Gulf Keystone Petroleum Regulatory News (GKP)

16 May 2007 07:01

Gulf Keystone Petroleum Ld16 May 2007 GULF KEYSTONE PETROLEUM LTD ("Gulf Keystone" or the "Company") 2006 PRELIMINARY RESULTS ANNOUNCEMENT Gulf Keystone Petroleum Limited (AIM: GKP), an independent oil and gasexploration company operating in the Republic of Algeria, today announces itspreliminary results for the year ending 31 December, 2006. Highlights • BG joined SONATRACH and Gulf Keystone as a strategic partner in the HBH licence. • £13.4 ($24.7) million raised in August 2006 via a placing of 21,600,000 new common shares. • HBH seismic programme under way. Drilling operations expected to commence around the year end. • Block 126a licence extension granted for finalization of commerciality of GKN and GKS. • Management and technical teams have been significantly strengthened during 2006. • Well HEK-3 in Block 129 acid-fractured and tested at a stabilized rate of 1,040 bbl/day in April 2007. • Proposed acquisition of the company by RAK Petroleum has been recommended by the Board for shareholder approval. Todd Kozel, Chief Executive Officer of Gulf Keystone said: "2006 has been a transformational year for Gulf Keystone. Completion of the HBHfarm out, a successful placing of new shares and the building of both a firstrate technical and executive management team has provided the Company with theresources to pursue an aggressive programme of activities across its Algerianportfolio in the coming years." Enquiries Gulf Keystone Petroleum: 020 7514 1400Todd Kozel, CEOBill Guest, PresidentJon Cooper, Finance Director Hoare Govett Limited: 020 7678 8000Andrew Foster Tristone Capital Limited: 020 7399 2470Simon Ashby Rudd Citigate Dewe Rogerson: 020 7638 9571Media enquiries: Martin Jackson / George CazenoveAnalyst enquiries: Nina Soon or visit: www.gulfkeystone.com GULF KEYSTONE PETROLEUM LTD ("Gulf Keystone" or the "Company") 2006 PRELIMINARY RESULTS ANNOUNCEMENT CHAIRMAN'S STATEMENT 2006 was a pivotal year for the Gulf Keystone. Gazetting of the HBH concession("HBH") farm out, a successful placing of new shares and the building of ahighly experienced management and technical team placed the Company in a strongposition by the year end. The subsequent completion of the transaction with the BG Group ("BG") in early2007 significantly enhanced the Company's financial position and provided theCompany with the resources to pursue an aggressive programme of activitiesacross its Algerian asset portfolio over the next 18 months. BG's farm-in to the HBH Concession represented a strategically importanttransaction for the Company, substantially enhancing the technical, operationaland commercial capabilities of the joint venture partnership. Under theagreement, BG assumed the role as operator of the concession and earned a 36.75%interest in the joint venture, leaving Gulf Keystone and SONATRACH with 38.25%and 25% interests respectively. Operationally, the Company has made important strides forward as it embarks on anew and intensive programme of exploration and appraisal activities. On theregionally extensive HBH Concession, located in Central Algeria and acquired in2005, significant progress has already been made on the acquisition of a major2D seismic survey which, together with a planned 3D survey over the existing HBHgas discovery, will form the basis for a six well exploration and appraisaldrilling programme, to be initiated in late 2007. In addition to the gas discovery already made on the HBH Concession, theDirectors believe that this area holds considerable future exploration potentialfor gas. Algeria is very well placed to exploit the international gas marketsvia pipelines into Southern Europe and as Liquefied Natural Gas into NorthernEurope and other international markets. The Directors believe that BG's andSONATRACH's expertise in international gas commercialization will play animportant part in ensuring early development and commercialization of gas fromthe HBH Concession. In its northern, oil prone, licences the Company has made important progress inthe exploration and appraisal of its portfolio of leads and prospects, andtowards the development of its existing oil discoveries. On Block 126a, asignificant volume of study work has been carried out in conjunction with ourpartner SONATRACH to finalise and optimize the first phase of development of theGKN and GKS oil discoveries. The reservoir complexity and the requirement, undernew Algerian legislation, to develop a utilization scheme for gas produced inassociation with oil in this remote area, has introduced significant delays inprogressing this important project. However, I am now pleased to be able to report that all the technical elementsrelating to this combined development of the GKN and GKS fields have now beenagreed fully with our partner SONATRACH and we now simply await formal approvalfrom the SONATRACH Executive Committee before proceeding with a jointDeclaration of Commerciality, the pre-cursor to an immediate commencement ofdevelopment operations. Elsewhere on Block 126a we were disappointed that it did not prove possible toaccess moveable hydrocarbons during our recent test of the GRJ-2 well and thatwell is presently being plugged and abandoned. On Block 129, important progress has been made towards the evaluation andexploitation of exploration and appraisal opportunities on this licence. TheCompany has recently completed the workover and testing of well HEK-3, an oildiscovery well drilled by SONATRACH in 2004. The Company is very pleased to havesuccessfully re-entered well HEK-3 and achieved what we believe to be acommercial rate of oil production. The successful use of acid fracturingtechnology on this well, to optimise production performance from this complexreservoir, provides us with the encouragement to consider a wider use of thistechnology within the HEK area and elsewhere within our northern licence areas. CHAIRMAN'S STATEMENT (continued) Further activity on Block 129 in 2007 will be geared towards the development andranking of prospects ahead of the next phase of exploration drilling. With regard to the Ben Guecha contract, covering Blocks 108 & 128b, formalapproval of the contract has now been given by the Algerian Council ofMinisters. The announcement of this approval in January 2007 marked thecommencement of the first three year period of this exploration contract andenabled Gulf Keystone to commence the detailed evaluation of these blocks. The full evaluation of Blocks 108, 128b and 129 during 2007 is geared towards athree well exploration drilling programme on the northern blocks, presentlyscheduled for the