NLG.L Regulatory News (NLG)

14 Nov 2005 07:00

14 November 2005 NELSON RESOURCES LIMITED REPORTS THIRD QUARTER RESULTS, FURTHER GROWTH IN PRODUCTION AND REVENUENelson Resources Limited (TSX / AIM: NLG), a leading exploration and productioncompany operating in Kazakhstan, today reports its results for the three andnine months ended September 30, 2005. All amounts are expressed in U.S. dollarsunless otherwise indicated.HIGHLIGHTS==========Year on year, nine months 2005 versus nine months 2004: - Oil revenue up 160% to $401.1 million (9 months 2004 $154.1 million)- Oil production increased by 79% to 8.6 million barrels (9 months 2004 4.8 million barrels)- Net profit after tax increased ten-fold to $108.0 million (9 months 2004 $10.2 million)Quarter on quarter, Q3 2005 versus Q2 2005: - Oil revenue up 45% to $178.9 million (Q2 2005 $123.7 million)- Production net to Nelson averaged 31,530 barrels of oil per day - up 6% from 29,693 bopd for Q2 2005- Gross operating profit increased 77% to $136.4 million (Q2 2005 $77.0 million)- Net profit after tax increased by 98% to $47.9 million (Q2 2005 $24.2 million)Operations:- At North Buzachi, new processing facilities have been completed and further drilling rigs commissioned, which has substantially increased production rates at the field- At Alibekmola, the main pressure maintenance program has been initiated with five wells converted to water injection- 35 new wells were drilled during the quarter, with the total well stock reaching 220 producing wells and 27 water injection wells across the group's five producing fieldsNick Zana, Nelson's Chief Executive Officer, commented, "Throughout the firstnine months of 2005, the Company has benefited from the diversification that ithas achieved through acquisition of interests in multiple fields over the pasttwo years. The operating environment remains challenging in upstream businessworldwide. Nelson has benefited from higher oil prices, but this in itself hascreated a number of challenges that need to be managed to maintain ourdemonstrated success." "As previously announced on October 13, Nelson has reached an agreement toamalgamate with Lukoil Overseas Holding Ltd., and a shareholder's meeting toconsider the proposed amalgamation will take place on December 2. After carefulconsideration, the Board of Directors of the Company unanimously recommend avote in favour of this amalgamation."FINANCIAL REVIEW================================================================================================(in thousands of U.S. dollars, Three Months Ended Nine Months Endedexcept per barrel and September 30 September 30share amounts) 2005 2004 2005 2004--------------------------------------------------------------------------------Crude oil prices ($/bbl) Brent 61.53 41.36 53.67 36.24 Net realization - gross of royalties 56.09 36.46 48.85 32.33 Net realization - net of royalties 54.10 35.76 47.54 31.85Revenues - net of royalties 178,887 77,683 401,055 154,075Gross operating profit* 136,441 51,284 279,971 92,967EBIT** 95,780 39,522 217,820 64,831Net profit after tax 47,920 16,766 107,972 10,183Debt 128,603 188,282 128,603 188,282Cash on hand 40,034 106,868 40,034 106,868Net debt after cash 88,569 81,414 88,569 81,414Not included in gross operating profit: Other compensation costs (22,238) (3,898) (15,925) (8,672) Derivative instruments (10,806) (2,835) (23,087) (19,121) Depreciation and amortization (18,423) (7,864) (46,226) (19,464)================================================================================* Gross operating profit is revenues less costs of production, sales and transportation expenses and general and administrative expenses** EBIT, earnings before interest and taxes, is gross operating profit less other compensation costs and depreciation and amortizationNelson is pleased to report increase in unit sales, revenues and earnings in thethird quarter ended September 30, 2005.For the nine months ended September 30, unit sales increased 74% to 8.4 millionbarrels of oil, revenues (net of royalties) increased 160% to $401.1 million,gross operating profit increased 201% to $280.0 million and net profit after taxincreased 960% to $108.0 million. In the third quarter, Nelson realized production of 3.1 million bbls, unit salesof 3.3 million bbls, revenues of $178.9 million (net of royalties), grossoperating profit of $136.4 million, and after tax profits of $47.9 million.Some of these results are somewhat modest when measured against the priorquarter - total gross production increased about 7% from quarter to quarter andthe 22% increase in unit sales, on this comparative basis, is attributable toinventory work down.Growth in revenues was driven largely by the global rise in crude oil priceswhich, on a quarter to quarter basis, using dated Brent as a reference price,increased 19% to average $61.53/bbl in Q3. Marketing activities againmeaningfully enhanced this exogenous market development by increasing netrealization by 23% to $56.09/bbl.Operating costs declined on a $/bbl basis when compared with the previousquarter; however, this decline is attributable more to the non-recurrence in Q3of certain expenses recognized in Q2; notably, the levy and recognition in Q2of the increased gas flaring charges for the first quarter of 2005 and in Q3 areduced level, relative to Q2, of investment in corporate infrastructure. Asnoted in the MD&A, a court has ruled that the levels of flaring are withinlimits approved by the Kazakh Central Development Committee and therefore notsubject to additional levies. While this ruling is subject to appeal, ifultimately confirmed by the Kazakh courts levies paid to date will be refundedor offset, and further increased levies will not be applicable during theperiod granted for the implementation of gas utilization programs.Gross operating profit, defined as revenues less costs of