7 Dec 2009 18:12
7 December 2009
Urals Energy Public Company Limited
("Urals Energy", or the "Company")
Annual Financial Report
Urals Energy (LSE: UEN), an independent exploration and production company with operations in Russia, today announces its audited financial results for the year ended 31st December 2008.
Strategy
Following divestiture of Dulisma and Taas Yuriakh, Urals now well positioned to recommence development programmes on two producing fields, Arcticneft and Petrosakh
Restructuring of Petraco indebtedness is Company's immediate priority as it seeks to advance its strategy
Operational
Average 2008 production decreased to 6,285 BOPD (8,857 bopd in 2007) due to divestiture of the Komi assets in April 2008
Production from Arcticneft and Petrosakh decreased to 1.126 million barrels in 2008 from 1.262 million barrels in 2007
Current daily levels of production at Petrosakh and Arcticneft decreased in 2008 to 1,672 BOPD and 648 BOPD from an average of 2,246 BOPD and 829 BOPD in 2008
Financial
Gross Revenues excluding crude oil purchased for resale decreased by $24 million to $134 million, largely due to the divestiture of the Komi region assets in April 2008
An operating loss of $132 million was recorded, largely due to the impairment losses recognized with respect to production assets in the amount of $95 million.
Subsequent to year end, the Company sold Dulisma and Taas Yuriakh for the full discharge of $630 million of debt owed to Sberbank.
The Company also terminated a Put option agreement with Limenitis Holdings (an affiliate of the Ashmore Funds).
Net debt to Petraco, the second largest creditor, was $41.3 million at 10 November, 2009 ($50.5 million at 31 December 2008)
Subsequently the Company received additional prepayment from Petraco to finance two more export deliveries. These prepayments to be offset against gross proceeds
Extensive cost reduction programme introduced subsequent to year end
Corporate
Completed significant corporate transactions:
Subsequent to year-end divestiture of Dulisma and Taas Yuriakh for full discharge of $630 million of debt
Divestiture of Komi region assets during 2008
Divestiture of Chepetskoye NGDU
Significant Board and Senior Management changes including appointment of Alexei Maximov as Chief Executive Officer and a Director post period end
Outlook
Main priority is to agree restructuring of Petraco indebtedness
Concentrate on early production increase from existing wells
Complete geological studies in 2010 to develop a drilling program
Look for possible corporate transactions to derive maximum value to shareholders
Alexei Maximov, Chief Executive, commented:
"We are pleased to be able to release our results today, which marks a significant milestone in the turnaround of the Company. We are now focused on refinancing the remaining Petraco debt, which has been reduced further in the last few months through our ongoing crude sale agreements.
The Company is now considering different options to increase production from the existing wells by means of side track drilling and installation of down hole pumps.
"The Company has started geological studies for both remaining fields with the aim of reviewing and approving new development schemes with the governmental bodies. This work is anticipated to be completed during 2010. Depending on the results of the studies and the restructuring of indebtedness with Petraco, the Company will develop a drilling programme and will announce it during 2010.
"Cost control also remains a priority and we are pleased with the progress made to date in this regard.
"With the Sberbank debt restructuring now resolved and the right team in place, Urals Energy is well set to maximize the potential of its existing assets and recommence development programmes, whilst also looking to increase further production by identifying new acquisition opportunities, in order to return to the creation of shareholder value."
Enquiries:
| Allenby Capital Limited | +44 (0)20 3328 5656 |
| Rod Venables/James Reeve | |
| Pelham PR | +44 (0)20 7337 1500 |
| Mark Antelme | |
| Evgeniy Chuikov |
Urals Energy will be holding an investor conference call on Thursday 10th December at 9.30am (GMT).
To participate please dial +44 (0)20 7190 1596 or +1 480 629 9724.
Investors wishing to submit questions should email them in advance to uralsenergy@pelhampr.com
CEO STATEMENT AND ANNUAL REPORT TO SHAREHOLDERS
From its IPO in 2005, Urals Energy grew rapidly, mostly through the acquisition of high quality assets in the Russian Komi region and, subsequently, East Siberia. Over the past two or three years the Company concentrated its efforts on developing assets in a single East Siberian region and made a decision to divest its smaller scale assets in other areas of Russia. The objective of being among the first companies to develop top quality assets in East Siberia was designed to create significant benefits for the Company and placed it extremely well amongst its Eastern Siberian peer group. The proximity of the East Siberian Pacific Ocean ("ESPO") pipeline, the mineral extraction tax break and expected export duty holiday were thought to create significant economic benefits for the Company.
Following its strategy to focus on key East Siberian assets, in 2008 and in early 2009 the Company sold all other non-core assets except Arcticneft and Petrosakh and used the proceeds to finance development of Dulisma and to pay interest and trade debt.
In November 2007, the Company received two loans from Sberbank: $130 million to refinance a Goldman Sachs facility for Dulisma and a $500 million loan for the acquisition of a stake in Taas-Yuryakh Neftegas Dobycha ("Taas"), the owner and operator of the Srednebotuobinskoye field. Both loans had an initial one year maturity, which was designed to be extended automatically upon the satisfaction of certain technical conditions. Also, the $130 million loan facility was to be increased by $140 million, which was planned to be spent on further drilling and infrastructure construction at Dulisma. In connection with the Sberbank loans, the Company pledged its 100% share in Dulisma and 35.3% share in Taas. Also, major management and founder shareholders of the Company pledged their own shares to the bank as further credit support.
The Company believed that it had fulfilled all conditions precedent for the loans to be extended and to drawdown the additional $140 million. However, unfortunately in part due to a shift in corporate policy following a major change in management at Sberbank, the company was unsuccessful in persuading the new management of Sberbank to agree with its long term strategy. In addition, as a direct consequence of the global crisis the Company's share price decreased below level acceptable to Sberbank and the bank delivered a margin call. The Company and individual shareholders were not able to satisfy the margin call and the bank did not extend the maturity nor did it provide the additional draw down, leaving the Company in a state of limited liquidity.
At the end of 2008, the Company was in negotiations with Sberbank and another possible investor, who was interested in acquiring all of Urals Energy with its existing properties. As was announced in early January 2009, the deal with a possible investor did not proceed and the Company had to return to the plan previously discussed and agreed with Sberbank. According to that agreement the Company intended to transfer all of its shares in Dulisma and Taas for the full discharge of the existing loans with the bank. Also, as part of the transaction, the bank agreed to release all other pledges to Limenitis and Finfund (other shareholders of Taas) and Limenitis agreed to cancel a Put option agreement and deeds of charge associated with that agreement.
A resolution was approved at an EGM, held 26 January 2009, to proceed with the planned transaction with Sberbank. Then, during the first half of 2009, the management of the Company proposed alternative solutions to the bank, which were designed to be more favourable to the Company and shareholders. Unfortunately, these discussions did not yield a mutually agreeable solution other than the previously announced divestiture of assets with Sberbank which had been approved at the Company's shareholder meeting held on 26 January 2009.
Also, since the announcement and implementation of the process of divestiture of the remaining non-core assets, the Company did not receive any acceptable bids for the assets and therefore decided that in view of the recovering oil prices it would be in the interest of all shareholders to maintain these assets and derive value through developing and operating them.
Corporate
Since the year end, key management changes have been made, reflecting the Company's efforts to develop and agree on an alternative solution with Sberbank, and subsequently to complete the previously announced and approved deal with Sberbank and manage more effectively the challenges presented by the adverse economic environment.
Following the resignation of Leonid Dyachenko as CEO in April 2009, and of Vladimir Sidorovich as CFO in May, and the subsequent resignation of Vyatchesla Ivanov, I assumed the role of Chief Executive and Director, and Grigory Kazakov was appointed as CFO. Leonid Dyachenko took on the role as Chairman of the Board. In June 2009, Vasiliy Sechin was appointment as a Non-Executive director.
Operational
Dulisma Field
Despite current financial difficulties which slowed down the Company's development efforts, a significant effort was made towards extensive infrastructure preparation, namely the construction of infield roads and land for facilities, drilling pads and rights-of-way on the Dulisma field.
Notable progress was also made with construction of the field facilities. The Central Processing Facilities at year end was at its final phase of equipment installation and could be launched within 3-6 months once the Company resumed its investment program. 90% of equipment had been delivered, 60% had been installed.
The first Phase of the Central Transfer Facility (to the ESPO pipeline) was scheduled for completion for the first half 2010. To date, 31 km of pipeline has been constructed, representing 42% of the planned workload. 100% of pipe has been acquired and delivered, right of way has been cleared of forest, 26 km of pipe welded and buried and the rest of the 42 km pipeline is at various phases of completion ranging from 40% to 60%.
The drilling campaign at Dulisma was on track with 1 well completed and two wells spudded in 2008. One well was completed in early 2009.
During the testing phase, the production rate from the Dulisma field varied from 1,094 to 1,703 BOPD and oil was sold through a temporary pipeline operated by a neighboring production company.
Overall, in 2008, the Company spent approximately $60 million in cash to finance Dulisma development.
Other Assets
In 2008, the management of the Company decided to focus on key East Siberian assets and divest other non-core assets. As a result of this decision, Dinyu, Michayuneft, NizhneomrinskayaNeft, CNPSEI and Chepetskoe NGDU were sold during 2008 and the early part of 2009.
With that disposal strategy in mind, the management did not commit funds for the development of Arcticneft and Petrosakh except for the mandatory capital expenditures to comply with the license requirements. During 2008, a total of $6.5 million was spent on capital expenditures at both assets.
As a result of such limited operations, production at Petrosakh decreased from 1,998 BOPD in January 2008 to 1,650 BOPD in November 2009, and at Arcticneft from 873 BOPD in January 2008 to 648 BOPD.
The management of the Company is now reviewing the budget for 2010 and will concentrate on the actions necessary to increase production from the existing wells and consider locations for new drilling. The geological studies have already begun and should be completed during 2010. After the results of these studies are analyzed, the management will develop a proposed drilling program.
2008 Financial
Operating Environment
After rising for several months in late 2007, crude oil prices surpassed $100 per barrel in January 2008. Rising up to $110 in March, Brent price reached a record of $145.11 per barrel in July for August delivery. Following some indications of global demand destruction and economic downturn in the United States and Europe, crude oil fell below $100 in September for the first time in over six weeks. The worsening of global crises led to a further sell-off with crude oil prices collapsed to $36.45 in December. The Russian market followed the global trend with crude oil prices of $86.05 per barrel at the beginning of the year and $20.40 per barrel at year end.
The rouble continued to appreciate against the dollar during the first six months of the year and continued its stability until the end of August. Starting September the government of Russian Federation announced plans to depreciate the Russian currency for the benefit of the economy which faced global financial crisis. As a result the rouble depreciated by 20% by the year end, resulting in lower operating costs for Russian oil companies.
The squeezing of financial markets led to the sharp decrease in the ability to attract financing both in Russia and internationally, which negatively affected the Company's operations.
Operating Results
| $ '000 | Year ended 31 December: | |
|
| 2008 | 2007 |
| Gross revenues before excise, export duties | 222,291 | 194,111 |
| Net revenues after excise, export duties and VAT | 174,854 | 152,428 |
| Gross (loss)/profit | (88,613) | (10,000) |
| Operating (loss)/profit | (132,092) | 139,677 |
| Normalised management EBITDA (unaudited) | (8,920) | 14,093 |
| Total net finance costs | 316,656 | 33,775 |
| Profit for the year | (403,249) | 113,791 |
In 2008, total gross revenues excluding crude oil for resale declined by $24 million. Positive price variance resulting from higher weighted average gross price per barrel of $64.48 comparing to $54.94 in 2007 was negatively offset by a decrease in sales volumes amounting to 2,183 thousand barrels in 2008 comparing to 3,124 thousand barrels in 2007, which was primarily due to the divestment of non-core assets and bad weather on Kolguev island in December, which prevented the Company to load 162,139 barrels of crude. These volumes were presented as finished goods in the balance sheet and were subsequently sold in October 2009.
Following the divestiture of subsidiaries in the Komi Republic, the Company continued to re-sell crude oil produced by these former subsidiaries on the export and domestic markets. The total cost of this purchased crude oil amounted to $98 million during the year ended 31 December 2008. Also the Company charged a commission on these operations, which was included in gross revenues in the financial statements. The profit margin on these operations is substantially lower than for the self-produced oil, as the price of purchased crude oil also includes a seller's mark-up. There were no such operations with the Komi subsidiaries in 2007.
Summary table: Gross Revenues ($'000)
| Year ended 31 December: | ||
| 2008 | 2007 | |
| Crude oil | 206,764 | 180,199 |
| Export sales | 74,859 | 112,091 |
| Export sales of purchased crude oil from AMNGR and Komi assets | 72,518 | 22,217 |
| Domestic sales (Russian Federation) | 59,387 | 45,891 |
| Petroleum (refined) products - domestic sales | 12,163 | 12,386 |
| Other sales | 3,364 | 1,526 |
| Total gross revenues | 222,291 | 194,111 |
In 2008, the Company's total net revenues increased to $174.9 million from $152.4 million in 2007. Netback, in the case of exports, is gross oil sales less export duty, customs charges, marketing costs and transportation, and, in the case of domestic crude oil sales, the gross sales net of VAT. Netback for domestic product sales is defined as gross product sales minus VAT, transportation, excise tax and refining costs.
The weighted average netback price for crude oil sales during 2008 was $43.74 versus $40.26 per barrel in 2007.
In 2007, netbacks for export sales (excluding sales of purchased crude oil) were $45.96 per barrel and $41.96 per barrel for domestic sales. Netback prices for domestic product sales are defined as gross product sales price minus VAT, transportation, excise tax and refining costs. The average products netback for the year was $65.48 per barrel (all domestic, as the Company does not export products).
Summary table: Net backs ($/bbl)
| Year ended 31 December: | ||
| 2008 | 2007 | |
| Crude oil | 43.74 | 40.26 |
| Export sales | 45.96 | 41.96 |
| Export sales (AMNGR crude oil) | 112.22 | 80.36 |
| Domestic sales (Russian Federation) | 33.44 | 30.95 |
| Petroleum (refined) products - domestic sales | 65.48 | 32.61 |
| Other sales | N/A | N/A |
The gross loss of the Company for the year 2008 was $87 million comparing to $10 million in 2007. The main drivers of the increased loss were impairment charges recognized by the Company in 2008 in the amount of $95 million. According to IFRS, those expenses were included in the Cost of sales. Without those write-offs the Gross profit would be $8.1 million. Cost of sales excluding cost of crude oil purchased for resale was relatively stable as compared to the year 2007. The depreciation and depletion decrease by $12 million was due to divestment of non-core Komi assets.
Selling, General and Administrative expenses decreased during the year 2008 by $15 million to $44.3 million from $59.2 million in 2007. This was primarily due to settlement of unvested stock and cash compensation for the former senior management who resigned during 2007. Also a decrease in the SG&A amounting to $5 million was driven by non-recurring fees paid by the Company to professional advisors in relation to certain significant acquisitions and other corporate actions undertaken in 2007.
Following the acquisition of 35.329% stake in Taas in 2007 the Group recognized $208 million negative goodwill in consolidated income statement. Without that item the Company would record an operating loss of $69 million in 2007 as compared to $134 million loss in 2008.
The net finance costs increased substantially by $283 million due to recognized loss from equity investment in Taas amounting to $160 million and interest expense paid on two loans received from Sberbank mentioned below (amounting to $98 million).
Net loss for the year attributable to shareholders was $402.0 million as compared to net profit of $114 million in 2007. The other non-recurring factor for this result is recognized loss of investment in Taas following sharp decrease in oil prices in the end of 2008 and reassessment of future discounted cash flows from this asset performed by the Company. The method for calculating the fair market value is a conservative discounted cash flow valuation based on factors known at the time
Consolidated normalized management EBITDA decreased by $21.2 million to a negative figure of $7.1 million in 2008 compared with positive $14.1 million in 2007, with EBITDA margins of (1.6) % and 9% respectively.
Management EBITDA ($'000) - Unaudited
| Year ended 31 December | ||
| 2008 | 2007 | |
| Profit for the year attributable to shareholders of UEPCL | (403,249) | 113,791 |
| Net interest and foreign currency (income)/expense | 316,656 | 33,775 |
| Income tax | (37,377) | (9,602) |
| Depreciation, depletion and amortization | 16,514 | 28,974 |
| Total non-cash expenses | 295,793 | 53,147 |
| Negative Goodwill | - | (208,713) |
| Share-based payments | 8,971 | 14,113 |
| Impairment of property, plant and equipment | 94,955 | 31,997 |
| Resignation fees to top-managers | - | 8,107 |
| (Release)/accrual of other taxes risk provision | (189) | (1,929) |
| Expenses related to unsuccessful PP in August '07 | - | 1,504 |
| Gain from disposal of assets held for sale | (8,121) | - |
| Write-off non-producing wells | 2,552 | - |
| - | ||
| Other non-recurrent losses | 2,161 | 3,034 |
| Total non-recurrent and non-cash items | 100,329 | (152,845) |
| Normalized EBITDA | (7,127) | 14,093 |
Cash Flow
The cash position was negatively affected by the interest expense accrued on outstanding borrowing amounting to $78 million and continuing capital investment outflows for Dulisma development amounting to $60 million. Proceeds from sale of subsidiaries generated $93 million of positive cash flow improving the cash position and providing additional resources to keep on track with day-to-day operations. As a result Company's cash position decreased by $27 million to $1 million at the year end.
Net debt Position
Towards the end of the 2007, the Company entered into two loan agreements with Sberbank, aiming to finance the acquisition of Taas and to further develop the Dulisma field. The principal amount outstanding as at 31 December 2008 was $630 million. As collateral for these loans, certain of the Company's major non-institutional shareholders pledged UEPCL shares and the Company pledged 100% of the Company's shares in Dulisma and Taas. As at 31 December 2008 both loans were overdue. Subsequent to the year-end the Company transferred all of its shares of Dulisma and Taas to Sberbank Capital for the full discharge of those loans. As part of that deal, the Company was released of any obligations under a Put option agreement with Ashmore, which was valued at $161 million in the consolidated financial statements.
Accounts payable and advances from customers at the year end mainly represented outstanding debt for completed items of Construction in progress amounting to $19 million and the revolving prepayment agreement with Petraco, amounting to $50.5 million. Under the terms of the agreement, prepayments shall be made in one or more advances against specified future deliveries of agreed volumes of crude oil to be sold to Petraco.
In December 2008, the original Petraco repayment schedule was modified to take into account decreased oil prices and Company's financial position. Under this schedule the Company would have to decrease the amount outstanding to $25 million by July 1, 2009 with the remaining balance payable by deliveries to be made in 2009 and 2010. Subsequent to year-end management realized that the proposed repayment schedule was not feasible and the Company proposed an amendment to the repayment schedule allowing for a more gradual repayment of the currently outstanding $41.3 million in 2009 and 2010 and providing additional security to Petraco. At the date of these financials statements, those discussions were on going and were subject to certain other negotiations where the Company is a party.
Disposal of assets
In 2008, the Company completed the sale of Komi assets - Dinyu, Michayuneft, NizhneomrinskayaNeft and CNPSEI for the total cash consideration of $93 million. The gain from disposal amounting to $8 million was recognized in the consolidated income statement for the year 2008. Subsequent to the year end, the Company sold Chepetskoye NGDU for the equivalent of cash consideration of $5 million. The result of the disposal will be recognized in the interim financial statements for the 6 months ended 30 June 2009.
As at 31 December 2008, management assessed Chepetskoye NGDU for impairment using the information regarding the transaction which was available at that date as an indicator of the fair value of the asset. As a result of this analysis, an impairment charge of $17 million was recognized in the consolidated income statement.
Cost reduction initiatives
The dramatic changes in market conditions in the second half of the year, including sharp decrease in oil prices, both domestic and international, notable decline in demand and squeezing of financial markets and borrowing capacities, forced the Company's management to implement extensive cost reduction activities, capital investments preservation and liquidity improving measures in order to mitigate these challenges and be able to operate as effectively as possible in such an unstable environment. Management expects that the Company will start yielding the benefits from this program in 2009.