first quarter of 2008. I'm pleased to be able to report the further strengthening of Gulf Keystone'smanagement team, in particular the building of a strong technical team. This hascompleted the building of the management and operational team, and at a timewhen the market for skilled and highly qualified upstream personnel is extremelytight, this places Gulf Keystone in a strong competitive position to developfurther its business activities. Financially, the Company is now in a strong position. This transformation of theCompany's finances has resulted firstly from the HBH transaction with BG, whichincluded both a significant cash component and a material carry of the Company'sshare of expenditure during the first exploration and appraisal stage. Secondly,the Company achieved a successful share placing in the middle of the year whichfurther enhanced its financial position. However, notwithstanding the success of Gulf Keystone in building its portfolioof assets within Algeria and developing the prospects of the Company goingforward, the Directors believe that for a Company of Gulf Keystone's size andresources in Algeria, there will continue to be material challenges ingenerating future cash flow and realising the full potential of the Company'sportfolio, in a timely and predictable manner, given the regulatory andoperational environment in which the Company is working. In this regard, as I have already reported, progress towards securing thenecessary declarations and consents to achieve first oil production from Block126a has been significantly slower than expected. In addition, the Directorsbelieve that active portfolio management within Algeria will continue to be achallenge for the Company and that Gulf Keystone cannot necessarily expect to beable to pursue the further risk spreading activities that would be an importantpart of the strategy of a company of its size. This, together with therelatively short exploration licence periods that govern the Company's presentProduction Sharing Contracts ("PSC's"), leads the Directors to conclude that thetimely realisation of the full value of Gulf Keystone's portfolio would be bestachieved by a Company of greater scale and wider financial and operationalresources. In the face of these continuing challenges, the unsolicited approach by RAKPetroleum ("RAK") to acquire the whole of the issued and to be issued sharecapital of Gulf Keystone was considered carefully, and ultimately leads to theproposed acquisition of the Company by RAK which has been recommended, by theBoard, for approval by the Shareholders at the Special General Meeting to beheld on 22nd May, 2007. Further details as to the background of, and remainingconditions to, this proposed transaction with RAK may be found in the recentlyissued Circular to Shareholders. I would like in conclusion to express my thanks to all those employed by theCompany in London, Algeria and Bermuda for their unstinting efforts in buildingthe Company to its present position and transforming its prospects goingforward. As the Company goes forward to a new phase in conjunction with RAKPetroleum, I would also like to express my deepest gratitude to you theshareholders for your support since the Company's flotation in 2004. Roger ParsonsNon-executive Chairman CHIEF EXECUTIVE OFFICER'S STATEMENT I'm pleased to be able to report on the progress made by Gulf Keystone in itsexploration and production business over the past year. 2006 has been a year of transformation for the Company. We commenced the yearwith a radically expanded portfolio of exploration and appraisal assets onshoreAlgeria, following significant success in the 6th Algerian InternationalLicencing Round, and we set ourselves a number of important technical, financialand strategic objectives for the year, geared towards progressing, diversifying,and adding value to that portfolio of assets. I am delighted to inform you that substantial progress has been made on a numberof key fronts. Gulf Keystone commenced the year as operator, and a holder of,100% of the working interest available to foreign partners in all of itsAlgerian Licence interests. A key objective was to embark on a portfoliomanagement exercise with the objectives of spreading technical risk,crystallising elements of value from our existing portfolio, and introducing astrategic partner to make available, to the existing joint venture partnership,additional operational and commercial expertise. The introduction of BG as apartner in the Hassi Ba Hamou Concession achieved many of our objectives in thatregard. A second core objective for the year was to initiate, and make solid progresson, the exploration and appraisal programmes for the newly acquired licences inboth the northern, oil prone area of Algeria and the gas prone central area, andagain I'm pleased to be able to report important progress on that front. I amdisappointed that it has not, as yet, been possible to secure first productionfrom our GKN and GKS oil discoveries in Block 126a. This has been due primarilyto a change in Algerian legislation which now precludes gas flaring on futureoil and gas developments, and which therefore required a solution to be foundfor any gas that will be produced in association with oil from the joint GKN andGKS oil development. Together with our partner SONATRACH, a solution to thischallenge has now been found and agreed, which should enable us to progresstowards the commencement of development operations. A further key objective for the year was a re-financing of the Company to enablethe Company to embark on an aggressive second phase of exploration and appraisalactivities, and to expand further its upstream portfolio. A successful shareplacing in August 2006 and completion of the transaction with BG in January 2007has transformed the financial position of the Company. Finally, in order to maximise the competitive edge of the Company going forward,it was important to ensure that, during 2006, we completed the recruitment of afirst rate technical and management team. That team is now in place and theCompany is well positioned to move into the next phase of its development. Hassi Ba Hamou Perimeter (Blocks 317b, 322b, 347b, 348, 349b) In August 2006, BG was introduced as a strategic partner to the HBH Concession.BG is a world class operator who brings highly complementary technical andoperational expertise and is firmly focussed on proving and commercialising thegas from this concession area. Under the agreement, BG has acquired 49% of GulfKeystone's interest in HBH and has assumed the role of Operator. Gulf Keystonenow holds a 38.25% interest, BG a 36.75% interest