production, sales andtransportation, and administration, improved 77%, in comparison to the priorquarter, to $136.4 million.Net profit after tax increased by 98% over the prior quarter. The improvement inoperating profitability more than offset a rise in certain financing costs andnon-cash accounting charges, notably, a $3.8 million increase in the cost ofwritten puts due to the rise in market price of crude oil, and $19.4 millionincreased other compensation costs, attributable to the increase in the shareprice by Cdn$0.70 or 36%, from the end of the second quarter, to Cdn$2.67 at theend of the third quarter.Driven by improved profitability, cash flow from operating activities in Q3increased more than 300% to $79.7 million, supporting both a meaningful increasein capital expenditures, with net cash used in investing activities almostdoubling to $45.0 million, compared with $29.0 million in Q2, and a significantreduction in funded bank debt by $56.2 million, compared with a net increase ofdebt of $3.0 million in Q2.MANAGEMENT'S DISCUSSION AND ANALYSIS====================================Management's Discussion and Analysis of the consolidated financial statementsfor the third quarter 2005 will be available on the Company's website,www.nelsonresources.com, and on SEDAR, www.sedar.com. The document can also beobtained on application from the Company. REVIEW OF OPERATIONS====================During the third quarter of 2005, further progress was made by Nelson'soperating subsidiaries, with the Company's share of production from its fieldsincreasing quarter-on-quarter, and 35 new wells drilled across all fields.Highlights include:- The completion of new processing facilities and the commissioning of further drilling rigs at North Buzachi, which have substantially increased production rates at the field.- The initiation of the main pressure maintenance program at Alibekmola.- The start of construction of a rail loading facility at Karakuduk which will allow higher netbacks from crude oil sales from this field to be achieved.During the quarter, production of crude oil net to Nelson (with the KKM sharetaken as 76%) averaged 31,530 bopd, an increase of 6% over the average rate forthe previous quarter of 29,693 bopd, and a 62% increase over the comparablequarter of 2004. Larger increases at North Buzachi and KKM, due to new wellscommencing production, were offset by a decline in production at KOA due to adelay in water injection project completion and the transfer of five producingwells to injection wells at the beginning of September. The following tables detail production volumes, production rates and salesvolumes over the quarter, as given for financial reporting purposes - KOA andNorth Buzachi at 50%, Chaparral/KKM at 100%, and Arman at 50% since February 14, 2005.================================================================================ Production Production rate Sales (bbls) (bopd) (bbls) Q3 2005 Q3 2004 Q3 2005 Q3 2004 Q3 2005 Q3 2004--------------------------------------------------------------------------------KOA 1,292,618 1,085,261 14,050 11,796 1,433,869 1,047,839North Buzachi 674,657 434,664 7,333 4,725 702,412 450,351Chaparral/KKM 1,020,165 762,993 11,089 8,293 984,364 674,445Arman(1) 158,160 - 1,719 - 185,670 - --------- --------- ------- ------- --------- ---------Total 3,145,600 2,282,918 34,191 24,814 3,306,315 2,172,635================================================================================(1) Nelson had no interest in Arman prior to February 2005Kazakhoil Aktobe (KOA)----------------------During the quarter, KOA continued with a four-rig drilling program atAlibekmola, with four new wells drilled. At Kozhasai the one-rig pilot drillingprogram finished drilling the second test well in the field's West Block. Thiswell is now under completion, while drilling is continuing on the third testwell.Two additional drilling rigs have also been contracted at KOA - one additionalfor Kozhasai and one for Alibekmola. Both are expected to be mobilized to thefield and operational by the end of the year, thus increasing the total numberof drilling rigs in operation to seven with five at Alibekmola and the othertwo at Kozhasai.Other activities at KOA include: - Water injection - at Alibekmola the field-wide program to maintain reservoir pressure was initiated in early September, when the new water injection equipment was commissioned and five producing wells were converted to water injection. As a result, water injection has increased from 700 cubic meters per day under the pilot waterflood scheme to about 3,500 cubic meters per day at the end of the quarter. The conversion of producing wells to injectors has resulted in a decrease in production of approximately 5,000 bopd. This decrease is expected to be made up as the wells begin to respond to the pressure maintenance program, and as new producing wells are completed and brought on-line. However, the pace of future production increase will depend on the rate with which water injection supports reservoir repressurization.- Gas utilization - plans to utilize gas for power generation and reinjection, thus eliminating flaring at Alibekmola, have been submitted to the Kazakh government and are awaiting approval. In September, the government changed the law on gas flaring, giving oil companies until mid-2006 to gain approval for their gas utilization plans. This overrules the previous law requiring immediate 100% gas utilization. North Buzachi-------------During the quarter, 27 new wells were drilled at the field, with three drillingrigs in full-time operation by the end of September. Each well is taking lessthan 10 days to drill. The operating company is tendering for an additional rig,which if available will go into operation by the end of the year. Other activities at the field include:- Processing facilities - the new central processing facility (CPF) was commissioned in mid-June and has increased the nameplate processing capacity at the field from 13,000 to 20,000 bopd. Testing of the new CPF was completed mid-September and, with additional small process changes, the facility is currently capable of processing 24,000 bopd. As a result, back pressure on existing wells was lowered, and with the addition of new wells, field production increased to 20,000 bopd by the end of the quarter. With the removal of processing capacity constraints, several low producing wells that were shut down at the beginning of the year are being switched back on.