5 million (2008: £nil)
·; Commencement of litigation against certain former executives and suppliers with settlement reached with two third parties in 2009 and 2010
·; Continued vigorous defence of Pirkovskoe and Zagoryanksa licences in Ukrainian Court
·; Total capital expenditure of £23.5 million (2008: £73.2 million) during the year
·; Net cash and cash equivalents at year end of £30.5 million (2008: £72.0 million)
Enquiries
|
|
|
|
|
|
|
|
|
|
|
|
| Cadogan Petroleum plc | +44 20 7245 0801 |
| Ian Baron, Interim Chief Executive Officer |
|
|
|
|
| Stefan Bort, Company Secretary |
|
| Bankside |
|
| Simon Rothschild | +44 20 7367 8888 |
| Rose Oddy | +44 20 7367 8853 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Chairman's Statement
_______________________________________________________________________________________
Introduction and background
This statement and the accompanying Notice of Meeting and Resolutions present you with some clear alternatives and decisions about the future of your Company. You are invited to decide whether you want the Company to return capital or to build on the work undertaken by the new management team and retain capital to enable it to participate in the Ukrainian oil and gas sector. You are also invited to decide whether you want the current Board and management team to stay in place or whether you would prefer to elect a new Board comprising entirely of nominees of the Company's largest shareholder. The first sections of this statement review the events since the IPO. The last four sections - Board structure and governance, Control of the Company, Strategic alternatives and Outlook and recommendation - discuss the alternatives and provide you with additional material for your decisions.
The IPO of Cadogan in June 2008 was intended to be the beginning of a new and positive period in the Company's history. The Company had licences that contained promising prospects and seemed set for a period of successful development and good growth. Instead, the period since then has been one of great difficulty, challenge and disappointment for shareholders and employees alike. The problems began with the challenges to the Pirkovskoe and Zagoryanska licences in July 2008 and were compounded by poor operational performance and commercial judgement by the then management. Initially management seemed to be making good progress in resolving the licence challenges and, despite operational and commercial concerns, the Board felt it was in the best interests of shareholders to continue with the management team in place at least until the licence issues had been resolved. However, the reversal of a court judgment in February 2009, combined with continuing operational problems, caused the Board to lose its remaining confidence in management.
It appointed Ian Baron as Interim Chief Executive Officer in March 2009 to undertake both a strategic review of the Group's operations and an evaluation of the commercial viability of its assets. At around the same time, the Board launched an internal investigation into a number of commitments that had been entered into by the previous management. This investigation unexpectedly revealed serious procurement irregularities and in June 2009 the Company commenced litigation in the High Court in London against a number of parties, including its former Chief Executive Officer and Chief Operating Officer. Between March and June 2009 all the previous executive Directors departed, both as executives and as Directors of the Company.
Under the new management team operations were curtailed as quickly as was feasible given the constraints imposed by safety, environmental and technical considerations as well as the requirements of the Group's licence obligations. A major re-organisation was implemented and overheads reduced, thereby both cutting costs and increasing efficiency. The Group's headcount has been reduced by more than 70 per cent from over 500 employees at the start of 2009 to about 130 today and will remain appropriate for the level of ongoing activity. A revised business strategy was adopted to focus on operating at lower cost and reducing the overall risk profile of the Company's portfolio. By the end of 2009 the Company had significantly reduced the level of capital expenditure and had initiated a farm-out campaign on its four main licences.
Results of the strategic review
The key conclusions from the strategic review were as follows:
·; Previous technical and operational analysis of the Group's assets had underestimated their risk profile.
·; The high ownership levels the Group held in its major licences encumbered it with work obligations and financial commitments that were overdependent on major success in a short time frame.
·; The drilling equipment and seismic acquisition systems in Ukraine were inadequate and hindered proper evaluation and development of the Group's assets.
·; The disappointing test results from the Group's wells in east Ukraine were likely to have been a function of mechanical problems in the wells and operational practices, rather than poor reservoir characteristics as stated at the time.
·; The Group lacked clear reporting lines, had too many people and offices in Ukraine and duplicated its efforts through unnecessary and inappropriate use of contractors.
As a result of this analysis, the Group curtailed all major operational expenditures, focused efforts on rigorously evaluating its assets, embarked on a programme to balance the risk profile of its portfolio and sought alternative ways to secure funding of its future work obligations.
By the end of the year the Group had reduced its asset base by three licences, having relinquished or allowed the expiration of licences that were considered unattractive. The evaluation of the four major assets (Bitlyanska, Pirkovskoe, Porkovskoe and Zagoryanska) was almost complete and a farm-out programme had been initiated with the aim of reducing our percentage ownership in these assets in return for funding of future work obligations. The minor fields and assets have been made profitable by streamlining the operations and the organisation.
As part of our financial reporting and to assist with the farm-out programme, a new Reserves and Resources Evaluation ('the Report') was commissioned at the end of 2009. This Report, an independent review of the Group's assets, was received in March 2010 and resulted in a downward reclassification of a large part of the Group's reserves to the resource category (refer to the Statement of Reserves and Resources) and an impairment to the Group's net assets of £63.5 million. Notwithstanding this downgrade, the Report still recognises the merits of the assets and lists the Group's reserves and contingent resources as 110 million barrels of oil/condensate and 2.5 trillion cubic feet of gas. However, it remains to be demonstrated that the Group can economically develop the oil and gas believed to be present.
In order to expedite the marketing of the Group's major assets in the farm-out programme, the Board appointed IndigoPool, part of the Schlumberger Group and an industry leader in marketing oil and gas assets. Through the farm-out programme, Cadogan is seeking industry partners to take an equity interest in its major assets in return for contributing to the future work programme. This will improve the risk profile of the portfolio by reducing the Group's commitments whilst retaining sufficient equity to capture the potential upside in these assets. Several companies are actively evaluating the technical and commercial data on the assets under farm-out and the Company has requested that offers of interest are submitted by 31 May 2010.
In summary, having centralised all geological and geophysical evaluation work in Kiev, the Group has improved its knowledge of its asset base, disposed of non-strategic licences, curtailed capital expenditures, reduced administrative and other costs and embarked on a farm-out programme.
Operations summary
During 2009, the new management team curtailed the Group's deep drilling programme in east Ukraine. All wells are currently suspended with the exception of Pirkovskoe 1 and Zagoryanska 3, where joint venture agreements were entered into with local companies to finance further testing of the wells. This resulted in the Pirkovskoe 1 well producing approximately 70 barrels of light oil per day from Upper Visean sands which is being recovered and sold. Testing on the Zagoryanska 3 well is currently underway.
In west Ukraine drilling of the Borynya 3 well on the Bitlyanska licence area was terminated at a drilling depth of 5,325 metres and the well was suspended for future evaluation. The well provided valuable data and demonstrated that an active hydrocarbon system is present over an extended interval. Several discrete gas bearing pressure regimes were penetrated and good quality logs and data were obtained. In June 2009, Borynya 3 tested gas from a secondary reservoir at an estimated maximum flow rate of 128,000 cubic metres of gas per day during a limited duration drill stem test.
During the year, oil and gas continued to be produced from certain of the Group's minor fields. Although modest, these fields now produce at economic rates, particularly since operating costs have been reduced. Other minor assets at the exploration stage were disposed of or allowed to expire. These include the Krasnoyilske licence, the Mizrichinska licence and the Monastryetska licence, and at the end of 2009 the Malynovetska licence was annulled by the Government.
Licence developments
During 2009, the Group continued to support its position in the courts of Ukraine against the indirect challenges to the Pirkovskoe and Zagoryanska special permits. Following an ambiguous but nevertheless disquieting announcement concerning five of Cadogan's licences on a Government website in September, the Company embarked on a series of negotiations with the Ministry for Protection of the Environment (the 'Ministry'). As a result, in October 2009 the Ministry confirmed that 'there are no grounds for invalidation or annulment or any doubts as to the validity of the Group's special permits and licence interests with respect to Pirkovskoe, Zagoryanska, Bitlyanska, Monastryetska and Krasnoyilske'. In light of this confirmation, the Group continues to seek resolution of the previously mentioned indirect legal challenges to the Pirkovskoe and Zagoryanska special permits. Following the recent election in Ukraine, the Company has received positive indications of support for its position from Government departments within an administration that has stated its support for foreign investment in the country.
Overview of financial position
At 27 April 2010 the Group had current cash and cash equivalents of approximately £29.3 million. The Directors have a reasonable expectation that the Company and the Group have adequate resources to continue in operational existence for the foreseeable future.
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. This action was initiated to seek a return of funds to the Company associated with the procurement of and payment for certain assets and services.
For the year ended 31 December 2009, the Group has incurred £4.1 million of fees associated with the investigation and litigation against these parties. As a result of the litigation, the Group has already entered into settlement agreements with two suppliers, Global Processing Systems LLC ('GPS') and Smith Eurasia. GPS has agreed to return up to US$38.5 million and has also released the Group from GPS's US$10.9 million contractual claim for what would have been the balance of the consideration for the two gas plants it was constructing. After the end of the year, the Group reached a settlement with Smith Eurasia whereby the Group has received US$5.6 million, of which US$1.1 million was for unused plant and equipment (included within inventories at 31 December 2009) which we have returned to Smith Eurasia. As part of the settlement, the Group from its side has paid its outstanding invoices to Smith Eurasia of US$2.9 million (included within trade and other payables at 31 December 2009).The Board has been advised that it has a strong case against all the remaining parties to the litigation including, the former Chief Executive Officer and Chief Operating Officer and certain other individuals. Although the matter will not go to trial until February 2011 at the earliest, the Board fully expects that, with reduced legal spend, it will make recoveries from the defendants, including from those whose assets are presently secured by worldwide asset freezing orders.
Employees
The actions taken by the Board in early 2009 led to a complete reorganisation of the Group and the development of a new strategy, which in turn resulted in significant reductions in headcount. This inevitably caused significant uncertainty for the Group's employees, which was compounded by the global economic crisis which hit Ukraine particularly hard. Despite this, the Company's employees have remained committed to rebuilding a robust business for the Group in Ukraine and the Board would like to thank them for their commitment and hard work.