and SONATRACH a 25% interestin HBH. The HBH Concession covers 18,380 km2 in the Bechar Oued Namous Basin of CentralAlgeria, a gas prone area that includes the HBH gas discovery and a number ofsignificant leads and prospects. The main reservoir targets lie at Devonianlevel where gas is contained in sandstones at average depths of between 750 and1,000 metres. In line with the significant prospectivity that we see within this concession,the partnership has embarked upon a materially expanded work program includingthe acquisition of 2,000 line km's of 2D seismic, 500 km2 of 3D seismic and thedrilling of 3 appraisal wells and 3 exploration wells during the initial licencephase. Acquisition of the 2D seismic commenced in February 2007, andapproximately 600 line kms have been completed to date. Early, field processed,seismic lines from the first phase of this acquisition programme areencouraging. The 500 km2 3D seismic survey will be focused on the existing HBHgas discovery, and this started in May 2007. The first drilling on the block isscheduled for Q4 2007. CHIEF EXECUTIVE OFFICER'S STATEMENT (continued) Northern Blocks Ben Guecha (Blocks 108/128b) - Gulf Keystone: 75% equity interestBottena Perimeter (Block 129) - Gulf Keystone: 75% equity interestBlock 126a - Gulf Keystone: 60% interest Over the last year the Company has made considerable progress in its technicalunderstanding of its north-eastern Algerian asset base. The geology of thistectonically active area is complex with hydrocarbons often residing infractured carbonates with low matrix porosity. Commercial exploitation of suchreservoirs requires specific techniques that are likely to include theacquisition of 3D seismic data, specialist testing and completion techniques,and, potentially, high angle or horizontal wells. In pursuit of this strategy,the Company has completed a two well workover and testing operation of potentialoil discoveries in Blocks 129 (well HEK-3) and 126a (well GRJ-2). In Block 129, the completion of the HEK-3 well test produced a large amount ofgood quality engineering data. This, combined with the produced volume of oiland the long flow and shut in periods, will provide valuable data for reservoirevaluation and field development study purposes. The well achieved a stablisedflow rate of 1040bopd. Production optimisation studies will be carried out toanalyse options for further increasing well productivity with a view to thepossible early development of this discovery. In this regard, consideration willbe given to pump and/or gas lift options to further improve both the rate anddelivery pressure of the well. The Company carried out a test of well GRJ-2 located on Block 126a. Well GRJ-2was drilled by Gulf Keystone in late 2005. The well encountered encouraginghydrocarbon indications, from both core and log data in Cenomanian / Turoniancarbonates, the same reservoir interval that is producing in the GKN-1 well. Atthe time of drilling, the well was not tested due to the lack of availability ofsuitable test equipment within Algeria. During April/May 2007, Gulf Keystone tested two potential reservoir zones andperformed an injectivity and step rate test followed by matrix acidisation (minifrac) in both zones. The aim of the test program was to connect the fracture and/or the matrix permeability in the surrounding reservoir, and thereby accessmoveable hydrocarbons. Whilst technically, operations were performed successfully, no hydrocarbonsflowed into the wellbore under test. Although it is unlikely that there will beany further operations on the GRJ structure, we will, as part of our widerongoing technical assessment of the northern blocks, now review all geological,geophysical and engineering data that was collected during this operation toestablish the likely reasons for lack of commercial flow from this particularwell. The second phase of the Block 126a exploration and appraisal licence ended inApril 2006. However, a fifteen month licence extension was awarded by theAlgerian authorities to facilitate completion of the process leading to theDeclaration of Commerciality for the GKN/GKS oil discoveries and the testing ofwell GRJ-2. A comprehensive programme of exploration and appraisal activities is now plannedfor the northern blocks over the next two years. During the remainder of 2007,the focus of activities in Block 129 will be on building and ranking aninventory of exploration leads and prospects utilizing the 3D seismic surveythat the Company has recently processed over the DDN area of the block, andpre-existing 2D seismic acquired by SONATRACH. The award of the Block 108 / 128b licence which was negotiated and agreed during2005, was ratified in January 2007 by publication in the Algerian officialgazette. Publication marks commencement of the first (three year) explorationand appraisal phase of the licence. Preliminary analysis has already been madeof the 3D seismic survey acquired by the Company in the region of the Ras Toumboil field in Block 108 and, as further pre-existing seismic and well data isacquired from SONATRACH, following this licence award, so the pace of evaluationof these blocks will accelerate. The above detailed evaluation of Blocks 108, 128b and 129 is geared towards athree well drilling programme, currently planned for the first quarter of 2008. CHIEF EXECUTIVE OFFICER'S STATEMENT (continued) GKN / GKS oil development In late 2006, new legislation necessitated a revision to the field developmentplan for the GKN Field and the GKS oil discovery. The revised Phase 1development plan now includes the injection and storage of gas produced inassociation with oil, at the nearby Ras Toumb Field. The GKN Field currentlyproduces approximately 1,000 bopd (from a single well). On entering theexploitation phase of the licence, the Company will take over production fromthe GKN Field and bring the GKS-2 discovery into production. This latter wellproduced, under test, at a rate of 4,586 barrels of oil and 4.61 million cubicfeet of gas per day in 2005. In addition, Phase 1 of the combined GKN / GKSdevelopment calls for the acquisition of 3D seismic data over the twostructures, to firm up the reservoir morphology, and the drilling of two furtherdevelopment wells. Plans for Phases 2 and 3 of the GKN / GKS development willdepend on data acquired during the first phase. All discussions with our partner SONATRACH relating to the technical,operational and environmental plans for Phase 1 of the GKN / GKS developmenthave now been completed. Commencement of the Exploitation Phase of the licencenow awaits formal approval from SONATRACH and gazetting by the competentauthorities. Management 