- Export routes - as a result of the increase in processing capacity, crude is no longer processed at the neighboring Arman field as before, and the pipeline from North Buzachi to Arman has been reconnected directly to the KTO export pipeline. New tanks have been installed allowing 5,000 bopd to be trucked to Arman for processing, and another pipeline connecting North Buzachi to the KTO export pipeline is being constructed, due for completion by mid-2006, after which the original pipeline to Arman will be restored. These measures allow additional North Buzachi crude to be processed at Arman, thus further increasing the total available processing capacity to meet the anticipated increases in production.- Gas utilization - 60% of gas produced is currently being used for heating purposes at the new CPF. A hot water injection pilot program, further increasing the use of gas for heating, has also been initiated.Karakudukmunai (KKM)--------------------Three new wells were drilled during the third quarter, with one drilling rig andtwo workover rigs continuing to operate at the field. An additional three wells are expected to be drilled during the fourth quarter, including the field's first horizontal well. Other activities at the field include:- Water injection - an additional well was transferred to injection during the quarter, and the injection program is continuing to have positive results on oil production rates.- Export routes - construction of a rail loading facility commenced in September. When completed in mid-2006, this will allow KKM to export crude by rail to Aktau, thus reducing its dependency on the KTO export pipeline system. KKM produces a higher quality crude than the blend exported via KTO, a quality differential for which it currently receives no compensation. The rail loading facility will offer the field alternative export routes and allow KKM to market its crude independently, thus achieving better netbacks.- Gas utilization - Construction of the gas pipeline connecting the field to the Central Asian gas transit pipeline has been completed. After installation of the necessary condensate traps and gas compressors, this will allow all gas not used in field operations to be sold, thus eliminating gas flaring at the field before the end of 2006.Arman-----Production from Arman's 16 producing wells continued throughout the quarter,with production from the field being maintained at approximately 3,700 bopdaverage since acquisition in February 2005.LUKOIL AMALGAMATION AGREEMENT=============================Under the terms of the previously announced Agreement to Amalgamate with LukoilOverseas Holding Ltd. ("Lukoil"), Lukoil proposes to acquire, though anamalgamation of Nelson with and into Caspian Investments Resources Ltd.,("Caspian") Lukoil's wholly-owned subsidiary (the "Amalgamation"), all of theissued and outstanding common shares of Nelson it does not already own inconsideration for US$2.19162 per share in cash. Lukoil announced on October 14,2005 that Caspian had acquired from four Nelson shareholders an aggregate of566,393,162 common shares of Nelson representing approximately 65% of theissued and outstanding common shares of Nelson. The Management Information Circular (the "Circular") in connection with thespecial general meeting of its shareholders (the "Meeting") called to approvethe Amalgamation describes the proposed transaction in detail. All shareholdersare urged to read the Circular in its entirety. As discussed in the Circular,the Board of Directors of Nelson unanimously recommends that shareholders votein favour of the Amalgamation. For the Amalgamation to be approved, the Amalgamation resolution must be passedby at least 75% of the votes cast by shareholders present in person orrepresented by proxy at the Meeting and entitled to vote thereon. The Meeting will be held at 10:00 a.m. (UK time) on December 2, 2005, at theLondon Hilton on Park Lane, Coronation Room, 22 Park Lane, London W1K 1BE,United Kingdom. The Circular has been mailed to all shareholders of record as ofOctober 25, 2005. Interested parties may also view the Circular on the SEDARwebsite at www.sedar.com and on the Nelson website at www.nelsonresources.com. ****For further information, please contact:----------------------------------------Nick Greene, Chief Financial Officer Tel: 020 7495 8908Nelson Resources Limited ngreene@nelsonresources.co.ukFred Hodder Tel: 020 7495 8908Nelson Resources Limited fhodder@nelsonresources.co.ukInvestor Relations:Ann-marie Wilkinson / Nick Lambert Tel: 020 7861 3232Bell Pottinger Corporate & Financial (London)Notes-----Nelson Resources Limited is an oil exploration and production company withoperations in the Republic of Kazakhstan. The Company established its presencein the Kazakhstan oil sector in 2000 and its management team, comprising bothinternational and Kazakh executives, has extensive experience of the Kazakhoperating and regulatory environment. The Company owns 50% of Kazakhoil AktobeLLP (KOA), a 50/50 joint venture between Nelson and Kazmunaigas, the nationaloil company of Kazakhstan, which is developing the Alibekmola and Kozhasaifields. The Company owns a 50% participatory interest in the North Buzachi oilfield located in western Kazakhstan (50% Nelson, 