30 Jun 2008 08:43
Urals Energy Public Company Limited
("Urals Energy", the "Company" or the "Group")
Urals Energy (LSE: UEN) a leading independent exploration and production company with operations in Russia today announces its financial results for the year ended 31st December 2007. This follows the Company's operational and reserves update of 3 June 2008.
Strategy
Portfolio now positioned to offer significant upside through major field development with focus on East Siberia
Pursuing sale options for non-strategic assets
Corporate
Acquisition of an interest in SRB ("Taas") field together with upgrades to Dulisma reserves resulting in 104% increase in 2P reserves to 1,183 MBOE
Appointment of Leonid Dyachenko as Chief Executive Officer
Appointment of Vladimir Sidorovich as Chief Financial Officer and Kerry Kendrick as Chief Operating Officer
Operational
2007 average production stable at 8,859 BOPD
Commenced significant construction and drilling activity on Dulisma
Targeting production of 85,000 BOPD by 2015
Financial
137% increase in PV10 of the Company's 2P reserves to US$3,248 million
234% increase in net income to $113.7 million
Gross loss of $10 million in 2007 driven by exploration well and other fixed assets write offs (gross profit of $21.6 million without write offs)
Leonid Dyachenko, Chief Executive Officer, commented:
"2007 was a transformational year for the Company and its long term growth prospects. Urals now offers greater upside potential and opens opportunities to significant production growth. We've begun this year with a strong focus on operational targets and we are on track to meet our objectives."
30 June 2008
Enquiries:
| Pelham PR | ||
| Evgeniy Chuikov | +44(0)20 3008 5506 / +44(0)7894 608 606 | |
| Elena Dobson | +44(0)20 3178 4418 / +44(0)7932 524 760 | |
CEO STATEMENT
2007 was a significant year for the Company, as our East Siberian focus and strategy to capitalise on acquisition opportunities in the region saw the Company continue to grow in size and scale. The acquisition of an interest in the SRB field ("Taas") in East Siberia was the key event of the year and together with upgrades to our Dulisma reserves resulted in a more than 100% increase in our reserve base. Urals Energy is now the only Russian independent oil producer to offer such critical mass, in a region that enjoys attractive fiscal regime and access to the growing Asian-Pacific markets.
Operationally, important milestones were achieved in 2007 that place the Company in a strong position to deliver on our stated targets. In January 2007 the Dulisma development plan was approved by the Russian State Field Development Committee and development activity commenced immediately, with the construction of initial field infrastructure and the purchase of two new drilling rigs. In July, the Company also signed an important cooperation agreement with Gazprom, which outlined the Company's plans to commercialise the significant Dulisma gas reserves and will allow us to develop the field to its full potential.
Average production in 2007 remained stable at 8,859 BOPD versus 9,569 BOPD in 2006. The Company worked to overcome production challenges at Dinyu and Petrosakh and restored production from eight wells at Dulisma. In 2008 production is set to increase as the Dulisma development drilling programme gathers momentum, and following the acquisition of the 35% interest in Taas, the Company is now targeting total combined production for Dulisma and Taas of 58,000 BOPD in 2012 and 85,000 BOPD in 2015.
The most significant measure of the Company's growth in 2007 is the 137% year on year increase in the PV10 of the Company's 2P reserves to US$3,248 million. This exemplifies the rationale behind the focus on East Siberia and demonstrates management's ability to deliver value enhancing acquisitions.
The Company's strategic focus remains the development of its key strategic assets in East Siberia. Having disposed of principal Komi assets in April of 2008, we continue to evaluate possible disposals of other non-strategic assets.
Financial
In 2007, the Company benefited from increasing oil prices with total revenues increasing to $194.1 million (2006: $169.5 million). A higher weighted average gross price realized per barrel and a lower percentage per barrel paid to the government in the form of production taxes resulted in a sharp rise in average net revenues per barrel to $43.19 from $34.63 in 2006. These positive trends were offset by decreases in production and increase of SG&A costs, with gross loss for 2007 being $10.0 million driven by a write off of exploration well and investments in Nadezhdenskaya licence, without those write offs the gross profit would be $21.6 million (gross profit for 2006: $27.1 million). Approximately $12.3 million of the $30.2 million year-on-year increase in SG&A costs were non-recurring payments relating the departure of senior managers. The balance of the increase reflected the Company's investment in additional personnel, both through acquisitions and expansion of the existing workforce, as the development of key assets gathers pace.
During the course of the year, several important financing arrangements were put in place to strengthen the Group's financial platform and ensure funding for the Company's key developments. The $130 million Goldman Sachs finance facility arranged in January 2007 was fully repaid in November 2007 through the partial drawdown of a replacement $270 million loan facility with Sberbank for the development of Dulisma. Furthermore, in November 2007 the Company also secured a US$500 million facility for the Taas acquisition and a US$600 million facility for the development of the acquired field. In addition, in 2007 and early 2008 the Company raised a total of $132.0 million in new funds through a successful private placement of new shares, which includes a green-shoe exercised by Morgan Stanley and associated fees and charges.
In addition the Company realised proceeds from the sale of the Komi properties of US$93 million as of 23 April 2008.
Corporate
To reflect the Company's growing profile in Russia and the scale of its operations, in 2007 Urals Energy took important steps to further strengthen its board and operational management.
I assumed the role of Chief Executive and Vladimir Sidorovich was appointed as Chief Financial Officer. On the operations side, in August, Kerry Kendrick was brought in as the Group's Chief Operating Officer and Vyatcheslav Rovneiko became Senior VP of Business Development. In addition Mervyn Goddings was appointed as Deputy Operations Officer, and Stephen Kirton as Vice President, Technical Services.
The Company's Board of Directors also welcomed Alexei Ogarev our VP of Government Relations, and he will play an important role in managing the Company's external relations. As announced in April this year, due to his other business interests, Bob Maguire has stepped down from the Board and we will seek to appoint another non-executive director in due course.
Reserves Report
On 3 June 2008 the Company announced the latest estimates published by DeGolyer and MacNaughton (D&M) for its total proven, probable and possible petroleum reserves as at 31 December 2007 and the value of those reserves.