2006 has seen a strong focus on building the optimum technical and managementteam to run and grow our business. During the year, the Company recruited 7additional technical staff in the key disciplines; geology, geophysics,engineering and economics. The Company also completed the building of itsExecutive Team with a Finance Director, a group Commercial / Legal Director andan EVP of Exploration and Technical. We believe that this is a particularlystrong achievement given the background of an unprecedented skills shortagewithin the industry. Financial Following the successful share placing in August 2006 and completion of the HBHdeal in January 2007, Gulf Keystone is on a solid financial footing. TheCompany reports a profit for the year after taxation of US$46.3 million (2005loss US$40.8 million). At the end of the year, the Company had cash and cashequivalents of US$59.3 million (2005 US$51.4 million) and trade and otherreceivables US$60 million (2005 US$3.4 million). The increase in profit and thetrade and other receivables was primarily a result of the HBH farm outtransaction. The conditions of this transaction were fully satisfied prior tothe end of 2006 hence the transaction has been accounted for as a 2006 event.However, the outstanding cash consideration contained within trade receivableswas paid by BG during January 2007 following legal completion of the deal. TheCompany has US$21.6 million (2005 US$34.7 million) of cash guarantees in placefor the Company's Algerian work programme. The Company had trade and otherpayables of US$10.8 million (2005 US$8.5 million). This included US$5 millionof short term debt that was repaid shortly after the year end. Todd KozelChief Executive Officer CONSOLIDATED INCOME STATEMENT FOR THE YEAR ENDED 31 DECEMBER 2006 NOTES 2006 2005 $'000 $'000Continuing OperationsOther income/(expense):Gain on sale of assets 3 61,103 - Impairment of intangible exploration assets - (35,145)General and administrative expenses (16,589) (7,719)Profit/(Loss) from operations 44,514 (42,864)Interest revenue 2,160 2,213Interest expense (229) -Profit/(Loss) before tax 46,445 (40,651)Tax expense (136) (135)Profit/(Loss) after tax for the year 46,309 (40,786) Profit/(Loss) per share (cents)Basic 1 17.69 (16.08)Diluted 16.74 (16.08) CONSOLIDATED BALANCE SHEET AS AT 31 DECEMBER 2006 NOTES 2006 2005 $'000 $'000Non-current assets Property, plant and equipment 2 26,782 25,594Intangible assets (2005 restated -note 3) 3 19,955 16,851Financial asset 5,597 - 52,334 42,445Current assetsInventories 4,711 3,472Trade and other receivables 59,999 3,386Cash and cash equivalents 59,328 51,439 124,038 58,297Total Assets 176,372 100,742 Current liabilities Trade and other payables 10,835 8,491Tax liabilities 136 135Provisions 2,050 2,050 Total liabilities (2005 restated - note 3) 13,021 10,676 Net Assets 163,351 90,066 EquityShare capital 1,853 1,638Share premium account 159,063 135,349Share option reserve 3,535 502Exchange translation reserve (43) (57)Accumulated losses (1,057) (47,366)Total Equity 163,351 90,066 CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 2006 Attributable to equity holders of the Group Share based Exchange Share Share Payment Convertible Accumulated Translation Total Capital premium reserve warrants Deficit Reserve Equity $'000 $'000 $'000 $'000 $'000 $'000 $'000 Balance as at 1 January 2005 1,626 135,349 108 12 (6,580) - 130,515Share based payment expense - - 394 - - - 394Exchange differences arising on - - - - - (57) (57)translation of overseas operationsWarrants subscribed 12 - - (12) - - -Net profit for the year - - - - (40,786) - (40,786) Balance at 1 January 2006 1,638 135,349 502 - (47,366) (57) 90,066Share based payment expense - - 3,033 - - - 3,033Exchange differences arising on - - - - - 14 14translation of overseas operationsShare conversion and issue 215 23,714 - - - - 23,929Net profit for the year - - - - 46,309 - 46,309 Balance at 31 December 2006 1,853 159,063 3,535 - (1,057) (43) 163,351 CONSOLIDATED CASH FLOW STATEMENT FOR THE YEAR ENDED 31 DECEMBER 2006 NOTES 2006 2005 $'000 $'000Operating activitiesCash used in operations 4 (13,418) (13,932)Interest received 2,160 2,213Net cash (used)/generated in operating activities (11,258) (11,719) Investing ActivitiesPurchase of intangible assets (3,166) (25,863)Purchase of property, plant and equipment (1,401) (804)Net cash used in investing activities (4,567) (26,667) Financing activitiesInterest paid (229) -Proceeds on issue of share capital 23,929 -Net cash generated in financing activities 23,700 - Net increase/(decrease) in cash and cash equivalents 7,875 (38,386)Cash and cash equivalents at beginning of year 51,439 89,882Effect of foreign exchange rate changes 14 (57) Cash and cash equivalents at end of the year being bank 59,328 51,439balances and cash CONSOLIDATED FINANCIAL STATEMENTSSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES General Information The Company is incorporated in Bermuda and it is quoted on the AlternativeInvestment Market of the London Stock Exchange. The Company serves as theholding company for the Group, which is engaged in oil and gas exploration,operating in the Republic of Algeria. This preliminary results announcement is for the year ended 31 December 2006.While the financial information contained in this preliminary resultsannouncement has been computed in accordance with International FinancialReporting Standards ("IFRS"), this announcement does not itself containsufficient information to comply with IFRS. For these purposes, IFRS comprisethe Standards issued by the International Accounting Standards Board ("IASB")and Interpretations issued by the International Financial ReportingInterpretations Committee ("IFRIC"). The financial information set out above does not constitute the company's AnnualReport for the years ended 31 December 2006 or 2005, but is derived from thoseaccounts and is consistent with the accounting policies described therein. Theauditors have reported on those accounts; their reports were unqualified. Basis of accounting The financial statements have been prepared in accordance with InternationalFinancial Reporting Standards ("IFRS"). The financial statements have been prepared under the historical cost accountingrules, except for the valuation of share options and contingent deferredconsideration, and on a going concern basis. The principal accounting policiesadopted are set out below. At the date of authorisation of these financial statements the followingStandards and Interpretations which have not been applied in these financialstatements were in issue but not yet effective: IFRS 7 