50% CNPC International (Buzachi) Inc.). In May 2004, Nelson purchased 60% of Chaparral Resources Inc.,which has a 60% interest in the joint stock company Karakudukmunai, operator ofand owner of a 60% interest in the Karakuduk field. In January of 2005, Nelsonacquired the 40% interest in this field previously owned by Kazmunaigas,bringing the Company's aggregate ownership interest in the field to 76%. InFebruary 2005, the Company also acquired a 50% interest in the Arman field, withthe other 50% held by Shell. The Company also holds an option to acquire aminimum 25% participatory interest in two Caspian Sea offshore blocks, ZhambaiSouth and South Zaburunye. The Company maintains its operational office inAlmaty, Kazakhstan, which oversees the field joint ventures in westernKazakhstan. Nelson and its affiliated companies employ approximately 1,100people. Common shares of Nelson are listed on the Toronto Stock Exchange andLondon's Alternative Investment Market under the symbol NLG.Further information on Nelson Resources can be found on the Company's website atwww.nelsonresources.com.Readers are cautioned that the preceding statements and information may include certain estimates, assumptions and other forward-looking information. The actualfuture performance, developments and/or results of the Company may differ materially from any or all of the forward-looking statements, which include current expectations, estimates and projections, in all or part attributable to general economic conditions and other risks, uncertainties and circumstances partly or totally outside the control of the Company, including oil prices, imprecision of reserve estimates, drilling risks, future production of gas and oil, rates of inflation, changes in future costs and expenses related to the activities involving the exploration, development, production and transportationof oil, hedging, financing availability and other risks related to financial activities, and environmental and geopolitical risks. Discussion of the various factors that may affect future results is contained in the Company's recent filings with Canadian securities regulatory authorities. The Company disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. ****The following financial statements can also be found on the Company's website, www.nelsonresources.com.================================================================================NELSON RESOURCES LIMITEDUnaudited Consolidated Statements of OperationsExpressed in thousands of U.S. dollars, except per share amounts-------------------------------------------------------------------------------- Three months ended Nine months ended Sept 30 June 30 Sept 30 Sept 30 Sept 30 2005 2005 2004* 2005 2004*--------------------------------------------------------------------------------Revenues Crude oil 178,887 123,700 77,683 401,055 154,075 Expenses Cost of production 14,773 15,478 8,159 41,039 17,917 Sales and transportation 18,767 19,499 11,263 52,896 25,008 Depreciation and amortization 18,423 14,882 7,864 46,226 19,464 General and administration 8,906 11,752 6,977 27,149 18,183 Derivative instruments 10,806 6,961 2,835 23,087 19,121 Other compensation costs 22,238 2,792 3,898 15,925 8,672 ------- ------- ------- ------- ------- 93,913 71,364 40,996 206,322 108,365--------------------------------------------------------------------------------Profit from operations 84,974 52,336 36,687 194,733 45,710--------------------------------------------------------------------------------Other income/(expenses) Foreign exchange gain/(loss) (233) (749) (1,175) (1,733) (3,019) Interest and financing costs (4,831) (6,232) (5,379) (16,547) (15,406) Interest and other income 1,540 3,658 1,815 6,428 3,924 Minority interest (5,498) (2,470) (4,264) (9,501) (6,209) ------- ------- ------- ------- ------- (9,022) (5,793) (9,003) (21,353) (20,710)--------------------------------------------------------------------------------Profit before income taxes 75,952 46,543 27,684 173,380 25,000--------------------------------------------------------------------------------Income taxes (28,032) (22,336) (10,918) (65,408) (14,817)--------------------------------------------------------------------------------Net profit 47,920 24,207 16,766 107,972 10,183--------------------------------------------------------------------------------Basic earnings per share 0.0553 0.0280 0.0201 0.1249 0.0132Diluted earnings 0.0542 0.0275 0.0194 0.1224 0.0127Weighted average common shares outstanding 866066303 863398095 834097895 864194282 774209619Diluted weighted average common shares outstanding 884575158 879535280 864057760 881771699 800396191================================================================================* as restated ****================================================================================NELSON RESOURCES LIMITEDConsolidated Balance SheetsExpressed in thousands of U.s. dollars, except share amounts-------------------------------------------------------------------------------- Septmber 30 December 31 September 30 2005 2004 2004* unaudited audited unaudited--------------------------------------------------------------------------------AssetsCurrent assetsCash and cash equivalents 40,034 56,486 106,868Accounts receivable and prepaid expenses 100,863 57,693 33,828Inventory 29,103 15,175 6,264Deferred tax 17,289 - - -------- -------- --------Total current assets 187,289 129,354 146,960Oil and gas properties, full cost 355,748 297,879 257,899Property, plant and equipment 23,375 20,119 24,355Advances to oil and gas limited partnership 31,200 26,646 26,088Inventory - - 3,942Deferred tax 5,620 9,359 10,887Other non-current assets 5,399 3,871 3,535--------------------------------------------------------------------------------Total assets 608,631 487,228 473,666--------------------------------------------------------------------------------LiabilitiesCurrent