The report saw upgrades driven by the acquisition of Taas and upward revisions to Dulisma reserves estimates, resulting in a 104% increase in total group 2P reserves on a BOE basis to 1,183 MMbbls BOE (Q1- 2007: 579MMbbls BOE).
D&M reported a 117% year on year increase in 2P liquids reserves to 560MMbbls (oil plus condensate) net to Urals (Q1-2007: 258 MMbbls). Of this 302MMbbl increase, the Taas acquisition contributes 253 MMbbls (net to Urals Energy), with the remaining increase resulting from an upward revision of the oil and condensate reserves in the Dulisma field, together with reserves adjustments in Urals' legacy assets.
The sale of Urals' Komi properties in April 2008 resulted in a decrease in the Group's total reserves of 16.6MMbbls according to D&M. The Nizny Omrinskoye and Voyvozh fields' reserves that were part of the sale were not included in the D&M report, and therefore this reserves reduction does not account for these fields.
Also recorded were 100% and 78% increases in Dulisma free gas and condensate 2P reserves to 3.8 TCF and 82MMbbls respectively (Q1-2007: 1.9TCF and 46MMbbls). On a BOE basis this equates to 642MMbbls BOE for the free gas reserves only in Dulisma.
As of March 23, 2008 the Russian State reserves Committee adjusted the total Taas Yuriakh C1+C2 recoverable oil reserves in a State Reserves Balance upwards to 900MMbbls (317MMbbls net to Urals) from 414MMbbls, including the southern Kurungsky extension of the Sredne Botuobinskoye (SRB) field.
License rights to overlying gas have been confirmed for Taas as of 27 May 2008. According to the Russian State Balance, the C1+C2 gas reserves total 6.3 Tcf (2.2 TCF net to Urals, or 366 MMbbls BOE). These reserves have not been included in the D&M report as of December 31, 2007.
The changes included in the 2007 year-end report resulted in a 137% year on year increase in the PV10 of the Group's 2P reserves to US$3,248 million (Q1-2007: US$1,368 million).
The full report by DeGolyer and MacNaughton is available on the Company's website in the Investor Relations section at the following address: http://www.uralsenergy.com/ir_presentations.htm
Operations
Dulisma Field
During 2007, the Company prepared infield roads, cleared the land for facilities, drilling pads, and rights-of-way on the Dulisma field. The tendering phase for the central processing facility and oil export pipeline was also completed, as was the work for the power generation station. New well drilling operations commenced using the Company's first drilling rig in December 2007. The Company restored production from its eight wells to approximately 1000 BOPD currently.
Dulisma CAPEX funding in 2007 was $50.6 million, total CAPEX paid to date in 2008 is $56.8 million and the full capex budget for 2008 is US$159.2 million.
The programme for drilling at Dulisma in 2008 is well underway and a second mobile drilling rig is onsite and spudded mid-June 2008. Dulisma well # 105's pilot hole was evaluated extensively and provided flow rate estimates based on a drill stem test above expectations. Drill of the horizontal lateral for this well is complete.
In 2008, central processing facility and pipeline construction has commenced and both are on schedule for completion by the year end. The central transfer facility (to ESPO) is currently being tendered for construction, with completion and start up planned for end Q1 2009. To date 25 kilometres of the pipeline have been constructed.
Taas
Following the acquisition of a 35.3% interest in Taas in November 2007, considerable focus has been placed upon the initial development plans for the field. In 2008, the tenth horizontal sidetrack well was drilled at Taas and in-field roads and pads are currently undergoing construction.
Required designs for the first phase drilling program and infrastructure for the SRB field and the connection pipeline are being finalized for State approval this summer.
A major 2D & 3D seismic acquisition program was completed over the SRB field during the winter 2007/08 with processing underway and interpretation to be ready in Q3 / Q4 2008.
Other Assets
Given the Company's stated intention to focus on its key East Siberia assets, it has scaled back development and exploration plans at its other assets. The process of rationalisation of these assets continues, with a view to completing further divestitures by the end of 2008.
Outlook
The SRB and Dulisma fields have established Urals as one of the largest Russian independents by reserve base and PV10 value, and with financing now in place we are well placed to deliver on our operational objectives.
Development work has already gathered substantial momentum on our Dulisma field and as we continue to assess strategic options for our non core assets, our focus on East Siberia is set to strengthen further.
As such 2008 is set to be another important year in the Company's continued growth as a leading Russian independent E&P company.
Leonid Dyachenko
Chief Executive Officer
30 June 2008
FINANCIAL RESULTS
Operating Environment
2007 was characterized by rising world oil prices which affected independent oil companies, including the Company, in many ways. Brent oil prices began the year at $58.62 per barrel and reached a peak of $96.02 per barrel by December. The Russian oil market broadly tracked these movements. Industry average domestic oil prices began at $25.48 per barrel and averaged approximately $32.35 per barrel for the year.
The rouble continued to appreciate against the dollar, rising 6% during the year, which combined with continued increases in costs for critical items such as steel, services and labour, translate to higher operating costs for all Russian oil companies.
Availability of debt financing in Russia and internationally was restricted by credit market events. Despite the liquidity issues experienced by most financial institutions, the Company succeeded to fund its new acquisition in East Siberia, a 35.3% stake in Taas, mostly with debt provided by Sberbank.
Operating Results
| $ '000 | Year ended 31 December: | |
|
| 2007 | 2006 |
| Gross revenues before excise, export duties | 194,111 | 169,590 |
| Net revenues after excise, export duties and VAT | 152,428 | 119,197 |
| Gross (loss)/profit | (10,000) | 27,126 |
| Operating profit | 139,677 | 33,864 |
| Normalised management EBITDA (unaudited) | 14,093 | 22,158 |
| Total net finance costs | (33,775) | (2,726) |
| Profit for the year | 113,791 | 34,422 |
The Company's year on year oil production decreased by 6% from 3.4 million barrels in 2006 to 3.2 million barrels in 2007, with average daily production decreasing from 9,194 barrels per day in 2006 to 8,859 in 2007. The primary reasons for the decrease was the fact that production at the Company's Dulisma subsidiary was interrupted for the majority of the year due to shut down of the temporary pipeline which belongs to a neighbouring company, and also due to a production decline at Petrosakh resulting from, a decrease of reservoir pressure. These lower than expected results at Dulisma and Petrosakh were partially offset by increased production in Dinyu as a result of improved pressure maintenance and new wells put into use.