Financial instruments: Disclosures; and the related amendment to IAS 1 on capital disclosures IFRS 8 Operating Segments IFRIC 8 Scope of IFRS 2 Share -based Payment IFRIC 9 Reassessment of Embedded Derivatives IFRIC 10 Interim Financial Reporting and Impairment IFRIC 11 IFRS-2 Group and Treasury Share Transactions IFRIC 12 Service Concession Arrangements The Directors anticipate that the adoption of these Standards andInterpretations in future periods will have no material impact on the financialstatements of the Group when the relevant standards come into effect for periodscommencing on or after 1 January 2007 (IFRS 8: 1 January 2008). CONSOLIDATED FINANCIAL STATEMENTSSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Basis of consolidation The consolidated financial statements incorporate the financial statements ofthe Company and enterprises controlled by the Company (its subsidiaries) made upto 31 December each year. The Group uses the purchase method of accounting forthe acquisition of subsidiaries. The results of subsidiaries acquired or disposed of during the year are includedin the consolidated income statement from the effective date of acquisition orup to the effective date of disposal, as appropriate. Where necessary,adjustments are made to the financial statements of subsidiaries to bring theaccounting policies used into line with those of the Group. All intra-Group transactions, balances, and unrealised gains on transactionsbetween Group companies are eliminated on consolidation. Unrealised losses arealso eliminated unless the transaction provides evidence of an impairment of theasset transferred. Leasing Rentals payable under operating leases are charged to income on a straight-linebasis over the term of the relevant lease. Benefits received and receivable as an incentive to enter into an operatinglease are also spread on a straight line basis over the shorter of the period tothe next rent review date and the lease term. Foreign currencies The functional and presentation currency of the Company is US Dollars. Transactions in currencies other than US Dollars are recorded at the rates ofexchange prevailing on the dates of the transactions. At each balance sheetdate, monetary assets and liabilities that are denominated in foreign currenciesare retranslated at the rates prevailing on the balance sheet date. Non-monetaryassets and liabilities carried at fair value that are denominated in foreigncurrencies are translated at the rates prevailing at the date when the fairvalue was determined. Gains and losses arising on retranslation are included inthe income statement for the period. On consolidation, the assets and liabilities of the Group's operations which usefunctional currencies other than the US Dollar are translated at exchange ratesprevailing on the balance sheet date. Income and expense items are translated atthe average exchange rates for each month in the period. Exchange differencesarising, if any, are classified as equity and transferred to the Group'stranslation reserve. Such translation differences are recognised as income or asexpenses in the period in which the operation is disposed of. Taxation The tax expense represents the sum of tax currently payable and deferred tax. The tax currently payable is based on taxable profit for the year earned in theUnited Kingdom by the Group's subsidiary. Taxable profit differs from net profitas reported in the income statement because it excludes items of income orexpense that are taxable or deductible in other years and it further excludesitems that are never taxable or deductible. The Group's liability for currenttax is calculated by using tax rates that have been enacted or substantivelyenacted by the balance sheet date. Deferred tax is the tax expected to be payable or recoverable on differencesbetween the carrying amounts of assets and liabilities in the financialstatements and the corresponding tax bases used in the computation of taxableprofit, and is accounted for using the balance sheet liability method. Deferredtax liabilities are generally recognised for all taxable temporary differencesand deferred tax assets are recognised to the extent that it is probable thattaxable profits will be available against which deductible temporary differencescan be utilised. Such assets and liabilities are not recognised if CONSOLIDATED FINANCIAL STATEMENTSSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) the temporary difference arises from the initial recognition of goodwill or fromthe initial recognition of other assets and liabilities in a transaction thataffects neither the tax profit nor the accounting profit. Deferred tax liabilities are recognised for taxable temporary differencesarising on investments in subsidiaries and associates and interests in jointventures, except where the Group is able to control the reversal of thetemporary difference and it is probable that the temporary difference will notreverse in the foreseeable future. The carrying amount of deferred tax assets is reviewed at each balance sheetdate and reduced to the extent that is no longer probable that sufficienttaxable profits will be available to allow all or part assets to be recovered. Deferred tax is calculated at the tax rates that are expected to apply in theperiod when the liability is settled or the asset is realised. Deferred tax ischarged or credited in the income statement, except when it relates to itemscharged or credited directly to equity, in which case the deferred tax is alsodealt with in equity. Property, plant and equipment other than oil and gas interests Property, plant and equipment are stated at cost less accumulated depreciationand any accumulated impairment losses. Depreciation is provided at ratescalculated to write each asset down to its estimated residual value evenly overits expected useful life as follows:- Fixtures and equipment - 20% straight line Intangible assets other than oil and gas Intangible assets, other than oil and gas assets, have finite useful lives andare measured at cost and amortised over their expected useful economic lives asfollows:- Computer software - 33% straight line Intangible and tangible non current assets - oil and gas interests The Group adopts the full cost method of accounting for its oil and gasinterests. Under the full cost method of accounting all costs relating to theexploration for and development of oil and gas exploration and evaluationinterests, whether productive or not, are accumulated and capitalised asnon-current assets within geographic costs pools. Exploration and evaluationcosts are generally classified as intangible non-current