liabilities Accounts payable 20,531 31,471 19,723Accrued liabilities and deferred income 18,732 21,638 9,379Income taxes payable 43,094 5,398 11,431Derivative instruments 55,436 29,638 38,116Note payable to related party - 23,912 23,912Current portion of long-term debt 28,384 41,523 59,189 -------- -------- --------Total current liabilities 166,177 153,580 161,750Long-term liabilities - debt 100,219 121,776 105,181Deferred tax 13,205 3,258 6,501Other provisions and creditors 3,701 1,972 1,703Minority interest 31,377 21,877 30,963--------------------------------------------------------------------------------Total liabilities 314,679 302,463 306,098--------------------------------------------------------------------------------Shareholders' equityShare capital 8,719 8,620 8,575Additional paid in capital 312,729 294,462 293,658Other compensation costs 33,916 31,221 12,512 -------- -------- -------- 355,364 334,303 314,745Accumulated deficit (28,988) (136,960) (130,472)Other comprehensive loss (32,424) (12,578) (16,705)--------------------------------------------------------------------------------Total shareholders' equity 293,952 184,765 167,568--------------------------------------------------------------------------------Total liabilities and shareholders' equity 608,631 487,228 473,666--------------------------------------------------------------------------------Outstanding share capital--------------------------------------------------------------------------------Common shares, U.S.$0.01, 1,500,000,000 authorized 871,943,094 862,036,095 857,458,095Preferred shares, U.S.$0.01, 50,000,000 authorized - - -================================================================================* as restated ****================================================================================NELSON RESOURCES LIMITEDUnaudited Consolidated Statements of Cash FlowsExpressed in thousands of U.S. dollars, except per share amounts-------------------------------------------------------------------------------- Three months ended Nine months ended Sept 30 June 30 Sept 30 Sept 30 Sept 30 2005 2005 2004* 2005 2004*--------------------------------------------------------------------------------Cash flows from continuing operationsNet profit from continuing operations 47,920 24,207 16,766 107,972 10,183Adjustments to reconcile net profit to net cash provided by operating activities: Deferred tax (6,103) 6,059 2,073 (258) (1,889)Interest income (1,755) (661) - (2,822) -Other compensation costs 22,237 2,792 3,898 15,924 8,672Exchange rate (gain)/loss (10) 68 (43) 99 2,175Depreciation and amortization 18,423 14,882 7,864 46,226 19,464Discount accretion 392 380 347 1,141 1,012Derivative instruments (1,861) (1,898) (1,951) (5,640) 11,147Retirement obligation accretion 62 26 25 135 59Amortization of note discount - 71 129 222 188Loan arrangement fee amortized 790 214 101 1,738 1,255Minority interest 5,498 2,470 4,264 9,501 6,209 ------- ------- ------- ------- ------- 85,593 48,610 33,473 174,238 58,475(Increase)/decrease in working capital (5,899) (30,437) 3,845 (41,302) (12,200)--------------------------------------------------------------------------------Net cash provided by operating activities 79,694 18,173 37,318 132,936 46,275--------------------------------------------------------------------------------Cash flows from investing activitiesCapital expenditure on oil and gas properties (40,543) (27,579) (30,133) (91,529) (58,269)Acquisition of interest in Arman and North Buzachi - - - 3,451 (32,250)Acquisition of Chaparral (net of cash acquired) - - - - 3,153Purchase of property, plant and equipment (2,715) (1,427) 2,560 (4,157) (7,750)Advances to oil and gas limited partnership (1,732) - (558) (1,732) (2,770)--------------------------------------------------------------------------------Net cash used in investing activities (44,990) (29,006) (28,131) (93,967) (97,886)--------------------------------------------------------------------------------Cash flows from financing activitiesProceeds from exercise of stock options 4,734 - 46 5,137 2,494Proceeds from equity offering (net of fees) - - 110,774 - 110,774Loans received 1,246 43,404 4,780 71,016 136,780Loans repaid (57,446) (16,523) (44,229) (107,075) (134,229)Note repaid to related party - (23,912) - (23,912) -Other non-current assets 1,800 287 (61) (587) (586)--------------------------------------------------------------------------------Net cash provided by/(used in) financial activities (49,686) 3,256 71,310 (55,421) 115,233--------------------------------------------------------------------------------Net increase/(decrease) in cash and cash equivalents (14,982) (7,577) 80,497 (16,452) 63,622Cash and cash equivalents at beginning of period 55,016 62,593 26,371 56,486 43,246--------------------------------------------------------------------------------Cash and cash equivalents at end of period 40,034 55,016 106,868 40,034 106,868================================================================================* as restated ****NELSON RESOURCES LIMITEDNotes to Third Quarter 2005Interim Unaudited Consolidated Financial StatementsNote 1 Basis of Presentation and Significant Accounting PoliciesThe accompanying consolidated financial statements as of September 30, 2005 andfor the three month periods ended September 30, 2005 and 2004 are unaudited butinclude all adjustments (consisting of normal recurring adjustments) that theCompany considers necessary for a fair presentation of the consolidatedfinancial information set forth therein and in accordance with generallyaccepted accounting principles. The accompanying consolidated financialstatements have been prepared in accordance with U.S. generally acceptedaccounting principles ("U.S. GAAP"). The auditor did not conduct a review of theoriginal consolidated financial