Planning ahead, the first new development well was commenced in Dulisma in December and a second drilling rig was ordered and despatched from China for planned delivery to the field in Q1 2008. Contracts were also awarded at year end for construction of the Dulisma central processing facilities and export pipeline connection to the new ESPO pipeline system scheduled for early 2009. In the newly acquired Sredne Botuobinsky meanwhile, sidetracking of existing exploration wells to provide a stock of horizontal production wells was continued and a program of 3D seismic acquisition was commenced.
Summary table: Production (bbl)
| Year ended 31 December: | ||
| 2007 | 2006 | |
| Petrosakh | 940,568 | 1,142,837 |
| Dinyu | 1,256,184 | 1,061,161 |
| CNPSEI | 269,615 | 279,634 |
| Nizhnaya Omra | 106,365 | 25,039 |
| KOMI | 1,632,064 | 1,365,834 |
| Arcticneft | 321,612 | 356,069 |
| Chepetskoye NGDU | 314,498 | 339,396 |
| Dulisma | 24,811 | 151,674 |
| Total production | 3,233,553 | 3,355,810 |
Despite the decrease in production, the increased world and Russian oil prices resulted in a significant increase in gross revenues. During the period, the Company's 2007 gross revenues totalled $194.1 million versus $169.6 million in 2006. The Group realized a weighted average gross price of $54.94 per barrel of oil sold in 2007 versus $48.39 in 2006. Export sales prices for the Group averaged $74.18 per barrel, and domestic sales prices averaged $31.23 per barrel. Domestic refined product prices averaged $57.88 per barrel.
Summary table: Gross Revenues ($'000)
| Year ended 31 December: | ||
| 2007 | 2006 | |
| Crude oil | 180,199 | 153,606 |
| Export sales | 112,091 | 104,363 |
| Export sales of purchased crude oil from AMNGR | 22,217 | 13,577 |
| Domestic sales (Russian Federation) | 45,891 | 35,666 |
| Petroleum (refined) products - domestic sales | 12,386 | 14,798 |
| Other sales | 1,526 | 1,186 |
| Total gross revenues | 194,111 | 169,590 |
The Company's net revenues increased to $152.4 million from $119.2 million in 2006. The weighted average gross price realized per barrel was $6.55 higher than in 2006, and the percentage per barrel paid to the government in the form of production taxes and export duties in 2007 was 42.86% versus 50.18% in 2006. As a result, the average net revenues per barrel rose to $43.19 from $34.63 for 2006. Netback prices, in the case of exports, are gross oil sales price less export duty, customs charges, marketing costs and transportation, and, in the case of domestic crude sales, the gross sales price net of VAT. The weighted average netback for crude oil sales during 2007 was $40.26 versus $29.23 per barrel in 2006. In 2007, netbacks for export sales (including sales of purchased crude oil) were $47.82 per barrel and $30.95 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 $32.61 per barrel (all domestic, as the Company does not export products).
Summary table: Net backs ($/bbl)
| Year ended 31 December: | ||
| 2007 | 2006 | |
| Crude oil | 40.26 | 29.23 |
| Export sales | 41.96 | 29.34 |
| Export sales (AMNGR crude oil) | 80.36 | 45.82 |
| Domestic sales (Russian Federation) | 30.95 | 28.14 |
| Petroleum (refined) products - domestic sales | 32.61 | 17.56 |
| Other sales | N/A | N/A |
The Company's gross loss for the year (net revenues minus the cost of production) was $10.0 million as compared to gross profit of $27.1 million in 2006. During 2007 the Group wrote off oil and gas evaluation and exploration expenses in the amount $32.0 million comprising $28.3 million resulting from unsuccessful drilling of an exploration well in Nadezhdenskiy block (Urals Nord) and $2.8 million corresponding to decrease of the reserves in Chepetskoye. The remaining amounts relate to impairment and write offs of fixed assets in other subsidiary production companies. According to IFRS those expenses were included in the Cost of sales. Without those write-offs the Gross profit would be $21.6 million. Cost of sales in 2007 totalled $162.4 million as compared to $92.1 million in 2006 of which $28.9 million and $18.7 million respectively represented non-cash items, principally ADDA. An increase in ADDA was due to decrease of the Proved Developed Reserve category which resulted in an increased depreciation ratio, since the Group uses a unit-of-production method for depletion of it's oil and gas properties Also imbedded in these costs are $21.6 million and $9.3 million in 2007 and 2006, respectively of crude oil purchased from Arcticneft's neighbouring operator on Kolguyev Island, AMNGR Urals Energy purchased this oil from AMNGR and resold it together with its own produced oil for a modest profit margin, but a lesser profit margin than would be the case if Arcticneft had produced the oil itself. Other increases in cash operating costs are primarily associated with impairment of oil and gas properties and write-offs discussed earlier in this paragraph and the increased expenses in Dulisma as a result of increased level of activity as well as general increase of costs in line with inflation and Rouble appreciation against US Dollar during 2007.
SG&A costs for 2007 were $59.2 million as compared to $29.0 million in 2006. The largest component of SG&A in 2007 was wages and salaries in the amount of $35.9, compared to $14.7 in 2006, which increased year-on-year due to additional personnel from acquisitions and increased operations as well as severance payments in the aggregate amount of $12.3 million to those top managers who resigned during 2007. Therefore, the adjusted increase in salaries and wages was $8.9 million which was due to increase in headcount in operating companies as well as hire of new personnel in the Russian management company, OOO "Urals Energy". SG&A also includes a number of non-cash expense items, primarily related to the Company's stock incentive plan, totalling in 2007 $14.1 million and $5.1 million in 2006, including early vesting of restricted stock grants in the amount of $4.2 million as part of separation agreement of the top managers resigned during 2007. Also a non-recurring increase in the SG&A was driven by fees paid by the Company to professional advisors in relation to certain significant acquisitions and other corporate actions undertaken in 2007.