assets during theexploration and evaluation phase and are carried forward where activities in anarea have not yet reached a stage which permits reasonable assessment of theexistence of economically recoverable reserves, and subject to there being noimpairment. Costs dealt with in this way include seismic data, licence acquisition costs,technical work, exploration and appraisal drilling, general technical supportand directly attributable administrative and overhead costs. Exploration and evaluation costs are transferred to property, plant andequipment upon declaration of commerciality and amortised, together withdevelopment costs, over the life of the area, generally the field. Upon cessation of exploration on each licence, or otherwise when an impairmentof an exploration and evaluation asset arises, an impairment test is performedfor the pool and any balance of unsuccessful exploration and evaluation costscarried forward in the pool is amortised over the life of the pool. Depreciation, depletion and amortisation is provided under the unit ofproduction method which uses the estimated remaining commercial reserves and thenet book value and any further anticipated costs to develop such reserves. CONSOLIDATED FINANCIAL STATEMENTSSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Impairment of tangible and intangible non-current assets At each balance sheet date, the Group reviews the carrying amounts of itstangible and intangible assets to determine whether there is any indication thatthose assets have suffered an impairment loss. If any such indication exists,the recoverable amount of the asset, or group of assets, is estimated in orderto determine the extent of the impairment loss (if any). For exploration andevaluation assets, the group of assets considered is the pool. For other assetswhere the asset does not generate cash flows that are independent from otherassets, the Group estimates the recoverable amount of the cash-generating unitto which the asset belongs, generally the field. Recoverable amount is the higher of fair value less costs to sell and value inuse. In assessing value in use, the estimated future cash flows are discountedto their present value using a pre-tax discount rate that reflects currentmarket assessments of the time value of money and the risks specific to theasset for which the estimates of future cash flows have been adjusted. If the recoverable amount is estimated to be less than its carrying amount, thecarrying amount is reduced to its recoverable amount. An impairment loss isrecognised as an expense immediately. Disposals of oil and gas interests The difference between the fair value of the consideration receivable and thecarrying value of the relevant proportion of the oil and gas asset disposed ofis first applied to reduce any unsuccessful exploration and evaluation costcarried in the pool, with any excess gain recognised in the income statement. Carry of expenditures and farm-in arrangements Where the Group enters into a commercial agreement which includes carry ofexpenditures or a farm-in, the arrangement is accounted for according to itscommercial substance. Generally, in the case of a farm-in, the substance is thatthe counterparty has acquired a share, or a greater share, of the underlying oiland gas reserves and the arrangement is treated as a partial disposal. Where thesubstance is that the counterparty has acquired a right, or a conditional rightto be reimbursed by the Group out of future production, a liability isrecognised at the time the obligation arises. In the case of a carry, aliability is recognised when the obligation is probable and is no longerconditional upon factors under the Group's control. Inventories Inventories relate to materials acquired for use in exploration activities.These are valued at the lower of cost and net realisable value. Warrants Proceeds in respect of convertible warrants subscribed are shown as a reserve,and upon issue of the shares, the proceeds are transferred to share capital. Capitalisation of Interest Any interest payable on funds borrowed to for the purpose of obtaining aqualifying asset will be capitalised as a cost of that asset. However, anyassociated interest charge from funds borrowed principally to address a shortterm cash flow shortfall during the suspension of development activities shallbe expensed in the period. CONSOLIDATED FINANCIAL STATEMENTSSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Financial instruments The Group's financial instruments comprise of cash and borrowings together withvarious items such as other receivables and trade payables, which arise directlyfrom its operations. The main purpose of these financial instruments is toprovide working capital. Financial assets and financial liabilities are recognised on the Group's balancesheet when the Group has become a party to the contractual provisions of theinstrument. Trade receivables Trade receivables do not carry any interest and are stated at their nominalvalue as reduced by appropriate allowances for estimated irrecoverable amounts. Contingent deferred consideration Contingent deferred consideration embedded in certain asset sale contracts istreated as a financial instrument and recognised immediately at its fair valueand then reviewed on a periodic basis until the contractual rights to the cashflows from the financial asset expire. Movements in the fair value are taken tothe income statement. Financial liabilities and equity Financial liabilities and equity instruments are classified according to thesubstance of the contractual arrangements entered into. An equity instrument isany contract that evidences a residual interest in the assets of the Group afterdeducting all of its liabilities. Borrowings Interest-bearing loans and overdrafts are recorded at the proceeds received, netof direct issue costs. Finance charges, including premiums payable on settlementor redemption, are accounted for on an accrual basis and are added to thecarrying amount of the instrument to the extent that they are not settled in theperiod in which they arise. Trade payables Trade payables are not interest bearing and are stated at their nominal value. Cash and Cash Equivalents Cash and cash equivalents comprise of cash on hand and demand deposits and othershort-term highly liquid investments that are readily convertible to a knownamount of cash and are subject to an insignificant risk of changes in value. Equity instruments Equity instruments issued by the Company are recorded at the proceeds received,net of direct issue costs. Provisions Provisions are recognised when the Group has a present obligation as