Sincerely,
Alexei Maximov
Chief Executive Officer
Urals Energy Public Company Limited
International Financial Reporting Standards
Consolidated Financial Statements As of and for the Year Ended 31 December 2008
| Independent Auditors' Report To the Members of Urals Energy Public Limited |
Report on the Financial Statements
We have audited the consolidated financial statements of Urals Energy Public Limited (the "Company") and its subsidiaries (the "Group") on pages 4 to 53, which comprise the consolidated balance sheet as at 31 December 2008, and the consolidated income statement, consolidated statement of changes in equity and consolidated cash flow statement for the year then ended and a summary of significant accounting policies and other explanatory notes.
Board of Directors' Responsibility for the Financial Statements
The Company's Board of Directors is responsible for the preparation and fair presentation of these financial statements in accordance with International Financial Reporting Standards as adopted by the European Union (EU). This responsibility includes: designing, implementing and maintaining internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error; selecting and applying appropriate accounting policies; and making accounting estimates that are reasonable in the circumstances.
Auditors' Responsibility
Our responsibility is to express an opinion on these financial statements based on our audit. Except as discussed in the Basis for Qualified Opinion paragraph, we conducted our audit in accordance with International Standards on Auditing. Those Standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance whether the financial statements are free from material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor's judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity's preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity's internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by the Board of Directors, as well as evaluating the overall presentation of the financial statements.
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion
Basis for Qualified Opinion
The Company's management have classified the assets and liabilities of its subsidiary Chepetskoye NGDU ('Chepetskoye') as held-for-sale as of 31 December 2008. A sale agreement was agreed in substance prior to 31 December 2008 and was concluded in January 2009 with a third party for the disposal of Chepetskoye. The sale agreement included a currently exercisable call option for the Group to repurchase Chepetskoye. Due to the existence of the call option, not all of the criteria under IFRS 5 ''Non current assets held for sale and discontinued operations'' required for classification of Chepetskoye as an asset held-for-sale were met as of 31 December 2008. As a result assets held-for-sale and liabilities associated with non-current assets held-for-sale were overstated by US$ 20.0 million and US$ 17.2 million, respectively. This matter does not impact either total assets or total liabilities as of 31 December 2008.
Qualified Opinion
In our opinion, except for the effect on the financial statements of the matter described in the Basis for Qualified Opinion paragraph, the consolidated financial statements give a true and fair view of the financial position of Urals Energy Public Limited and its subsidiaries as of 31 December 2008, and of its financial performance and its cash flows for the year then ended in accordance with International Financial Reporting Standards as adopted by the EU.
Emphasis of matter - Going Concern
Without further qualifying our audit opinion, we draw attention to Note 3 to the consolidated financial statements which indicates that the Group incurred a loss for the year amounting to US$ 403.2 million, was as of 31 December 2008 in default with respect to its financing arrangements and that the Group's current liabilities exceed its current assets by US$ 758.2 million as of 31 December 2008. These conditions, along with other matters as set forth in Note 3, indicate the existence of a material uncertainty which may cast significant doubt about the Group's ability to continue as a going concern.
Other Matter
This report, including the opinion, has been prepared for and only for the Company's members as a body and for no other purpose. We do not, in giving this opinion, accept or assume responsibility for any other purpose or to any other person to whose knowledge this report may come to.
PricewaterhouseCoopers Limited
Chartered Accountants
Nicosia, 7 December 2009
Urals Energy Public Company Limited
Consolidated Balance Sheets
(presented in US$ thousands)
| 31 December: | |||
| Note | 2008 | 2007 | |
| Assets | |||
| Current assets | |||
| Cash and cash equivalents | 912 | 28,400 | |
| Accounts receivable and prepayments | 9 | 28,912 | 38,771 |
| Promissory notes receivable | 16 | - | 64,581 |
| Current income tax prepayments | 15 | 905 | |
| Inventories | 10 | 4,100 | 21,464 |
| Assets held for sale | 8 | 99,163 | 133,363 |
| Total current assets | 133,102 | 287,484 | |
| Non-current assets | |||
| Property, plant and equipment | 11 | 336,968 | 518,323 |
| Supplies and materials for capital construction | 13,892 | 22,422 | |
| Financial derivatives | 7 | - | 5,103 |
| Other non-current assets | 12 | 39,885 | 23,729 |
| Investment in joint venture | 7 | 751,600 | 911,433 |
| Deferred tax assets | 15 | - | 1,925 |
| Total non-current assets | 1,142,345 | 1,482,935 | |
| Total assets | 1,275,447 | 1,770,419 | |
| Liabilities and equity | |||
| Current liabilities | |||
| Accounts payable and accrued expenses | 13 | 29,796 | 23,397 |
| Income tax payable | 3,810 | 2,079 | |
| Other taxes payable | 15 | 402 | 3,429 |
| Financial instruments | 7 | 161,300 | 118,657 |
| Short-term borrowings and current portion of long-term borrowings | 16 | 629,749 | 614,031 |
| Advances from customers | 14 | 55,778 | 55,179 |
| Liabilities associated with non-current assets held for sale | 8 | 10,248 | 27,477 |
| Current liabilities before warrants classified as liabilities | 891,083 | 844,249 | |
| Warrants classified as liabilities | 177 | 1,326 | |
| Total current liabilities | 891,260 | 845,575 | |
| Long-term liabilities | |||
| Long-term borrowings | - | 29 | |
| Long-term finance lease obligations | - | 1,164 | |
| Dismantlement provision | 17 | 15 | 1,448 |
| Deferred tax liabilities | 15 | 34,344 | 93,835 |
| Total long-term liabilities | 34,359 | 96,476 | |
| Total liabilities | 925,619 | 942,051 | |
| Equity | |||
| Share capital | 18 | 1,122 | 990 |
| Share premium | 18 | 640,080 | 625,111 |
| Difference from conversion of share capital into US$ | 18 | (113) | - |
| Translation difference | (40,321) | 49,919 | |
| Retained earnings (accumulated deficit) | (251,045) | 150,744 | |
| Equity attributable to shareholders of Urals Energy Public Company Limited | 349,723 | 826,764 | |
| Minority interest | 105 | 1,604 | |
| Total equity | 349,828 | 828,368 | |
| Total liabilities and equity | 1,275,447 | 1,770,419 | |
Approved on behalf of the Board of Directors on 24 November 2009
| A.D. Maximov Chief Executive Officer | G.B.Kazakov Chief Financial Officer |
Urals Energy Public Company Limited
Consolidated Statements of Cash Flows
(presented in US$ thousands)
| Year ended 31 December: | |||
|
| Note | 2008 | 2007 |
| Revenues | |||
| Gross revenues | 19 | 222,291 | 194,111 |
| Less: excise taxes | 19 | (287) | 1,103 |
| Less: export duties | (47,150) | (42,786) | |
| Net revenues after excise taxes, export duties and VAT | 174,854 | 152,428 | |
| Cost of sales | 20 | (166,721) | (131,389) |
| Impairment charges | 6, 11 | (94,955) | (31,039) |
| Gross loss | (86,822) | (10,000) | |
| Selling, general and administrative expenses | 21 | (44,331) | (59,233) |
| Excess of net assets acquired over purchase price | - | 208,713 | |
| Other operating (loss) gain | (939) | 197 | |
| Total operating costs | (45,270) | 149,677 | |
| Operating (loss) profit | (132,092) | 139,677 | |
| Gain from disposal of assets held for sale | 8 | 8,121 | - |
| Interest income | 16 | 5,654 | 2,622 |
| Interest expense | 16 | (98,451) | (47,648) |
| Foreign currency (loss) gain | (17,428) | 9,651 | |
| Loss from equity investment in joint venture | 7 | (159,833) | - |
| Change in fair value of financial derivatives | 7 | (46,597) | 1,600 |
| Total net finance costs | (316,655) | (33,775) | |
| (Loss) Profit before income tax | (440,626) | 105,902 | |
| Income tax benefit | 15 | 37,377 | 7,889 |
| (Loss) Profit for the year | (403,249) | 113,791 | |
| (Loss) Profit for the year attributable to: - Minority interest | (1,460) | 69 | |
| - Shareholders of Urals Energy Public Company Limited | (401,789) | 113,722 | |
| (Loss) Earnings per share of profit attributable to shareholders of Urals Energy Public Company Limited: | 18 | ||
| - Basic earnings per share (in US dollar per share) | (2.26) | 0.94 | |
| - Diluted earnings per share (in US dollar per share) | (2.26) | 0.82 | |
Urals Energy Public Company Limited
Consolidated Statements of Cash Flows
(presented in US$ thousands)
| Year ended 31 December: | |||
|
| Note | 2008 | 2007 |
| Cash flows from operating activities | |||
| (Loss) Profit before income tax | (440,626) | 105,902 | |
| Adjustments for: | |||
| Depreciation, amortization and depletion | 20 | 16,514 | 28,974 |
| Change in fair value of financial derivatives | 7 | 46,597 | (1,600) |
| Loss from equity investment in joint venture | 7 | 159,833 | - |
| Share-based payment | 18 | 8,971 | 14,113 |
| Interest income | 16 | (5,654) | (2,622) |
| Interest expense | 16 | 98,451 | 47,648 |
| Gain from disposal of assets held for sale | 8 | (8,121) | - |
| Accrual (release) of provision on inventory | 10 | 4,307 | (882) |
| Impairment charges | 6, 11 | 94,955 | 31,039 |
| Write-off of unsuccessful drilling costs | 11 | 2,552 | - |
| Bad debt write-off | 21 | 2,161 | - |
| Release of other taxes provision | 15 | (189) | (1,929) |
| Excess of net assets acquired over purchase price | 7 | - | (208,713) |
| Foreign currency (gain) loss | 17,428 | (9,651) | |
| Other non-cash transactions | (7) | 620 | |
| Operating cash flows before changes in working capital | (2,828) | 2,899 | |
| Increase in inventories | (10,666) | (7,507) | |
| Increase in accounts receivable and prepayments | (12,848) | (6,627) | |
| Increase in accounts payable and accrued expenses | 25,781 | 5,130 | |
| Increase in advances from customers | 693 | 24,322 | |
| Decrease in other taxes payable | (2,187) | (8,710) | |
| Cash (used in) generated from operations | (2,055) | 9,507 | |
| Interest received | 2,389 | 2,156 | |
| Interest paid | (78,022) | (35,632) | |
| Income tax paid | (2,136) | (1,824) | |
| Net cash used in operating activities | (79,824) | (25,793) | |
| Cash flows from investing activities | |||
| Proceeds from sale of subsidiaries, net of cash acquired | 8 | 93,107 | - |
| Acquisition of joint venture | (589) | (495,283) | |
| Purchase of property, plant and equipment | (68,354) | (80,357) | |
| Purchase of intangible assets | (82) | (1,626) | |
| Loans issued | (26,616) | (6,057) | |
| Proceeds on loans issued | 774 | - | |
| Purchase of promissory notes | 16 | - | (70,000) |
| Repayment of promissory notes | 16 | 64,247 | 5,753 |
| Net cash generated from (used in) investing activities | 62,487 | (647,570) | |
| Cash flows from financing activities | |||
| Proceeds from borrowings | 16 | 18,000 | 776,000 |
| Repayment of loan organization fees | 16 | (10,000) | (11,586) |
| Repayment of borrowings | 16 | (18,365) | (198,924) |
| Purchase of financial derivatives | - | (20,457) | |
| Repayment of financial derivatives | - | 7,737 | |
| Finance lease principal payments | (468) | (423) | |
| Cash proceeds from issuance of ordinary shares gross | 18 | 6,155 | 125,830 |
| Expenses related to issuance of ordinary shares | 18 | (263) | (9,228) |
| Cash proceeds from exercise of options | 18 | 125 | - |
| Net cash (used in) generated from financing activities | (4,816) | 668,949 | |
| Effect of exchange rate changes on cash and cash equivalents | (5,354) | 111 | |
| Net decrease in cash and cash equivalents | (27,507) | (4,303) | |
| Cash and cash equivalents at the beginning of the year | 28,779 | 33,082 | |
| Cash and cash equivalents at the end of the year | 1,272 | 28,779 | |
| Cash and cash equivalents at the end of the year of the Group, excluding those classified as held for sale | 912 | 28,400 | |
| Cash and cash equivalents at the end of the year of the assets classified as held for sale | 8 | 360 | 379 |
Urals Energy Public Company Limited
Consolidated Statements of Changes in Shareholder's Equity
(presented in US$ thousands)
| Notes | Share capital | Share premium | Difference from conversion of share capital into US$ | Cumulative Translation Adjustment | Retained earnings (accumulated deficit) | Equity attributable to Shareholders of Urals Energy Public Company Limited | Minority interest | Total equity | |
| Balance at 1 January 2007 | 633 | 401,448 | - | 22,445 | 37,022 | 461,548 | 1,428 | 462,976 | |
| Effect of currency translation | - | - | - | 27,474 | - | 27,474 | 107 | 27,581 | |
| Profit for the year | - | - | - | - | 113,722 | 113,722 | 69 | 113,791 | |
| Total recognized income | - | - | - | 27,474 | 113,722 | 141,196 | 176 | 141,372 | |
| Issuance of shares | 18 | 357 | 209,550 | - | - | - | 209,907 | - | 209,907 |
| Share-based payment | 18 | - | 14,113 | - | - | - | 14,113 | - | 14,113 |
| Balance at 31 December 2007 | 990 | 625,111 | - | 49,919 | 150,744 | 826,764 | 1,604 | 828,368 | |
| Effect of currency translation | - | - | - | (76,982) | - | (76,982) | (39) | (77,021) | |
| Accumulative translation adjustment relating to disposed subsidiaries | - | - | - | (13,258) | 13,258 | - | - | - | |
| Loss for the year | - | - | - | (415,047) | (415,047) | (1,460) | (416,507) | ||
| Total recognized loss | - | - | - | (90,240) | (401,789) | (492,029) | (1,499) | (493,528) | |
| Issuance of shares | 18 | 19 | 5,998 | - | - | - | 6,017 | - | 6,017 |
| Share-based payment | 18 | - | 8,971 | - | - | - | 8,971 | - | 8,971 |
| Difference from conversion of share capital into US$ | 18 | 113 | - | (113) | - | - | - | - | - |
| Balance at 31 December 2008 | 1,122 | 640,080 | (113) | (40,321) | (251,045) | 349,723 | 105 | 349,828 |
Urals Energy Public Company Limited
Notes to the Consolidated Financial Statements
(presented in US$ thousands)
1 Activities
Urals Energy Public Company Limited ("Urals Energy" or the "Company" or "UEPCL") was incorporated as a limited liability company in Cyprus on 10 November 2003. Urals Energy and its subsidiaries (the "Group") are primarily engaged in oil and gas exploration and production in the Russian Federation and processing of crude oil for distribution on both the Russian and international markets.
The registered office of Urals Energy is at 31 Evagorou Avenue, Suite 34, CY-1066, Nicosia, Cyprus. UEPCL's shares are traded on the AIM Market operated by the London Stock Exchange. On 30 June 2009 the Company's shares were suspended from trading on LSE AIM due to non-compliance with Rule 19 of the AIM rules for not publishing 2008 year-end accounts. For more information see Note 25.
The Group comprises UEPCL and the following main subsidiaries and joint venture (Note 7):
| Entity | Jurisdiction | Effective ownership interest at 31 December | |
| 2008 | 2007 | ||
| Exploration and production | |||
| OOO Oil Company Dulisma ("Dulisma") | Irkutsk | 100.0% | 100.0% |
| ZAO Petrosakh ("Petrosakh") | Sakhalin | 97.2% | 97.2% |
| ZAO Arcticneft ("Arcticneft") | Nenetsky | 100.0% | 100.0% |
| OOO Lenskaya Transportnaya Kompaniya ("LTK") | Irkutsk | 100.0% | 100.0% |
| ZAO Chepetskoye NGDU ("Chepetskoye") | Udmurtia | 100.0% | 100.0% |
| OOO Taas-Yuryakh Neftegazdobycha ("Taas") | Sakha-Yakutia | 35.3% | 35.3% |
| OOO CNPSEI ("CNPSEI") | Komi | 0.0% | 100.0% |
| OOO Dinyu ("Dinyu") | Komi | 0.0% | 100.0% |
| OOO Michayuneft ("Michayuneft") | Komi | 0.0% | 100.0% |
| OOO Nizhneomrinskaya Neft ("Nizhneomrinskaya Neft") | Komi | 0.0% | 100.0% |
| Management company | |||
| OOO Urals Energy | Moscow | 100.0% | 100.0% |
| Urals Energy (UK) Limited (dormant starting from May 2007) | United Kingdom | 100.0% | 100.0% |
| Exploration | |||
| OOO Urals-Nord ("Urals-Nord") | Nenetsky | 100.0% | 100.0% |
2 Summary of Significant Accounting Policies
Basis of preparation. The consolidated financial statements of the Group have been prepared in accordance with International Financial Reporting Standards (IFRS), as adopted by the European Union (EU).
All International Financial Reporting Standards issued by the International Accounting Standards Board (IASB) and effective as at 1 January 2008 have been adopted by the EU through the endorsement procedure established by the European Commission, with the exception of certain provisions of IAS 39 "Financial Instruments: Recognition and Measurement" relating to portfolio hedge accounting.
These consolidated financial statements have been prepared under the historical cost convention as modified by the change in fair value of financial instruments. The preparation of consolidated financial statements in conformity with IFRS requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the reporting date and the reported amounts of revenues and expenses during the reporting period. These policies have been consistently applied to all the periods presented, unless otherwise stated. Critical accounting estimates and judgements are disclosed in Note 5. Actual results could differ from the estimates.
Functional and presentation currency. The United States dollar ("US dollar or US$ or $") is the presentation currency for the Group's operations as management have used the US dollar accounts to manage the Group's financial risks and exposures, and to measure its performance. Financial statements of the Russian subsidiaries are measured in Russian Roubles, their functional currency.
Translation to functional currency. Monetary balance sheet items denominated in foreign currencies have been remeasured using the exchange rate at the respective balance sheet date. Exchange gains and losses resulting from foreign currency translation are included in the determination of profit or loss. The US dollar to Russian Rouble exchange rates were 29.38 and 24.55 as of 31 December 2008 and 2007, respectively.
Translation to presentation currency. The Group's financial statements are presented in US dollars in accordance with IAS 21 The Effects of Changes in Foreign Exchange Rates. The results and financial position of each group entity having a functional currency different from the presentation currency are translated into the presentation currency as follows:
(i) Assets and liabilities for each balance sheet presented are translated at the closing rate at the date of that balance sheet. Goodwill and fair value adjustments arising on the acquisitions are treated as assets and liabilities of the acquired entity.
(ii) Income and expenses for each income statement are translated at average exchange rates (unless this average is not a reasonable approximation of the cumulative effect of the rates prevailing on the transaction dates, in which case income and expenses are translated at the dates of the transactions).
(iii) All resulting exchange differences are recognised as a separate component of equity.
When a subsidiary is disposed of through sale, liquidation, repayment of share capital or abandonment of all, or part of, that entity, the exchange differences deferred in equity are reclassified to the consolidated income statement.
2 Summary of Significant Accounting Policies (continued)
Group accounting. Subsidiaries, which are those entities in which the Group has an interest of more than one half of the voting rights, or otherwise has power to exercise control over the operations, are consolidated. Subsidiaries are consolidated from the date on which control is transferred to the Group and are no longer consolidated from the date that control ceases. The purchase method of accounting is used to account for the acquisition of subsidiaries by the Group. The cost of an acquisition is measured as the fair value of the consideration provided or liabilities incurred or assumed at the date of exchange plus costs directly attributable to the acquisition.
All intercompany transactions, balances and unrealised gains on transactions between group companies are eliminated; unrealised losses are also eliminated unless the transaction provides evidence of an impairment of the asset transferred.