Net finance costs increased twelve times in 2007 to $33,8 million as compared to $2.7 million in 2006. Total interest expense in 2007 increased five-fold to $47.6 million as compared to $9.8 million in 2006. This increase was primarily due to interest expense and early repayment fees paid to Goldman Sachs on its Dulisma development loan, which was received and repaid during 2007 in the amount of $28.4 million and accrued interest on two loans which were received from Sberbank: 1) in the amount of $130 million, which was used to refinance Goldman Sachs loan, and 2) $500 million loan for the acquisition of 35.3% stake in Taas- Yuryakh Neftegazdobycha ("Taas") in late 2007 as discussed later.
Net profit for the year attributable to shareholders was $113.7 million as compared to $34.3 million in 2006. The largest non-cash item affecting this result is an extraordinary gain through a negative goodwill charge of $208.7 million related to our acquisition of Taas. This reflects the excess in fair market value of the assets purchased above the price paid. The method for calculating the fair market value is a conservative discounted cash flow valuation based on factors known at the time.
Adjusting for non-recurring costs and other standard non-cash items, the Company's management-adjusted EBITDA for the period was $14.1 million, or 9.3% of net revenues. This decrease of management EBITDA in 2007 compared to 2006 was primarily due to increase of operating expenses in Dulisma, which as noted above was not producing crude oil for the majority of the year, and the increase of SG&A as also explained above.
Management EBITDA ($'000) - Unaudited
| Year ended 31 December | ||
| 2007 | 2006 | |
| Profit for the year attributable to shareholders of UEPCL | 113722 | 34,308 |
| Net interest and foreign currency (income)/expense | 33,775 | 2,726 |
| Income tax | (7,889) | (3,284) |
| Depreciation, depletion and amortization | 28,974 | 18,721 |
| Total non-cash expenses | 54,860 | 18,163 |
| Negative Goodwill | (208,713) | (35,895) |
| Share-based payments | 14,113 | 5,087 |
| Impairment of property, plant and equipment | 31,997 | - |
| Resignation fees to top-managers | 8,107 | - |
| (Release)/accrual of other taxes risk provision | (1,929) | 56 |
| Expenses related to unsuccessful PP in August'07 | 1,504 | - |
| Other non-recurrent losses | 1,390 | 439 |
| Total non-recurrent and non-cash items | (154,489) | (30,313) |
| Normalized EBITDA | 14,093 | 22,158 |
Taxes
Russia has a relatively high cost tax regime when compared with other oil producing countries, and the Company pays a variety of taxes that are levied as a result of production, exported oil, assets and profits. The largest taxes for the Group as a percentage of revenues during 2007 were export duties (22%) and the unified production tax (21%). The Company paid a total of $106.8 million in cash taxes for the year. Unified production taxes are calculated based on production volumes, and in 2007 the Group paid $39.1 million. It is expected that the proportion of unified production taxes paid overall by the Company will decline substantially as production from Dulisma increases, where a holiday for this tax has been granted through 2016. Export duties are set according to a fixed schedule that increases as export prices rise with a maximum rate of 65% of gross export prices above $25 per barrel. High export prices in 2007 resulted in an average export duty for the Company of 32%, and resulted in $43.0 million of cash being paid by the Company. This tax can be particularly punitive in rapidly declining crude price scenarios, as happened in the fall of 2006, due to the fact that the regressive formula for calculating the rate has a 60 day lag period. However, 2007 was not impacted similarly since crude oil market prices showed a consistent increase during the year. VAT payments totalled $9.7 million and VAT reimbursements in cash from the budget were $3.1 million, which were received by Dulisma.
At 31 December 2007, the Group's deferred tax liability was $93.8 million and deferred tax asset was $1,925 million. This is a non-cash liability derived under IFRS methodology by accruing the difference of the fair market value of the company's producing reserves versus the amount actually paid to acquire them. The decrease of the deferred tax liability represents a decrease of the value of assets in the Company's books as a result of depreciation and depletion accrued during the year. This liability will decrease over time if no further acquisitions are made.
During 2007, the Company was successful in defending its tax position on certain claims from Governmental tax authorities. As a result, the Company managed to decrease the amount of tax provisions by $4.7 million, which was recorded as income in the financial statements.
Cash Flow
For the 2007 period, operating cash flow before working capital changes was $4.5 million. Changes in working capital due to receiving advance payments from the domestic and export off-takers resulted in a positive cash flow from operations of $9.5 million. Capital expenditures for development in 2007 were $80.4 million of which $50.6 million was invested in Dulisma. Total cash paid for the acquisitions during 2007 was $495.3 million. Also included in cash flows from investing activities are purchases of Sberbank interest-bearing promissory notes in the amount of $70 million (utilised by the Company to prepay 12-months interest under a $500 million acquisition loan for Taas) resulting in a total use of cash for investments and acquisitions of $647.5 million.
During the course of the year, a total of $116.6 million in new funds were raised (net of associated fees and charges) through a private placement of new shares. At 31 December 2007, the Group's short- and long-term debt net of capitalised organisation fees, which will be amortised during the life of the loans, was $614.1 million. During 2007, a total of $776.0 million in new debt was borrowed and $198.9 million in debt principle repaid, including refinancing of BNP Paribas Senior Reserve Based Loan and Mezzanine, and the above mentioned Goldman Sachs development loan for Dulisma, which was taken and repaid within 2007. As a result of refinancing of these loans the Group recorded a total cost of $17.3 million representing a non-recurring expense.