Board structure and governance
In view of the events at the Company since the IPO and the significant changes described above, the Board has implemented changes in its cost and governance in line with the changes in the rest of the Company. My fee as Chairman has been reduced from £125,000 to £40,000 and fees for the non-executive directors have been reduced from £40,000 to £25,000, all with effect from 1 April 2010. In addition, the Board will be reduced in size from seven to five with effect from the AGM. To this end, Jim Donaldson and Nick Corby, both of whom have served the Company since before the IPO, have suggested that they should resign after the forthcoming AGM. I would like to thank them both for the significant contributions they have made towards resolving the difficulties the Company has faced. The changes in fees and numbers will result in a reduction of more than 60 per cent in the cost of the Board.
In addition, the Board believes that shareholders should have the opportunity of choosing their Board both at this AGM and at all future annual meetings. It has therefore decided that all five remaining directors will put themselves forward for re-election at the AGM and, if re-elected, will stand for re-election every year as long as they remain on the Board. In putting itself forward for annual re-election, the Board is in effect giving shareholders the opportunity not just to comment but to vote each year on its performance in the most direct way possible.
Control of the Company
During the year, Weiss Asset Management LP ('Weiss'), a fund management company based in the USA, became the Company's largest shareholder and currently owns 25.01 per cent of the Company's shares. Weiss has made a number of requests of the Company, including that the Board should be reduced in size from seven to three. They initially suggested that they should appoint two of the three members of the reduced Board and that I might remain as Chairman. However, since that would amount to giving Weiss control of the Company without their having to make an offer for the remaining shares in issue, the Board has informed Weiss that it is unwilling to agree to their proposals. Furthermore, since, as explained below in the section on Strategic alternatives, none of the existing Board believes that Weiss's plans are in the best interests of the Company or its shareholders as a whole, it would clearly not be right for any existing Director to remain on the Board should Weiss obtain control of it. Weiss subsequently proposed that they should nominate an entirely new Board of three directors. Their proposals and reasoning are set out in the accompanying letter from them to shareholders.
As described in the Introduction and background above, the Board has already made substantial progress towards achieving the objectives Weiss outline for the Company in their letter, including reducing headcount by over 70 per cent. Weiss refer to over £17 million of administrative expenses in the first half of 2009, which they characterise as excessive. If the actual cost of administering the Company during the period had been over £17 million, the Board would strongly agree with Weiss that it was excessive. However, the interim accounts for the period ending 30 June 2009 disclosed that the figure for administrative costs included approximately £13.5 million for a non-cash impairment of VAT. It is evident that Weiss has misunderstood the actual level of costs within the business and that costs are less than a quarter of what Weiss apparently believe them to be.
The Board has seen no supporting argument or evidence for Weiss's assertion that 'new board members will be better suited to facing the challenges posed by the Company's new landscape'. To the contrary, we believe appointment of their nominees and implementation of their plan will almost certainly eliminate any prospect that shareholders may have of recovering more than the current cash balances plus proceeds from the GPS settlement and ongoing litigation, less the legal and administrative costs needed to ensure the recoveries. As argued below, the Board believes that shareholders should be given the opportunity to accomplish much more than this.
Shareholders should also be aware that the cost of the Board will be higher if Weiss's proposals are approved. Setting aside Ian Baron, who, if he is re-elected at the AGM, will continue to be compensated as an executive rather than as a Director, the aggregate fees of the four non-executive directors (myself, Philip Dayer, Alan Cole and Nick Hooke) will be £115,000 per annum. Although not mentioned in their letter to you, in response to our queries Weiss have informed us that their nominated Directors will each be paid £40,000 per annum, for an aggregate of £120,000, plus 'an incentive arrangement based on cash distributed to shareholders'. They have not specified the quantum of the proposed incentive arrangement, but in earlier discussions they suggested that Ian Baron and Nick Corby could together be paid three to five per cent of the cash distributed to shareholders as an incentive. As explained below, Ian and Nick have declined this proposal as a matter of principle as they do not believe election of the Weiss nominees to be in the best interests of the Company or shareholders as a whole. However, if the three Weiss nominees are paid anything even approaching their suggestion to Ian and Nick, the cost of their Directors will be substantially greater than the cost of the four non-executives proposed by the existing Board. Furthermore, shareholders should note that Weiss's proposals for an incentive scheme for non-executive directors would, according to the Combined Code, compromise their independence.
Although the Board does not agree that Weiss's proposals are in the best interests of the Company or its shareholders as a whole, it has no wish to obstruct a shareholder vote on them and has therefore cooperated with Weiss to enable them to put their proposals to you as shareholders. To that end, the Notice of Meeting contains a group of Resolutions (3, 4, 5 and 6) which, if passed, would give effect to the Weiss proposals on Board composition.
Strategic alternatives
The Board believes shareholders need to make the following key decisions -
1) Do you wish to build on the valuable work undertaken by the new management team in the past year and retain exposure to what could still be an interesting upside in the oil and gas sector in Ukraine, as recommended by the Board, or would you prefer the Company to return capital to shareholders?
2) Do you wish the Company to be managed by the current Board (other than Nick Corby and Jim Donaldson) or by the nominees proposed by Weiss?
Regarding the first decision, whilst fully acknowledging, and indeed sharing, the anger and dismay that shareholders must feel at events since the IPO, the Board nevertheless believes that, as a consequence of the actions taken by the new management team, there remains a significant opportunity for value to be created from the Company's sub-surface assets in Ukraine. This is where we disagree most strongly with Weiss. The independent report on Reserves and Resources prepared by Gaffney Cline & Associates as of 31 December 2009 states that the Group's assets contain reserves and contingent resources of approximately 110 million barrels of oil/condensate and 2.5 trillion cubic feet of gas. The Group is already producing oil and gas from three fields in west Ukraine and one field in east Ukraine and is currently testing a well that we expect to hook up for production in the coming weeks. The monthly net revenue from these wells alone will almost be sufficient to cover the Group's general and administrative expenses other than the ongoing cost of litigation.
Despite the challenges Ukraine presents, it is an environment with limited international competition, strong energy demand and attractive commercial terms in which a management team competent in oil and gas can make good returns on investment. Furthermore, the Board believes that many of the Company's problems were 'own goals' inflicted by the former management and that, with a different approach, many of those problems can be resolved. Since March 2009 the Group has moved forward swiftly. It has refined its portfolio by dropping assets considered unattractive and dramatically improved both its knowledge of its assets and the efficiency with which they are managed. We are also in the process of reducing risk by farming out expenditure obligations. We have opportunities to invest in increasing production from our existing assets and, now that we have 3D seismic interpretations on our east Ukraine assets, have identified targets that can be reached by deepening wells on one block. The 3D seismic has also identified "sweet spots" in some of the blocks we are seeking to farm-out. Having funds available to invest in these blocks if the farmed-out work proves successful could generate significant value. In addition the management team has secured a five-year extension to the Group's Bitlyanska licence in west Ukraine.
Pursuing this alternative does not rule out returning capital at a later date if the farm-outs are not successful, but in the Board's view it does optimise the chances of creating much more value than could be generated by focusing narrowly on short-term asset realisation. If shareholders wish to pursue this alternative, it would be sensible to vote against Resolutions 3, 4, 5, 6 and 14.
A variation of the above would be to return almost all of the available cash to shareholders immediately while continuing to pursue the litigation against former management and their associates, ensuring maximum recovery from GPS and pursuing the farm-out plan. Based on our most recent analysis, the Board believes this could result in an immediate return of 10 pence per share, representing all the cash available today less an amount needed to operate the Group while pursuing the activities described above. Depending on the outcome of the litigation and the receipts from GPS and asset disposals, our analysis indicates that another 7-16 pence per share could be available for return over the next 12-18 months. The analysis also suggests that, by investing £1.2 million this year to increase production and by continuing to reduce costs, the Group could become cash-breakeven during 2010. This alternative could be characterised as 'return most of the available cash now while retaining optionality over future commercial success'. However, while this variation might seem superficially attractive, shareholders should not underestimate the consequences in Ukraine of being seen to return the bulk of available cash and the risks that such a step could pose to the Company's assets there. For this reason, as well as for the more positive reasons outlined above, this is not the Board's recommended alternative. However, if shareholders wish to pursue it, they can do so by voting against Resolutions 3, 4, 5 and 6 but for Resolution 14, in which case the current Directors other than Nick Corby and Jim Donaldson will remain in place to oversee the return of capital, the ongoing litigation and the farm-out process.
Regarding the decision about the composition of the Board, the current Board does not know exactly what Weiss will do if they assume control of the Company, but from our interactions with them we do not believe, whatever their intentions or statements, that they are likely to maximise value for shareholders. They have candidly stated that they do not follow the oil and gas sector and that they view Cadogan as merely 'a balance-sheet play'. From this and from our discussions with them, we infer that their interest in Cadogan is based on the fact that the cost to them of acquiring their shares in the Company is below the value of the Company's cash and the expected proceeds from the GPS settlement and ongoing litigation. Their proposals for reconstructing the Board, besides potentially breaching the Combined Code, will undoubtedly increase its costs, perhaps substantially. We believe they have materially misunderstood and overstated the level of costs in the business and that there must be some risk that, in pursuit of cost savings that do not exist, they will damage the business and reduce the amount that could be returned to shareholders. Following extensive dialogue between management and Weiss, both in their office in Boston and on the telephone, the Board has concluded that allowing Weiss to take control of the Company would greatly reduce the probability of realising any value from the assets in Ukraine, whether through developing or disposing of them. Our best estimate is that under this scenario the return of capital is likely to be about the same amount (10 pence per share followed by 7-16 pence per share 12-18 months later), adjusted for any differences in costs, as would be delivered under the 'variation' described above. The principal difference is likely to be the amount of any value realised from the Company's sub-surface assets in Ukraine, which could be considerable.
On any rational analysis the risk-adjusted expected value of Weiss's proposals is almost certainly lower than that of the alternatives presented by the Board and the cost of implementing them is almost certainly higher. If the culture in Weiss is cerebral, if they are analytically rigorous and if their investment decisions are based on economic analysis, all of which they claim on their website (www.weissasset.com), they should vote against their own proposals.
While the Board and management will cooperate with Weiss to ensure a smooth handover of control if shareholders vote for the Weiss nominees, none of the existing management team would be prepared to continue in post under those circumstances as they believe that Weiss are likely to liquidate the company and, in so doing, will not maximise value for shareholders. However, if shareholders seek that outcome under a Board comprising Weiss's nominees, they should vote for Resolutions 3, 4, 5, 6 and 14.