Minority interest at the balance sheet date represents the minority shareholders' portion of the fair values of the identifiable assets, liabilities and contingent liabilities of the subsidiary at the acquisition date, and the minority's portion of movements in equity since the date of the combination. Minority interest is presented as a separate component of equity. Where the losses applicable to the minority in a consolidated subsidiary exceed the minority interest in the equity of the subsidiary, the excess and any further losses applicable to the minority are charged against the majority interest except to the extent that the minority has a binding obligation to, and is able to, make good the losses. If the subsidiary subsequently reports profits, the majority interest is allocated all such profits until the minority's share of losses previously absorbed by the majority has been recovered.
The Group applies a policy of treating transactions with minority interests as transactions with parties external to the Group. Disposals to minority interests result in gains or losses for the Group that are recorded in the consolidated income statement. Purchases from minority interests result in goodwill, being the difference between any consideration paid and the relevant share acquired of the carrying value of net assets of the subsidiary.
The Group accounts for the interest in a joint venture using the equity method of accounting. Investments in joint ventures are initially recognised at fair value. The group's investment in joint venture includes negative goodwill identified on acquisition, and immediately recognised as income in the consolidated income statement.
The Group's share of its joint venture's post-acquisition profits or losses is recognised in the consolidated income statement, and its share of post-acquisition movements in reserves is recognised in reserves. The cumulative post-acquisition movements are adjusted against the carrying amount of the investment. When the Group's share of losses in a joint venture equals or exceeds its interest in the joint venture, including any other unsecured receivables, the Group does not recognise further losses, unless it has incurred obligations or made payments on behalf of the associate.
Unrealised gains on transactions between the Group and its joint venture are eliminated to the extent of the Group's interest in the joint venture. Unrealised losses are also eliminated unless the transaction provides evidence of an impairment of the asset transferred. Accounting policies of joint venture have been changed where necessary to ensure consistency with the policies adopted by the Group.
Dilution gains and losses arising in investments in joint venture are recognised in equity.
2 Summary of Significant Accounting Policies (continued)
Property, plant and equipment. Property, plant and equipment acquired as part of a business combination is recorded at fair value at the acquisition date and adjusted for accumulated depreciation, depletion and impairment. All subsequent additions are recorded at historical cost of acquisition or construction and adjusted for accumulated depreciation, depletion and impairment. Oil and gas exploration and production activities are accounted for in a manner similar to the successful efforts method. Costs of successful development and exploratory wells are capitalised. The cost of property, plant and equipment includes provisions for dismantlement, abandonment and site restoration (see Provisions below).
The Group accounts for exploration and evaluation activities in accordance with IFRS 6, Exploration for and Evaluation of Mineral Resources. Geological and geophysical exploration costs are charged against income as incurred. Costs directly associated with an exploration well are initially capitalised as an intangible asset until the drilling of the well is complete and the results have been evaluated. These costs include employee remuneration, materials and fuel used, rig costs, delay rentals and payments made to contractors. If hydrocarbons are not found, the exploration expenditure is written off as a dry hole. If hydrocarbons are found and, subject to further appraisal activity, which may include the drilling of further wells (exploration or exploratory-type stratigraphic test wells), are likely to be capable of commercial development, the costs continue to be carried as an asset. All such carried costs are subject to technical, commercial and management review at least once a year to confirm the continued intent to develop or otherwise extract value from the discovery. When this is no longer the case, the costs are written off. When proved reserves of oil and natural gas are determined and development is sanctioned, the relevant expenditure is transferred to property, plant and equipment.
Depletion of capitalized costs of proved oil and gas properties is calculated using the unit-of-production method for each field based upon proved reserves for property acquisitions and proved developed reserves for exploration and development costs. Oil and gas reserves for this purpose are determined in accordance with Society of Petroleum Engineers definitions and were estimated by DeGolyer and MacNaughton, the Group's independent reservoir engineers. Gains or losses from retirements or sales of oil and gas properties are included in the determination of profit for the year.
Depreciation of non oil and gas property, plant and equipment is calculated using the straight-line method over their estimated remaining useful lives, as follows:
| Estimated useful life | ||
| Refinery and related equipment | 19 | |
| Buildings | 20 | |
| Other assets | 6 to 20 |
The assets' residual values and useful lives are reviewed, and adjusted if appropriate, at each balance sheet date. Gains and losses on disposals are determined by comparing the proceeds with the carrying amount and are recognised within 'Other (losses)/gains - net' in the consolidated income statement.
Intangible assets. The Group measures intangible assets at cost less accumulated amortisation and impairment losses. All of the Group's other intangible assets have finite useful lives and primarily include capitalised computer software and licences.
Acquired computer software licences are capitalised on the basis of the costs incurred to acquire and bring them to use.
Development costs that are directly associated with identifiable and unique software controlled by the Group are recorded as intangible assets if probable future economic benefits will be generated. Capitalised costs include staff costs of the software development team and an appropriate portion of relevant overheads. All other costs associated with computer software, e.g. its maintenance, are expensed when incurred.
Intangible assets are amortised using the straight-line method over their useful lives:
| Estimated useful life | |
| Software licences | 1-5 |
| Capitalised internal software development costs | 3 |
| Other licences | 5 to 7 |
2 Summary of Significant Accounting Policies (continued)
Provisions. Provisions are recognised when the Group has a present legal or constructive obligation as a result of past events and when it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation, and a reliable estimate of the amount of the obligation can be made.
Provisions, including those related to dismantlement, abandonment and site restoration, are evaluated and re-estimated annually, and are included in the financial statements at each balance sheet date at the present value of the expenditures expected to be required to settle the obligation using pre - tax discount rates which reflect the current market assessment of the time value of money and the risks specific to the liability.
Changes in provisions resulting from the passage of time are reflected in the consolidated income statement each year under financial items. Other changes in provisions, relating to a change in the expected pattern of settlement of the obligation, changes in the discount rate or in the estimated amount of the obligation, are treated as a change in accounting estimate in the period of the change. Changes in provisions relating to dismantlement, abandonment and site restoration are added to, or deducted from, the cost of the related asset in the current period. The amount deducted from the cost of the asset should not exceed its carrying amount. If a decrease in the liability exceeds the carrying amount of the asset, the excess is recognised immediately in profit or loss.
The provision for dismantlement liability is recorded on the balance sheet, with a corresponding amount being recorded as part of property, plant and equipment in accordance with IAS 16.
Leases. Leases of property, plant and equipment where the Group has substantially all the risks and rewards of ownership are classified as finance leases. Finance leases are capitalised at the commencement of the lease at the lower of the fair value of the leased property or the present value of the minimum lease payments. The corresponding rental obligations, net of finance charges, are presented as finance lease obligations on the consolidated balance sheet. The interest element of the finance cost is charged to the consolidated income statement over the lease period. Property, plant and equipment acquired under finance leases are depreciated over the shorter of the useful life of the asset or the lease term.
Leases in which a significant portion of the risks and rewards of ownership are retained by the lessor are classified as operating leases. Payments made under operating leases are charged to the consolidated income statement on a straight-line basis over the period of the lease.
Impairment of assets. Assets that are subject to depreciation and depletion are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. An impairment loss is recognised for the amount by which the asset's carrying amount exceeds its recoverable amount. The recoverable amount is the higher of an asset's fair value less costs to sell or value in use. For the purposes of assessing impairment, assets are grouped by license areas, which are the lowest levels for which there are separately identifiable cash flows (cash-generating units).
Inventories. Inventories of extracted crude oil, materials and supplies and construction materials are valued at the lower of the weighted-average cost and net realisable value. General and administrative expenditure is excluded from inventory costs and expensed in the period incurred.
Trade receivables. Trade receivables are recognised initially at fair value and subsequently measured at amortised cost using the effective interest method, net of provision for impairment. A provision for impairment of trade receivables is established when there is objective evidence that the Group will not be able to collect all amounts due according to the original terms of receivables. The amount of the provision is the difference between the asset's carrying amount and the present value of estimated future cash flows, discounted at the original effective interest rate. The change in the amount of the provision is recognised in the consolidated income statement.
2 Summary of Significant Accounting Policies (continued)
Cash and cash equivalents. Cash and cash equivalents includes cash in hand, deposits held at call with banks, and other short-term highly liquid investments with original maturities of three months or less. Cash and cash equivalents are carried at amortised cost using the effective interest method. Restricted balances are excluded from cash and cash equivalents for the purposes of the consolidated cash flow statement. Balances restricted from being exchanged or used to settle a liability for at least twelve months after the balance sheet date are included in other non-current assets.
Value added tax. Output value added tax related to sales is payable to tax authorities on the earlier of (a) collection of receivables from customers or (b) delivery of goods or services to customers. Input VAT is generally recoverable against output VAT upon receipt of the VAT invoice. The tax authorities permit the settlement of VAT on a net basis. VAT related to sales and purchases is recognised in the balance sheet on a gross basis and disclosed separately as an asset and liability. Where provision has been made for impairment of receivables, impairment loss is recorded for the gross amount of the debtor, including VAT.
Borrowings. Borrowings are recognised initially at the fair value of the liability, net of transaction costs incurred. In subsequent periods, borrowings are stated at amortised cost using the effective yield method; any difference between amount at initial recognition and the redemption amount is recognised as interest expense over the period of the borrowings. Borrowings are classified as current liabilities unless the Group has an unconditional right to defer settlement of the liability for at least 12 months after the balance sheet date. Interest costs on borrowings to finance the construction of property, plant and equipment are capitalised during the period of time that is required to complete and prepare the asset for its intended use.
Loans receivable. The loans advanced by the Group are classified as "loans and receivables" in accordance with IAS 39 and stated at amortised cost using the effective interest method. These loans are individually tested for impairment at each reporting date.
Income taxes. Income taxes have been provided for in the consolidated financial statements in accordance with Russian legislation enacted or substantively enacted by the balance sheet date. The income tax charge or benefit comprises current tax and deferred tax and is recognised in the consolidated income statement unless it relates to transactions that are recognised, in the same or a different period, directly in equity.
Current tax is the amount expected to be paid to or recovered from the taxation authorities in respect of taxable profits or losses for the current and prior periods. Taxes other than on income are recorded within operating expenses.
Deferred income tax is calculated at rates enacted or substantively enacted by the balance sheet date, using the balance sheet liability method, for all temporary differences between the tax bases of assets and liabilities and their carrying values for financial reporting purposes. The principal temporary differences arise from depreciation on property, plant and equipment, provisions and other fair value adjustments to long-term items, and expenses which are charged to the consolidated income statement before they become deductible for tax purposes.
Deferred income tax assets attributable to deducible temporary differences, unused tax losses and credits are recognised only to the extent that it is probable that future taxable profit or taxable temporary differences will be available against which they can be utilised.
Deferred income tax assets and liabilities are offset when the Group has a legally enforceable right to set off current tax assets against current tax liabilities, when deferred tax balances relate to the same regulatory body, and when they relate to the same taxable entity.
The Group's uncertain tax positions are reassessed by management at every balance sheet date. Liabilities are recorded for income tax positions that are determined by management as more likely than not to result in additional taxes being levied if the positions were to be challenged by the tax authorities. The assessment is based on the interpretation of tax laws that have been enacted or substantively enacted by the balance sheet date and any known court or other rulings on such issues. Liabilities for penalties, interest and taxes other than on income are recognized based on management's best estimate of the expenditure required to settle the obligations at the balance sheet date.
2 Summary of Significant Accounting Policies (continued)
Employee benefits. Wages, salaries, contributions to the Russian Federation state pension and social insurance funds, paid annual leave and sick leave, bonuses, and non-monetary benefits (such as health services and kindergarten services) are accrued in the year in which the associated services are rendered by the employees of the Group.
Social costs. The Group incurs employee costs related to the provision of benefits such as health insurance. These amounts principally represent an implicit cost of employing production workers and, accordingly, are included in the cost of inventory.
Prepayments. Prepayments are carried at cost less provision for impairment. A prepayment is classified as non-current when the goods or services relating to the prepayment are expected to be obtained after one year, or when the prepayment relates to an asset which will itself be classified as non-current upon initial recognition. Prepayments to acquire assets are transferred to the carrying amount of the asset once the Group has obtained control of the asset and it is probable that future economic benefits associated with the asset will flow to the Group. Other prepayments are written off to profit or loss when the goods or services relating to the prepayments are received. If there is an indication that the assets, goods or services relating to a prepayment will not be received, the carrying value of the prepayment is written down accordingly and a corresponding impairment loss is recognised in profit or loss.
Pension costs. The Group makes required contributions to the Russian Federation state pension scheme on behalf of its employees. Mandatory contributions to the governmental pension scheme are expensed or capitalized to inventories on a basis consistent with the associated salaries and wages.
Revenue recognition. The Group recognises revenue when the amount of revenue can be reliably measured and it is probable that economic benefits will flow to the entity, typically when crude oil or refined products are dispatched to customers and title has transferred. Gross revenues include export duties and excise taxes but exclude value added taxes.
Interest income is recognised on a time-proportion basis using the effective interest method. When a receivable is impaired, the Group reduces the carrying amount to its recoverable amount, being the estimated future cash flow discounted at the original effective interest rate of the instrument, and continues unwinding the discount as interest income. Interest income on impaired loans is recognised using the original effective interest rate.
Segments. The Group operates in one business segment which is crude oil exploration and production. The Group assesses its results of operations and makes its strategic and investment decisions based on the analysis of its profitability as a whole. The Group operates within one geographic segment, which is the Russian Federation.
Warrants. Warrants issued that allow the holder to purchase shares of the Group's stock are recorded at fair value at issuance and recorded as liabilities unless the number of equity instruments to be issued to settle the warrants and the exercise price are fixed in the issuing entities' functional currency at the time of grant, in which case they are recorded within shareholders' equity. Changes in the fair value of warrants recorded as liabilities are recorded in the consolidated income statement.
Financial derivatives. The fair value of options is evaluated using market prices if available, taking into account the terms and conditions of the options, upon which those derivative instruments were issued. If market prices are not available, the fair value of the equity instruments granted is estimated using a valuation technique to estimate what the price of those equity instruments would have been on the measurement date in an arm's length transaction between knowledgeable, willing parties.
Share capital. Ordinary shares are classified as equity. Incremental costs directly attributable to the issue of new shares are shown in equity as a deduction, net of tax, from the proceeds. Any excess of the fair value of consideration received over the par value of shares issued is presented in the notes as a share premium.
Share-based payments. The fair value of the employee services received in exchange for the grant of options is recognised as an expense. The total amount to be expensed over the vesting period is determined by reference to the fair value of the options granted, using market prices, taking into account the terms and vesting conditions upon which those equity instruments were granted.
2 Summary of Significant Accounting Policies (continued)
Earnings per share. Earnings per share are determined by dividing the profit or loss attributable to equity holders of the Group by the weighted average number of participating shares outstanding during the reporting year.
Non-current assets classified as held for sale. Non-current assets and disposal groups (which may include both non-current and current assets) are classified in the consolidated balance sheet as 'Non-current assets held for sale' if their carrying amount will be recovered principally through a sale transaction within twelve months after the balance sheet date. Assets are reclassified when all of the following conditions are met: (a) the assets are available for immediate sale in their present condition; (b) the Group's management approved and initiated an active programme to locate a buyer; (c) the assets are actively marketed for a sale at a reasonable price; (d) the sale is expected to occur within one year and (d) it is unlikely that significant changes to the plan to sell will be made or that the plan will be withdrawn. Non-current assets or disposal groups classified as held for sale in the current period's consolidated balance sheet are not reclassified or re-presented in the comparative consolidated balance sheet to reflect the classification at the end of the current period.
A disposal group is assets (current or non-current) to be disposed of, by sale or otherwise, together as a group in a single transaction, and liabilities directly associated with those assets that will be transferred in the transaction. Goodwill is included if the disposal group includes an operation within a cash-generating unit to which goodwill has been allocated on acquisition. Non-current assets are assets that include amounts expected to be recovered or collected more than twelve months after the balance sheet date. If reclassification is required, both the current and non-current portions of an asset are reclassified.
Held for sale property, plant and equipment, intangible assets or disposal groups as a whole are measured at the lower of their carrying amount and fair value less costs to sell. Held for sale property, plant and equipment and intangible assets are not depreciated or amortised. Reclassified non-current financial instruments and deferred taxes are not subject to the write down to the lower of their carrying amount and fair value less costs to sell.
Liabilities directly associated with the disposal group that will be transferred in the disposal transaction are reclassified and presented separately in the consolidated balance sheet.
Reclassifications and adjustments. Certain reclassifications have been reflected in the twelve months ended 31 December 2007 amounts to conform to the consolidated financial information for the year ended 31 December 2008. The table below discloses the amounts before and after reclassification. Management believes that the current presentation is preferable to that presented in prior years.
| As originally reported | Following reclassification or adjustment | |
| At 31 December 2007 | ||
| Inventories | 43,886 | 21,464 |
| Supplies and materials for capital construction | 22,422 | |
| Intangible assets | 1,816 | - |
| Loan receivable from related party | 2,264 | - |
| Other non-current assets | 19,649 | 23,729 |
| Other taxes payable | 2,900 | 3,429 |
| Other taxes provision | 529 | - |
| For the year ended 31 December 2007 | ||
| Cost of sales | (162,428) | (131,389) |
| Impairment charges | - | (31,039) |
At 31 December 2007, $22,422 thousand of materials and suppliers intended for construction of fixed assets were reclassified from inventories to supplies and materials for capital construction; $1,816 thousand of intangible assets and $2,264 thousand of loan receivable from related party were reclassified to other non-current assets; $529 thousand of other taxes provision were reclassified to other taxes payable.
3 Going Concern
A substantial portion of the Group's consolidated net assets of $349.8 million comprises undeveloped mineral deposits requiring significant additional investment. The Group is dependent upon external debt to fully develop the deposits and realise the value attributed to such assets.
During 2007, the Group attracted short term financing of $500 million and $130 million from Sberbank (totalling $630 million) to finance acquisitions and mineral development (Note 16). Despite detailed discussions with Sberbank this financing was not re-financed during 2008. The Group incurred a loss of US$ 403.2 million for the year ended 31 December 2008. As of 31 December 2008 the Group was in default of its financing arrangement with Sberbank and the Group's current liabilities exceed its current assets by $758.2 million.
Subsequent to 31 December 2008 the Group's management has been in discussion with Sberbank and OOO Sberbank Capital (a 100% subsidiary of OAO Sberbank) concerning the default. As a result of these discussions and discussions with other parties the following major transactions have taken place to reduce the Group obligations - these have resulted in a substantial accounting loss for shareholders in 2009:
In August 2009 the Group's 100% interest in its exploration and production subsidiary Dulisma was exchanged for $60 million of the above $500 million of short term financing from Sberbank. Net assets of Dulisma were equal to $179.0 million as of 31 December 2008. The net asset included the short term debt obligation of $130 million owed to Sberbank; (see Note 25)
In November 2009 the Group's 35.3% interest in Taas Yuryakh Neftegaazdobycha (''Tass'') was exchanged for the forgiveness of the remaining $440 million short term financing and accumulated interest owed to Sberbank. The carrying value of this 35.3% interest in Taas was equal to $751.6 million as of 31 December 2008 (see Notes 7 and 25); and
In November 2009 the Group was released from its put option for an additional 10.479% in Taas (see Note 25). As of 31 December 2008 a liability of $161.3 million was recognised in respect of this put option (see Note 7). Registration and actual release of the pledges associated with termination of Put option agreement were ongoing at the date of these financial statements.
Additionally, management continues to be in discussions with its creditors, the most significant of which is Petraco (advances of $49.8 million as of 31 December 2008, see Note 14). Through the shipment of oil the Group has partially reduced this balance during 2009. Group management are currently in ongoing discussions with Petraco with regard to this liability, see Note 14.
Management have prepared monthly cash flow projections for periods throughout 2009 and 2010. An annual cash flow model has been prepared in respect to 2011. Judgements with regard to future oil prices and planned production were required for the preparation of the cash flow projections and model. Positive overall cash flows are crucially dependant on the ability to re-schedule repayment to Petraco and to realise short term loans and receivables.
Despite the successful release from the above mentioned debt obligations in default and the release of the put option, an ongoing discussion with Petraco to re-schedule exiting indebtedness has not as yet yielded a restructuring agreement, though certain transactions have continued to take place since year end (see Note 14). Furthermore, the Company is taking actions to fully realise short term loans and receivables. As a result of the above there is a material uncertainty which may cast significant doubt about the Group's ability to continue as a going concern.