Net debt Position
At 31 December 2007, the Group's net debt position was $614.1 million. The largest part of which is comprised by two loans from Sberbank of $130 million and $500 million, which were classified as short - term in the financial statements. However, according to the loan agreements, those loans can be extended, by 5 years and 2 years from the original maturity respectively, subject to completion of certain covenants, which are technical in the nature. Because these covenants were not completed at the date of these financial statements, according to the IFRS they were classified as short-term. Management believes that these covenants will be successfully satisfied before November 2008 and loans will be extended as noted above.
In 2007 the company continued to develop sales-based working capital financing facilities. The export-related facility was increased from $20 million to $50 million in 2007, while in 2008 it was increased further to the level of $60 million with less volumes pledged, a situation that was made possible due to the substantial increase in oil prices. Also in 2007 the company has arranged for the first time a domestic sales - related facility in the amount of $22.4 million, which was reduced to $7.4 million in 2008 in proportion to the volumes supplied by the assets in Komi that were disposed of in 2008.
Acquisitions
In December 2007, the Group acquired 35.3% stake in OOO Taas Yurayakh Neftegazdobycha. Taas is a privately-held Russian exploration and production company operating in East Siberia with 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 (amended May 2008 to include gas reserves) 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").
The total consideration paid in cash and in stock amounted to $589.2 million including transaction costs. The investment is recorded in the balance sheet at the fair value of $911.4 million, and the excess of the fair value of the investment over the consideration paid represents a negative good will of $208.7 million, which was recorded as income in the financial statements.
As part of the transaction the Group also received a call and granted a put option, which were fair valued at the date of these financial statements and recorded as derivative assets and liabilities in the amount of $5.1 million and $118.7 million, respectively
Disposals of assets
Subsequent to the year-end, following its announced strategy to concentrate on Eastern Siberia assets, Dulisma and Taas, and dispose of the non-core assets; the Company has sold most of its assets located in the Republic of Komi for $93.2 million. The effect of this transaction on the financial statements is still being finalized by the Company; however, management estimates that the transaction will contribute to the income in its 2008 year financial statements. Also, during 2008 the Company is planning to complete the divestiture of CNPSEI to the same buyers of other Komi assets and to continue the disposal of other non-core assets, including Petrosakh, Arcticneft and Chepetskoye NGDU.
The proceeds from the disposal of Komi assets were used to partially repay a trade finance loan from a domestic off-taker and also to finance further development of Dulisma and Taas.
Hedging
The Company does not hedge any of its crude oil or product sales, costs or currency conversions.
International Financial Reporting Standards (IFRS)
The implementation of IFRS accounting procedures has resulted in a number of non-cash adjustments and non-recurring costs in the accounts.
As previously mentioned the Company's deferred tax liability of $93.8 million and deferred tax asset of $2.0 million is a non-cash items and are due to two factors. The first is, as mentioned above, the difference between the fair market value of the discounted producing reserves versus their purchase price, and the second is the difference between the Group consolidated profit taxes calculated for IFRS purposes versus those actually paid by each subsidiary as federal income taxes are accrued. These amounts are not due for payment by the Company, and are likely to decrease over the time as the value of those assets.
Under IFRS purchase accounting, the excess of the purchase price paid for a property over the fair market value of its tangible assets must be depleted over time using a unit of production formula. The result is an increase to the Company's Depreciation and Depletion, and will adjust depending on the estimate of future proven and producing barrels of oil.
Also as previously stated, IFRS treatment for the excess of the fair market value of the tangible and intangible assets at Taas over the amount paid for the business by the Company resulted in $208.7 million of negative goodwill for the period. This non-cash item increased operating profits by a corresponding amount.
Urals Energy Public Company Limited
International Financial Reporting Standards
Consolidated Financial Statements As of and for the Year Ended 31 December 2007
Urals Energy Public Company Limited
Consolidated Financial Statements
INDEPENDENT AUDITOR'S REPORT
TO THE MEMBERS OF URALS ENERGY PUBLIC COMPANY LIMITED
Report on the Consolidated Financial Statements
We have audited the consolidated financial statements of Urals Energy Public Company Limited (the "Company") and its subsidiaries (the "Group") on pages 4 to 57, which comprise the consolidated balance sheet as at 31 December 2007 and the consolidated statement of income, consolidated statement of cash flows and consolidated statement of changes in equity for the year then ended and a summary of significant accounting policies and other explanatory notes.
Board of Directors' Responsibility for the Consolidated 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 consolidated 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. 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.
Opinion
In our opinion, the consolidated financial statements give a true and fair view of the financial position of the Group as of 31 December 2007, 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.