statements as of September 30, 2004 and for thethree month period ended September 30, 2004. The auditor's review of there-statement of such September 30, 2004 financial statements was solely toreview the impact of the re-statements identified during the 2004 year-endaudit. All amounts are stated in U.S. dollars unless otherwise indicated.The accounting policies followed are consistent with those outlined in theannual audited financial statements. These unaudited consolidated financialstatements do not include all disclosures normally provided in annual financialstatements and should be read in conjunction with the Company's audited annualconsolidated financial statements for the year ended December 31, 2004.The consolidated financial statements of the Company include the accounts of theCompany and its wholly owned subsidiaries, Commonwealth & British ServicesLimited ("CBS"), NRL Acquisition Corp. ("NRLAC"), Nelson Petroleum BuzachiHoldings B.V. ("NPBH BV"), Nelson Petroleum Buzachi B.V. ("NPB BV"), NelsonBuzachi Holdings Limited ("NBHL"), Nelson Buzachi Limited ("NBL"), NelsonPetroleum (KKM) Holdings Limited, Nelson Petroleum (KKM) Limited, NR ExplorationHoldings Limited and NR Exploration Limited NPB BV holds a 50% participatoryinterest in the license to the North Buzachi field, which is reflected on aproportionate gross basis.The Company's interest in Kazakhoil Aktobe LLP ("KOA"), an oil and gas limitedpartnership in which the Company has a 50% equity interest, is reported usingthe proportional consolidation method under EITF 00 1 "Investor Balance Sheetand Income Statement Display under the Equity Method for Investments in CertainPartnerships and Other Ventures" as these operations are in the extractiveindustry where there is a longstanding practice of this treatment.Chaparral Resources, Inc. ("Chaparral") in which the Company bought a 60%controlling interest on May 17, 2004 is fully consolidated. The consolidatedfinancial statements of Chaparral include the accounts of Chaparral and itsgreater than 50% owned subsidiaries, Closed Type JSC Karakudukmunai ("KKM"),Central Asian Petroleum (Guernsey) Limited ("CAP-G"), Korporatsiya MangistauTerra International ("MTI"), Road Runner Services Company ("RRSC"), ChaparralAcquisition Corporation ("CAC") and Central Asian Petroleum, Inc. ("CAP-D").Chaparral owns 80% of the common stock of CAP-G directly and 20% indirectlythrough CAP-D. Chaparral owns, through its subsidiaries, a 60% interest in KKM.KKM was formed to engage in the exploration, development, and production of oiland gas properties in the Republic of Kazakhstan. KKM's only significantinvestment is in the Karakuduk field, an onshore oil field in the Mangistauregion of the Republic of Kazakhstan. Acquisitions------------On December 27, 2004, Nelson acquired a 40% interest in KKM, a 60% ownedsubsidiary of Chaparral from Kazmunaigas, the Kazakhstan state oil company. KKMholds a 100% interest in the Karakuduk field. The acquisition increased Nelson'seffective interest in the Karakuduk field from its 36% effective interest heldthrough Chaparral, to an aggregate 76% effective interest in the Karakuduk field.KKM's rights to the Karakuduk field may be terminated under certain conditionsspecified in the field agreement. The term of the agreement is 25 yearscommencing from the date of KKM's registration. The agreement can be extended toa date agreed between the Ministry of Energy and Mineral Resources and KKM aslong as production of petroleum and/or gas is continued in the Karakuduk field.On December 23, 2004, the Company entered into a definitive sale and purchaseagreement to acquire a 50% participating interest in Arman Joint Enterprise LLP("Arman") from the Kazakh state oil company Kazmunaigas. Arman holds the licensein the Arman field. Nelson paid a purchase price of $10.8 million from existingcash resources. The government and regulatory approval was obtained onFebruary 14, 2005 from which date the acquisition becomes effective. TheCompany's interest in Arman is reported using the proportional consolidationmethod under EITF 00-1. The fair value of assets and liabilities of Arman included in the accounts forthe quarter ended September 30, 2005 will be subjected to further investigationand review during 2005, as permitted by FAS No. 141 "Business Combinations".Certain data necessary to complete the Company's final purchase price allocationis not yet available. The Company expects to complete its purchase priceallocation during 2005 at which time the preliminary allocation will be revised,if necessary.The Company has finalized the assessment of the fair value of assets andliabilities acquired when the Company purchased a 60% controlling interest inChaparral on May 17, 2004 and when the Company acquired its 40% interest in KKMon December 27, 2004. The adjustment recorded during the quarter ended June 30,2004 for Chaparral was to decrease oil and gas properties by $4.6 million andto decrease deferred tax liabilities by the same amount. The adjustmentrecorded during the quarter ended June 30, 2004 for KKM was to increase oil andgas properties by $9.8 million and to decrease deferred tax liabilities by thesame amount.All material intercompany balances and transactions are eliminated. Note 2 Economic and operating environmentsThe Company's continued business activities are located in Kazakhstan. As anemerging market, Kazakhstan does not possess a well-developed business andregulatory infrastructure that would generally exist in a more mature marketeconomy. Furthermore, the Government of Kazakhstan has not yet fully implementedthe reforms necessary to create judicial, fiscal and regulatory systems thatfunction with the effectiveness often achieved in more developed markets. As aresult, operations in transitional countries involve risks that are nottypically associated with those in developed