Despite these uncertainties and based on cash flow projections performed, management considers that the application of the going concern assumption for the preparation of these financial statements is appropriate.
4 New accounting pronouncements and interpretations
Except as discussed below, the principal accounting policies followed by the Group are consistent with those disclosed in the financial statements for the year ended 31 December 2007.
Certain new standards and interpretations have been published that are mandatory for the Group's accounting periods beginning on or after 1 January 2008 or later periods, none of which were early adopted by the Group.
Beginning 1 January 2008, the Group has adopted the following interpretations:
IFRIC 11, IFRS 2 - Group and Treasury Share Transactions (effective for annual periods beginning on or after 1 March 2008). IFRIC 11 addresses accounting for certain transactions an entity may enter into to satisfy rights to equity instruments previously granted to employees. Additionally it provides guidance on accounting for rights to equity instruments of a parent company granted for employees of a subsidiary in the subsidiary's separate financial statements;
IFRIC 12, Service Concession Arrangements (effective for annual periods beginning on or after 1 January 2008). IFRIC 12 gives guidance on the accounting by operators for public-to-private service concession arrangements;
IFRIC 14, IAS 19 - The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction (effective for annual periods beginning on or after 1 January 2008). IFRIC 14 addresses the measurement of defined benefit plan assets and accounting for an obligation under a minimum funding requirement.
The adoption of these interpretations, if applicable, had an insignificant effect on the Group's consolidated financial statements.
Recently, the International Accounting Standards Board published the following new standards and interpretations which have not been early adopted by the Group:
Standards and interpretations endorsed by the European Union
IAS 1, Presentation of Financial Statements (revised September 2007; effective for annual periods beginning on or after 1 January 2009). The main change in IAS 1 is the replacement of the income statement by a statement of comprehensive income which will also include all non-owner changes in equity, such as the revaluation of available-for-sale financial assets. Alternatively, entities will be allowed to present two statements: a separate income statement and a statement of comprehensive income. The revised IAS 1 also introduces a requirement to present a statement of financial position (balance sheet) at the beginning of the earliest comparative period whenever the entity restates comparatives due to reclassifications, changes in accounting policies, or corrections of errors. The Group expects the revised IAS 1 to affect the presentation of its financial statements but to have no impact on the recognition or measurement of specific transactions and balances;
IFRS 8, Operating Segments (effective for annual periods beginning on or after 1 January 2009). IFRS 8 requires an entity to report financial and descriptive information about its operating segments and specifies how an entity should report such information. The Group is currently assessing what impact the new standard will have on its consolidated financial statements;
4 New accounting pronouncements and interpretations (continued)
Amendment to IAS 32 and IAS 1, Puttable financial instruments and obligations arising on liquidation (effective from 1 January 2009). The amendment requires classification as equity of some financial instruments that meet the definition of a financial liability. The Group is currently assessing what impact the new standard will have on its consolidated financial statements;
IAS 27, Consolidated and Separate Financial Statements (revised January 2008; effective for annual periods beginning on or after 1 July 2009). The revised IAS 27 will require an entity to attribute total comprehensive income to the owners of the parent and to the non-controlling interests (previously "minority interests") even if this results in the non-controlling interests having a deficit balance (the current standard requires the excess losses to be allocated to the owners of the parent in most cases). The revised standard specifies that changes in a parent's ownership interest in a subsidiary that do not result in the loss of control must be accounted for as equity transactions. It also specifies how an entity should measure any gain or loss arising on the loss of control of a subsidiary. At the date when control is lost, any investment retained in the former subsidiary will have to be measured at its fair value. The Group is currently assessing what impact the new standard will have on its consolidated financial statements;
Amendment to IFRS 2, Share-based Payment (issued in January 2008; effective for annual periods beginning on or after 1 January 2009). The amendment clarifies that only service conditions and performance conditions are vesting conditions. Other features of a share-based payment are not vesting conditions. The amendment specifies that all cancellations, whether by the entity or by other parties, should receive the same accounting treatment. The Group is currently assessing what impact the new standard will have on its consolidated financial statements;
IAS 23 (Revised), Recognition of Borrowing Costs. The revision removed the option of immediately recognizing as an expense borrowing costs that relate to assets that take a substantial period of time to get ready for use or sale. The revised standard applies to borrowing costs relating to qualifying assets for which the commencement date for capitalization is on or after 1 January 2009. The Group is currently assessing what impact the new standard will have on its consolidated financial statements;
Improvements to International Financial Reporting Standards (issued in May 2008). In 2007, the International Accounting Standards Board decided to initiate an annual improvements project as a method of making necessary, but non-urgent, amendments to IFRS. The amendments issued in May 2008 consist of a mixture of substantive changes, clarifications, and changes in terminology in various standards. The substantive changes relate to the following areas: classification as held for sale under IFRS 5 in case of a loss of control over a subsidiary; possibility of presentation of financial instruments held for trading as noncurrent under IAS 1; accounting for sale of IAS 16 assets which were previously held for rental and classification of the related cash flows under IAS 7 as cash flows from operating activities; clarification of definition of a curtailment under IAS 19; accounting for below market interest rate government loans in accordance with IAS 20; making the definition of borrowing costs in IAS 23 consistent with the effective interest method; clarification of accounting for subsidiaries held for sale under IAS 27 and IFRS 5; reduction in the disclosure requirements relating to associates and joint ventures under IAS 28 and IAS 31; enhancement of disclosures required by IAS 36; clarification of accounting for advertising costs under IAS 38; amending the definition of the fair value through profit or loss category to be consistent with hedge accounting under IAS 39; introduction of accounting for investment properties under construction in accordance with IAS 40; and reduction in restrictions over manner of determining fair value of biological assets under IAS 41. Further amendments made to IAS 8, 10, 18, 20, 29, 34, 40, 41 and to IFRS 7 represent terminology or editorial changes only, which the IASB believes have no or minimal effect on accounting. The Group is currently assessing what impact the new standard will have on its consolidated financial statements;
Amendment to IFRS 1 and IAS 27, Cost of an Investment in a Subsidiary, Jointly Controlled Entity or Associate (revised May 2008; effective for annual periods beginning on or after 1 January 2009). The amendment allows first-time adopters of IFRS to measure investments in subsidiaries, jointly controlled entities or associates at fair value or at previous GAAP carrying value as deemed cost in the separate financial statements. The amendment also requires distributions from pre-acquisition net assets of investees to be recognized in profit or loss rather than as a recovery of the investment. The Group is currently assessing what impact the new standard will have on its consolidated financial statements; and
IFRIC 13, Customer loyalty programmers, effective for annual periods beginning on or after 1 July 2008. IFRIC 13 is not relevant to the Group's operations;
4 New accounting pronouncements and interpretations (continued)
Amendment to IAS 39, Financial Instruments: Recognition and Measurement. Entities are required to apply the amendment retrospectively for annual periods beginning on or after 1 July 2009, with earlier application permitted. The amendment clarifies how the principles that determine whether a hedged risk or portion of cash flows is eligible for designation should be applied in particular situations. The Group is currently assessing what impact the new standard will have on its consolidated financial statements;
IFRIC 15, Agreements for the construction of real estate, effective for annual periods beginning on or after 1 January 2009. IFRIC 15 is not relevant to the Group's operations because it does not have any agreements for the construction of real estate;
IFRIC 16, Hedges of a net investment in a foreign operation, effective for annual periods beginning on or after 1 October 2008. The Group is currently assessing what impact the new interpretation will have on its consolidated financial statements;
IFRS 3, Business Combinations (revised January 2008; effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after 1 July 2009; not yet adopted by the EU). The revised IFRS 3 will allow entities to choose to measure non-controlling interests using the existing IFRS 3 method (proportionate share of the acquiree's identifiable net assets) or at fair value. The revised IFRS 3 is more detailed in providing guidance on the application of the purchase method to business combinations. The requirement to measure at fair value every asset and liability at each step in a step acquisition for the purposes of calculating a portion of goodwill has been removed. Instead, in a business combination achieved in stages, the acquirer will have to remeasure its previously held equity interest in the acquiree at its acquisition-date fair value and recognise the resulting gain or loss, if any, in profit or loss. Acquisition-related costs will be accounted for separately from the business combination and therefore recognised as expenses rather than included in goodwill. An acquirer will have to recognise at the acquisition date a liability for any contingent purchase consideration. Changes in the value of that liability after the acquisition date will be recognised in accordance with other applicable IFRSs, as appropriate, rather than by adjusting goodwill. The revised IFRS 3 brings into its scope business combinations involving only mutual entities and business combinations achieved by contract alone. The Group is currently assessing the impact of the amended standard on its financial statements;
Standards and interpretations not yet endorsed by the European Union
IFRIC 17, Distribution of Non-Cash Assets to Owners (effective for annual periods beginning on or after 1 July 2009). The amendment clarifies when and how distribution of non-cash assets as dividends to the owners should be recognised. An entity should measure a liability to distribute non-cash assets as a dividend to its owners at the fair value of the assets to be distributed. A gain or loss on disposal of the distributed non-cash assets will be recognised in profit or loss when the entity settles the dividend payable. IFRIC 17 is not relevant to the Group's operations because it does not distribute non-cash assets to owners;
IFRS 1, First-time Adoption of International Financial Reporting Standards (following an amendment in December 2008, effective for the first IFRS financial statements for a period beginning on or after 1 July 2009). The revised IFRS 1 retains the substance of its previous version but within a changed structure in order to make it easier for the reader to understand and to better accommodate future changes. The Group concluded that the revised standard does not have any effect on its financial statements;
IFRIC 18, Transfers of Assets from Customers (effective for annual periods beginning on or after 1 July 2009). The interpretation clarifies the accounting for transfers of assets from customers, namely, the circumstances in which the definition of an asset is met; the recognition of the asset and the measurement of its cost on initial recognition; the identification of the separately identifiable services (one or more services in exchange for the transferred asset); the recognition of revenue, and the accounting for transfers of cash from customers. IFRIC 18 is not expected to have any impact on the Group's financial statements;
4 New accounting pronouncements and interpretations (continued)
Improving Disclosures about Financial Instruments - Amendment to IFRS 7, Financial Instruments: Disclosures (issued in March 2009; effective for annual periods beginning on or after 1 January 2009). The amendment requires enhanced disclosures about fair value measurements and liquidity risk. The entity will be required to disclose an analysis of financial instruments using a three-level fair value measurement hierarchy. The amendment (a) clarifies that the maturity analysis of liabilities should include issued financial guarantee contracts at the maximum amount of the guarantee in the earliest period in which the guarantee could be called; and (b) requires disclosure of remaining contractual maturities of financial derivatives if the contractual maturities are essential for an understanding of the timing of the cash flows. An entity will further have to disclose a maturity analysis of financial assets it holds for managing liquidity risk, if that information is necessary to enable users of its financial statements to evaluate the nature and extent of liquidity risk. The Group is currently assessing the impact of the amendment on disclosures in its financial statements;
Embedded Derivatives - Amendments to IFRIC 9 and IAS 39 (effective for annual periods ending on or after 30 June 2009). The amendments clarify that on reclassification of a financial asset out of the 'at fair value through profit or loss' category, all embedded derivatives have to be assessed and, if necessary, separately accounted for;
Improvements to International Financial Reporting Standards (issued in April 2009; amendments to IFRS 2, IAS 38, IFRIC 9 and IFRIC 16 are effective for annual periods beginning on or after 1 July 2009; amendments to IFRS 5, IFRS 8, IAS 1, IAS 7, IAS 17, IAS 36 and IAS 39 are effective for annual periods beginning on or after 1 January 2010). The improvements consist of a mixture of substantive changes and clarifications in the following standards and interpretations: clarification that contributions of businesses in common control transactions and formation of joint ventures are not within the scope of IFRS 2; clarification of disclosure requirements set by IFRS 5 and other standards for non-current assets (or disposal groups) classified as held for sale or discontinued operations; requiring to report a measure of total assets and liabilities for each reportable segment under IFRS 8 only if such amounts are regularly provided to the chief operating decision maker; amending IAS 1 to allow classification of certain liabilities settled by entity's own equity instruments as non-current; changing IAS 7 such that only expenditures that result in a recognized asset are eligible for classification as investing activities; allowing classification of certain long-term land leases as finance leases under IAS 17 even without transfer of ownership of the land at the end of the lease; providing additional guidance in IAS 18 for determining whether an entity acts as a principal or an agent; clarification in IAS 36 that a cash generating unit shall not be larger than an operating segment before aggregation; supplementing IAS 38 regarding measurement of fair value of intangible assets acquired in a business combination; amending IAS 39 (i) to include in its scope option contracts that could result in business combinations, (ii) to clarify the period of reclassifying gains or losses on cash flow hedging instruments from equity to profit or loss and (iii) to state that a prepayment option is closely related to the host contract if upon exercise the borrower reimburses economic loss of the lender; amending IFRIC 9 to state that embedded derivatives in contracts acquired in common control transactions and formation of joint ventures are not within its scope; and removing the restriction in IFRIC 16 that hedging instruments may not be held by the foreign operation that itself is being hedged. The Group does not expect the amendments to have any material effect on its financial statements;
Group Cash-settled Share-based Payment Transactions - Amendments to IFRS 2, Share-based Payment (effective for annual periods beginning on or after 1 January 2010). The Group is currently assessing the impact of the amended standard on its financial statements;
Additional Exemptions for First-time Adopters - Amendments to IFRS 1, First-time Adoption of IFRS (effective for annual periods beginning on or after 1 January 2010). The revision to this standard is not relevant to the Group;
Classification of Rights Issues - Amendment to IAS 32, Financial Instruments: Presentation (effective for annual periods beginning on or after 1 February 2010). The Group is currently assessing the impact of the amendment on its financial statements;
IAS 24 Related Party Disclosures - Amended November 2009, effective for annual periods beginning on or after 1 January 2011). The Group is currently assessing the impact of the amended standard on disclosures in its financial statements;
4 New accounting pronouncements and interpretations (continued)
IFRS 9 Financial Instruments - The first part of a three-part project to replace IAS 39 Financial Instruments: Recognition and Measurement with a new standard was issued in November 2009. The first part affects classification and measurement of financial assets and uses a single approach to determine whether a financial asset is measured at amortised cost or fair value. The approach in IFRS 9 is based on how an entity manages its financial instruments and the contractual cash flow characteristics of the financial assets. The new standard also requires a single impairment method to be used. The standard applies for annual periods beginning on or after 1 January 2013 but it can be applied early. The Group is currently assessing the impact of the new standard.
5 Critical Accounting Estimates and Judgements in Applying Accounting Policies
The Group makes estimates and assumptions that affect the reported amounts of assets and liabilities. Estimates and judgements are continually evaluated and are based on management's experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances. Management also makes certain judgements, apart from those involving estimations, in the process of applying the accounting policies. Judgements that have the most significant effect on the amounts recognised in the financial statements and estimates that can cause a significant adjustment to the carrying amount of assets and liabilities are outlined below.
Estimation of oil and gas reserves. Engineering estimates of hydrocarbon reserves are inherently uncertain and are subject to future revisions. Accounting measures such as depreciation, depletion and amortization charges, impairment assessments and asset retirement obligations that are based on the estimates of proved reserves are subject to change based on future changes to estimates of oil and gas reserves.
Proved reserves are defined as the estimated quantities of hydrocarbons which geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic conditions. Proved reserves are estimated by reference to available reservoir and well information, including production and pressure trends for producing reservoirs. Furthermore, estimates of proved reserves only include volumes for which access to market is assured with reasonable certainty. All proved reserves estimates are subject to revision, either upward or downward, based on new information, such as from development drilling and production activities or from changes in economic factors, including product prices, contract terms or development plans. In some cases, substantial new investment in additional wells and related support facilities and equipment will be required to recover such proved reserves. Due to the inherent uncertainties and the limited nature of reservoir data, estimates of underground reserves are subject to change over time as additional information becomes available.
In general, estimates of reserves for undeveloped or partially developed fields are subject to greater uncertainty over their future life than estimates of reserves for fields that are substantially developed and depleted. As those fields are further developed, new information may lead to further revisions in reserve estimates. Reserves have a direct impact on certain amounts reported in the consolidated financial statements, most notably depreciation, depletion and amortization as well as impairment expenses. Depreciation rates on production assets using the units-of-production method for each field are based on proved developed reserves for development costs, and total proved reserves for costs associated with the acquisition of proved properties. Assuming all variables are held constant, an increase in proved developed reserves for each field decreases depreciation, depletion and amortization expenses. Conversely, a decrease in the estimated proved developed reserves increases depreciation, depletion and amortization expenses. Moreover, estimated proved reserves are used to calculate future cash flows from oil and gas properties, which serve as an indicator in determining whether or not property impairment is present.
The possibility exists for changes or revisions in estimated reserves to have a significant effect on depreciation, depletion and amortization charges and, therefore, reported net profit for the year.
5 Critical Accounting Estimates and Judgements in Applying Accounting Policies (continued)
Impairment provision for receivables. The impairment provision for receivables is based on management's assessment of the probability of collection of individual receivables. Significant financial difficulties of the debtor, probability that the debtor will enter bankruptcy or financial reorganization, and default or delinquency in payments are considered indicators that the receivable is potentially impaired. Actual results could differ from these estimates if there is deterioration in a debtor's creditworthiness or actual defaults are higher than the estimates.
When there is no expectation of recovering additional cash for an amount receivable, the expected amount receivable is written off against the associated provision.
Future cash flows of receivables that are evaluated for impairment are estimated on the basis of the contractual cash flows of the assets and the experience of management in respect of the extent to which amounts will become overdue as a result of past loss events and the success of recovery of overdue amounts. Past experience is adjusted on the basis of current observable data to reflect the effects of current conditions that did not affect past periods and to remove the effects of past conditions that do not exist currently.
Asset retirement obligations. Management makes provision for the future costs of decommissioning hydrocarbon production facilities, pipelines and related support equipment based on the best estimates of future cost and economic lives of those assets. Estimating future asset retirement obligations is complex and requires management to make estimates and judgments with respect to removal obligations that will occur many years in the future. Changes in the measurement of existing obligations can result from changes in estimated timing, future costs or discount rates used in valuation.
Useful lives of non-oil and gas properties. Items of non-oil and gas properties are stated at cost less accumulated depreciation. The estimation of the useful life of an asset is a matter of management judgement based upon experience with similar assets. In determining the useful life of an asset, management considers the expected usage, estimated technical obsolescence, physical wear and tear and the physical environment in which the asset is operated. Changes in any of these conditions or estimates may result in adjustments to future depreciation rates.
Financial derivatives. The fair value of derivative financial instruments is evaluated using market prices if available, taking into account the specific terms and conditions of these instruments. If market prices are not available, the fair value is estimated using a valuation technique to estimate what the price of those instruments would have been on the measurement date in an arm's length transaction between knowledgeable, willing parties. Such valuations are significantly impacted by certain market conditions and assumptions such as expected exercise dates and equity price volatility, and changes in any of these conditions may result in significant adjustments to future valuations. Management have estimated the fair value of financial liabilities to be $161.3 million using a 2.5 year remaining term. If the assumption with respect to the exercise date changed to a six month remaining term, the revised estimate of the financial liability would be $100.2 million.
Impairment. As discussed further in Note 6 and 7, management have estimated the recoverable amount of cash generating units. Changes in the assumptions used can have a significant impact on the amount of any impairment charge.
Fair values of acquired assets and liabilities. Since its inception, the Group has completed several significant acquisitions (Note 7). IFRS 3 requires that, at the date of acquisition, all identifiable assets (including intangible assets), liabilities and contingent liabilities of an acquired entity be recorded at their respective fair values. The estimation of fair values requires management judgement. For significant acquisitions, management engages independent experts to advice as to the fair values of acquired assets and liabilities. Changes in any of the estimates subsequent to the finalisation of acquisition accounting may result in losses in future periods.
Liquidity. These consolidated financial statements have been prepared under the going concern assumption (see Note 3).