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, Cyprus 29 June 2008
Urals Energy Public Company Limited
Consolidated Balance Sheets
(presented in US$ thousands)
| 31 December: | |||
| Note | 2007 | 2006 | |
| Assets | |||
| Current assets | |||
| Cash and cash equivalents | 28,400 | 33,082 | |
| Accounts receivable and prepayments | 8 | 38,771 | 24,717 |
| Promissory notes receivable | 16 | 64,581 | - |
| Current income tax prepayments | 905 | 4,401 | |
| Inventories | 9 | 43,886 | 26,679 |
| Non-current assets held -for -sale | 7 | 133,363 | - |
| Total current assets | 309,906 | 88,879 | |
| Non-current assets | |||
| Property, plant and equipment | 10 | 518,323 | 595,800 |
| Financial derivatives | 4 | 5,103 | - |
| Intangible assets | 11 | 1,816 | 1,141 |
| Other non-current assets | 12 | 19,649 | 14,932 |
| Investment in joint venture | 4 | 911,433 | - |
| Loan receivable from related party | 5 | 2,264 | - |
| Deferred tax assets | 15 | 1,925 | 1,799 |
| Total non-current assets | 1,460,513 | 613,672 | |
| Total assets | 1,770,419 | 702,551 | |
| Liabilities and equity | |||
| Current liabilities | |||
| Accounts payable and accrued expenses | 13 | 23,397 | 10,033 |
| Income tax payable | 2,079 | 3,281 | |
| Other taxes payable | 15 | 2,900 | 7,253 |
| Other taxes provision | 15 | 529 | 2,367 |
| Financial instruments | 4 | 118,657 | - |
| Short-term borrowings and current portion of long-term borrowings | 16 | 614,031 | 22,965 |
| Advances from customers | 14 | 55,179 | 30,913 |
| Liabilities associated with non-current assets held-for- sale | 7 | 27,477 | - |
| Current liabilities before warrants classified as liabilities | 844,249 | 76,812 | |
| Warrants classified as liabilities | 1,326 | 3,516 | |
| Total current liabilities | 845,575 | 80,328 | |
| Long-term liabilities | |||
| Long-term borrowings | 16 | 29 | 40,844 |
| Long term finance lease obligations | 1,164 | 1,192 | |
| Dismantlement provision | 17 | 1,448 | 3,327 |
| Deferred tax liability | 15 | 93,835 | 113,586 |
| Other long term liabilities | - | 298 | |
| Total long-term liabilities | 96,476 | 159,247 | |
| Total liabilities | 942,051 | 239,575 | |
| Equity | |||
| Share capital | 18 | 990 | 633 |
| Share premium | 18 | 625,111 | 401,448 |
| Translation difference | 49,919 | 22,445 | |
| Retained earnings | 150,744 | 37,022 | |
| Equity attributable to shareholders of Urals Energy Public Company Limited | 826,764 | 461,548 | |
| Minority interest | 1,604 | 1,428 | |
| Total equity | 828,368 | 462,976 | |
| Total liabilities and equity | 1,770,419 | 702,551 | |
Approved on behalf of the Board of Directors on 29 June 2008
| L.Y. Dyachenko Chief Executive Officer | V.G. Sidorovich Chief Financial Officer |
The accompanying notes on pages 8 to 57 are an integral part of these consolidated financial statements
Urals Energy Public Company Limited
Consolidated Income Statement
(presented in US$ thousands)
| Year ended 31 December: | |||
|
| Note | 2007 | 2006 |
| Revenues | |||
| Gross revenues | 19 | 194,111 | 169,590 |
| Less: excise taxes | 19 | 1,103 | (2,176) |
| Less: export duties | (42,786) | (48,217) | |
| Net revenues after excise taxes, export duties and VAT | 152,428 | 119,197 | |
| Cost of sales | 20 | (162,428) | (92,071) |
| Gross profit (loss) | (10,000) | 27,126 | |
| Selling, general and administrative expenses | 21 | (59,233) | (28,955) |
| Excess of net assets acquired over purchase price | 4,6 | 208,713 | 35,895 |
| Other non-operating gain (loss) | 197 | (202) | |
| Total operating costs | 149,677 | 6,738 | |
| Operating profit | 139,677 | 33,864 | |
| Interest income | 16 | 2,622 | 1,359 |
| Interest expense | 16 | (47,648) | (9,810) |
| Foreign currency gains | 9,651 | 7,491 | |
| Change in fair value of financial derivatives | 16 | 1,600 | (1,766) |
| Total net finance costs | (33,775) | (2,726) | |
| Profit before income tax | 105,902 | 31,138 | |
| Income tax benefit | 15 | 7,889 | 3,284 |
| Profit for the year | 113,791 | 34,422 | |
| Profit for the year attributable to: - Minority interest | 69 | 114 | |
| - Shareholders of Urals Energy Public Company Limited | 113,722 | 34,308 | |
| Earnings per share of profit attributable to shareholders of Urals Energy Public Company Limited: | 18 | ||
| - Basic earnings per share (in US dollar per share) | 0.94 | 0.33 | |
| - Diluted earnings per share (in US dollar per share) | 0.82 | 0.31 | |
The accompanying notes on pages 8 to 57 are an integral part of these consolidated financial statements
Urals Energy Public Company Limited
Consolidated Statements of Cash Flows
(presented in US$ thousands)
| Year ended 31 December: | |||
|
| 2007 | 2006 | |
| Cash flows from operating activities | |||
| Profit before income tax | 105,902 | 31,138 | |
| Adjustments for: | |||
| Depreciation, amortization and depletion | 30,567 | 18,882 | |
| Change in fair value of financial derivatives | 16 | (1,600) | 1,766 |
| Share-based payments | 18 | 14,113 | 5,089 |
| Interest income | 16 | (2,622) | (1,359) |
| Interest expense | 16 | 47,648 | 9,810 |
| Impairment of property, plant and equipment | 10 | 31,039 | - |
| Accrual (release) of tax provision | 15 | (1,929) | 56 |
| Excess of net assets acquired over purchase price | 4 | (208,713) | (35,895) |
| Foreign currency gains | (9,651) | (7,491) | |
| Other non-cash transactions | (262) | 441 | |
| Operating cash flows before changes in working capital | 4,492 | 22,437 | |
| (Increase) in inventories | (9,100) | (10,171) | |
| (Increase) in accounts receivables and prepayments | (6,627) | (1,257) | |
| Increase in accounts payable and accrued expenses | 5,130 | 13 | |
| Increase in advances from customers | 14 | 24,322 | 30,390 |
| (Decrease) increase in other taxes payable | (8,710) | 5,622 | |
| Cash generated from operations | 9,507 | 47,034 | |
| Interest received | 2,156 | 1,190 | |
| Interest paid | (35,632) | (8,900) | |
| Income tax paid | (1,824) | (3,890) | |
| Net cash (used in) generated from operating activities | (25,793) | 35,434 | |
| Cash flows from investing activities | |||
| Acquisitions of subsidiaries, net of cash acquired | 6 | - | (137,299) |
| Acquisition of joint venture | 4 | (495,283) | - |
| Purchase of property, plant and equipment | (80,357) | (59,538) | |
| Purchase of intangible assets | (1,626) | (908) | |
| Loan issued | (6,057) | - | |
| Purchase of promissory notes | (70,000) | - | |
| Repayment of promissory notes | 5,753 | - | |
| Net cash used in investing activities | (647,570) | (197,745) | |
| Cash flows from financing activities | |||
| Proceeds from borrowings | 776,000 | 14,000 | |
| Repayment of loan organization fees | (11,586) | (993) | |
| Repayment of borrowings | (198,924) | (29,946) | |
| Purchase of financial derivatives | 16 | (20,457) | - |