Outlook and recommendation
The Board believes that in practice the choices facing shareholders are as follows -
1) Reappoint four of the five current non-executive Directors plus Ian Baron and leave the cash within the Company to participate in the potential upside, which entails voting against Resolutions 3, 4, 5, 6 and 14.
2) Reappoint four of the five current non-executive Directors plus Ian Baron but require them to return almost all available cash now plus future surplus cash as it becomes available after participating in the potential upside from the farm-out programme, which entails voting against Resolutions 3, 4, 5 and 6 but for Resolution 14.
3) Elect the Weiss nominees, which the Board believes is tantamount to choosing to liquidate the Company and which entails voting for Resolutions 3, 4, 5, 6 and 14.
Despite the events that led to the change of management early in 2009, actions taken by the new management since then have greatly improved the Company's position and outlook. While understandable at a visceral level, it would seem non-commercial to call time on the Company's business and assets in Ukraine just when there is some prospect that the cloud over them might be lifting. With reserves and contingent resources of approximately 110 million barrels of oil/condensate and 2.5 trillion cubic feet of gas, the prospect of becoming cash breakeven during the current year and a management team that has the skills and experience to develop the Company's assets on your behalf, a rational choice for shareholders would be to retain their current level of investment in the Company as an option on the potential upside.
The Board therefore recommends that shareholders vote against Resolutions 3, 4, 5, 6 and 14. If you do so, we will continue to keep costs as low as possible while pursuing ways of realising value from our sub-surface assets in Ukraine. If at any time we conclude that these efforts are not being successful, we will revert to you with proposals for returning capital. In any event, all Directors will present themselves for re-election annually for as long as they remain on the Board.
The Notice of Meeting for the Annual General Meeting to be held on 2 June 2010 is available on the Company's website (www.cadoganpetroleum.com)
Operations Review
_______________________________________________________________________________________
Following the management changes in March 2009, the capital intensive drilling operations of the Company were safely curtailed in a manner that would maintain the licences legally and leave maximum flexibility in the event further studies revealed scope for additional work on the wells. Greater effort was applied to developing and understanding the hydrocarbon potential and the risks on the Group's licences through work carried out by the Group's new subsurface team based in Kiev. Additionally the team focused on building the technical database and developing a farm-out programme designed to balance the risk profile of the asset base through finding partners to fund future work programmes, in return for part of Cadogan's equity in the licences.
At the beginning of 2009 the Group held working interests in eleven (2008: eleven) gas, condensate and oil exploration and production licences in the east and west of Ukraine. This was reduced to eight licences by the end of 2009 (the Krasnoilska and Monastryetska licences expired in December 2009 and the Malynovetska licence was annulled by the Government in November 2009). 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.
| Summary of the Group's licences held during the year | |||
| Working | Licence | Expiry | Licence type(1) |
| interest (%) | |||
| Major licences |
|
|
|
| 96.5 | Bitlyanksa(2) | Dec-14 | E&D |
| 100 | Pokrovskoe | Aug-11 | E&D |
| 90 | Zagoryanska | Apr-14 | E&D |
| 97 | Pirkovskoe | Oct-10 | E&D |
| Minor licences |
|
|
|
| 98.3 | Debeslavtska | Oct-26 | Production |
| 49.8 | Cheremkhivska | May-18 | Production |
| 100 | Slobodo-Rungerska | Apr-11 | E&D |
| 95 | Monastyretska(3) | Dec-09 | E&D |
| 98.5 | Krasnoilska(3) | Dec-09 | E&D |
| 40 | Mizhrichenska | Jun-11 | E&D |
| 79.9 | Malynovetska(4) | Jan-12 | E&D |
(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 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) These licences expired in December 2009.
(4) This licence was annulled on 20 November 2009 (Order of Ministry of ecology #623).
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 211.54 mmboe (2008: 188.6 mmboe) and 113.92 mmboe (2008: 114.0 mmboe) of Contingent Resources respectively, while no Reserves and Resources have been attributed to the Vovchenska field.
In December 2009, the Group received a five year extension for this licence until December 2014. The required work programme 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.
In November 2009, drilling of the Borynya 3 well was terminated at a drilled depth of 5,325 metres and the well was suspended for future evaluation. Borynya 3 was a licence obligation well and confirmed that an active hydrocarbon system is present over an extended interval. 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.
The Borynya 3 well was designed to test the potential of the Verchovinsky formation at a projected depth below 4,800 metres. According to Soviet era records, this interval in the Borynya 2 well tested 400,000 cubic metres of gas per day in an open-hole test before the test failed due to formation blocking the test tool. The possible extent of the Borynya structure is currently poorly defined as there is a lack of adequate seismic data due to the complex geology and the challenges of acquiring good seismic results in the terrain of the Borynya region.
Prior to changing strategy earlier in 2009, the Group had planned to drill the Bitlya 2 well following Borynya 3. This well has been postponed into the extension phase of the licence, pending a decision to commence exploratory drilling. 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. Although the structure is confirmed by the interpretation the geometry and extent of the closure will need to be confirmed by a targeted seismic study planned for 2010.
Pokrovskoe licence
The Group has a 100 per cent working interest in the Pokrovskoe licence which holds 51.06 mmboe (2008: 58.6 mmboe) of Prospective Resources. The exploration licence covers 49.5 square kilometres and runs until August 2011. There is a four well drilling commitment (two of which have been drilled), 3D seismic work commitment as well as the construction of a gas treatment plant. Interpretation of the 3D seismic was completed in early 2010 and confirms 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.
Pokrovskoe 2 was the first exploration well drilled on the Pokrovskoe structure and was spudded in late 2006. Drilling of the well was terminated at a drilling depth of 5,185 metres and the well was suspended for future evaluation. During drilling and coring operations across the Visean (V17 to V22) formations, there was strong gas influx into the well bore. The main objectives of this well are to determine the productivity of the Upper and Lower Visean formations and to convert potentially Prospective Resources to Reserves.
Pokrovskoe 1 is the second exploration well on the licence and was spudded in early 2008. The well was temporarily suspended at 4,988 metres pending evaluation of data obtained from the well so far.
The processing of the previously acquired 3D seismic data over the entire field is now complete and it is planned to deepen Pokrovskoe 1 and Pokrovskoe 2 to the lower target horizons and their commitment depths.
Zagoryanska licence
The Group has a 90 per cent working interest in the Zagoryanksa licence area which is located immediately to the east of the Pirkovskoe licence. The Zagoryanska licences hold 96.4 mmboe of Contingent Resources (2008: 18.6 mmboe of Contingent Resources and 25.9 mmboe of Prospective Resources). The exploration and production licence covers 49.6 square kilometres and in January 2009 the Group received a five year extension for this licence which now expires in 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 has been drilled to a TD of 5,110 metres in the Lower Visean (V26) and was suspended in order to evaluate the data obtained from testing. Several potential gas bearing reservoirs were tested in the Carboniferous. In late 2009, additional testing of the well was farmed-out to a local company that is funding additional testing at their own expense in return for a share of any future production from the well. Following completion of this testing programme, management will consider the workover of two previously drilled wells (Zagoryanska 2 and 8).
Pirkovskoe licence
The Group has a 97 per cent working interest in the Pirkovskoe licence which holds 2.4 mmboe (2008: 82.4 mmboe) of proved and probable Reserves, 5.0 mmboe (2008: 73.0 mmboe) of possible Reserves, 134.0 mmboe of Contingent Resources (2008: 10.4 mmboe of Contingent Resources and 180.3 mmboe of Prospective Resources). The exploration and appraisal licence covers 71.6 square kilometres and runs until October 2010.
The required work programme includes work-over of the Pirkovskoe 460 well, and the drilling of Pirkovskoe 1 and Pirkovskoe 2 wells 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 is currently producing small volumes of oil and gas.
This 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.
Initial well testing of Pirkovskoe 460 was part of the Group's field development obligations and was completed in December 2007. Test results indicated that poor well integrity was causing water influx from behind casing. As a result, the well was producing at lower than anticipated gas rates and as the cost of remediation was prohibitive, the well has been plugged and abandoned.
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 0.3 mmboe of proved, probable and possible Reserves (2008: 0.5 mmboe). This licence is currently producing 132.0 boepd (2008: 168.8 boepd).
§ Cheremkhivska licence area
A production licence containing 0.1 mmboe of proved, probable and possible Reserves (2008: 0.1 mmboe). This licence is currently producing 56.2 boepd (2008: 65.6 boepd).
·; Slobodo-Rungerska licence area
An exploration and development licence, with no booked Reserves and Resources (2008: 20.0 mboe of proved, probable and possible Reserves and 10.3 mmboe Prospective Resources). This licence is currently producing 7.6 boepd (2008: 4.52 boepd).
·; Mizhrichenska licence area
An exploration and development licence, with no booked Reserves or Resources (2008: nil).
During the year, oil and gas continued to be produced from certain of these fields and although modest, they are now producing at economic rates because of a considerable reduction in operating costs. Other minor non-strategic assets which were either sub-commercial or at the exploration stage were disposed of or allowed to expire. These include the Krasnoilska and Monastryetska licences which expired in December 2009 and the Malynovetska licence which was annulled by the Government in November 2009.
Some capital expenditure on certain minor fields is planned for 2010 to sustain production levels. In addition, subsurface analysis is planned to identify further potential on these licences as well as evaluation of other opportunities for diversifying risk and obtaining additional capital through potential farm-outs.
Financial Review
_______________________________________________________________________________________
Impairment
IAS 36 Impairment of Assets and IFRS 6 Exploration for and Evaluation of Mineral Resources require that a review for impairment be carried out if events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. As a result of the significant downward revisions to the Group's Reserves and Resources estimates in the independent Reserves and Resources Evaluation (the 'Report') as outlined in the Statement of Reserves and Resources, poor test results on wells drilled to date and the Group's strategy of suspending operations on major licences, the Directors believed it appropriate to assess the carrying value of the Group's oil and gas assets including, goodwill, exploration and evaluation assets('E&E') and property, plant and equipment ('PP&E') for impairment at 31 December 2009.
In order to assess the present value of the future cash flows attributable to the Group's goodwill, E&E and PP&E assets at 31 December 2009, reference was made to the Report.