6 Impairment
Following a sharp decrease in actual and forecast crude oil prices at the end of 2008 management identified that there were indicators of impairment of production assets and cash generating units and consequently performed impairment calculations to assess their recoverable amounts.
In assessing whether a write-down is required in the carrying value of a potentially impaired item of property, plant and equipment or an equity-accounted investment, its carrying value is compared with its recoverable amount. The recoverable amount is the higher of the asset's fair value less costs to sell and value in use. As the Group is in the process of actively marketing three businesses it is unlikely that there will be significant future use. Consequently, unless indicated otherwise, the recoverable amount used in assessing the impairment charges described below is fair value less cost to sell. Additionally, management estimated the recoverable amount of other cash generating units. The Group estimated fair value less cost to sell using discounted cash flow models. An average oil price of $55 for 2009 and $75 in real terms for future sales was estimated for the impairment calculation and a real discount rate of 12% was used to discount the estimated future cash flows. The discount rate of 12% in real terms was derived from the Group's approximate post-tax weighted average cost of capital.
The Group recognized an impairment loss for the year ended 31 December 2008 of $34.6 million and $39.1 million for the Arcticneft and Petrosakh cash generating units, respectively. As discussed in Note 8 these cash generating units are classified as held for sale as of 31 December 2008.
If the oil price used in the calculation was reduced to $65 per barrel in real terms from 2010 onwards an additional impairment charge of $11.3 million and $3.1 million would be required for Arcticneft and Petrosakh, respectively. If the discount rate used in the calculation was increased to 14% in real terms an additional impairment charge of $7.8 million and $8.2 million would be required for Arcticneft and Petrosakh, respectively.
If the oil price used in the calculation was reduced to $65 per barrel in real terms from 2010 onwards an impairment charge of $32.2 million would be required for cash generating units other than the two aforementioned entities. If the discount rate used in the calculation was increased to 14% in real terms an impairment charge of $18.8 million would be required for cash generating units other than the two aforementioned entities.
A summary of the impairment charges incurred by the Group for the year ended 31 December 2008 is presented below:
| Year ended 31 December: | |||
| 2008 | |||
| Arcticneft | 34,561 | ||
| Petrosakh | 39,136 | ||
| Chepetskoe (Note 8, 11) | 16,499 | ||
| Write off of exploration and evaluation expenditures (Note 11) | 4,759 | ||
| Total | 94,955 | ||
Refer to Note 7 for detail of the impairment analysis of the Group's investment in joint ventures.
7 Investments in joint venture
Acquisition of equity interest of 35.3% in Taas Yuryakh Neftegazdobycha ("Taas"). In December 2007, the Group acquired a 35.329% stake in OOO Taas Yuryakh Neftegazdobycha. Taas is a privately-held Russian exploration and production company with oil development operations in East Siberia and licences to develop two adjacent blocks of the Srednebotuobinskoye oil, gas and condensate field in the region (the "SRB field"). The SRB field is essentially undeveloped. Taas holds (1) an oil production licence for the central block of the SRB field (the "Central Block"); and (2) a licence for geological prospecting, exploration and production of hydrocarbons in the adjacent Kurungsky allotment in East Siberia (the "Southern Block"). As part of the Acquisition, OOO Urals Energy, the Group's operating subsidiary in Russia, will become the operator for the development of the SRB field. Also, all shareholders signed a Joint Venture agreement to formalise the relationship between the new and existing shareholders of Taas. The agreement requires unanimous consent of all shareholders for major decisions relating to operating and financial activities of Taas. There are no restrictions on distributions of dividends, which are subject to approval by the Taas shareholders.
As part of the transaction the Company also acquired a call option and wrote a put option for additional interests in Taas of 4.182% and 10.479%, respectively. The exercise price for the call option to acquire an additional 4.2% of Taas, exercisable in January 2009, is $70.0 million, plus 11.95% per annum payable at the Seller's selection either in cash or in equivalent shares of the Company. The put option is exercisable from November 2008 and expires in December 2012 and allows the holder to put a 10.5% stake in Taas to the Group for $175.0 million plus accrued interest at 14.0% from December 2008 to the exercise date, or, at the holder's option, 50% in cash and 50% in shares of Urals Energy valued at a price determined by the average closing price in the two-week period following the initial closing. The fair values of the call and put options as at the valuation date were estimated at $5.1 million and $118.7 million, respectively.
As of 31 December 2008 management has reviewed the long-term model of discounted cash flows to asses the change in Taas equity value and revalue the financial instruments as required by IFRS. As a result of changes in macroeconomic parameters, primarily long-term oil price forecast, the equity value of Taas has decreased.
This change resulted in an increase of the put option value classified as a financial instrument from $118.7 million to $161.3 million as of 31 December 2007 and 31 December 2008, respectively. With respect to the call option, management has not assigned any value to this financial derivative, as the Group is not planning to exercise this option but rather plans to use funds available to the Group for value creation through the ongoing development of the Dulisma oil field. Furthermore, given current market conditions, the Group's ability to sell this option to a third party prior to its expiration in January 2009 was uncertain, and the option was ultimately not exercised. Therefore, for the purposes of the consolidated financial statements as of 31 December 2008, management have discounted the value of the call option to nil, and recognised a loss on the revaluation of the financial derivative in the consolidated income statement. The write down does not result in any loss of cash-flow for the Group.
The net change in these financial instruments value, as well as change in the value of the Warrants classified as liabilities, amounted to $46.6 million, which is recorded as a loss from changes in the fair value of financial derivatives in the consolidated income statement (2007: $1.6 million gain). The Put option agreement was terminated in November 2009 (see Note 25). Registration and actual release of the pledges associated with termination of Put option agreement were ongoing at the date of these financial statements.
The Group also recognized an impairment loss of $152.5 million on its investment in Taas. The impairment resulted in a reassessment of economics of the investment and the global economic downturn. Future oil prices of $75 per barrel in real terms and a discount rate of 12% in real terms was used to calculate the fair value less cost to sell. If the oil price used in the calculation was reduced to $65 per barrel in real terms from 2010 onwards an additional impairment charge of $148.7 million would be required for Taas. If the discount rate used in the calculation was increased to 14% in real terms an additional impairment charge of $137.0 would be required for Taas. The Group disposed of its equity interest in Taas in November 2009 (see Note 25).
7 Investments in joint venture (continued)
The table below summarises the movements in the carrying amount of the Group's investment in Taas.
| Year ended 31 December: | |||
| 2008 | 2007 | ||
| Carrying amount at 1 January | 911,433 | - | |
| Fair value of net assets of joint venture acquired | - | 911,433 | |
| Share of profit/(loss) of joint venture | (7,313) | - | |
| Share of other equity movements of joint venture | - | - | |
| Dividends received from joint venture | - | - | |
| Impairment of investments in joint venture | (152,520) | - | |
| Total loss from equity investment in joint venture during the year | (159,833) | - | |
| Carrying amount at 31 December | 751,600 | 911,433 | |
At 31 December 2008, the Group's interests in Taas and its summarised financial information, including total assets, liabilities, revenues and profit or loss, were as follows:
| Name | Total assets | Total liabilities | Revenue | Profit/(loss) | % interest held |
| Taas | 804,930 | (53,330) | 749 | (7,313) | 35.3 % |
At 31 December 2007, the Group's interests in Taas and its summarised financial information, including total assets, liabilities, revenues and profit or loss, were as follows:
| Name | Total assets | Total liabilities | Revenue | Profit/(loss) | % interest held |
| Taas | 933,619 | (22,186) | - | - | 35.3 % |
8 Non-current assets held for sale
As of 31 December 2007 the assets and liabilities related to Dinyu, Michayuneft, Nizhneomrinskaya Neft and CNPSEI have been presented as held for sale following the approval of the Group's Board of Directors in December 2007 to sell these subsidiaries. In April 2008, the Group completed the sale of Dinyu, Michayuneft and Nizhneomrinskaya Neft for $93.1 million and CNPSEI was sold to the same buyer on 31 December 2008 for $13.9 million. This consideration from the sale of CNPSEI was fully offset against outstanding unpaid liabilities of the Company under oil sales and other agreements involving Komi assets sold in April 2008; therefore, the Company had not received any cash proceeds from that transaction. The Group recognised a net gain on the above sales in the amount of $8.1 million.
During 2008 the Group's Board of Directors approved a plan to divest other non-core assets Arcticneft, Petrosakh and Chepetskoye. The assets and liabilities of those subsidiaries have been presented as held for sale as of 31 December 2008.
Subsequent to the year-end Chepetskoye was sold to a domestic off-taker Galaform for the full discharge of the domestic prepayment granted to the Group in the end of 2006 (see Note 14). As part of the transaction the Group assigned to the buyer intercompany loans amounting to $10.8 million. Sale consideration was equal to $5.2 million and included in the sales agreement was a call option for the Group to repurchase Chepetskoye for $5.2 million. This call option expires in January 2010. As at 31 December 2008 management assessed Chepetskoye for impairment using the information regarding the transaction which was available at that date as an indicator of the fair value of the asset. As a result of this analysis, an impairment charge of $16.5 million was recognized in the consolidated income statement.
8 Non-current assets held for sale (continued)
Non-current assets classified as held for sale are stated at their carrying amount, which is less than fair value less costs to sell. No impairment of the assets was necessary as a result of the decision to sell subsidiaries classified as assets held for sale at 31 December 2007.
For assets held for sale at 31 December 2008 an inventory provision of $2.1 million was charged to record oil and oil products inventory at net realizable value (Note 10). Additionally impairment charges discussed in Note 6 relating to the Arcticneft and Petrosakh assets were recognized.
Below is a breakdown of assets and liabilities of non-current assets of Arcticneft, Chepetskoye, and Petrosakh that are classified as held for sale at 31 December 2008. As of 31 December 2007 assets of CNPSEI, Dinyu, Michayuneft, and Nizhneomrinskaya Neft were classified as held for sale; a breakdown of assets and liabilities is also presented below.
| Year ended 31 December: | ||
| 2008 | 2007 | |
| Cash and cash equivalents | 360 | 379 |
| Accounts receivable and prepayments | 5,545 | 2,166 |
| Current income tax prepayments | 551 | 288 |
| Inventories | 18,426 | 3,313 |
| Property, plant and equipment | 70,710 | 126,052 |
| Supplies and materials for capital construction | 2,487 | - |
| Deferred tax assets | - | 726 |
| Other non-current assets | 1,084 | 439 |
| Total assets held for sale | 99,163 | 133,363 |
| Accounts payable and accrued expenses | 2,881 | 2,515 |
| Income tax payable | - | 1 |
| Other taxes payable | 1,518 | 3,099 |
| Advances from customers | 150 | 57 |
| Long-term borrowings | - | 41 |
| Long -term finance lease obligations | 846 | - |
| Dismantlement provision | 1,423 | 2,638 |
| Deferred tax liabilities | 3,430 | 19,126 |
| Total liabilities associated with non-current assets held for sale | 10,248 | 27,477 |
During the years ended 31 December 2008 and 2007 these assets had the following cash flows.
| Year ended 31 December: | ||
| 2008 | 2007 | |
| Operating cash flows | 3,443 | 15,298 |
| Investing cash flows | (7,053) | (6,109) |
| Financing cash flows | - | - |
| Total cash flows | (3,610) | 9,189 |
9 Accounts Receivable and Prepayments
| Year ended 31 December: | ||
| 2008 | 2007 | |
| Prepaid taxes | 13,883 | 13,566 |
| Advances to suppliers | 542 | 2,044 |
| Recoverable taxes including VAT | 1,874 | 9,301 |
| Receivables from related parties (Note 24) | 4,955 | 5,767 |
| Trade accounts and notes receivable | 2,043 | 3,079 |
| Other | 5,615 | 5,014 |
| Total accounts receivable and prepayments | 28,912 | 38,771 |
Included in total accounts receivable and prepayments are $7.9 million and $7.1 million at 31 December 2008 and 2007, respectively, denominated in US dollars and substantially all remaining amounts are denominated in Russian Roubles.
Trade accounts receivable arises primarily from sales to ongoing customers with standard payment terms. The category 'Other' primarily relates to short-term prepaid expenses, which will be expensed during 2009, and other accounts receivables and prepayments.
Changes in the provision for impairment of trade and other receivables related to the recognition of a provision against receivables from related parties and disposal of assets held for sale are as follows:
| Year ended 31 December: | ||
| 2008 | 2007 | |
| At 1 January | 664 | 640 |
| Disposals of assets held for sale | (555) | - |
| Accrual of additional provision (Note 24) | 1,243 | |
| Effect of currency translation | (109) | 24 |
| At 31 December | 1,243 | 664 |
The carrying values of trade and other receivables approximate their fair value. The maximum exposure to credit risk at the balance sheet date is the carrying value of each class of receivables mentioned above. The Group does not hold any collateral as security for trade and other receivables (see Note 23 for credit risk disclosures).
Trade and other receivables that are less than three months past due are generally not considered for impairment unless other indicators of impairment exist. Trade and other receivables of $0.1 million and $1.0 million at 31 December 2008 and 2007, respectively were past due but not impaired. The ageing analysis of these past due but not impaired trade and other receivables are as follows:
| Year ended 31 December: | ||
| 2008 | 2007 | |
| Up to 90 days past-due | - | - |
| 91 to 360 days past-due | 137 | 994 |
| Total past due but not impaired | 137 | 994 |
10 Inventories
| Year ended 31 December: | ||
| 2008 | 2007 | |
| Crude oil (net of adjustment on net realisable value of $2.2 million and $0.0 million at 31 December 2008 and 2007, respectively) | 10,556 | 9,536 |
| Oil products (net of adjustment on net realisable value of $0.1 million and $0.0 million at 31 December 2008 and 2007, respectively) | 2,264 | 2,269 |
| Materials and supplies (net of allowances of $2.3 million and $0.4million at 31 December 2008 and 2007, respectively) | 9,706 | 12,972 |
| Total inventories | 22,526 | 24,777 |
| - Inventories of the Group, excluding the portion classified as assets held for sale | 4,100 | 21,464 |
| - Inventories held for sale | 18,426 | 3,313 |
Inventory provision
| Year ended 31 December: | ||
| 2008 | 2007 | |
| At 1 January | 397 | 1,217 |
| Additional provisions | 4,307 | - |
| Reversal of previously booked provisions | - | (882) |
| Effect of currency translation | (66) | 62 |
| At 31 December | 4,638 | 397 |
| - Inventory provision of the Group, excluding the portion classified as assets held for sale | 2,584 | 397 |
| - Inventory provision held for sale | 2,054 | - |
The largest component of the provision reversal in 2007 is due to a technical review of materials performed by management which determined that a portion of the inventory related to power generating facilities at Petrosakh would be used to upgrade existing power supply units, and was therefore no longer considered obsolete.
11 Property, Plant and Equipment
|
| Oil and gas properties | Refinery and related equipment | Buildings | Other Assets | Assets under construction | Total |
| Cost at | ||||||
| 1 January 2007 | 542,060 | 9,879 | 5,066 | 10,362 | 57,092 | 624,459 |
| Translation difference | 39,822 | 720 | 369 | 952 | 4,822 | 46,685 |
| Additions | 8,680 | - | - | - | 57,362 | 66,042 |
| Capitalised borrowing costs (Note 16) | - | - | - | - | 3,576 | 3,576 |
| Transfers | 37,379 | 33 | - | 5,775 | (43,187) | - |
| Changes in estimates of dismantlement provision (Note 17) | 250 | - | - | - | - | 250 |
| Impairment | (31,039) | - | - | - | - | (31,039) |
| Disposals | (898) | (5) | (1) | (460) | (1,817) | (3,181) |
| 31 December 2007 | 596,254 | 10,627 | 5,434 | 16,629 | 77,848 | 706,792 |
| - PPE of the Group, excluding assets held for sale | 458,952 | 10,627 | 5,434 | 15,278 | 71,247 | 561,538 |
| - PPE held for sale | 137,302 | - | - | 1,351 | 6,601 | 145,254 |
| Translation difference | (76,824) | (1,748) | (884) | (2,662) | (20,433) | (102,551) |
| Additions | 93 | - | - | - | 100,136 | 100,229 |
| Capitalised borrowing costs (Note 16) | - | - | - | - | 5,863 | 5,863 |
| Transfers | 38,303 | - | - | 1,871 | (40,174) | - |
| Changes in estimates of dismantlement provision (Note 17) | 128 | - | - | - | - | 128 |
| Impairment | (84,702) | (3,329) | (793) | (1,675) | (4,456) | (94,955) |
| Disposals | (108) | - | (68) | (593) | (5,332) | (6, 101) |
| Disposals of assets held for sale (KOMI) | (142,106) | - | - | (1,439) | (6,825) | (150,370) |
| 31 December 2008 | 331,038 | 5,550 | 3,689 | 12,131 | 106,627 | 459,035 |
| - PPE of the Group, excluding assets held for sale | 229,044 | - | 2,446 | 8,843 | 103,145 | 343,478 |
| - PPE held for sale | 101,994 | 5,550 | 1,243 | 3,288 | 3,482 | 115,557 |
11 Property, Plant and Equipment (continued)
|
| Oil and gas properties | Refinery and related equipment | Buildings | Other Assets | Assets under construction | Total |
| Accumulated Depreciation, Amortization and Depletion at | ||||||
| 1 January 2007 | (25,696) | (1,084) | (635) | (1,244) | - | (28,659) |
| Translation difference | (3,005) | (104) | (59) | (187) | - | (3,355) |
| Depreciation, depletion and amortization | (27,075) | (604) | (270) | (2,618) | - | (30,567) |
| Disposals | 54 | - | - | 110 | - | 164 |
| 31 December 2007 | (55,722) | (1,792) | (964) | (3,939) | - | (62,417) |
| - PPE of the Group, excluding assets held for sale | (36,831) | (1,792) | (964) | (3,628) | - | (43,215) |
| - PPE held for sale | (18,891) | - | - | (311) | - | (19,202) |
| Translation difference | 7,797 | 372 | 196 | 812 | - | 9,177 |
| Depreciation, depletion and amortization | (15,935) | (500) | (254) | (1,754) | - | (18,443) |
| Disposals | 43 | - | 14 | 346 | - | 403 |
| Disposals of assets held for sale (KOMI) | 19,599 | - | - | 324 | - | 19,923 |
| 31 December 2008 | (44,218) | (1,920) | (1,008) | (4,211) | - | (51,357) |
| - PPE of the Group, excluding assets held for sale | (3,361) | - | (424) | (2,725) | - | (6,510) |
| - PPE held for sale | (40,857) | (1,920) | (584) | (1,486) | - | (44,847) |
|
| Oil and gas properties | Refinery and related equipment | Buildings | Other Assets | Assets under construction | Total |
| Net Book Value at | ||||||
| 31 December 2007 | 540,532 | 8,835 | 4,470 | 12,690 | 77,848 | 644,375 |
| - PPE of the Group, excluding assets held for sale | 422,121 | 8,835 | 4,470 | 11,650 | 71,247 | 518,323 |
| - PPE held for sale | 118,411 | - | - | 1,040 | 6,601 | 126,052 |
| 31 December 2008 | 286,820 | 3,630 | 2,681 | 7,920 | 106,627 | 407,678 |
| - PPE of the Group, excluding assets held for sale | 225,683 | - | 2,022 | 6,118 | 103,145 | 336,968 |
| - PPE held for sale | 61,137 | 3,630 | 659 | 1,802 | 3,482 | 70,710 |
Included within oil and gas properties at 31 December 2008 and 2007 were exploration and evaluation assets:
| Cost at 31 December 2007 | Additions | Transfers to tangible part of Oil and gas properties | Disposals: Impairment loss | Disposals: disposal of assets held for sale | Translation difference | Cost at 31 December 2008 | |
| Exploration and evaluation assets | |||||||
| Dulisma | 172,666 | - | - | - | - | (28,410) | 144,256 |
| Arcticneft | 20,995 | - | - | (9,908) | - | (3,455) | 7,632 |
| Petrosakh | 43,351 | - | - | (18,478) | - | (6,664) | 18,209 |
| Chepetskoye | 8,461 | - | - | (5,930) | - | (1,392) | 1,139 |
| Dinyu | 71,878 | 90 | - | - | (75,269) | 3,301 | - |
| CNPSEI | 92 | - | - | - | (77) | (15) | - |
| Total cost of exploration and evaluation assets | 317,443 | 90 | - | (34,316) | (75,346) | (36,635) | 171,236 |
11 Property, Plant and Equipment (continued)
| Cost at 31 December 2006 | Additions | Transfers to Tangible part of Oil and gas properties | Disposals: Impairment loss | Disposals: disposal of assets held for sale | Translation difference | Cost at 31 December 2007 | |
| Exploration and evaluation assets | |||||||
| Dulisma | 161,055 | - | - | (96) | - | 11,707 | 172,666 |
| Arcticneft | 19,572 | - | - | - | - | 1,423 | 20,995 |
| Petrosakh | 39,263 | 1,382 | - | - | - | 2,706 | 43,351 |
| Urals-Nord | 20,649 | 7,035 | - | (28,291) | - | 607 | - |
| Chepetskoye | 8,694 | - | (2,813) | (20) | - | 2,600 | 8,461 |
| Dinyu | 66,804 | 207 | - | - | - | 4,867 | 71,878 |
| CNPSEI | 86 | - | - | - | - | 6 | 92 |
| Total cost of exploration and evaluation assets | 316,123 | 8,624 | (2,813) | (28,407) | - | 23,916 | 317,443 |
Cash flows associated with exploration and evaluation assets during the years ended 31 December 2008 and 2007 were as follows:
| Year ended 31 December: | ||
| 2008 | 2007 | |
| Cash flows used in operating activities | 90 | 8,624 |
| Cash flows used in investing activities | - | - |
| Total cash used for exploration and evaluation of assets | 90 | 8,624 |
The Group's oil fields are situated in the Russian Federation on land owned by the Russian government. The Group holds licenses and associated mining plots and pays production taxes to extract oil and gas from the fields. The licenses expire between 2012 and 2067, but may be extended. Management intends to renew the licences as the properties are expected to remain productive subsequent to the license expiration date.