| Repayment of financial derivatives | 16 | 7,737 | - |
| Finance lease principle payments | (423) | (419) | |
| Repayment of promissory notes | - | (15,088) | |
| Cash proceeds from issuance of ordinary shares gross | 18 | 125,830 | 209,140 |
| Expenses related to issuance of ordinary shares | 18 | (9,228) | (14,088) |
| Cash proceeds from exercise of options | 18 | - | 125 |
| Net cash generated from financing activities | 668,949 | 162,731 | |
| Effect of exchange rate changes on cash and cash equivalents | 111 | 328 | |
| Net (decrease) increase in cash and cash equivalents | (4,303) | 748 | |
| Cash and cash equivalents at the beginning of the year | 33,082 | 32,334 | |
| Cash and cash equivalents at the end of the year | 28,779 | 33,082 | |
| Cash and cash equivalents at the end of the year of the Group, excluding those classified as held for sale | 28,400 | ||
| Cash and cash equivalents at the end of the year of the assets classified as held for sale | 7 | 379 | |
The accompanying notes on pages 8 to 57 are an integral part of these consolidated financial statements
Urals Energy Public Company Limited
Consolidated Statements of Changes in Shareholders' Equity
(presented in US$ thousands)
| Notes | Share capital | Share premium | 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 2006 | 460 | 201,355 | (2,296) | 2,714 | 202,233 | 1,199 | 203,432 | |
| Effect of currency translation | - | - | 24,741 | - | 24,741 | 115 | 24,856 | |
| Profit for the year | - | - | - | 34,308 | 34,308 | 114 | 34,422 | |
| Total recognized income | - | - | - | - | - | - | 59,278 | |
| Issuance of shares | 18 | 173 | 194,879 | - | - | 195,052 | - | 195,052 |
| Exercise of options | 18 | - | 125 | - | - | 125 | - | 125 |
| Share-based payment | 18 | - | 5,089 | - | - | 5,089 | - | 5,089 |
| Balance at 31 December 2006 | 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 | - | - | - | - | - | - | 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 |
The accompanying notes on pages 8 to 57 are an integral part of these consolidated financial statements
Urals Energy Public Company Limited
Consolidated Statements of Changes in Shareholders' Equity
(presented in US$ thousands)
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.
The Group comprises UEPCL and the following main subsidiaries and joint venture (Note 4):
| Entity | Jurisdiction | Effective ownership interest at 31 December | |
| 2007 | 2006 | ||
| Exploration and production | |||
| ZAO Petrosakh ("Petrosakh") | Sakhalin | 97.2% | 97.2% |
| ZAO Arcticneft ("Arcticneft") | Nenetsky | 100.0% | 100.0% |
| OOO CNPSEI ("CNPSEI") | Komi | 100.0% | 100.0% |
| ZAO Chepetskoye NGDU ("Chepetskoye") | Udmurtia | 100.0% | 100.0% |
| OOO Dinyu ("Dinyu") | Komi | 100.0% | 100.0% |
| OOO Michayuneft ("Michayuneft") | Komi | 100.0% | 100.0% |
| OOO Oil Company Dulisma ("Dulisma") | Irkutsk | 100.0% | 100.0% |
| OOO Lenskaya Transportnaya Kompaniya ("LTK") | Irkutsk | 100.0% | 100.0% |
| OOO Nizhneomrinskaya Neft | Komi | 100.0% | 100.0% |
| OOO Taas-Yuryakh Neftegazdobycha ("Taas") | Sakha-Yakutia | 35.3% | - |
| 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% |
Urals Energy Public Company Limited
Consolidated Statements of Changes in Shareholders' Equity
(presented in US$ thousands)
2. Summary of Significant Accounting Policies
Basis of preparation. These consolidated financial statements have been prepared in accordance with, and comply with, International Financial Reporting Standards ("IFRS"), as adopted by the EU. All International Financial Reporting Standards issued by the International Accounting Standards Board (IASB) and effective as at 1 January 2007 have been adopted by the EU through the endorsement procedure established by the European Commission, with the exception of certain provisions of IAS39 "Financial Instruments: Recognition and Measurement" relating to portfolio hedge accounting. These financial statements comply with IFRS and it is the Group's intention, to the extent possible, to comply with IFRS, as adopted by the European Union and as issued by the IASB since the Group is not affected by the hedging provisions. Since the Group is not affected by the provisions regarding portfolio hedging that are not required by the EU-endorsed version of IAS 39, the accompanying consolidated financial statements comply with both International Financial Reporting Standards as adopted by the European Union and International Financial Reporting Standards issued by the IASB.
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 3. 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 24.55 and 26.33 as of 31 December 2007 and 2006, respectively.
Translation to presentation currency. The Group's financial statements are presented in US dollars in accordance with IAS 21 (revised 2003), 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 (the functional currency of none of which is a currency of a hyperinflationary economy) 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 profit or loss.
Urals Energy Public Company Limited
Consolidated Statements of Changes in Shareholders' Equity
(presented in US$ thousands)
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 minorities'' 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 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 cost. The group's investment in joint venture includes goodwill identified on acquisition, net of any accumulated impairment loss.
The group's share of its joint venture's post-acquisition profits or losses is recognised in the 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.
Urals Energy Public Company Limited
Consolidated Statements of Changes in Shareholders' Equity
(presented in US$ thousands)
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, capitalizing exploration and evaluation costs until such time as the economic viability of producing the underlying resources is determined. Exploration and evaluation costs related to resources determined to be not economically viable are expensed through cost of sales in the consolidated income statement.
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 |
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 licenses 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 |
Urals Energy Public Company Limited
Consolidated Statements of Changes in Shareholders' Equity
(presented in US$ thousands)
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 statement of income 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 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 (net of any incentives received from the lessor) are charged to the 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 amount of the provision is recognised in the income statement.