For PP&E assets, the aggregate carrying value of each cash generating unit ('CGU') was compared against the expected recoverable amount of the related asset, by reference to the present value of the future cash flows expected to be derived from the production of commercial Reserves (2P Reserves) of that unit. An impairment loss of £4.9 million (2008: £nil) has been provided at 31 December 2009, reducing the carrying value of PP&E to £32.0 million (2008: £39.1 million).
As the Group applies the full cost method of accounting for E&E costs, the E&E assets are tested for impairment on a cost pool basis. At 31 December 2009, no commercial Reserves were assigned to the oil and gas licences within the Report, included within E&E assets, as insufficient work had been performed to determine the commerciality of the assigned Resources. Under the circumstances, a formal impairment test was triggered, however, as only the commercial Reserves (2P Reserves) assigned to the wider cost pool of Ukraine have been used to determine the present value of the future cash flows, the Contingent and Prospective Resources assigned to these licences are not, therefore, reflected in the recoverable amount. As a result the entire balance was provided for at 31 December 2009, resulting in the carrying value of £56.4 million being impaired in full.
The Group's goodwill was allocated to the wider cost pool of Ukraine and as such was assessed for impairment based on the present value of the future cash flows expected to be derived from production of commercial Reserves. The recoverable amount of the cash-generating unit to which goodwill was allocated was less than the carrying value of goodwill and as a result the entire balance was provided for at 31 December 2009, resulting in the carrying value of £2.3 million being impaired in full.
In addition to the impairment provided against the Group's goodwill, E&E and PP&E assets, further impairment charges against the carrying value of certain other assets have been provided. These are, a charge of £6.6 million (2008: £nil) to reduce the carrying value of the Group's inventory at 31 December 2009 to its net realisable value, a charge of £3.9 million (2008: £nil) to reduce the carrying value of other receivables in relation to the settlement agreement reached with Global Processing Systems LLC, and a charge of £13.2 million (2008: £0.8 million) against the carrying value of VAT receivable in Ukraine.
Total impairments charged to the Group's Condensed Consolidated Income Statement in 2009 were £87.3 million (2008: £0.8 million). Refer to note 6 to the condensed consolidated financial information.
Income statement
In 2009, being in an exploration and development stage, the Group continued to operate at a loss, recognising a loss before tax of £107.2 million (2008: £24.4 million) of which £87.3 million (2008: £0.8 million) arose from the impairments discussed above. Revenue of £2.3 million (2008: £1.8 million) consisted of the sale of gas and oil from the producing wells in the Debeslavetska and Cheremkhivskoe fields and the sale of oil from test production on the Pirkovskoe licence. To the extent that revenue arises from test production during an evaluation programme, an amount is charged from evaluation costs to cost of sales, to reflect a zero margin. This has resulted in a gross profit from the Group's hydrocarbon sales of £0.3 million (2008: loss £0.2 million).
Other administrative expenses of £20.7 million (2008: £26.1 million) comprise staff costs, professional fees, Directors' remuneration, depreciation charges for the Group's property, plant and equipment and its other intangible assets and any currency effects from operating transactions or from the currency-related restatement of the value of monetary assets or liabilities. In addition to recurring administrative expenses, the following non-recurring items were included in administrative expenses during the year:
·; £6.1 million (2008: £nil) recognised in relation to the investigation and litigation process of which £4.1 million (2008: £nil) was paid during 2009;
·; £0.8 million (2008: £6.4 million) of consultancy fees incurred to defend the legal challenges indirectly associated with the Pirkovskoe and Zagoryanska licences and also to extend the Zagoryanska licence;
·; loss on the disposal of property, plant and equipment of £5.0 million (2008: £0.1 million);
·; provision of £1.1 million (2008: £0.2 million) for doubtful assets to which recoverability is uncertain; and
·; income of 0.8 million (2008: £0.2 million) relates to the reversal of equity-settled share-based payment transactions previously expensed due to certain options being forfeited.
The loss for the year includes £87.3 million (2008: £0.8 million) of impairment losses reducing the carrying value of goodwill, E&E assets, PP&E assets, prepayments, inventories and other receivables as at 31 December 2009. Refer to note 6 to the condensed consolidated financial information.
Investment revenue decreased during the year to £0.4 million (2008: £2.9 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 £15.9 million (2008: £38.3 million) on intangible E&E assets and £7.6 million (2008: £32.4 million) on PP&E. No acquisitions of subsidiaries were made in the year ended 31 December 2009 (2008: £2.4 million).
Balance sheet
As at 31 December 2009, the Group had net cash and cash equivalents of £30.5 million (2008: £72.0 million) with no external borrowings. The PP&E balance of £32.0 million at 31 December 2009 (2008: £39.1 million), relates primarily to the cost of developing fields with commercial Reserves and bringing them into production. Net assets have decreased by £119.8 million to £83.6 million at 31 December 2009 from £203.4 million at 31 December 2008 which is principally due to the impairment losses provided at 31 December 2009 reducing the carrying value of the Group's goodwill, E&E assets, PP&E assets, prepayments, inventories and other receivables as discussed above.
Key performance indicators
The events and circumstances that took place during the year, as outlined in the Chairman's Statement, have forced the Group to focus primarily on reducing costs and headcount, as a result of which the KPIs which it had used to monitor performance have been related to cash flow, cost reduction and numbers employed.
The average monthly cash outflow from operating and investing activities decreased by £5.9 million from £9.4 million in 2008 to £3.5 million in 2009. During the first three months of 2010 the average monthly cash outflow has been reduced to £0.9 million. The Group's headcount reduced substantially from 518 employees (including executive Directors) at 31 December 2008 to 153 at 31 December 2008.
The Group would normally monitor 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 Reserves and Contingent and Prospective Resources 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.
These KPIs are applied across the Group. The Group's performance in 2009 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.
| Unit | 2009 | 2008 | |
| Financial KPIs |
|
|
|
| Average production (working interest basis) (1) | boepd | 234 | 263 |
| 2P Reserves (2) | mmboe | 2.7 | 83 |
| Finding and development cost per barrel (3) | £ | N/A (3) | 15.79 |
| Realised price per 1,000 cubic metres (4) | £ | 188.5 | 104.1 |
| Basic and diluted earnings per share (5) | £ | -0.46 | -0.17 |
| Non-financial KPIs |
|
|
|
| Lost time incidents (6) | Incidents | - | 1 |
(1) Average production is calculated as the average daily monthly production during the year.
(2) Quantity of 2P Reserves as at 31 December 2009 and 2008 is based on Gaffney, Cline & Associates' independent report on the Group's Reserves and Resources dated February 2010 and 30 November 2008, respectively.
(3) Calculated as exploration and acquisition expenditures paid during the year divided by 2P Reserves additions in the year. As a result of the significant downward revisions made to the Group's 2P Reserves (refer to Statement of Reserves and Resources), the finding and development cost per barrel for 2009 is not applicable.
(4) This represents the average price received for gas sold during the year (excluding VAT).
(5) Basic loss per Ordinary share is calculated by dividing the net loss for the year attributable to Ordinary equity holder of the parent by the weighted average number of Ordinary shares during the year. Dilutive loss per Ordinary share equals basic loss per Ordinary share, as due to the losses incurred in 2009 and 2008, there is no dilutive effect from the subsisting share warrants and share options. Refer to note 9 to the Condensed Consolidated Financial Information.
(6) Lost time incidents relate to injuries where an employee/contractor is injured and has time off work.
Related party transactions
Following the former Chief Executive Officer's resignation in March 2009, the Board initiated legal action against the former Chief Executive Officer and Chief Operating Officer, and certain third parties to obtain redress for the Company, arising from potential irregularities surrounding the procurement of and payment for certain assets and services by the Group. Some of these transactions may give rise to related party transactions that are not disclosed in the Condensed Consolidated Financial Information.
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.
There are a number of potential risks and uncertainties, which could have a material impact on the Group's long-term performance and could cause the actual results to differ materially from expected and historical results.
Statement of Reserves and Resources
_______________________________________________________________________________________
As advised during 2009, the Board commissioned an independent Reserves and Resources Evaluation of the Group's assets in Ukraine, as at 31 December 2009 (the 'Report'). The Board received the report on 22 March 2010 and the results of the report are summarised in the tables below.
Summary of Reserves
As of 31 December 2009
|
| Working interest basis | ||
|
| Gas bcf | Condensate mmbbl | Oil Mmbbl |
| Proved and Probable Reserves at 1 January 2009 | 330.5 | 22.7 | 0.8 |
| Revisions | (318.5) | (22.1) | (0.8) |
| Production | (0.5) | - | - |
| Proved and Probable Reserves at 31 December 2009 | 11.5 | 0.6 | - |
| Possible Reserves at 1 January 2009 | 284.0 | 21.2 | 0.9 |
| Revisions | (264.5) | (19.7) | (0.9) |
| Possible Reserves at 31 December 2009 | 19.5 | 1.5 | - |
Summary of Contingent Resources
As of 31 December 2009
|
| Working interest basis | |||
|
| Gas bcf | Condensate mmbbl | Oil Mmbbl | Total mmboe |
| Contingent Resources at 1 January 2009 | 1,583.2 | 48.0 | 1.5 | 334.4 |
| Revisions | 904.8 | (60.1) | (1.5) | 221.5 |
| Contingent Resources at 31 December 2009 | 2,488.0 | 108.1 | - | 555.9 |
The most significant change in the Group's Reserves and Resources, as compared to 1 January 2009, is the re-classification of most of the Reserves in the Pirkovskoe field as Contingent Resources. Additionally, best estimate Prospective Resources of 237 bcf gas and 8.4 mmbl condensate are attributed to the Pokrovskoe prospect.
Despite the re-classification, the Group retains a significant level of Reserves and Contingent and Prospective Resources. Successful operations in the future (based on in-house studies underway or completed) should enable some of these Resources to be re-classified as Reserves.
The reason for this re-classification is the disappointing results of the drilling campaign conducted by the Group during 2008 and the first part of 2009, under the previous management. Although petrophysical analysis of the well log data provided very promising results, the test results failed to meet expectations. This could be a function of either reservoir characteristics or poor drilling and testing practices. At that time, the Group relied upon low-cost Ukrainian drilling rigs and testing technology, and as a result the wells drilled lack mechanical integrity. During testing, the procedures applied and tools utilised were frequently insufficient to perforate adequately and stimulate the reservoir intervals. This was a conclusion of the independent report on well testing commissioned by the new management team in 2009, which was critical of and questioned many of the previous well testing practices.