Estimated costs of dismantling oil and gas production facilities, including abandonment and site restoration costs, amounting to $0.3 million and $2.4 million (including $0.3 million and $2.1 million recorded within assets held for sale) at 31 December 2008 and 2007, respectively, are included in the cost of oil and gas properties. The Group has estimated its liability based on current environmental legislation using estimated costs when the expenses are expected to be incurred.
Following a sharp decrease in crude oil prices at the end of 2008 the Group recognised impairment of property plant and equipment as of 31 December 2008 in the amount of $73.7 million (see Note 6) and write off of exploration and evaluation of reserves in the amount of $4.8 million. The write off of the exploration and evaluation of reserves relates to exploration expenses previously capitalised on the license block on Petrosakh for which the Group has no further plans as reserves were confirmed to be non-economic for further exploration and development. Additionally the Group recognised $16.5 impairment charge following the disposal of Chepetskoye subsequent to the year (see Notes 8 and 25).
Included within disposals of assets under construction were costs related to unsuccessful drilling in the amount of $2.6 recorded within assets held for sale in 2008.
At 31 December 2008 and 2007, no property, plant and equipment were pledged as collateral for the Group's borrowings.
12 Other Non-Current Assets
|
| Year ended 31 December: | |
| 2008 | 2007 | |
| Loan receivable from related party (Note 24) | 31,066 | 2,264 |
| Advances to contractors and suppliers for construction in process | 8,195 | 19,649 |
| Intangible assets | 624 | 1,816 |
| Total other non-current assets | 39,885 | 23,729 |
Other long-term investments represent US dollar denominated long-term loans of $31.1 million and $2.3 million at 31 December 2008 and 2007, respectively, issued by UEPCL to Taas, as part of the acquisition agreement. The loans were used to pay organisation fees for a $600.0 million project finance loan facility provided by Savings Bank of Russian Federation ("Sberbank") for the development of the SRB field, financing of interest payments and repayment of third party loans at Taas. The loans bear interest of 12% and mature in February 2015. The fair value of the loans approximates the carrying value at the balance sheet date. These loans are considered to be fully performing as of 31 December 2008. The loans are unsecured.
13 Accounts Payable and Accrued Expenses
|
| Year ended 31 December: | |
| 2008 | 2007 | |
| Accounts payable for loan organisation fees | - | 10,000 |
| Trade payables | 949 | 5,710 |
| Accounts payable for construction in process | 18,823 | 4,103 |
| Wages and salaries | 624 | 1,035 |
| Interest payable | 7,373 | 967 |
| Accounts payable for investment in joint venture | - | 589 |
| Advances from and payables to related parties (Note 24) | 74 | 113 |
| Other payable and accrued expenses | 1,953 | 880 |
| Total accounts payable and accrued expenses | 29,796 | 23,397 |
Total accounts payable and accrued expenses in the amount of $9.1 million and $19.2 million at 31 December 2008 and 2007, respectively, are denominated in US dollars and substantially all remaining amounts are denominated in Russian Roubles.
14 Advances from customers
| Year ended 31 December: | ||
| 2008 | 2007 | |
| Petraco | 49,418 | 32,011 |
| Galaform | 5,474 | 22,407 |
| Other | 886 | 761 |
| Total advances from customers | 55,778 | 55,179 |
Petraco Revolving Prepayment Agreement. In July 2007, the Group entered into a five year revolving prepayment agreement with Petraco. Under the terms of the agreement, US dollar denominated prepayments shall be made to the Group in one or more advances against specified future deliveries of agreed volumes of crude oil to be sold to Petraco. Interest accrues at LIBOR plus 5.00% on prepayments for which the related volumes have not been delivered, and LIBOR plus 1% on prepayments for which the related volumes have been delivered, in order to mirror normal commercial payment terms. During 2008 the maximum borrowing base was increased from $50.0 million to $60.0 million.
In December 2008 the original repayment schedule was modified to take into account decreased oil prices and Company's financial position. Under this schedule Company would have to decrease the amount outstanding to $25.0 million by 1 July 2009 with the remaining balance payable by deliveries to be made in 2009 and 2010. Subsequent to year-end management realized that the proposed repayment schedule was not feasible, and the Company proposed an amendment to the repayment schedule allowing for a more gradual repayment of the currently outstanding $46.0 million in 2009 and 2010 and providing additional security to Petraco. At the date of these financials statements these discussion were on going. Furthermore, transactions and cash flows between Petraco and the Group continue to take place. Specifically, during October and November 2009 the Group received from Petraco additional short term advances that were used to fund the loading of three tankers, the majority of the proceeds from these three tankers are to be used to partially repay the advance from Petraco.
Galaform domestic crude oil prepayment agreement. In November 2007, the Group received an interest free prepayment from a domestic offtaker, Galaform, for the amount of RR 550.0 million ($22.4 million). The prepayment was secured with the domestic crude oil deliveries from the resources of Dinyu, CNPSEI, Michayuneft, Nizhneomrinskaya Neft and Chepetskoye. The prepayment was due to be settled starting from November 2008 and should have been fully repaid in April 2009.
In May 2008, the Group repaid RR 374.6 million ($15.8 million) of the Galaform prepayment and subsequent to year-end the Group transferred to Galaform Chepetskoye for the discharge of the remaining amount of the prepayment (see Notes 8 and 25).
15 Taxes
Income taxes for the years ended 31 December 2008 and 2007 comprised the following:
|
| Year ended 31 December: | |
| 2008 | 2007 | |
| Current tax expense | 901 | 2,423 |
| Accrual (release) of income tax provision | 1,862 | (1,097) |
| Deferred tax (benefit) | (40,140) | (9,215) |
| Income tax (benefit) | (37,377) | (7,889) |
Below is a reconciliation of profit (loss) before taxation to income tax charge (benefit):
| Year ended 31 December: | ||
| 2008 | 2007 | |
| Profit before income tax | (440,626) | 105,902 |
| Theoretical tax (benefit) charge at the statutory rate of 24 % | (105,750) | 25,416 |
| Effect of recalculation of DTA/DTL at 20% at 31 December 2008 | (7,712) | - |
| Excess of net assets acquired over purchase price | - | (50,091) |
| Utilisation of previously unrecognised tax loss carry forward | - | (1,623) |
| Reversal of previously recognized DTA on loss carry forward | 1,974 | - |
| Unrecognised DTA on loss carry forward for the year | 10,202 | 425 |
| Accrual (release) of income tax provision | 1,862 | (1,097) |
| Effect of tax penalties | 46 | 9 |
| Expenses taxable at other tax rate | 59,805 | 12,867 |
| Other non-deductible expenses | 2,196 | 6,205 |
| Income tax (benefit) | (37,377) | (7,889) |
The movements in deferred tax assets and liabilities during the years ended 31 December 2008 were as follows:
|
| 2008 | Recognized in equity for translation differences | Credited (charged) to the income statement | Effect of disposals | 2007 |
| Deferred tax liabilities | |||||
| Inventories | - | (4) | - | 74 | (70) |
| Property, plant and equipment | (91) | 20 | (111) | - | - |
| Deferred tax assets | |||||
| Property, plant and equipment | - | 12 | 156 | (263) | 95 |
| Receivables | - | (2) | (85) | - | 87 |
| Payables | 38 | (9) | 47 | - | - |
| Dismantlement provision | - | 25 | - | (565) | 540 |
| Other deductible temporary differences | 53 | 30 | 23 | - | - |
| Tax losses | 0 | (25) | (1,974) | - | 1,999 |
| Net deferred tax assets | - | 47 | (1,944) | (754) | 2,651 |
| Net deferred tax assets of the Group, excluding those classified as held for sale | - | 14 | (1,939) | - | 1,925 |
| Net deferred tax assets classified as assets held for sale at 31 December 2008 | - | - | - | - | - |
| Net deferred tax assets classified as assets held for sale at 31 December 2007 | - | 33 | (5) | (754) | 726 |
15 Taxes (continued)
|
| 2008 | Recognized in equity for translation differences | Credited (charged) to the income statement | Effect of disposals | 2007 |
| Deferred tax liabilities | |||||
| Property, plant and equipment | (48,262) | 15, 304 | 31,199 | 20,400 | (115,165) |
| Inventories | (1,474) | 435 | -169 | 20 | (1,760) |
| Payables | - | - | 54 | 4 | (58) |
| Other taxable temporary differences | (34) | (146) | 450 | - | (338) |
| Deferred tax assets | |||||
| Receivables | 209 | (70) | 172 | (192) | 299 |
| Dismantlement provision | 288 | (68) | 4 | (89) | 441 |
| Payables | 315 | (73) | 18 | - | 370 |
| Inventories | 645 | (36) | 726 | (45) | - |
| Other deductible temporary differences | 5 | 2 | 3 | ||
| Tax losses | 10,534 | (2,343) | 9,627 | - | 3,250 |
| Net deferred tax liabilities | (37,774) | 13,005 | 42,084 | 20,098 | (112,961) |
| Net deferred tax liabilities of the Group, excluding the portion classified as liabilities directly associated with non-current assets classified as held for sale | (34,344) | 8,277 | 17,825 | - | (60,446) |
| Net deferred tax liabilities classified as liabilities directly associated with non-current assets classified as held for sale at 31 December 2008 | (3,430) | 5,387 | 24,572 | - | (33,389) |
| Net deferred tax liabilities classified as liabilities directly associated with non-current assets classified as held for sale at 31 December 2007 | - | (659) | (313) | 20,098 | (19,126) |
|
| 2007 | Recognized in equity for translation differences | Credited (charged) to the income statement | Effect of acquisitions | 2006 |
| Deferred tax liabilities | |||||
| Inventories | (70) | (3) | (67) | - | - |
| Deferred tax assets | |||||
| Property, plant and equipment | 95 | 8 | (163) | - | 250 |
| Receivables | 87 | 1 | 83 | - | 3 |
| Dismantlement provision | 540 | 34 | 95 | - | 411 |
| Tax losses | 1,999 | 123 | 741 | - | 1,135 |
| Net deferred tax assets | 2,651 | 163 | 689 | - | 1,799 |
| Net deferred tax assets of the Group, excluding those classified as assets held for sale | 1,925 | - | - | - | - |
| Net deferred tax assets classified as assets held for sale at 31 December 2007 | 726 | - | - | - | - |
15 Taxes (continued)
|
| 2007 | Recognized in equity for translation differences | Credited (charged) to the Income statement | Effect of acquisitions | 2006 |
| Deferred tax liabilities | |||||
| Property, plant and equipment | (115,165) | (8,020) | 7,493 | - | (114,638) |
| Inventories | (1,760) | (75) | (1,561) | - | (124) |
| Payables | (58) | (5) | 22 | - | (75) |
| Other taxable temporary differences | (338) | (14) | (285) | - | (39) |
| Deferred tax assets | |||||
| Receivables | 299 | 23 | 24 | - | 252 |
| Dismantlement provision | 441 | 29 | 24 | - | 388 |
| Payables | 370 | 28 | (117) | - | 459 |
| Inventories | - | 5 | (135) | - | 130 |
| Other deductible temporary differences | - | (2) | (59) | - | 61 |
| Tax losses | 3,250 | 130 | 3,120 | - | - |
| Net deferred tax liabilities | (112,961) | (7,901) | 8,526 | - | (113,586) |
| Net deferred tax liabilities of the Group, excluding the portion classified as liabilities directly associated with non-current assets classified as held for sale | (93,835) | - | - | - | - |
| Net deferred tax liabilities classified as liabilities directly associated with non-current assets classified as held for sale at 31 December 2007 | (19,126) | - | - | - | - |
The Group is subject to corporation tax on taxable profits at the rate of 10%. Most of the individual operating entities are taxed in the Russian Federation at the rate of 24%. Under certain conditions interest may be subject to defence contribution at the rate of 10%. In such cases 50% of the same interest will be exempt from corporation tax thus having an effective tax rate burden of approximately 15%. In certain cases dividends received from abroad may be subject to defence contribution at the rate of 15%.
There is no concept of consolidated tax returns in the Russian Federation and, consequently, tax losses and current tax assets of different subsidiaries cannot be set off against tax liabilities and taxable profits of other subsidiaries. Accordingly, taxes may accrue even where there is a net consolidated tax loss. Similarly, deferred tax assets of one subsidiary cannot be offset against deferred tax liabilities of another subsidiary. At 31 December 2008 and 2007, deferred tax assets of $45.6 million and $12.6 million, respectively, have not been recognized for deductible temporary differences for which it is not probable that sufficient taxable profit will be available to allow the benefit of that deferred tax assets to be utilised. Accumulated tax losses were $409.6 million and $119.0 million at 31 December 2008 and 2007, respectively; of which $363.4 million in 2008 and $114.2 million in 2007 can be carried forward indefinitely. The remaining $46.2 million of the accumulated tax losses at 31 December 2008 expire in 2018 and of the remaining $4.8 million at 31 December 2007 expire in 2017.
The Group has not recognised deferred tax liabilities for temporary differences associated with investments in subsidiaries as the Group is able to control the timing of the reversal of those temporary differences and does not intend to reverse them in the foreseeable future. Such amounts are permanently reinvested. At 31 December 2008 and 2007, the estimated unrecorded deferred tax liabilities for such differences were $0.0 million and $1.7 million, respectively. Unremitted earnings amounted nil and $34.4 million at 31 December 2008 and 2007, respectively
In the Russian Federation, an income tax rate of 20% has been enacted in November 2008 which becomes effective starting from 1 January 2009. As this tax rate was enacted by 31 December 2008, the effect of the change on closing deferred tax liabilities (assets) amounted to $7.7 million has been recognised in these financial statements.
15 Taxes (continued)
Other taxes payable at 31 December 2008 and 2007 were as follows:
| Year ended 31 December: | ||
| 2008 | 2007 | |
| Unified production tax | 940 | 4,424 |
| Value added tax | - | 459 |
| Other taxes payable | 728 | 1,116 |
| Other taxes provision | 252 | 529 |
| Total other taxes payable | 1,920 | 6,528 |
| Total other taxes payable of the Group, excluding the portion classified as liabilities directly associated with non-current assets classified as held for sale | 402 | 3,429 |
| Total other taxes payable classified as liabilities directly associated with non-current assets classified as held for sale | 1,518 | 3,099 |
Other taxes provision
| Year ended 31 December: | ||
| 2008 | 2007 | |
| Other taxes provision at 1 January | 529 | 2,367 |
| Release of taxes provision: | ||
| Excise tax (Note 19) | - | (1,717) |
| Value added tax (Note 20) | (167) | (137) |
| Other taxes (Note 20) | (22) | (75) |
| Effect of currency translation | (88) | 91 |
| Total other taxes provision at 31 December | 252 | 529 |
| Total other taxes provision of the Group, excluding the portion classified as liabilities directly associated with non-current assets classified as held for sale | 38 | 529 |
| Total other taxes provision classified as liabilities directly associated with non-current assets classified as held for sale | 214 | - |
In 2008 the Group released $0.2 million tax risks due to expiration of limitation period. During 2007 the Group was successful in defending its position in the courts and released $1.9 million of income in the consolidated income statement.
16 Borrowings
Short-term borrowings. Short-term borrowings were as follows at 31 December 2008 and 2007:
| Year ended 31 December: | ||
| 2008 | 2007 | |
| Sberbank acquisition loan | 499,635 | 500,000 |
| - loan organization fees | - | (14,678) |
| Sberbank field development loan | 130,000 | 130,000 |
| - loan organization fees | - | (1,415) |
| Other | 114 | 124 |
| Total short-term borrowings | 629,749 | 614,031 |
Sberbank Taas acquisition loan. In December 2007, the Group entered into a loan agreement with the Savings Bank of the Russian Federation ("Sberbank") in the amount of $500.0 million to finance the acquisition of its participation interest in Taas. The loan bears interest of 14% per annum payable monthly. The interest payments are secured with interest bearing promissory notes acquired from Sberbank that will be redeemed as payment for interest. The loan matured in November 2008. The Group incurred loan organisation fees of $6.250 million (or 1.25% of the loan amount), which are recorded net against the loan balance and are amortised over the life of the loan using the effective interest method. The Group will be subject to a 3.9% penalty for any early repayments of the loan.
Additionally, the Group is contracted to pay $10.0 million fees to Ashmore Investment Management Limited ("Ashmore"), a fellow shareholder in Taas, in exchange for a pledge of 10.5% of Ashmore share in Taas to
16 Borrowings (continued)
Sberbank in support of the Group's acquisition loan. The payment was rendered in 2008. The Group also pledged its 100% stakes in Petrosakh and Arcticneft to Ashmore as part of the arrangement. The Group was released from these pledges in November 2009 (see note 25).
The Group guaranteed its obligations under the loan by pledging its interest in Taas. Additionally, other shareholders of Taas and of the Group have pledged a portion of their shares in Taas and in UEPCL as collateral for the Group's obligations under the loan. The Company incurred additional $3.6 million of expenses associated with this pledge.
Additionally, according to the loan agreement the Group has to secure interest payment for the next year by Sberbank promissory notes, which should be acquired by the Group and pledged in the deposit with Sberbank. In November 2007 the Group acquired $70.0 million of promissory notes of which $5.8 million were released in December 2007 to make a repayment of interest on due date. The outstanding promissory notes receivable was $64.6 million as at 31 December 2007 which included $64.2 million of principal amount of promissory notes and $0.4 million of interest receivable. The promissory notes were fully released at 31 December 2008.
Sberbank Dulisma field development loan. In November 2007, the Group entered into a loan agreement with Sberbank in the amount of $130.0 million bearing interest of 14% per annum and maturing in November 2008. The Group incurred loan organization fees of $1.625 million (1.25% of the facility amount) which are recorded net against the loan balance and are amortised over the life of the loan using the effective interest method. If the Group meets certain technical conditions, the loan can be extended for six years with 15 equal quarterly principal installments payable starting May 2010. Sberbank did not consider the requirements as being met and consequently as of 31 December 2008 this loan was overdue.
The Group pledged 100% of its shares in Dulisma as collateral for its obligations under the loan. Additionally, major shareholders of the Group agreed to pledge UEPCL shares to Sberbank as additional collateral.
As of 31 December 2008 both loans to Sberbank were overdue (see note 25).