markets.Uncertainties regarding the political, legal, tax or regulatory environment,including the potential for adverse changes in any of these factors couldsignificantly affect the Company's ability to operate commercially. It isdifficult for management to estimate what changes may occur or the resultingeffect of any such changes on the Company's financial position or future resultsof operations. The accompanying consolidated financial statements do not include anyadjustments that may result from the future clarification of theseuncertainties. Such adjustments, if any, will be reported in the Company'sconsolidated financial statements in the period when they become known andestimable.Note 3 Short-term and Long-term debtAt September 30, 2005 and December 31, 2004 short-term debt comprised:-------------------------------------------------------------------------------- September 30 December 31 2005 2004 ($'000) ($'000)--------------------------------------------------------------------------------BNP Paribas loan - KOA 22,917 25,000ECGD facility - KOA 745 745Kazkommertsbank loan - KKM - 15,778BNP Paribas loan - KKM 4,722 - ------- ------- 28,384 41,523--------------------------------------------------------------------------------At September 30, 2005 and December 31, 2004 long-term debt comprised:-------------------------------------------------------------------------------- September 30 December 31 2005 2004 ($'000) ($'000)--------------------------------------------------------------------------------Due to the Republic of Kazakhstan - KOA 13,315 12,175ECGD facility - KOA 3,725 4,097BNP Paribas loan - KOA 1 16,667BNP Paribas loan - KKM 12,278 -Kazkommertsbank loan - KKM - 12,000Vitol loan - NPB BV - 23,837BNP Paribas loan - NPB BV 17,900 -HSBK - NPB BV 53,000 53,000 ------- ------- 100,219 121,776--------------------------------------------------------------------------------Note 4 Shareholders' equityAs of September 30, 2005 the Company had 871,943,094 shares outstanding. As ofsuch date, the Company had the following contingently issuable shares.-------------------------------------------------------------------------------- Number Weighted average exercise price (Cdn$)--------------------------------------------------------------------------------Stock options oustanding 40,625,875 1.65--------------------------------------------------------------------------------Note 5 Commitments and contingencies a) Under the license for the Alibekmola and Kozhasai fields, KOA is required to invest a minimum of $47.5 million and $24.5 million over the term of the license, respectively. The license expires on October 19, 2023. As at September 30, 2005 the minimum investment requirement for Alibekmola has been met. All minimum investment requirements under the license for the North Buzachi field have also been met.b) Mr. Roy Meade, the former President of the Company, has brought an action in the Ontario Superior Court against Nelson with respect to stock options issued by the Company to Mr. Meade in September 1999. In 2000, the Company cancelled all of Mr. Meade's benefits, including stock options, on the basis that Nelson found Mr. Meade to have intentionally and fundamentally breached his employment contract and fiduciary duties to Nelson by certain omissions and actions that he undertook prior to his departure from the Company. Mr. Meade claims specific performance granting him 4 million shares as well as a mandatory injunction requiring the Company to issue such 4 million shares to be held in escrow. In the alternative to this relief, Mr. Meade seeks damages in the amount of Cdn$10,080,000. The substance of this matter, along with a related wrongful dismissal claim, was raised by Mr. Meade and has been the subject of discussions between Mr. Meade's UK counsel and the Company's UK counsel for some time. The Company is of the view that this action is without merit and intends to vigorously defend the action.c) Extensive national, regional and local environmental laws and regulations affect all of the oil operations conducted through the Company's joint ventures in Kazakhstan. These laws and regulations set various standards regulating certain aspects of health and environmental quality, provide for user fees, penalties and other liabilities for the violation of those standards and establish in some circumstances obligations to remediate current and former facilities and off-site locations. The Company believes it is currently in compliance with all existing Kazakhstan environmental laws and regulations. However, in the future, compliance with more stringent laws or regulations, or more vigorous enforcement policies of any regulatory agency, could require material expenditures for the installation and operations of systems and equipment for remedial measures, any or all of which could have a material adverse affect on its business, financial condition and results of operations.d) Certain loans of KOA, NPB BV and KKM are secured against the export revenues of those companies. Under these agreements cash from the export revenues must be paid into "collection accounts" held at nominated banks. The balance of funds in these accounts must not fall below the interest and principal repayments due in the following month.Note 6 Reconciliation of results from U.S. GAAP to Canadian GAAPThese consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the U.S. (U.S. GAAP), which conform in all material respects with those applicable in Canada (Canadian GAAP), exceptas described below: (a) Stock-Based Compensation and Other Stock-Based PaymentsApplicable for financial periods beginning on or after January 1, 2004, the Canadian Institute of Chartered Accountants ("CICA") has amended CICA Handbook Section 3870 "Stock-Based Compensation and Other Stock-Based Payments". This Section requires stock-based compensation and