a result ofa past event which it is probable will result in an outflow of economic benefitsthat can be reliably estimated. Decommissioning provision The decommissioning provision represents management's best estimate of theGroup's liability for restoring the sites of drilled wells to their originalstatus, discounted where the effect is material. CONSOLIDATED FINANCIAL STATEMENTSSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Share-based payments The Group has applied the requirements of IFRS 2 to bonus shares and shareoption schemes allowing certain employees within the Group to acquire or receiveshares of the Company. For all grants of bonus shares and share options, thefair value as at the date of grant is calculated using an appropriate optionpricing model and the corresponding cost is recognised over the expected life ofthe option. The fair value of the bonuses granted is recognised as an employeeexpense with a corresponding increase in equity. The fair value of the bonusesgranted is measured using the standard methodology applied by the Company takinginto account the terms and conditions upon which the bonuses were granted. Critical accounting estimates and judgements Estimates and judgements are continually evaluated and are based on historicalexperience and other factors, including expectations of future events that arebelieved to be reasonable under the circumstances. The Group makes estimates andassumptions concerning the future. The resulting accounting estimates andassumptions will, by definition, seldom equal related actual results. Theestimates and assumptions that have a significant risk of causing a materialadjustment to the carrying amounts of assets and liabilities within the nextfinancial year are discussed below. Decommissioning costs The Group has estimated that decommissioning costs for wells will now be$550,000 per well discounted to money of the day. It has provided for thisamount for GKS-3, RDL-1, GRJ-1, GRJ-2 and GKS-3. The total amount provided inthe balance sheet as at 31 December 2006 at net present value is $2,050,000. Impairment review of GKN and GKS The Group employs an economist to calculate the net present value of GKN and GKSbased on, and with sensitivities associated with, a gross production profile of4 thousand barrels per day, an oil price of $45 - $60bbl and a discount rate of10%. The positive net present value from this model exceeded the carrying valueas at 31 December 2006 of $26.8 million which was, therefore, retained astangible assets. Contingent deferred consideration from HBH sale As part of the HBH agreement with the BG group ("BG"), if gas reserves of theHBH field are agreed (in accordance with the agreement) to be greater than 800bcf BG will pay the Group an additional $4,000,000 for every 100 bcf over 800bcf from a minimum of 900 bcf up to a maximum of 1,300 bcf. The Group estimates,based on an independent review of potential reserves that the Group willreceive $8,000,000 contingent deferred income, which discounted to money of theday at 10% per annum results in an estimated receivable contingent deferredincome of $5,597,000 at 31 December 2006. Carry value of intangible exploration and evaluation assets The outcome of ongoing exploration, and therefore whether the carrying value ofintangible exploration and evaluation assets will ultimately be recovered, isinherently uncertain. Management makes the judgments necessary to implement theGroup's policy with respect to exploration and evaluation assets and considersthese assets for impairment at least annually with reference to indicators inIFRS6. NOTES 1 EARNINGS PER SHARE The calculation of the basic and diluted earnings per share is based on the following data: Earnings 2006 2005 $'000 $'000 Profit/(Loss) for the purposes of basic and diluted loss per 46,309 (40,786) share Number of shares 2006 2005 Number Number Weighted average number of ordinary shares for the purposes of 261,769,050 253,677,757 basic profit/(loss) per share Adjustments for: -bonus shares 1,669,707 - -share options 13,240,500 - Weighted average number of ordinary shares for the purposes of 276,679,257 253,677,757 diluted profit/(loss) per share There is a dilutive effect from the options and bonus shares issued by the company. 2 PROPERTY, PLANT AND EQUIPMENT Oil & Gas Fixtures & Properties Equipment Total $'000 $'000 $'000 At 1 January 2005 Cost - 119 119 Accumulated depreciation - (36) (36) Net book value - 83 83 Year ended 31 December 2005 Opening net book value - 83 83 Additions - 804 804 Transfer from intangible assets 24,849 - 24,849 Depreciation charge - (142) (142) Closing net book value 24,849 745 25,594 At 31 December 2005 Cost 24,849 923 25,772 Accumulated depreciation - (178) (178) Net book value 24,849 745 25,594 Year ended 31 December 2006 Opening net book value 24,849 745 25,594 Additions 1,233 167 1,400 Transfer from intangible assets - - - Depreciation charge - (212) (212) Closing net book value 26,082 700 26,782 At 31 December 2006 Cost 26,082 1,090 27,172 Accumulated depreciation - (390) (390) Net book value 26,082 700 26,782 In 2005, $24.8 million was transferred from oil & gas exploration and evaluationcosts to oil & gas properties within property, plant and equipment during theyear. This transfer was triggered by the SONATRACH and Gulf Keystone PetroleumLimited joint venture management committee i) recognising the potentialcommerciality of the GKN field, which in turn is expected to lead toconfirmation of commerciality by Sonatrach and then in turn to the Ministry ofEnergy and Mining in Algeria endorsing a production license and; ii) theanticipated declaration of commerciality of GKS and subsequent recommendationvia SONATRACH to the Ministry of Energy and Mining in Algeria for the award ofan early production license. The additions in 2006 represent the continuingexpenditures on these assets. 