Goldman Sachs project finance loan. In January 2007, the Group entered into a loan agreement to fund the development of the Dulisminskoye field in Irkutsk Region, Eastern Siberia. The loan was fully repaid and the swap agreement terminated in November 2007 when the Group obtained new financing under the Sberbank Dulisma field development loan. As a result of the repayment of this loan and the termination of the swap agreement, the Group incurred early repayment fees which were recognized as interest expense.
Weighted average interest rate. The Group's weighted average interest rates on borrowings were 14.0% and 14.6% at 31 December 2008 and 2007, respectively.
16 Borrowings (continued)
Interest expense and income. Interest expense and income for the years ended 31 December 2008 and 2007, respectively, comprised the following:
| Year ended 31 December: | ||
|
| 2008 | 2007 |
| Short-term borrowings | ||
| Sberbank | ||
| - interest at coupon rate | 77,959 | 8,505 |
| - accretion of issuance costs | 16,005 | 1,689 |
| - pledge fee | 3,636 | - |
| BNP Paribas | - | 58 |
| Evrofinance | 408 | - |
| Total interest expense associated with short-term borrowings | 98,008 | 10,252 |
| Long-term borrowings | ||
| BNP Paribas Subordinated Loan | ||
| - interest at coupon rate | - | 628 |
| - commitments and break up cost | - | 26 |
| - accretion of issuance costs and discount associated with warrants | - | 1,694 |
| BNP Paribas Reserve Based Loan Facility | ||
| - interest at coupon rate | - | 2,303 |
| - commitments | - | 610 |
| - accretion of issuance costs | - | 2,132 |
| Goldman Sachs | ||
| - interest at coupon rate | - | 11,817 |
| - early repayment fees | - | 12,193 |
| - accretion of issuance costs | - | 4,379 |
| Total interest expense associated with long-term borrowings | - | 35,782 |
| Finance leases | 271 | 272 |
| Less capitalised borrowing costs | (5,863) | (3,576) |
| Change in dismantlement provision due to passage of time (Note 17) | 138 | 438 |
| Interest on advance from Petraco Oil Company Limited | 5,661 | 4,310 |
| Interest on advance from Galaform | 175 | - |
| Other interest expense | 61 | 170 |
| Total interest expense | 98,451 | 47,648 |
| Interest income | ||
| JP Morgan Liquidity Fund | - | (76) |
| Related party loans issued (Note 24) | (3,704) | (146) |
| Sberbank promissory notes | (1,737) | (343) |
| Bank deposit | (70) | (2,052) |
| Other interest income | (143) | (5) |
| Total interest income | (5,654) | (2,622) |
| Total finance costs | 92,797 | 45,026 |
The capitalisation rates used to determine the amount of borrowing costs eligible for capitalisation were 14.0% and 13.5% in 2008 and 2007, respectively.
17 Dismantlement Provision
The dismantlement provision represents the net present value of the estimated future obligation for dismantlement, abandonment and site restoration costs which are expected to be incurred at the end of the production lives of the oil and gas fields, which vary from 10 to 40 years depending on the field and type of assets. The discount rate used to calculate the net present value of the dismantling liability was 13.0%.
| Year ended 31 December: | ||
| 2008 | 2007 | |
| Opening dismantlement provision | 4,086 | 3,327 |
| Translation difference | (311) | 264 |
| Additions | 2 | 13 |
| Disposals | (2,605) | (206) |
| Changes in estimates | 128 | 250 |
| Change due to passage of time | 138 | 438 |
| Closing dismantlement provision | 1,438 | 4,086 |
| - Dismantlement provision of the Group, excluding the portion classified as liabilities directly associated with non-current assets classified as held for sale | 15 | 1,448 |
| - Dismantlement provision classified as liabilities directly associated with non-current assets classified as held for sale | 1,423 | 2,638 |
As further discussed in Note 22, environmental regulations and their enforcement are being developed by governmental authorities. Consequently, the ultimate dismantlement, abandonment and site restoration obligation may differ from the estimated amounts, and this difference could be significant.
18 Equity
Redenomination of shares. Following the adoption of the Euro on 1 January 2008 as the official currency of the Republic of Cyprus, replacing the Cyprus Pound, the Company was obliged to convert its authorised and issued share capital first to Euro and subsequently was permitted to change to any other approved currency. On 22 January 2008 following the Extraordinary General Meeting, the Company converted its shares first into Euro at a conversion rate of 1.71 Euro to 1 Cypriot Pound and subsequently into US dollars at a conversion rate of $1.48 to 1 Euro. As a result of this at 22 January 2008 the authorised share capital was changed to $1,890 thousand divided into 300 million shares of $0.0063 each and the issued share capital was changed to $1,103 thousand divided into 175.1 million shares of $0.0063 each. The effect of this redenomination was to increase share capital by $113 thousand.
At 31 December 2008 authorised share capital was $1,890 thousand divided into 300 million shares of $0.0063 each and issued share capital was $1,122 thousand divided into 178.1 million shares of $0.0063 each.
Shares issued for cash. In January 2008, Morgan Stanley, the Group's nominated adviser of a private placement in December 2007, executed an option for 5% of overallotment of UEPCL shares in the amount of 1,643,000 shares. Proceeds from the overallotment issuance totalled $5.9 million net of transaction costs of $0.3 million.
18 Equity (continued)
| Number of Shares (thousand of shares) | Share capital | Share premium | Difference from conversion of share capital into US$ | ||
| Balance at 1 January 2007 | 118,113 | 633 | 401,448 | - | |
| Shares issued for cash | 32,857 | 205 | 116,397 | - | |
| Shares issued for payment of investment in TYNGD | 22,738 | 143 | 93,162 | - | |
| Shares issued under restricted stock plans | 811 | 5 | (5) | - | |
| Shares issued immediately under restricted stock plans | 602 | 4 | (4) | - | |
| Share-based payment under restricted stock | - | - | 9,898 | - | |
| Share-based payment related to immediate vesting |
| - | - | 4,215 | - |
| Balance at 31 December 2007 | 175,121 | 990 | 625,111 | - | |
| Shares issued for cash | 1,643 | 10 | 5,882 | - | |
| Shares issued under restricted stock plans | 753 | 5 | (5) | - | |
| Early vested shares issued under restricted stock plans | 460 | 3 | (3) | - | |
| Share issued under option agreement | 167 | 1 | 124 | - | |
| Share-based payment under restricted stock | - | - | 8,971 | - | |
| Difference from conversion of share capital into US$ | - | 113 | - | (113) | |
| Balance at 31 December 2008 |
| 178,144 | 1,122 | 640,080 | (113) |
Restricted Stock Plan. In February 2006, the Group's Board of Directors approved a Restricted Stock Plan (the "Plan") authorizing the Compensation Committee of the Board of Directors to issue restricted stock of up to five percent of the outstanding shares of the Group. Restricted stock grants entitle the holder to shares of stock for no consideration upon vesting. There are no performance conditions beyond continued employment with the Group. Upon adoption, the Group granted restricted stock awards in the amount of 1,332,355 shares of which 145,952 shares were forfeited during 2007. Also, of the initially granted in 2007 restricted stock of 3,075,393 shares, 93,901 and 75,275 granted shares were cancelled as a result of retirement of certain employees of the Company during years 2008 and 2007.
In March 2008, the Group substantially granted an additional 2,281,677 shares of restricted stock of which 71,796 granted shares were cancelled as a result of retirement of certain employees of the Company during 2008.
The total costs associated with the restricted stock granted during the years ended 31 December 2008, 2007 and 2006, were $7.6 million, $19.6 million and $5.9 million, respectively, based upon the market value of the Group's shares on the date of grant. Such amounts are being recognized over the vesting period of the respective awards. During the years ended 31 December 2008 and 2007, $9.0 million and $14.1 million, respectively, of expense related to share-based payments were recognized in the consolidated statements of income. Such expense for the year ended 2007 includes $4.2 million of expense related to restricted stock granted to certain members of the Group's executive management, who resigned 2007. As part of the severance agreement with those employees, all unvested restricted stock grants which they held were immediately vested in 2007 and early 2008.
At 31 December 2008 and 31 December 2007, restricted stock grants for 1,213,407 shares and 1,413,307 shares were fully vested and issued.
18 Equity (continued)
As of 31 December 2008, the number of unvested restricted stock grants and their respective vesting dates are presented in the table below.
| Date of Grant | January 2008 | January 2009 | January 2010 | January 2011 | Total |
| Unvested Restricted Stock Granted as of 31 December 2007 | 753,588 | 798,931 | 715,530 | 45,344 | 2,313,393 |
| Restricted Stock Granted in 2008 | - | 760,559 | 760,559 | 760,559 | 2,281,677 |
| Forfeitured in 2008 | - | (63,915) | (74,365) | (27,415) | (165,695) |
| Vested in 2008 | (753,588) | - | - | - | (753,588) |
| Total Restricted Stock Granted as of 31 December 2008 | - | 1,495,575 | 1,401,724 | 778,488 | 3,675,787 |
Subsequent to 31 December 2008, the Group issued 1,432,062 shares which included early vesting of grants of 290,581 shares to the retired employees in early 2009 as part of severance payments and issue of 1,141,481 shares as a result of normal vesting of previously issued restricted stock grants. The vesting of 354,094 shares under plans of restricted stock grants to certain top managers was deferred.
Share options granted. In September 2005, the Group granted options to purchase 20,000 shares at an exercise price of GBP 2.40 per share to one of its non-executive directors. These options were granted for zero consideration. All of these options remain unexercised. The fair value of this option was evaluated at $7 thousand. The options vest on 30 September 2006, 2007 and 2008 in equal parts and expire on 30 September 2009. No option had been exercised at the date of these financial statements.
During 2005, the Group granted a share-based award to one of its officers who is no longer with the Company. Under the award, the officer had the option to purchase a certain number of the Company's shares at a share price equal to $131.0 million divided by the number of the Company's shares that are issued and outstanding at both 1 August 2006 and 1 August 2007. The option is in two parts comprised of the number of shares that can be purchased for a payment of $125 thousand on 1 August 2006 and of $125 thousand on 1 August 2007, which are the respective vesting dates of the two parts of the award. The Group estimated the total fair value of the award to be $120 thousand.
During the year ended 31 December 2008, 167 thousand shares were issued as a result of execution of the award. The option was executed in full in February 2008, when the Group issued 167,100 shares to the former officer. Overall the Group issued 280 thousand shares in accordance with that plan.
Earnings per share. Basic earnings per share is calculated by dividing the profit attributable to equity holders of the company by the weighted average number of ordinary shares in issue during the year.
The weighted average number of ordinary shares issued was calculated as following:
| Year ended 31 December: | ||
| 2008 | 2007 | |
| Balance at 1 January | 175,120,478 | 118,112,135 |
| Shares issued for cash | 1,607,087 | 1,260,269 |
| Shares issued for payment of investment in Taas | - | 1,121,328 |
| Shares issued under restricted stock plans | 704,174 | 606,663 |
| Early vested shares under restricted stock plans | 405,797 | 318,660 |
| Exercise of options | 147,468 | - |
| Weighted average number of ordinary shares in issue | 177,985,004 | 121,419,055 |
18 Equity (continued)
| Year ended 31 December: | ||
| 2008 | 2007 | |
| (Loss) Profit attributable to equity holders of the Company | (401,789) | 113,722 |
| Weighted average number of ordinary shares in issue (thousands) | 177,985 | 121,419 |
| Basic earnings per share (in US dollar per share) | (2.26) | 0.94 |
The company has three categories of potential ordinary shares: warrants, share options and restricted stock plan, and call and put options associated with the purchase of Taas. Diluted earnings per share is calculated by adjusting the weighted average number of ordinary shares outstanding and the profit attributable equity holders of the Company to assume conversion of all dilutive potential ordinary shares. For the year ended 31 December 2008, basic and diluted earnings per share and the corresponding weighted average shares outstanding used in each calculation are identical as all potentially dilutive instruments are antidilutive. The diluted earning per share for 2007 was 0.82 USD per share.
19 Revenues
| Year ended 31 December: | ||
| 2008 | 2007 | |
| Crude oil | ||
| Export sales | 147,377 | 134,308 |
| Domestic sales (Russian Federation) | 59,387 | 45,891 |
| Petroleum (refined) products - domestic sales | 12,163 | 12,386 |
| Other sales | 3,364 | 1,526 |
| Total gross revenues | 222,291 | 194,111 |
Substantially all of the Group's export sales are made to third party traders with title passing at the Russian border. Accordingly, management does not monitor the ultimate consumers and geographic markets of its export sales.
Included within excise taxes was a gain from release of tax risk provisions of $1.7 million in the year ended 31 December 2007. There were no such adjustments in the year ended 31 December 2008.
20 Cost of Sales
| Year ended 31 December: | ||
| 2008 | 2007 | |
| Unified production tax | 37,952 | 41,509 |
| Depreciation, amortization and depletion | 16,514 | 28,974 |
| Cost of purchased products | 70,799 | 21,624 |
| Wages and salaries (including payroll taxes of $3.5 million and $3.5 million for the years ended 31 December 2008 and 2007, respectively) | 22,175 | 21,489 |
| Materials | 7,184 | 7,285 |
| Oil treating, storage and other services | 6,571 | 5,467 |
| Write-off unsuccessful drilling costs (Note 11) | 2,552 | - |
| Other taxes | 2,721 | 3,214 |
| Rent, utilities and repair services | 1,534 | 1,611 |
| Energy services | 774 | 1,377 |
| Release of other taxes provision (Note 15) | (189) | (212) |
| Accrual (release) provision on inventory (Note 10) | 4,307 | (882) |
| Other expenses | 4,203 | 4,086 |
| Change in finished goods | (10,376) | (4,153) |
| Total cost of sales | 166,721 | 131,389 |
21 Selling, General and Administrative Expenses
| Year ended 31 December: | ||
| 2008 | 2007 | |
| Wages and salaries | 13,431 | 21,812 |
| Share-based payment | 8,971 | 14,113 |
| Professional consultancy fees | 3,350 | 5,309 |
| Office rent and other expenses | 2,411 | 3,440 |
| Transport and storage services | 2,244 | 2,327 |
| Loading services | 3,331 | 3,658 |
| Trip expenses and communication services | 1,630 | 1,824 |
| Audit fees | 1,479 | 1,307 |
| Bad debt write-off | 2,161 | - |
| Other expenses | 5,323 | 5,443 |
| Total selling, general and administrative expenses | 44,331 | 59,233 |
Directors' fees for the years ended 31 December 2008 and 2007 were $172 thousand and $170 thousand, respectively, and do not include amounts related to share-based payments provided to the Group's directors (Note 24).
22 Contingencies, Commitments and Operating Risks
Operating environment. The Russian Federation continues to display some characteristics of an emerging market economy. These characteristics include, but are not limited to, the existence of a currency that is not yet fully convertible in many countries outside of the Russian Federation, and relatively high inflation. Tax and customs legislation within the Russian Federation is subject to varying interpretations, and changes can occur frequently.
The future economic direction of the Russian Federation is largely dependent upon the effectiveness of economic, financial and monetary measures undertaken by the Government, together with tax, legal, regulatory, and political developments.
Oilfield licenses. The Group is subject to periodic reviews of its activities by governmental authorities with respect to the requirements of its oil field licenses. Management of the Group correspond with governmental authorities to agree on remedial actions, if necessary, to resolve any findings resulting from these reviews. Failure to comply with the terms of a license could result in fines, penalties or license limitations, suspension or revocations. Management believes any issues of non-compliance will be resolved through negotiations or corrective actions without any materially adverse effect on the financial position or the operating results of the Group.
Management believes that proved reserves should include quantities that are expected to be produced after the expiry dates of the Group's production licenses. These licenses expire between 2012 and 2067.
The principal licenses of the Group and their expiry dates are:
| Field | License holder | License expiry date |
| Okruzhnoye | Petrosakh | 2012 |
| Peschanozerskoye | Arcticneft | 2067 |
| Dulisminskoye | Dulisma | 2019 |
| Srednebotuobinskoye | Taas-Yuryakh Neftegazdobycha | 2016 |
| Kurungsky | Taas-Yuryakh Neftegazdobycha | 2032 |
Management believes the licenses may be extended at the initiative of the Group and management intends to extend such licenses for properties expected to produce subsequent to their license expiry dates.
22 Contingencies, Commitments and Operating Risks (continued)
As of 31 December 2008 the Group was not in compliance with all of the conditions as set forth in its license agreements. As a result, the Group is exposed to potential penalties, but not revocation of the license. Management does not believe that any of its significant exploration or production licenses are at risk of being withdrawn by the licensing authorities because subsequent to year end, management has taken steps to amend license agreements with the relevant authorities. Management plans to complete all the required exploration and development work, in accordance with the timetables established in the amended licenses.
Taxation. Russian tax and customs legislation is subject to varying interpretations, and changes, which can occur frequently. Management's interpretation of such legislation as applied to the transactions and activity of the Group may be challenged by the relevant authorities. The Russian tax authorities may be taking a more assertive position in their interpretation of the legislation and assessments, and it is possible that transactions and activities that have not been challenged in the past may be challenged. The Supreme Arbitration Court issued guidance to lower courts on reviewing tax cases providing a systemic roadmap for anti-avoidance claims, and it is possible that this will significantly increase the level and frequency of tax authorities scrutiny. As a result, significant additional taxes, penalties and interest may be assessed. Fiscal periods remain open to review by the authorities in respect of taxes for three calendar years preceding the year of review. Under certain circumstances reviews may cover longer periods.
Russian transfer pricing legislation introduced 1 January 1999 provides the possibility for tax authorities to make transfer pricing adjustments and impose additional tax liabilities in respect of all controllable transactions, provided that the transaction price differs from the market price by more than 20%.
Controllable transactions include: transactions with interdependent parties, as determined under the Russian Tax Code; all cross-border transactions (irrespective whether performed between related or unrelated parties); transactions where the price applied by a taxpayer differs by more than 20% from the price applied in similar transactions by the same taxpayer within a short period of time; and barter transactions. There is no formal guidance as to how these rules should be applied in practice. In the past, the arbitration court practice with this respect has been contradictory.
Tax liabilities arising from intercompany transactions are determined using actual transaction prices. It is possible with the evolution of the interpretation of the transfer pricing rules in the Russian Federation and the changes in the approach of the Russian tax authorities, that such transfer prices could potentially be challenged in the future. Given the brief nature of the current Russian transfer pricing rules, the impact of any such challenge cannot be reliably estimated; however, it may be significant to the financial condition and/or the overall operations of the entity.
The Group includes companies incorporated outside of Russia. Tax liabilities of the Group are determined on the assumptions that these companies are not subject to Russian profits tax because they do not have a permanent establishment in Russia. Russian tax laws do not provide detailed rules on taxation of foreign companies. It is possible that with the evolution of the interpretation of these rules and the changes in the approach of the Russian tax authorities, the non-taxable status of some or all of the foreign companies of the Group may be challenged. The impact of any such challenge cannot be reliably estimated; however, it may be significant to the financial condition and/or the overall operations of the Group.
Russian tax legislation does not provide definitive guidance in certain areas. From time to time, the Group adopts interpretations of such uncertain areas that reduce the overall tax rate of the Group. As noted above, such tax positions may come under heightened scrutiny as a result of recent developments in administrative and court practices; the impact of any challenge by the tax authorities cannot be reliably estimated; however, it may be significant to the financial condition and/or the overall operations of the entity.
22 Contingencies, Commitments and Operating Risks (continued)
Management regularly reviews the Group's taxation compliance with applicable legislation, laws and decrees as well as interpretations published by the authorities in the jurisdictions in which the Group has operations. However, from time to time potential exposures and contingencies are identified and at any point in time a number of open matters exist, management believes that its tax positions are sustainable. Management estimates that possible tax exposures that are more than remote but for which no liability is required to be recognised under IFRS, could be up to $10.1 million of the Group's profit before tax for the current year. These exposures primarily relate to income tax, VAT and other taxes. This estimation is provided for the IFRS requirement for disclosure of possible taxes and should not be considered as an estimate of the Group's future tax liability.