There have also been some revisions to the Resource volume estimates in Pirkovskoe and Zagoryanska based on a preliminary interpretation of the 3D seismic data. This interpretation was carried out by the local contractor, Ukrgeofizika, and was considered to be inaccurate, as it relied heavily on the structural model based on pre-conceived geological concepts. An in-house interpretation of the 3D seismic and well data is currently being prepared.
In the Report, Reserves are only assigned to the currently producing fields, specifically Pirkovskoe, Debeslavetska and Cheremkhivska. Slobodo-Rungurske field is excluded, as production is currently considered uneconomical, pending further analysis.
Contingent Resources are assigned to Pirkovskoe, Zagoryanska, Borynya and Bitlya fields, where development is contingent on further appraisal. The positive revision of 904.8 bcf in the Contingent Resources category comprises 585 bcf of re-classified 3P Reserves from Pirkovskoe field plus 321.8 bcf of additional Contingent Resources from the Borynya field and Zagoryanska field.
Prospective Resources are attributed to Pokrovskoe, where there has not yet been a production test.
Condensed Consolidated Income Statement
For the year ended 31 December 2009
_______________________________________________________________________________________
|
| Notes | 2009 £'000 | 2008 £'000 |
| CONTINUING OPERATIONS |
|
|
|
| Revenue |
| 2,342 | 1,792 |
| Cost of sales |
| (2,022) | (1,966) |
| Gross profit / (loss) |
| 320 | (174) |
|
|
|
|
|
| Administrative expenses: |
|
|
|
| IPO fees expensed |
|
- |
(4,399) |
| Other administrative expenses |
| (20,658) | (21,750) |
| Impairment of oil and gas assets | 6 | (63,499) | - |
| Impairment of other assets | 6 | (23,752) | 834 |
| Operating loss |
|
(107,589) |
(27,157) |
|
|
|
|
|
| Investment revenue |
|
407 |
2,850 |
| Finance costs |
|
(8) |
(56) |
| Loss before tax |
| (107,190) | (24,363) |
|
|
|
|
|
| Tax | 8 | (113) | (514) |
| Loss for the year | 7 | (107,303) | (24,877) |
|
|
|
|
|
| Attributable to: |
|
|
|
| Equity holders of the parent |
| (107,303) | (24,039) |
| Minority interest |
| - | (838) |
|
|
| (107,303) | (24,877) |
|
|
|
|
|
| Loss per ordinary share |
| £ | £ |
| Basic and diluted | 9 | (0.46) | (0.17) |
Condensed Consolidated Statement of Comprehensive Income
For the year ended 31 December 2009
|
|
|
|
| |
|
|
|
|
2009 £'000 | Unaudited 2008 £'000 |
|
|
|
|
|
|
| Loss for the year |
|
|
(107,303) |
(24,877) |
|
|
|
|
|
|
| Unrealised currency translation differences |
|
|
(11,377) |
(9,486) |
|
|
|
|
|
|
| Total comprehensive loss for the year |
|
| (118,680) |
(34,363) |
Condensed Consolidated Balance Sheet
As at 31 December 2009
_______________________________________________________________________________________
| Notes | 2009 £'000 | 2008 £'000 | |
| ASSETS |
|
|
|
| Non-current assets |
|
|
|
| Goodwill | 10 | - | 2,508 |
| Intangible exploration and evaluation assets | 11 | - | 47,870 |
| Property, plant and equipment | 12 | 32,009 | 39,067 |
| Other non-current receivables | 14 | 18,835 | 18,866 |
| Restricted cash |
| 450 | - |
|
|
| 51,294 | 108,311 |
| Current assets |
|
|
|
| Inventories | 13 | 5,522 | 8,156 |
| Trade and other receivables |
| 5,390 | 21,489 |
| Cash and cash equivalents |
| 30,505 | 72,026 |
|
|
| 41,417 | 101,671 |
| Total assets |
| 92,711 | 209,982 |
|
|
|
|
|
| LIABILITIES |
|
|
|
| Non-current liabilities |
|
|
|
| Deferred tax liabilities |
|
(973) |
(1,238) |
| Long-term provisions |
|
(176) |
(469) |
|
|
|
(1,149) |
(1,707) |
| Current liabilities |
|
|
|
| Trade and other payables |
| (7,237) | (4,325) |
| Current tax liabilities |
| (16) | (55) |
| Current provisions |
| (698) | (450) |
|
|
| (7,951) | (4,830) |
| Total liabilities |
| (9,100) | (6,537) |
|
|
|
|
|
| NET ASSETS |
| 83,611 | 203,445 |
|
|
|
|
|
| EQUITY |
|
|
|
| Share capital |
| 6,933 | 6,933 |
| Share premium account |
| - | 250,373 |
| Retained earnings/(accumulated deficit) |
| 93,593 | (49,477) |
| Cumulative translation reserves |
| (21,374) | (9,997) |
| Other reserves |
| 5,093 | 6,247 |
| Equity attributable to equity holders of the parent |
| 84,245 | 204,079 |
|
|
|
|
|
| Minority interest |
| (634) | (634) |
| TOTAL EQUITY |
| 83,611 | 203,445 |
Condensed Consolidated Cash Flow Statement
For the year ended 31 December 2009
_______________________________________________________________________________________
| Notes | 2009 £'000 | 2008 £'000 | |
| Net cash outflow from operating activities | 16 | (18,952) | (42,532) |
|
|
|
|
|
| Investing activities |
|
|
|
| Acquisition of subsidiaries |
| - | (2,416) |
| Purchases of property, plant and equipment |
| (7,569) | (32,444) |
| Purchases of intangible exploration and evaluation assets |
| (15,896) | (38,329) |
| Proceeds from sale of property, plant and equipment |
| 432 | 5 |
| Interest received |
| 501 | 2,761 |
| Net cash used in investing activities |
| (22,532) | (70,423) |
|
|
|
|
|
| Financing activities |
|
|
|
| Proceeds from issue of shares |
|
- |
171,404 |
| Net cash from financing activities |
|
- |
171,404 |
|
|
|
|
|
| Net (decrease)/increase in cash and cash equivalents |
|
(41,484) |
58,449 |
| Effect of foreign exchange rate changes |
|
(37) |
(380) |
|
|
|
|
|
| Cash and cash equivalents at beginning of year |
|
72,026 |
13,957 |
| Cash and cash equivalents at end of year |
|
30,505 |
72,026 |
Condensed Consolidated Statement of Changes in Equity
For the year ended 31 December 2009
_______________________________________________________________________________________
| | | | | | | Other reserves | | | |
| | Share capital £’000 | Share premium account £’000 | Shares to be issued £’000 | Retained earnings £’000 | Cumulative translation reserves £’000 | Share-based payment £’000 | Reorganisation £’000 | Minority interest £’000 | Total £’000 |
| | | | | | | | | | |
| As at 1 January 2008 | 4,169 | 78,028 | 2,260 | (25,438) | (511) | 4,674 | 890 | 204 | 64,276 |
| Issue of equity shares | 2,709 | 179,423 | - | - | - | - | - | - | 182,132 |
| Equity shares to be issued | 55 | 2,205 | (2,260) | - | - | - | - | - | - |
| Expenses of issue of equity shares | - | (9,145) | - | - | - | - | - | - | (9,145) |
| Share-based payments | - | (138) | - | - | - | 683 | - | - | 545 |
| Net loss for the year | - | - | - | (24,039) | - | - | - | (838) | (24,877) |
| Exchange translation differences on foreign operations | - | - | - | - | (9,486) | - | - | - | (9,486) |
| As at 1 January 2009 | 6,933 | 250,373 | - | (49,477) | (9,997) | 5,357 | 890 | (634) | 203,445 |
| Share-based payments | - | - | - | - | - | (1,154) | - | - | (1,154) |
| Net loss for the year | - | - | - | (107,303) | - | - | - | - | (107,303) |
| Capital reduction | - | (250,373) | - | 250,373 | - | - | - | - | - |
| Exchange translation differences on foreign operations | - | - | - | - | (11,377) | - | - | - | (11,377) |
| As at 31 December 2009 | 6,933 | - | - | 93,593 | (21,374) | 4,203 | 890 | (634) | 83,611 |
Notes to the Condensed Consolidated Financial Information
For the year ended 31 December 2009
_______________________________________________________________________________________
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 2009 or 2008, but is derived from those accounts. Statutory accounts for 2008, which comprise the Revised Financial Statements, have been delivered to the Registrar of Companies and those for 2009 will be delivered following the Company's Annual General Meeting. The auditors have reported on both sets of accounts. Their report on the 2009 accounts was qualified in respect of the limitation to obtain sufficient appropriate audit evidence regarding the carrying values of assets as at 31 December 2008 and 31 December 2007 and regarding the completeness and accuracy of the disclosures of related party transactions and directors' remuneration (refer to note 2(b)). In their report on the Revised 2008 accounts, the auditors stated that they were unable to form an opinion as to whether the revised financial statements gave a true and fair view of the state of the Group's and the company's affairs as at 31 December 2008 and of the Group's result for the year then ended. Both reports contained a statement under sections 498(2) (accounting records inadequate) and (3) (failure to obtain necessary information and explanations) (or equivalent preceding legislation) and an emphasis of matter in relation to the current status of legal proceedings surrounding the validity of certain of the Group's licences in Ukraine (refer to note 3(c)). In addition, the report on 2009 drew attention by way of emphasis of matter to the proposed Annual General Meeting resolutions and potential impact on going concern if passed as set out in note 2(c).
2. Significant accounting policies
(a) Basis of accounting
The financial information has been prepared in accordance with International Financial Reporting Standards ('IFRSs') as adopted by the European Union and has been prepared on the basis of the accounting policies set out in the Group's 2008 Revised 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 preliminary announcement was approved by the Board on 27 April 2010.
(b) Fundamental uncertainty associated with opening balances 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 (of which £3.9 million represented the attributable decrease to equity as at 31 December 2007). The comparative amounts for the year ended 31 December 2008 are those which were issued in the 2008 Revised Annual Financial Report.