other payments to be recognized inthe financial statements through expense, and share-based transactions to be measured on a fair value method. Under U.S. GAAP, the Company values stock options using the intrinsic value method. Under Canadian GAAP, the impact on netprofit of valuing stock options using the fair value method would be as follows:-------------------------------------------------------------------------------- Three months ended September 30($'000) except per share amounts 2005 2004--------------------------------------------------------------------------------Net profit Per U.S. GAAP 47,920 16,766 Reverse other compensation costs per the intrinsic method 22,238 3,898 Other compensation costs per the fair value method (3,321) (9,257) ------- ------- Per Canadian GAAP 66,837 11,407Basic earnings Per U.S. GAAP 0.0553 0.0201 per share Per Canadian GAAP 0.0772 0.0137 Diluted earnings Per U.S. GAAP 0.0542 0.0194 per share Per Canadian GAAP 0.0756 0.0132---------------------------------------------------------------------------------------------------------------------------------------------------------------- Nine months ended Sepember 30($'000) except per share amounts 2005 2004--------------------------------------------------------------------------------Net profit Per U.S. GAAP 107,972 10,183 Reverse other compensation costs per the intrinsic method 15,925 8,672 Other compensation costs per the fair value method (10,286) (9,391) ------- ------- Per Canadian GAAP 113,611 9,464Basic earnings Per U.S. GAAP 0.1249 0.0132 per share Per Canadian GAAP 0.1315 0.0122 Diluted earnings Per U.S. GAAP 0.1224 0.0127 per share Per Canadian GAAP 0.1288 0.0118--------------------------------------------------------------------------------(b) Financial InstrumentsIn January 2005, CICA introduced three new Handbook Sections relating tofinancial instruments, Section 1530 "Comprehensive Income, Section 3855"Financial Instruments - Recognition and Measurement", and Section 3865"Hedges". As permitted by these standards, the Company adopted these standardsas of January 1, 2004. As a result, the accounting for the Company's cash flowhedges in 2004 and 2003 is consistent under U.S GAAP and Canadian GAAP.Note 7 Subsequent events and change of controlOn September 30, 2005, the Company announced that it had entered intonegotiations with Lukoil Overseas Holding Limited ("Lukoil") regarding aproposed acquisition of Nelson by Lukoil. On October 13, 2005, the Companyannounced that it had entered into an agreement with Lukoil to effect anamalgamation (the "Proposed Amalgamation") between Nelson and a wholly-ownedsubsidiary of Lukoil. The Proposed Amalgamation is subject to the approval of75% of the votes case by Nelson's shareholders at a special meeting ofshareholders expected to be held on December 2, 2005. Closing is subject tocertain other conditions, including the exercise, cancellation or termination ofall outstanding options to acquire shares of Nelson, the receipt of allrequisite regulatory approvals and consents necessary to consummate the ProposedAmalgamation, and the resignation of each director and officer of Nelsoneffective as of the effective date of the Proposed Amalgamation.On October 14, 2005 Lukoil acquired approximately 65% of the shares of Nelsonand therefore became the Company's principal shareholder.In connection with the Proposed Amalgamation, on October 13, 2005 all options inthe Company's Stock Option Plan vested. The additional charge to income ascalculated under the intrinsic value method in respect of the vesting of theseshares is approximately $1.8 million when calculated under US GAAP. Thecorresponding figure under Canadian GAAP is $7.7 million. The Company will incur significant expenditure in connection with the proposedamalgamation including bankers' fees, legal counsel fees, other special fees andpayments for contractual matters that are not in the ordinary course ofbusiness. On October 26, 2005, the Company announced that the Ontario SecuritiesCommission ("OSC") is conducting an investigation of the trading in the sharesof Nelson. The OSC advised that the investigation is prompted by theannouncement of the Lukoil transaction on September 30, 2005.On October 28, 2005, the Company announced that China National PetroleumCorporation ("CNPC"), the Company's joint venture partner on the North Buzachioil field, intends to take the necessary measures to exercise its pre-emptiveright under the North Buzachi Joint Operating Agreement to acquire theCompany's 50% interest in the North Buzachi field, following the purchase byLukoil of a 65% controlling interest in the Company. Nelson takes the positionthat no such pre-emptive right exists in the current circumstances. While CNPC has advised the Company that it will take the necessary measures toexercise its pre-emptive right in accordance with the Joint Operating Agreement,to the knowledge of the Company, no formal legal proceedings have yet beencommenced.The Company takes the position that Lukoil's purchase of the 65% controllinginterest in the Company on October 14, 2005, does not breach the subjectprovisions of the Joint Operating Agreement and no pre-emptive right arises inthe current circumstances. The Company therefore intends to oppose any measurestaken by CNPC to prove and exercise this right.On October 17, 2005 and October 18, 2005, respectively Paul Maxwell and AskarAlshinbaev resigned as directors.On November 4, 2005 KOA received a court ruling in its favour regarding theCompany's appeal against the increased levies for gas flaring in Kazakhstan.This ruling is subject to further appeal by the Kazakh Ministry of Ecology on orbefore November 19, 2005. If no appeal is made or any appeal is unsuccessful itwill result in the reversal of the excess charge for gas flaring during thefourth quarter of 2005.ENDNELSON RESOURCES LIMITED