Insurance policies. The Group insured all of its major assets, including oil in stock, plant and equipment, transport and machinery with a total limit of $7.3 million. Also, a liability insurance policy covering property, plant and equipment, hazardous objects, including environmental liability, was put in place with a total limit of $1.7 million and directors and officers liability with total limit up to $100.0 million. Staff and personal insurance includes casualty, medical and travel insurance for losses of up to $2.4 million. The associated expenses are included within selling, general and administrative expenses in the consolidated income statement.
Restoration, rehabilitation and environmental costs. The Group companies have operated in the upstream and refining oil industry in the Russian Federation for many years, and their activities have had an impact on the environment. The enforcement of environmental regulations in the Russian Federation is evolving and the enforcement posture of government authorities is continually being reconsidered. The Group periodically evaluates its obligations related thereto. The outcome of environmental liabilities under proposed or future legislation, or as a result of stricter enforcement of existing legislation, cannot reasonably be estimated at present, but could be material. Under the current levels of enforcement of existing legislation, management believes there are no significant liabilities in addition to amounts which are already accrued and which would have a material adverse effect on the financial position of the Group.
Legal proceedings. The Group is involved in a number of court proceedings (both as a plaintiff and a defendant) arising in the ordinary course of business. In the opinion of management, there are no current legal proceedings or other claims outstanding, which could have a material effect on the result of operations or financial position of the Group and which have not been accrued or disclosed in these consolidated financial statements.
Impact of the ongoing global financial and economic crisis. The ongoing global financial and economic crisis that emerged out of the severe reduction in global liquidity which commenced in the middle of 2007 (often referred to as the "Credit Crunch") has resulted in, among other things, a lower level of capital market funding, lower liquidity levels across the banking sector and wider economy, and, at times, higher interbank lending rates and very high volatility in stock and currency markets. The uncertainties in the global financial markets have also led to failures of banks and other corporates, and to bank rescues in the United States of America, Western Europe, Russia and elsewhere. The full extent of the impact of the ongoing financial crisis is proving to be difficult to anticipate or completely guard against.
The availability of external funding in financial markets has significantly reduced since August 2007. Such circumstances may affect the ability of the Group to obtain new borrowings and re-finance its existing borrowings at terms and conditions similar to those applied to earlier transactions.
Management is unable to reliably determine the effects on the Group's future financial position of any further deterioration in the liquidity of the financial markets and the increased volatility in the currency and equity markets. Management believes it is taking all the necessary measures to support the sustainability and development of the Group's business in the current circumstances.
Other capital commitments. At 31 December 2008, the Group had no significant contractual commitments for capital expenditures.
23 Financial Risks
The accounting policies for financial instruments have been applied to the line items below:
| At 31 December: | ||
| 2008 | 2007 | |
| Financial assets | ||
| Investments held-to-maturity: current assets | ||
| Promissory notes | - | 64,581 |
| Total investments held-to-maturity | - | 64,581 |
| Loans and receivables: current assets | ||
| Cash and cash equivalents | 912 | 28,400 |
| Trade receivables | 6,998 | 8,846 |
| Total loans and receivables: current assets | 7,910 | 37,246 |
| Measured at fair value - non-current assets | ||
| Financial derivatives | - | 5,103 |
| Total non-current assets measured at fair value | - | 5,103 |
| Loans and receivables: non-current assets | ||
| Loans receivable: non-current | 31,066 | 2,264 |
| Total loans and receivables | 38,976 | 44,613 |
| Financial liabilities | ||
| Measured at fair value - current liabilities | ||
| Derivative financial instruments | 161,300 | 118,657 |
| Warrants classified as liabilities | 177 | 1,326 |
| Total current liabilities measured at fair value | 161,477 | 119,983 |
| Measured at amortized cost: current liabilities | ||
| Trade and other payables | 27,742 | 22,362 |
| Short-term borrowings and current portion of long-term borrowings | 629,749 | 614,031 |
| Total current liabilities measured at amortized cost | 657,491 | 636,393 |
| Measured at amortized cost: non-current liabilities | ||
| Long-term borrowings | - | 29 |
| Total long-term liabilities measured at amortized cost | - | 29 |
Financial risk management objectives and policies. In the ordinary course of business, the Group is exposed to market risks from fluctuating prices on commodities purchased and sold, credit risk, liquidity risk, currency exchange rates and interest rates. Depending on the degree of price volatility, such fluctuations in market price may create volatility in the Group's financial results. As an entity focused upon the exploration and development of oil and gas properties, the Group's overriding strategy is to maintain a strong financial position by securing access to capital to meet its capital investment needs.
The Group's principal risk management policies are established to identify and analyze the risks faced by the Group, to set appropriate risk limits and controls, and to monitor risks and adherence to these limits. Risk management policies and systems are reviewed regularly to reflect changes in market conditions and the Group's activities.
23 Financial Risks (continued)
Market risk. Market risk is the risk that changes in market prices and rates, such as foreign exchange rates, interest rates, commodity prices and equity prices, will affect the Group's financial results or the value of its holdings of financial instruments. The primary objective of mitigating these market risks is to manage and control market risk exposures. The Group is exposed to market price movements relating to changes in commodity prices such as crude oil, gas condensate, petroleum products and natural gas (commodity price risk), foreign currency exchange rates, interest rates, equity prices and other indices that could adversely affect the value of the Group's financial assets, liabilities or expected future cash flows.
(a) Foreign exchange risk
The Group is exposed to foreign exchange risk arising from various exposures in the normal course of business, primarily with respect to the US dollar. Foreign exchange risk arises primarily from commercial transactions, and recognized assets and liabilities when such transactions, assets and liabilities are denominated in a currency other than the functional currency.
The Group's overall strategy is to have no significant net exposure in currencies other than the Russian rouble or the US dollar.
The carrying amounts of the Group's financial instruments are denominated in the following currencies (all amounts expressed in thousands of US dollars at the appropriate 31 December 2008 and 2007 exchange rates):
| At 31 December 2008 | Russian rouble | US dollar | Other | Total |
| Financial assets | ||||
| Non-current | ||||
| Loans receivable | - | 31,066 | - | 31,066 |
| Current | ||||
| Cash and cash equivalents | 396 | 491 | 25 | 912 |
| Accounts receivable | 2,043 | 4,955 | - | 6,998 |
| Financial liabilities | ||||
| Current | ||||
| Accounts payable and accrued expenses | (18,594) | (9,148) | - | (27,742) |
| Derivative financial instruments | - | (161,300) | - | (161,300) |
| Short-term borrowings and current portion of long-term borrowings | (53) | (629,696) | - | (629,749) |
| Warrants classified as liabilities | - | - | (177) | (177) |
| Net exposure at 31 December 2008 | (16,208) | (763,632) | (152) | (779,992) |
23 Financial Risks (Continued)
| At 31 December 2007 | Russian rouble | US dollar | Other | Total |
| Financial assets | ||||
| Non-current | ||||
| Financial derivatives | - | 5,103 | - | 5,103 |
| Loans receivable | - | 2,264 | - | 2,264 |
| Current | ||||
| Cash and cash equivalents | 2,968 | 5,414 | 20,018 | 28,400 |
| Accounts receivable | 3,079 | 5,767 | - | 8,846 |
| Promissory notes | - | 64,581 | - | 64,581 |
| Financial liabilities | ||||
| Non-current | ||||
| Long-term borrowings | - | - | (29) | (29) |
| Current | ||||
| Accounts payable and accrued expenses | (3,169) | (19,193) | - | (22,362) |
| Derivative financial instruments | - | (118,657) | - | (118,657) |
| Short-term borrowings and current portion of long-term borrowings | (63) | (613,968) | - | (614,031) |
| Warrants classified as liabilities | - | - | (1,326) | (1,326) |
| Net exposure at 31 December 2007 | 2,815 | (668,689) | 18,663 | (647,211) |
In accordance with IFRS requirements, the Group has provided information about market risk and potential exposure to hypothetical loss from its use of financial instruments through sensitivity analysis disclosures. The sensitivity analysis depicted in the table below reflects the hypothetical income (loss) that would occur assuming a 15% change in exchange rates and no changes in the portfolio of instruments and other variables held at 31 December 2008 and 2007, respectively.
| Year ended 31 December: | |||
| Effect on pre-tax profit | Increase in exchange rate | 2008 | 2007 |
| $/RUS | 15% | (114,545) | (100,303) |
| $/Other | 15% | (23) | 2,799 |
The effect of a corresponding 15% decrease in exchange rate is approximately equal and opposite.
(b) Commodity price risk
The Group's overall commercial trading strategy in crude oil and related products is centrally managed. Changes in commodity prices could negatively or positively affect the Group's results of operations.
The Group sells all its crude oil and petroleum products under spot contracts. Crude oil sold internationally is based on benchmark reference crude oil prices of Brent dated, plus or minus a discount for quality and on a transaction-by-transaction basis for volumes sold domestically. As a result, the Group's revenues from the sales of liquid hydrocarbons are subject to commodity price volatility based on fluctuations or changes in the crude oil benchmark reference prices. Presently, the Group does not use commodity derivative instruments for trading purposes to mitigate price volatility.
23 Financial Risks (continued)
(c) Cash flow and fair value interest rate risk
The Group is not significantly exposed to cash flow interest rate risk on its financial liabilities as most of its financial liabilities bear fixed rates of interest. However, changes in market interest rates impact the fair values of fixed rate financial liabilities or future cash flows in the case of variable financial liabilities. Management does not have a formal policy on the proportion of the Group's exposure interest rate risk on its financial liabilities.
At 31 December 2008 and 2007, the Group's interest rate profiles for interest-bearing financial liabilities were:
| Year ended 31 December: | ||
| 2008 | 2007 | |
| At fixed rate | 629,749 | 614,060 |
| Total interest bearing financial liabilities | 629,749 | 614,060 |
To the degree possible, the Group centralizes the cash requirements and surpluses of controlled subsidiaries and the majority of their external financing requirements, and applies, on its consolidated net debt position, a funding policy to optimize its financing costs and manage the impact of interest-rate changes on its financial results in line with market conditions.
The Group's financial results are sensitive to changes in interest rates on the floating rate portion of the Group's debt portfolio. If the weighted average interest rates applicable to floating rate debt were to increase by 100 basis points for the years in question, assuming all other variables remain constant, it is estimated that the Group's profit before taxation for the years ended 31 December 2008 and 2007 would decrease by the amounts shown below.
| Year ended 31 December: | ||
| Effect on pre-tax profit | 2008 | 2007 |
| Increase by 100 basis point | - | - |
The effect of a corresponding 100 basis points decrease in interest rates is approximately equal and opposite.
Credit risk. Credit risk refers to the risk exposure that a potential financial loss to the Group may occur if a counterparty defaults on its contractual obligations.
Credit risk is managed on a Group level and arises from cash and cash equivalents, including short-term deposits with banks, promissory notes, loans issued as well as credit exposures to customers, including outstanding trade receivables and committed transactions. Cash and cash equivalents are deposited only with banks that are considered by the Group at the time of deposit to minimal risk of default.
The Group's domestic trade and other receivables consist of a large number of customers, spread across diverse industries and geographical areas. All of the Group's export crude oil sales are made to one customer, Petraco, with whom the Group was trading for the past several years (see Note 14). A majority of domestic sales of petroleum products are made on a prepayment basis. Although the Group does not require collateral in respect of trade and other receivables, it has developed standard credit payment terms and constantly monitors the status of trade receivables and the creditworthiness of the customers. The maximum exposure to credit risk is represented by the carrying amount of each financial asset exposed to credit risk.
Liquidity risk. Liquidity risk is the risk that the Group will not be able to meet its financial obligations as they fall due. The Group's approach to managing liquidity has been to ensure that it will have sufficient liquidity to meet its liabilities when due, under both normal and stressed conditions. As discussed in Note 3 and Note 25, the Group is in process of negotiations with a major creditor with a view to securing a more stable financial position.
The Group prepares various financial and operational plans (monthly, quarterly and annually) to ensure that the Group has sufficient cash on demand to meet expected operational expenses. Additionally, the Group has pursued a program of divesting certain assets in order to both raise funds to meet its short term liabilities and save on the cash outflows necessary to maintain those assets.
23 Financial Risks (continued)
The following tables summarize the maturity profile of the Group's financial liabilities based on contractual undiscounted payments, including interest payments:
| At 31 December 2008 | Less than 1 year | Between 1 and 2 years | Between 2 and 5 years | After 5 years | Total |
| Debt at fixed rate | |||||
| Principal | 629,749 | - | - | - | 629,749 |
| Interest | 5,943 | - | - | - | 5,943 |
| Warrants classified as liability | 177 | - | - | - | 177 |
| Financial instruments | 161,300 | - | - | - | 161,300 |
| Accounts payable and accrued expenses | 21,799 | - | - | - | 21,799 |
| Total financial liabilities | 818,968 | - | - | - | 818,968 |
As discussed in Note 25 the debt liabilities and financial instruments were settled in November 2009.
| At 31 December 2007 | Less than 1 year | Between 1 and 2 years | Between 2 and 5 years | After 5 years | Total |
| Debt at fixed rate | |||||
| Principal | 630,124 | 29 | - | - | 630,153 |
| Interest | 967 | - | - | - | 967 |
| Warrants classified as liability | 1,326 | - | - | - | 1,326 |
| Financial instruments | 118,657 | - | - | - | 118,657 |
| Accounts payable and accrued expenses | 21,395 | - | - | - | 21,395 |
| Total financial liabilities | 772,469 | 29 | - | - | 772,498 |
Significant assumptions included in the option valuation model for the financial instruments associated with Taas are summarized as follows:
| Call option | Put option | |
| Share price | $4.06 | $4.06 |
| Dividend yield | - | - |
| Expected volatility | 41.25% | 57.14% |
| Risk-free interest rate | 4.25% | 4.40% |
| Expected life | 1.099 year | 2.5 years |
| Correlation coefficient | N/A | 75% |
Put option. The Group's evaluation of the put option associated with the Taas investment (Note 7) was assessed as $161.3 million at 31 December 2008.
23 Financial Risks (continued)
Capital management. The primary objectives of the Group's capital management policy is to ensure a strong capital base to fund and sustain its business operations through prudent investment decisions and to maintain investor, market and creditor confidence to support its business activities.
The capital as defined by management at 31 December 2008 and 2007 was as follows:
| 2008 | 2007 | |
| Total borrowings | 629,749 | 614,060 |
| Less cash and cash equivalents | (912) | (28,400) |
| Net debt | 628,837 | 585,660 |
| Total equity | 349,828 | 828,368 |
| Gearing ratio | 1.8 | 0.7 |
For the capital management, the Group manages and monitors its liquidity on a corporate-wide basis to ensure adequate funding to sufficiently meet group operational requirements. The Group controls all external debts at the Parent level, and all financing to Group entities for the operating and investing activity is facilitated through inter-company loan arrangements, except for the specific project financing, which are taken on the subsidiary level.
There were no changes to the Group's approach to capital management during the year.
24 Balances and transactions with Related Parties
Parties are generally considered to be related if one party has the ability to control the other party, is under common control, or can exercise significant influence over the other party in making financial or operational decisions as defined by IAS 24 "Related Party Disclosures". Key management personnel are considered to be related parties. In considering each possible related party relationship, attention is directed to the substance of the relationship, not merely the legal form.
| As of or for the year ended 31 December | ||
| 2008 | 2007 | |
| Interest income | 3,704 | 146 |
| Rental expenses (included in selling, general and administrative expense) | 56 | - |
| Other expenses | - | 34 |
| Accounts and notes receivable | 73 | 48 |
| Loans receivable | 5,250 | 5,372 |
| Interest receivable | 875 | 347 |
| Impairment of receivables from related parties (Note 9) | (1,243) | - |
| Receivables from related parties | 4,955 | 5,767 |
| Loans issued to Taas (Note 12) | 28,099 | 2,261 |
| Interest receivable from Taas (Note 12) | 2,967 | 3 |
| Advances from and payables to related parties (Note 13) | (13) | (24) |
| Loans payable (Note 13) | (61) | (89) |
Compensation to senior management. The Group's senior management team compensation totalled $15.042 million and $26.732 million for the periods ended 31 December 2008 and 2007, respectively, including salary, bonuses and severance payments of $0.946 million and $12.891 million respectively and stock compensation of $8.971 million and $13.841 million, respectively. No other compensation was paid for either year. Additionally, included in loans receivable at 31 December 2008 and 2007 were loans receivable of $4.142 million and $3.743 million, respectively from the Group's senior management team.
Within loans receivable the largest part relates to a short-term loan provided to one of the senior managers of the company in the amount of $4.1 million, including accrued interest. The loan bears 15% interest and matures on 30 September 2008. The loan is secured with real estate properties located in Moscow. The loan receivable was past-due and impaired at 31 December 2008 by $1.2 million as a result of valuation of the pledge which decreased following lack of liquidity in the real estate market in Moscow.
24 Balances and transactions with Related Parties (Continued)
Additionally, loans receivable include amounts due by OOO Komineftegeophysica in the amount of $0.866 million, where major shareholders of the Group hold the majority of shares. The loans bear interest from 5% to 15% and are short term in nature. These loans are not secured, however, in the ordinary course of business and on market terms Komineftegeophysica provides geological and geophysical services to the Group companies.
Interest income is earned from the loan provided by the Group to Taas (Note 12) and the loans provided to senior management of the Group as described above.
Other loans and receivable balances are short-term in the nature, immaterial individually and expire during 2009.
25 Subsequent events
Sale of non-core assets. Sale of Chepetskoye to Galaform for $5.2 million of total consideration in January 2009. For more details refer to Note 8.
Changes to management. In April 2009 Vyacheslav Ivanov was elected to the Board of Directors and was subsequently appointed Chairman of the Board and Chief Executive Officer. In May 2009 there were further significant changes to the management team, including appointment of a new Chief Financial Officer of the Group, Grigory Kazakov. Further, in October 2009 Vyacheslav Ivanov resigned from the positions of CEO and Chairman of the Board of Directors and Mr. Leonid Dyachenko was appointed as a Chairman of the Board of Directors and as interim Chief Executive Officer. In November 2009 Mr. Alexei Maximov was appointed as a Chief Executive Officer of the Company and a director in the Board of Directors.
Repayment of Sberbank loans. Subsequent to 31 December 2008 the Company sold it's 100% interest in Dulisma (August 2009) and 35.3% interest in Taas (November 2009) for the full discharge of the Company's debt to Sberbank Capital plus assumption of all trade accounts payable accrued by Dulisma and Taas at the date of the transaction. Additionally, subsequent to the two sales the Company was released from any obligations under Taas Shareholders' agreement and terminated the Put Option agreement with Ashmore for nil consideration. Registration and actual release of the pledges associated with termination of Put option agreement were ongoing at the date of these financial statements. This matter is discussed in greater detail in Note 3.
Change in the long-term strategy of the Company. During the negotiations with Sberbank Capital (which resulted in the above repayment of Sberbank loans) the Board of Directors and management of the Company reconsidered a previously announced strategy to divest the remaining assets of the Company Arcticneft and Petrosakh. As a result of an improvement in world oil prices and a lack of acceptable offers for Arcticneft and Petrosakh management decided to keep these assets and to concentrate on the operations of these assets in order to increase production.
Suspension of Company's shares trading. On 30 June 2009 the Company's shares were suspended from trading on LSE AIM due to non-compliance with Rule 19 of the AIM rules for not publishing 2008 year-end accounts. Management considered in June 2009 that due to uncertainties over the direction of negotiations with Sberbank Capital it was not in a position to complete its 2008 annual financial statements. Also in August 2009 Morgan Stanley retired from Nominated Adviser ("NOMAD") and Company's Broker positions. As a result of the above the Company's shares were suspended from trading.
In October 2009 the Company appointed a new NOMAD, Allenby Capital. Following the appointment of the NOMAD and following the completion of the transactions with Sberbank Capital and others, the Company is now in a position to release its 2008 year-end consolidated financial statements and plans to release the interim 2009 accounts and report before 31 December 2009 and thus intends to be compliant with AIM rules. As a result of this management expects there will be a resumption of trading of the Company's shares on LSE AIM.