In view of the events and circumstances which occurred in the Group during the year, which indicated that there could be doubts concerning the recoverability of the Group's goodwill, E&E and PPP&E assets, the Board has taken the following action:
·; 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; 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 (see note 6).
The investigation has concluded in respect of the capitalisation and recoverability of assets as at 31 December 2009, but it is not possible to conclude retrospectively whether the values of assets as at 31 December 2008 and 31 December 2007 were correct. 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 Sheet. Although uncertainties still exist over the balances at 31 December 2008, the Board does not consider that an exercise to restate the position as at 31 December 2008 would be an effective use of the Group's resources, and therefore such an exercise has not been performed.
(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 2009 was £30.5 million (2008: £72.0 million), with no external debt financing to date and the Directors believe that the capital available at the date of the issue of this financial information is sufficient for the Group to manage its business risks successfully despite the current uncertain economic outlook.
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 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 further delays encountered in achieving commercial production from the Group's major fields. In order to conserve cash, the Group has curtailed capital expenditure and is actively pursuing a farm-out campaign. If successful, the farm-out campaign will enable the Group to farm-out a portion of its interests in its oil and gas licences to spread the risks associated with further exploration and development. Whilst such curtailments and other measures if undertaken could have an adverse effect on the Group over the longer term, including putting certain of its licence interests potentially at risk if the Group is not able to fulfil its licence obligations, there would not be any significant doubt over the Group's ability to continue as a going concern for the foreseeable future.
For the reasons set out above, the Directors consider that the Company and the Group have adequate resources to continue in operational existence for the foreseeable future. However, as disclosed in the Chairman's Statement certain resolutions have been proposed by the Company's largest shareholder, Weiss Asset Management LLP ('Weiss'), to replace the current Board and management with a new Board comprising nominees of Weiss, and to return almost all of the available cash of the Group to the Company's shareholders. These resolutions are being put to the forthcoming Annual General Meeting and the Directors believe Weiss' actions are likely to result in the liquidation of the Group's assets and ultimately of the Company. More details of these resolutions can be found in the Chairman's Statement. The Directors do not believe that these resolutions are in the best interests of the Company's shareholders and therefore have recommended the shareholders to vote against these resolutions. However, as the outcome of the Annual General Meeting cannot be predicted with certainty, this therefore gives rise to a material uncertainty which casts significant doubt as to the Company's and the Group's ability to continue as a going concern, and therefore to realise its assets and liabilities in the ordinary course of business rather than to cease exploration and by liquidating the Group's assets to return the remaining cash to investors.
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 and key sources of estimation uncertainty
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 estimations 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 information:
(a) Impairment of E&E, PP&E, and goodwill
IAS 36 Impairment of Assets and IFRS 6 Exploration for and Evaluation of Mineral Resources require that a review for impairment be carried out if events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. As a result of the significant downward revisions to the Group's Reserves and Resources estimates in the independent Reserves and Resources Evaluation (the 'Report') as outlined in the Statement of Reserves and Resources poor test results on wells drilled to date and the Group's strategy of suspending operations on major licences, the Directors believed it appropriate to assess the carrying value of the Group's oil and gas assets including exploration and evaluation('E&E') assets, property, plant and equipment ('PP&E') and associated goodwill for impairment at 31 December 2009.
In order to assess the present value of the future cash flows attributable to the Group's goodwill, E&E and PP&E assets at 31 December 2009, reference was made to the Report. The present value of the Group's commercial reserves (2P reserves) estimated within the Report as at 31 December 2009 is £25.7 million, which has been used to support that carrying value of the Group's PP&E, E&E and goodwill assets.
For PP&E assets the aggregate carrying value of each cash generating unit ('CGU') was compared against the expected recoverable amount of the related asset, by reference to the net present value of the future cash flows expected to be derived from the production of commercial Reserves (2P Reserves) of that unit. On this basis, an impairment loss of £4.9 million (2008: £nil) has been provided at 31 December 2009, reducing the carrying value of PP&E to £32.0 million (2008: £39.0 million).
As the Group applies the full cost method of accounting for E&E costs, the E&E assets are tested for impairment on a cost pool basis. At 31 December 2009, no commercial Reserves were assigned to the oil and gas licences within the Report included within E&E assets as insufficient work had been performed to determine the commerciality of the assigned Resources. Under the circumstances, a formal impairment test was triggered, however, as only the commercial Reserves (2P Reserves) assigned to the wider cost pool of Ukraine have been used to determine the net present value of the future cash flows, the Contingent and Prospective Resources assigned to these licences are not reflected in the recoverable amount. As a result the entire balance was provided for at 31 December 2009, resulting in the carrying value of £56.4 million being impaired in full.
The Group's goodwill was allocated to the wider cost pool of Ukraine and as such was assessed for impairment based on the net present value of the future cash flows expected to be derived from production of commercial Reserves. The recoverable amount of the cash generating unit to which goodwill was allocated was less than the carrying value of goodwill and as a result the entire balance was provided for at 31 December 2009, resulting in the carrying value of £2.3 million being impaired in full.
In addition to the impairment provided against the Group's goodwill, E&E and PP&E assets, further impairment charges against the carrying value of certain other assets have been provided for. These are: a charge of £6.6 million (2008: £nil) to reduce the carrying value of the Group's inventory at 31 December 2009 to its net realisable value; a charge of £3.9 million (£2008: £nil) to reduce the carrying value of other receivables, in relation to the settlement agreement reached with Global Processing Systems LLC; and a charge of £13.2 million (2008: £0.8 million) against the carrying value of VAT receivable in Ukraine.
Total impairments charged to the Group's Condensed Consolidated Income Statement in 2009 were £87.3 million (2008: £0.8 million).
The recoverable amounts are determined with reference to value in use calculations. The key assumptions for the value in use calculations are those regarding the production flow rates, discount rates, relevant elements of Ukraine fiscal regime for petroleum operators, and expected changes to selling prices and direct cost during the year. These assumptions reflect management's best estimates and have been revised in the year in light of the current economic environment which has resulted in more conservative estimates about the future. Management estimates discount rates that reflect the current market assessments of the time value of money and the risks specific to the CGUs. Changes in selling prices and direct costs are based on past practices and expectations of future changes in the market.
The key assumptions used to forecast cash flows from Ukraine operations are as follows:
(1) production flow rates confirmed by experienced in-house geologists and engineers, supported by the Report produced by an independent reservoir engineer, Gaffney, Cline & Associates Ltd;
(2) pre-tax discount rate of 20% (post-tax of 15%);
(3) inclusion of relevant elements of Ukraine fiscal regime for petroleum operators (such as production and royalty tax relevant to each licence and corporate income tax of 25%);
(4) expected future selling prices (based on current and anticipated market conditions for oil, condensate and gas);
(5) costs based on best estimates with consideration to previous experience and inflation; and
(6) cash flows projected up to 2032 depending on the field to which they relate and an assumption has been made that the relevant licences will be extended.
Refer to notes 10, 11 and 12 for further details on the carrying values and the impairments recognised on goodwill, E&E and PP&E assets, respectively and note 6 for the total impairment provided for by the Group at 31 December 2009.
(b) Reserves
Commercial Reserves are proven and probable 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 Reserves and Resources Evaluation (the 'Report') provided by independent advisers.
In March 2010, the Group commissioned a Report to estimate the Group's Reserves and Resources at 31 December 2009 (refer to Statement of Reserves and Resources).
(c) Legal proceedings surrounding the validity of the Pirkovskoe and Zagoryanska licences
The Group is currently involved in legal proceedings surrounding the validity of the Pirkovskoe and Zagoryanska licences. The Poltava Regional Commercial Court ('Poltava Court') made a ruling dated 12 June 2008, in favour of Poltavanaftogazgeology ('PNG'), a subsidiary of the Group's joint venture partner, NJSC Nadra Ukraine, a state-owned company ('Nadra'), in relation to the licences held formerly by PNG, relating to the Pirkovskoe and Zagoryanska fields. These licences had been re-registered from PNG to Nadra prior to re-registration to the Group. The court: (a) declared as invalid the re-registration of the licences from PNG to Nadra; and (b) recognised as valid the earlier licences held by PNG.
On 28 July 2008, the Ministry of Environmental Protection of Ukraine (the 'Ministry') issued an order, making reference to the decisions of the Poltava Court on 12 June 2008, in favour of PNG, invalidating the Group's licences for its Pirkovskoe and Zagoryanska fields.
The following developments have occurred as a result of legal actions taken by the Group to protect its licences:
(1) on 29 September 2008, the Kharkiv Appeal Administrative Court (the 'Appeal Court') cancelled the written rulings of the Poltava Court of 12 June 2008. The Administrative Court rejected in full the claim filed by PNG that the special permit which was issued to Nadra was invalid and that the earlier licences held by PNG remained valid;
(2) on 7 October 2008, following a court judgement, the Group received written confirmation that the Ministry had revoked its earlier orders nullifying the Pirkovskoe and Zagoryanska licences and declared the special permits dated 19 October 2007, issued to Group subsidiary companies LLC Astroinvest-Ukraine and LLC Astro Gas JAA for the Pirkovskoe licence and LLC Astroinvest-Energy for the Zagoryanska licence, as valid;
(3) on 7 October 2008, the Group signed a co-operation agreement with the Ministry demonstrating the Ministry's full confirmation of Cadogan's rights to licences;
(4) on 17 October 2008, PNG, and on 24 October 2008 Nadra, submitted their claims on the Appeal Court judgements of 29 September 2008 to the High Administrative Court of Ukraine (the 'High Court');
(5) in January 2009, the Group received from the Ministry a five year extension for the Zagoryanska licence now expiring in April 2014;
(6) on 25 February 2009, the High Court found in favour of PNG in the appeal hearing in relation to the transfer of the Pirkovskoe licence to Nadra in June 2007 (the 'Resolution'). Notwithstanding this decision, the Group's licence to operate the Pirkovskoe field remains valid and there has to date been no direct legal challenge to the Group's interest in this licence. The Group has been advised that new legal proceedings would need to be brought against it and would need to succeed before its interests in its licences would be affected. The Group has yet to receive a date for the PNG initiated appeal hearing with respect to the Zagoryanska licence;
(7) on 23 March 2009, LLC Astro Gas filed a claim supported by the claim dated 30 March 2009 made by the Prosecutor General Office of Ukraine (the 'Prosecutor General Office') to the Supreme Court of Ukraine (the 'Supreme Court') arguing that the High Court had been mistaken in reaching its decision and that the Resolution is therefore invalid;
(8) on 16 June 2009, the Supreme Court upheld the claim made by the Prosecutor General Office and partially upheld the claim made by LLC Astro Gas JAA. The Resolution of the High Court dated 25 February 2009 was cancelled and the case was returned to the court of first instance, the Poltava Court, for further consideration;
(9) on 11 December 2009, the High Court commenced the appeal on the decision made by the Appeal Court associated with the Pirkovskoe licence. The date of the hearing has not yet been set, however the High Court requested LLC Astro Gas to submit information on PNG's and Nadra's claims dated 17 October 2008 and 24 October 2008 respectively; and
(10) there have been no developments in the case concerning the Zagoryanska field licence.