3 INTANGIBLE ASSETS Exploration & Computer evaluation costs software Total $'000 $'000 $'000 At 1 January 2005 Cost and net book value 41,708 - 41,708 Year ended 31 December 2005 Opening net book value 41,708 - 41,708 Additions (restated) 35,008 156 35,164 Transferred to tangible assets (24,849) - (24,849) Impairment write off (35,145) - (35,145) Amortisation charge - (27) (27) Closing net book value 16,722 129 16,851 At 31 December 2005 Cost (restated) 51,867 156 52,023 Accumulated amortisation (35,145) (27) (35,172) Net book value 16,722 129 16,851 Year ended 31 December 2006 Opening net book value 16,722 129 16,851 Additions 3,330 61 3,391 Disposal of HBH (223) - (223) Amortisation charge - (64) (64) Closing net book value 19,829 126 19,955 At 31 December 2006 Cost 54,974 217 55,191 Accumulated amortisation (35,145) (91) (35,236) Net book value 19,829 126 19,955 The expiry of the exploration license on Block 126a in April 2006 and theGroup's decision only to focus on the GKN,GKS and GRJ fields within Block 126atriggered an impairment test under IFRS 6 and IAS 36 for Block 126a's group ofcash generating units. This led to a $35.1 million write off in 2005. The additions to oil & gas exploration and evaluation costs in the period relateto the wells in the GRJ field on block 126a (see note 25) that was granted alicence extension until July 2007 and expenditures on the Group's other Bottenaand Ben Guecha blocks whose exploration licences expire late in 2008 and early2010 respectively Restatement of prior year exploration and evaluation costs: Under the terms of various of the Group's production sharing agreements,SONATRACH is entitled to receive an amount of any future production to the valueof $11.8m as cost recovery for past exploration expenditures. However, if nocommercially exploitable deposits are discovered, the Group does not oweSONATRACH for the data acquired. In prior years, such obligations had beenrecorded as liabilities with the associated cost included in non-current assets.In these financial statements, the Group has restated non-current assets toderecognise this liability, on the basis that these amounts are moreappropriately regarded as an integral part of the future production attributableto SONATRACH under the production sharing contract. 3 INTANGIBLE ASSETS (continued) Disposal of 36.75 per cent interest in HBH In August 2006, Gulf Keystone announced the introduction of BG North SeaHoldings Limited, a subsidiary of BG Group Plc, as strategic partner in theHassi Ba Hamou Perimeter exploration, appraisal and exploitation contract. Underthe joint venture agreement ("JV"), BG has acquired 49 per cent of GulfKeystone's interest in HBH and assumed the role of Operator. Gulf Keystone holdsa 38.25 per cent interest, BG a 36.75 per cent interest and SONATRACH a 25 percent interest in HBH. In accordance with Article 14 of the HBH Contract, therate of participation of the investors in the financing of the investment costsfor exploration, evaluation, development, exploitation and operating costs isset at 25 per cent for SONATRACH, 38.25 per cent for Gulf Keystone and 36.75 percent for BG. However, in the absence of the discovery of a commerciallyexploitable deposit, the JV partners may not claim any reimbursement orcompensation from SONATRACH. As part of the joint venture agreement, BG carriesGulf Keystone for up to $30 million of its share of exploitation expenditures onthe block, which is repayable from Gulf Keystone's share of future production.As a result of the benefit of the cost carry under the HBH sale agreement, theGroup carries no intangible assets on HBH, other than the expenditures incurredprior to entering the transaction with BG. The gain on sales of assets wasprincipally comprised of funds received from the farm in deal with BG. 4 RECONCILIATION OF PROFIT/(LOSS) FROM OPERATIONS TO NET CASH 2006 2005 USED IN OPERATING ACTIVITIES $'000 $'000 Profit/(loss) from operations 44,514 (42,864) Adjustments for: Depreciation of property, plant & equipment 212 142 Amortisation of intangible assets 64 27 Impairment of intangible exploration assets - 35,145 Share based payment expense 3,033 394 Increase in inventories (1,239) (987) Increase in provision - 2,050 Increase in receivables (62,210) (2,961) Increase/(decrease) in payables 2,208 (4,878) Net cash (used)/generated in operating activities (13,418) (13,932) 5 BANK GUARANTEES As part of the contractual terms of the Algerian contracts, the Group has givenbank guarantees to SONATRACH of $21.6 million. These are cash backed guaranteeswhich effectively reduce the free cash available that the Group has on itsbalance sheet. The US$21.6 million total is comprised of, $6 million for theBottena ("129 Contract") work programme and $15.6 million for the Ben Guecha ("108/128b Contract") work programme. These guarantees are for the exploration andevaluation work programmes stipulated in the contracts and are reduced as thework programmes are completed. A previous guarantee of $13.1 million for theHassi Be Hamou (Blocks 317b, 322b3, 347b, 348 and 349b) work programme wasreplaced by a BG guarantee as part of the JV agreement. 6 SUBSEQUENT EVENTS On 13 April 2007 the board of directors of Gulf Keystone, RAK Petroleum and RAKBermuda, a wholly owned subsidiary of RAK Petroleum, announced the terms of arecommended acquisition of Gulf Keystone by RAK Petroleum to be effected by wayof an amalgamation of Gulf Keystone with RAK Bermuda. Under the terms of theproposed amalgamation Gulf Keystone shareholders will receive amalgamationconsideration of 74 pence per Gulf Keystone share, which are to be cancelledpursuant to the amalgamation. The total consideration on a fully diluted basisincluding the cash cancellation consideration for in the money Gulf Keystoneoptions and amounts due under the Gulf Keystone Executive bonus scheme isapproximately £208 million ($412 million). On 13 January 2007 the Group repaid in full its outstanding debts to GIBCALimited and Falcon Partners Trust, both related parties, who had provided anunsecured debt facility in aggregate of $5 million at an interest rate of 7% andfor a term of up to 12 months. On 7th April 2007 Gulf Keystone commenced workover operations on well HEK-3 anoil and gas discovery well drilled by SONATRACH in 2004. At that time, the wellwas tested over the Cretaceous, Coniacian limestone interval and achieved, postacidisation, flow of 184 barrels of oil over a 4 hour period, prior to the wellbeing suspended. Gulf Keystone re-entered the well and tested the same zone,over the measured interval 2,439 to 2,446 metres, employing an acid fracturingtechnique to improve connectivity between the reservoir and the wellbore. Aftercleaning up the well, a stabilised flow rate of 1,040 barrels per day of 31degrees API oil was achieved through a 32/64 inch choke. During April Gulf Keystone performed well test operations on well GRJ-2, nohydrocarbons flowed into the wellbore under test and this well is being pluggedand abandoned. Whilst final expenditures on the GRJ field are forecast to bearound US$24 million, as at 31 December 2006 expenditures of US$18.9 million areincluded in intangible assets. In accordance with the Group's accountingpolicies for intangible oil and gas interests, these amounts will be subject toan impairment test in 2007. This information is provided by RNS The company news service from the London Stock Exchange