The Group's licences remain valid and effective despite the Resolution. The Board remains firmly of the view that the challenges to the licences previously held by PNG are wholly unwarranted and this would result in a curtailment of a significant part of the Group's operations. An appeal is currently being lodged against the Resolution at the Appeal Court in Ukraine.
As of the date of this preliminary announcement, the above outcomes remain subject to appeal.
The Directors have considered the implications of IAS 36 Impairment of Assets and IFRS 6 Exploration for and Evaluation of Mineral Resources, and have concluded that recognition of impairment in respect of these matters is not appropriate on the basis that the Directors believe that, notwithstanding the uncertainties described above, the validity of the Group's licences is expected to be reconfirmed. However, the ultimate outcome is uncertain and should the Courts in Ukraine ultimately rule that the licences were improperly awarded, and further annul the existing licences, the Group would be required to further impair the value of these assets in Ukraine. The amounts capitalised within intangible exploration and evaluation assets and property, plant and equipment in respect of these licences at 31 December 2009 was £22.7 million (2008: £43.3 million) and the related VAT recoverable was £nil (2008: £4.5 million).
(d) Other receivable recognised in relation to settlement with Global Processing Systems LLC ('GPS)
Non-current and current other receivables have been recognised at 31 December 2009, of £18.8 million and £4.1 million respectively, representing receivables from a settlement agreement reached with Global Processing Systems LLC ('GPS') (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 has 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 paid to GPS in respect of the gas plants as at 31 December 2008 of USD43.5 million were previously 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.
The portion that is not expected to be recovered within the next twelve months has been presented as a non-current receivable.
An impairment charge of £3.9 million has been provided in the year to reduce the carrying value of the original prepayments to their fair value, being the expected proceeds from the settlement.
(e) Recoverability of value added tax ('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. Management anticipates no significant cash settlements of receivables from the State Budget. Consequently, the Group 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 are uncertain as to the commercial viability of the Group's major fields and therefore believe it inappropriate to present these amounts as assets given the uncertainties surrounding the expectation for recovery. A provision of £13.2 million (2008: £0.8 million) has been recognised as at 31 December 2009 as the Directors are no longer certain that VAT previously recognised as an asset will be recovered.
(f) 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. In addition, note 2(c) of this announcement provides details as to the basis on which the Directors have adopted the going concern basis of accounting in preparing the annual financial information.
(g) Decommissioning
The Group recognises a provision for asset retirement obligation for expected decommissioning and site restoration costs expected to incur in approximately one to 17 years. At 31 December 2009, a provision has been made for costs of £0.7 million (2008: £0.5 million) which are expected to be incurred within the next year due to the demobilisation of drilling equipment and respective site restoration. A further provision of £0.1 million (2008: £0.4 million) has been made for long-term costs. The provision is estimated taking into consideration existing technology and current prices of site restoration after adjusting for expected future inflation as discounted using rates reflecting current market assessments of the time value of money and, where appropriate, the risks specific to the liability. The Group makes an estimate based on its experience and historical data.
(h) 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
Following the adoption of IFRS 8 Operating Segments with effect from 1 January 2009 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 (2008: £nil).
6. Impairment of oil and gas and other assets
|
|
|
|
2009 £'000 | 2008 £'000s |
| Goodwill (note 10) |
|
| 2,258 | - |
| Exploration and evaluation costs (note 11) |
|
| 56,379 | - |
| Property, plant and equipment (note 12) |
|
| 4,862 | - |
| Impairment of oil and gas assets |
|
| 63,499 | - |
| Inventories (note 13) |
|
| 6,586 | - |
| Other receivables (note 14) |
|
| 3,925 | - |
| VAT recoverable (note 14) |
|
| 13,241 | 834 |
| Impairment of other assets |
|
| 23,752 | 834 |
| Total impairment |
|
| 87,251 | 834 |
Refer to notes 10, 11 and 12 for further details on the impairment of goodwill, E&E and PP&E assets, respectively.
The carrying value of inventory as at 31 December 2009 has been impaired to reduce it to net realisable value (see note 13).
Prepayments previously recognised at 31 December 2008 related to payments made for the acquisition of two new gas plants on the Pirkovskoe and Bitlyanska licences. As discussed in note 3(d), the total amount paid for the gas plants has been impaired reducing the carrying value to the expected proceeds from the settlement agreement which was reclassified at 31 December 2009 to other receivables. Refer also to note 14.
VAT recoverable has been impaired as at 31 December 2009 as the Directors are no longer certain that VAT recoverable in Ukraine previously recognised as an asset will actually be recovered.
7. Loss for the year
The loss for the year has been arrived at after charging/(crediting):
|
| 2009 £'000 | 2008 £'000 |
| Depreciation of property, plant and equipment | 1,112 | 1,067 |
| Loss on disposal of property, plant and equipment | 5,000 | 112 |
| Impairment (note 6) | 87,251 | 834 |
| Consultancy fees | 785 | 6,358 |
| Staff costs | 2,748 | 3,715 |
| Net foreign exchange (gains)/losses | (4,641) | 1,482 |
Consultancy fees 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 income of £0.8 million (2008: £nil) relating to the reversal of equity-settled share-based payment transactions previously recognised.
In addition to the depreciation of property, plant and equipment of £1.1 million (2008: £1.1 million), in the year ended 31 December 2009, depreciation of £1.6 million (2008: £1.7 million) was capitalised to exploration and evaluation ('E&E') assets being depreciation of tangible assets used in E&E activities.
8. Tax
|
| 2009 £'000 | 2008 £'000 |
| Current tax | 241 | 392 |
| Deferred tax | (128) | 122 |
|
| 113 | 514 |
The Group's operations are conducted primarily outside the UK. The most appropriate tax rate for the Group is therefore considered to be 25% (2008: 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 condensed consolidated income statement as follows:
|
| 2009 £'000 | 2009 % | 2008 £'000 | 2008 % |
| Loss before tax |
|
|
|
|
| Continuing operations | (107,190) | 100 | (24,363) | 100 |
| Tax credit on loss at Ukraine corporation tax rate of 25% | (26,798) | 25 | (6,091) | 25 |
| Permanent differences | 8,320 | (8) | 4,453 | (18) |
| Foreign exchange on operating activities | 227 | - | (545) | 2 |
| Tax losses generated in the year not yet recognised | 3,201 | (3) | 592 | (2) |
| Other temporary differences for which no deferred tax has been recognised. |
16,204 | (14) |
2,134 |
(9) |
| Utilisation of deferred tax asset not previously recognised on losses | (91) | - | (29) | - |
| Non-taxable income | (29) | - | - | - |
| Reversal of deferred tax liability due to impairment | (338) | - | - | - |
| Effect of different tax rates | (452) | - | - | - |
| Prior year adjustment | (131) | - | - | - |
| Tax expense and effective tax rate for the year | 113 | - | 514 | (2) |
9. Loss per Ordinary share
Basic loss per Ordinary share is calculated by dividing the net loss for the year attributable to Ordinary equity holders of the parent by the weighted average number of Ordinary shares outstanding during the year. The calculation of the basic and diluted loss per share is based on the following data:
| Losses | 2009 £'000 | 2008 £'000 |
| Loss for the purposes of basic loss per share being net loss attributable to equity holders of the parent |
(107,303) |
(24,039) |
|
|
|
|
|
Number of shares | 2009 Number '000 | 2008 Number '000 |
| Weighted average number of Ordinary shares for the purposes of basic loss per share | 231,092 | 139,721 |
|
|
|
|
|
| 2009 £ | 2008 £ |
| Loss per Ordinary share |
|
|
| Basic and diluted | (0.46) | (0.17) |
Diluted loss per Ordinary share equals basic loss per Ordinary share as, due to the losses incurred in 2009 and 2008, there is no dilutive effect from the subsisting share warrants and share options.
10. Goodwill
| Cost |
| £'000 |
| At 1 January 2008 |
| 2,804 |
| Exchange differences |
| (296) |
| At 1 January 2009 |
| 2,508 |
| Exchange differences |
| (281) |
| At 31 December 2009 |
| 2,227 |
|
|
|
|
| Impairment |
|
|
| At 1 January 2008 and 2009 |
| - |
| Impairment charge (note 6) |
| 2,258 |
| Exchange differences |
| (31) |
| At 31 December 2009 |
| 2,227 |
|
|
|
|
| Carrying amount |
|
|
| At 31 December 2009 |
| - |
| At 31 December 2008 |
| 2,508 |
Goodwill acquired in a business combination is allocated, at acquisition, to the cash generating units (CGUs) that are expected to benefit from that business combination. The fair value of goodwill was allocated to all Ukraine assets as management believes that the anticipated future operating synergies gained on business acquisition can be used across the Group's entire asset base in Ukraine.
The Group tests goodwill annually for impairment or more frequently if there are indications that goodwill might be impaired.
The Group's goodwill was allocated to the wider cost pool of Ukraine and as such was assessed for impairment based on the present value of the future cash flows expected to be derived from production of commercial Reserves. The recoverable amount of the cash-generating unit to which goodwill was allocated was less than the carrying value of the unit due to changes during the year in the assumptions detailed in note 3(a) and as a result the entire amount of goodwill was provided for at 31 December 2009, resulting in an impairment loss of £2.3 million (2008: £nil).
11. Intangible exploration and evaluation assets
| Cost |
| £'000 |
| At 1 January 2008 |
| 25,024 |
| Additions on acquisition of subsidiaries |
| 2,077 |
| Additions |
| 24,065 |
| Change in estimate of decommissioning assets |
| 190 |
| Transfer to property, plant and equipment |
| (537) |
| Exchange differences |
| (2,949) |
| At 1 January 2009 |
| 47,870 |
| Additions |
| 17,428 |
| Change in estimate of decommissioning assets |
| (29) |
| Transfer to property, plant and equipment |
| (298) |
| Disposals |
| (4,073) |
| Exchange differences |
| (5,299) |
| At 31 December 2009 |
| 55,599 |
|
|
|
|
| Impairment |
|
|
| At 1 January 2008 and 2009 |
| - |
| Impairment charge (note 6) |
| 56,379 |
| Exchange differences |
| (780) |
| At 31 December 2009 |
| 55,599 |
|
|
|
|
| Carrying amount |
|
|
| At 31 December 2009 |
| - |
| At 31 December 2008 |
| 47,870 |
IFRS 6 Exploration for and Evaluation of Mineral Resources requires that a review for impairment be carried out if events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. As outlined in note 3(a), due to a change in events and circumstances during the year, the Directors believed it was appropriate to reassess the carrying value of Group's oil and gas assets including, exploration and evaluation assets ('E&E').
As the Group applies the full cost method of accounting for E&E costs, the E&E assets are tested for impairment on a cost pool basis. At 31 December 2009, no commercial Reserves were assigned to the oil and gas licences within the independent Reserves and Resources Evaluation included within E&E assets as insufficient work had been performed to determine the commercial recoverability of the assigned Resources. Under the circumstances, a formal impairment test has been triggered. In accordance with the Group's accounting policy, only the commercial Reserves (2P Reserves) assigned to the wider cost pool of Ukraine have been used to determine the net present value of the future cash flows, resulting in the Contingent and Prospective Resources assigned to these licences not being reflected in the recoverable amount due to the uncertainties associated with these Resources. As a result, the entire amount of E&E was provided for at 31 December 2009, resulting in an impairment loss of £56.4 million (2008: £nil).
Total intangible exploration and evaluation assets at 31 December 2009 include £nil (2008: £0.9 million) in respect of decommissioning assets. Additions during the year to the pre-impairment amount include £1.6 million (2008: £1.7 million) of capitalised depreciation of development and production assets used in exploration and evaluation activities.
Refer to note 3(c) for a detailed discussion on the legal proceedings surrounding the validity of the Group's licences.
12. Property, plant and equipment
|
|
Other £'000 | Development and production assets £'000 | Total £'000 |
| Cost |
|
|
|
| At 1 January 2008 | 1,815 | 22,077 | 23,892 |
| Additions on acquisition of subsidiaries | - | 21 | 21 |
| Additions | 1,957 | 19,414 | 21,371 |
| Transfer from intangible exploration and evaluation assets | (545) | 1,082 | 537 |
| Change in estimate of decommissioning assets | - | 21 | 21 |
| Disposals | (151) | (3) | (154) |
| Exchange differences | (162) | (2,334) | (2,496) |
| At 1 January 2009 | 2,914 | 40,278 | 43,192 |
| Additions | 353 | 7,248 | 7,601 |
| Transfer from intangible exploration and evaluation |
- |
298 |
298 |
| Change in estimate of decommissioning assets | - | 102 | 102 |
| Disposals | (411) | (3,800) | (4,211) |
| Exchange differences | (295) | (4,479) | (4,774) |
| At 31 December 2009 | 2,561 | 39,647 | 42,208 |
|
|
|
|
|
| Accumulated depreciation and impairment |
|
|
|
| At 1 January 2008 | 217 | 1,205 | 1,422 |
| Charge for the year | 566 | 2,463 | 3,029 |
| Disposals | (37) | - | (37) |
| Exchange differences | (68) | (221) | (289) |
| At 1 January 2009 | 678 | 3,447 | 4,125 |
| Charge for the year | 568 | 2,222 | 2,790 |
| Impairment charge (note 6) | - | 4,862 | 4,862 |
| Disposals | (179) | (864) | (1,043) |
| Exchange differences | (72) | (463) | (535) |
| At 31 December 2009 | 995 | 9,204 | 10,199 |
|
|
|
|
|
| Carrying amount |
|
|
|
| At 31 December 2009 | 1,566 | 30,443 | 32,009 |
| At 31 December 2008 | 2,236 | 36,831 | 39,067 |
IAS 36 Impairment of Assets requires that a review for impairment be carried out if events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. As outlined in note 3(a), due to a change in events and circumstances during the year, the Directors believed it was appropriate to reassess the carrying value of Group's oil and gas assets including, PP&E assets.
For PP&E assets the aggregate carrying value was compared against the expected recoverable amount of the asset, by reference to the present value of the future cash flows expected to be derived from production of commercial Reserves (2P Reserves). An impairment loss of £4.9 million (2008: £nil) was provided at 31 December 2009, reducing the carrying value of PP&E to £32.0 million (2008: £39.1 million).
13. Inventories
|
|
| 2009 £'000 | 2008 £'000 |
| Cost |
| 12,108 | 8,156 |
| Impairment provision (note 6) |
| (6,586) | - |
| Carrying amount |
| 5,522 | 8,156 |
The impairment as at 31 December 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
|
|
| 2009 £'000 | 2008 £'000 |
| Other receivables |
| 18,835 | 301 |
| VAT recoverable |
| - | 8,153 |
| Prepayments |
| - | 10,412 |
|
|
| 18,835 | 18,866 |
Trade and other receivables
|
|
| 2009 £'000 | 2008 £'000 |
|
Other receivables |
|
4,675 | 304 |
|
VAT recoverable |
|
336 | 1,814 |
|
Prepayments |
|
379 | 19,371 |
|
|
|
5,390 | 21,489 |
All sales are made on a prepayment basis, so there are no trade debtors.
The amounts of £18.8 million and £4.1 million shown as other receivables represent receivables from a settlement agreement with Global Processing Systems LLC ('GPS'). This amount is stated after impairment of £3.9 million representing the difference between the original prepayment and the amount receivable in accordance with the settlement. Refer to further discussion in note 3(d).
Value Added Tax ('VAT') recoverable from Ukraine tax authorities will only be recovered once significant production commences. As at 31 December 2009, the Directors are uncertain as to the commercial viability of 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 £13.2 million (2008: £0.8 million) has thus been recognised as at 31 December 2009.
15. Capital reduction
On 9 December 2009, the High Court approved the cancellation of the Company's share premium account (£250.4 million) and on 28 December 2009 the approval was registered with Companies House. The cancellation of the share premium account has been offset against the Group's accumulated deficit creating retained earnings of £93.6 million as at 31 December 2009.
16. Notes to the condensed consolidated cash flow statement
|
| 2009 £'000 | 2008 £'000 |
| Operating loss | (107,589) | (27,157) |
| Adjustments for: |
|
|
| Depreciation of property, plant and equipment | 1,112 | 1,067 |
| Impairment of other receivables | 3,925 | - |
| Impairment of property, plant and equipment and evaluation and exploration assets | 61,241 | - |
| Impairment of goodwill | 2,258 | - |
| Impairment of inventories | 6,586 | - |
| Impairment of VAT recoverable | 13,241 | 834 |
| Loss on disposal of property, plant and equipment | 5,000 | 112 |
| Share-based payments | (814) | 205 |
| Effect of foreign exchange rate changes | (1,693) | (3,961) |
| Operating cash flows before movements in working capital | (16,733) | (28,900) |
| Increase in inventories | (2,065) | (6,494) |
| Increase in receivables | (2,316) | (8,242) |
| Increase in payables | 2,882 | 1,383 |
| Increase in restricted cash | (450) | - |
| Cash used in operations | (18,682) | (42,253) |
| Income taxes paid | (270) | (279) |
| Net cash outflow from operating activities | (18,952) | (42,532) |
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.
17. Other related party transactions
The completeness of the disclosure of related party transactions is affected by the ongoing investigations into alleged irregularities involving certain former Directors.
18. Commitments and contingencies
Joint activity agreements
The Group has interests in eight 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:
|
| 2009 £'000 | 2008 £'000 |
| Within one year | 13,482 | 24,475 |
| Between two and five years | 32,944 | 7,399 |
|
| 46,426 | 31,874 |
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 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.
Ramet Holdings Limited
Under the terms of acquisition of Ramet Holdings Limited, the Group had a contingent liability in relation to the deferred consideration equal to the number of recoverable proven and probable barrels of oil equivalent from the first two wells drilled and tested in the Malynovestske Field (the Malynovestske licence area in the Bogorodchansky Administration District of the Ivano-Frankiviska Administration Region in western Ukraine) as assessed by a suitably qualified and insured independent expert of at least 10 years' standing. Payment should be made within 30 days of the expert's report and, notwithstanding that report, should not exceed USD5.0 million. At the end of 2009, the Malynovestske licence was annulled by the Government and it is therefore unlikely that the targets relating to this contingent liability will be met. A counterclaim has been made by the former Chief Executive Officer relating to this payment, however, the Company has been advised that the counterclaim has no merit.
19. Events after the balance sheet date
Smith Eurasia
In June 2009, the Company and several of its subsidiaries commenced litigation at the High Court in London against the former Chief Executive Officer and Chief Operating Officer and certain third parties in order to seek return of funds to the Company associated with the procurement of and payment for certain assets and services. In February 2010, the Group reached an agreement with one of the Defendants in the litigation, Smith Eurasia Limited ('Smith Eurasia'), and various related parties with respect to potentially improper payments made by Smith Eurasia to former executives of the Company prior to March 2009. In accordance with the agreement, Smith Eurasia does not accept fault or liability in relation to the allegedly improper payments and the Company will receive USD4,500,000. In addition, the agreement resolves all other outstanding commercial issues between Smith Eurasia and the Company as follows:
(1) The Group will pay outstanding invoices totalling approximately USD2,900,000 owing to Smith Eurasia and related parties for goods and services supplied to the Company in Ukraine. These amounts are included in Trade creditors as at 31 December 2009; and
(2) Smith Eurasia will repurchase from the Group certain unused plant and equipment and Smith Eurasia will pay the Group approximately USD1,000,000. These assets were included within the Group's inventory balance at 31 December 2009 at amounts not more than the amount of repurchase.
All amounts due under the Agreement have been settled in full.