Urals Energy Public Company Limited
Consolidated Statements of Changes in Shareholders' Equity
(presented in US$ thousands)
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. Value added taxes related to sales are payable to tax authorities upon collection of receivables from customers. Input VAT is reclaimable against sales VAT upon payment for purchases. The tax authorities permit the settlement of VAT on a net basis. VAT related to sales and purchases which have not been settled at the balance sheet date (VAT deferred) is recognised in the balance sheet on a gross basis and disclosed separately as a current asset and liability. Where provision has been made against debtors deemed to be uncollectible, an impairment loss is recorded for the gross amount of the debtor, including VAT. The related VAT deferred liability is maintained until the debtor is written off for statutory accounting purposes.
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 substantially enacted at 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 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.
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.
Urals Energy Public Company Limited
Consolidated Statements of Changes in Shareholders' Equity
(presented in US$ thousands)
2. Summary of Significant Accounting Policies (Continued)
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 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.
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.
2. Summary of Significant Accounting Policies (Continued)
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.
Urals Energy Public Company Limited
Consolidated Statements of Changes in Shareholders' Equity
(presented in US$ thousands)
Summary of Significant Accounting Policies (Continued)
Adoption of new or revised standards and interpretations. Certain new standards and interpretations became effective for the Group from 1 January 2007. Unless otherwise described below, these new standards and interpretations do not significantly affect the Group's financial position or results of operations.
IFRS 7, Financial Instruments: Disclosures and a complementary Amendment to IAS 1 Presentation of Financial Statements - Capital Disclosures (effective from 1 January 2007). The IFRS introduces new disclosures to improve the information about financial instruments. Specifically, it emphasizes quantitative aspects of risk exposures and the methods of risk management. The quantitative disclosures provide information about the extent to which the entity is exposed to risk, based on information provided internally to the entity's key management personnel. Qualitative and quantitative disclosures cover exposure to credit risk, liquidity risk and market risk including sensitivity analysis to market risk. IFRS 7 replaces IAS 30, Disclosures in the Financial Statements of Banks and Similar Financial Institutions, and some of the requirements in IAS 32, Financial Instruments: Disclosure and Presentation. The Amendment to IAS 1 introduces disclosures about level of an entity's capital and how it manages capital. The adoption of IFRS 7 does not have any impact on the classification and valuation of the Group's financial instruments. The Group added required disclosures to comply with IFRS 7 in these financial statements.
IFRIC 8, Scope of IFRS 2 (effective for periods beginning on or after 1 May 2006, that is from 1 January 2007). The interpretation introduces guidance for accounting for transactions in which the entity cannot identify specifically some or all of the goods or services received in exchange for equity instruments. The adoption of IFRIC 8 did not have any impact on the Group's disclosures, financial position or results of operations.
IFRIC 10, Interim Financial Reporting and Impairment (effective for annual periods beginning on or after 1 November 2006). The interpretation prohibits reversal of an impairment loss recognised in a previous interim period in respect of goodwill or an investment in either an equity instrument or a financial asset carried at cost. The adoption of IFRIC 10 did not have any impact on the Group's disclosures, financial position or results of operations.
Other new standards and interpretations that did not significantly affect the Group's financial position and results of operations when adopted on 1 January 2007 are: IFRIC 7, Applying the Restatement Approach under IAS 29 (effective for periods beginning on or after 1 March 2006, that is from 1 January 2007); and IFRIC 9, Reassessment of Embedded Derivatives (effective for annual periods beginning on or after 1 June 2006).
New accounting pronouncements. 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 and which the Group has not yet adopted:
IFRS 8, Operating Segments (effective for annual periods beginning on or after 1 January 2009). The standard applies to entities whose debt or equity instruments are traded in a public market or that file, or are in the process of filing, their financial statements with a regulatory organisation for the purpose of issuing any class of instruments in a public market. 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 does not expect the amendment to affect its consolidated financial statements.
Puttable financial instruments and obligations arising on liquidation-IAS 32 and IAS 1 Amendment (effective from 1 January 2009). Have not been endorsed by the European Union. The amendment requires classification as equity of some financial instruments that meet the definition of a financial liability. The Group is currently assessing the impact of the amendment on its consolidated financial statements.
IAS 23, Borrowing Costs (revised March 2007; effective for annual periods beginning on or after 1 January 2009). Have not been endorsed by the European Union. The revised IAS 23 was issued in March 2007. The main change to IAS 23 is the removal of the option of immediately recognising as an expense borrowing costs that relate to assets that take a substantial period of time to get ready for use or sale. An entity is, therefore, required to capitalise such borrowing costs as part of the cost of the asset. The revised standard applies prospectively to borrowing costs relating to qualifying assets for which the commencement date for capitalisation is on or after 1 January 2009. The Group does not expect the amendment to affect its consolidated financial statements.
Urals Energy Public Company Limited
Consolidated Statements of Changes in Shareholders' Equity
(presented in US$ thousands)
2. Summary of Significant Accounting Policies (Continued)
IAS 1, Presentation of Financial Statements (revised September 2007; effective for annual periods beginning on or after 1 January 2009). Have not been endorsed by the European Union. 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.
IAS 27, Consolidated and Separate Financial Statements (revised January 2008; effective for annual periods beginning on or after 1 July 2009). Have not been endorsed by the European Union. 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 the impact of the amended standard 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). Have not been endorsed by the European Union. 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, goodwill will be measured as the difference at acquisition date between the fair value of any investment in the business held before the acquisition, the consideration transferred and the net assets acquired. 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 consolidated financial statements.
Vesting Conditions and Cancellations-Amendment to IFRS 2, Share-based Payment (issued in January 2008; effective for annual periods beginning on or after 1 January 2009). Have not been endorsed by the European Union. 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 does not expect the amendment to materially affect its consolidated financial statements.
IFRIC 13, Customer Loyalty Programmes (issued in June 2007; effective for annual periods beginning on or after 1 July 2008). Have not been endorsed by the European Union. IFRIC 13 clarifies that where goods or services are sold together with a customer loyalty incentive (for example, loyalty points or free products), the arrangement is a multiple-element arrangement and the consideration receivable from the customer is allocated between the components of the arrangement using fair values. IFRIC 13 is not relevant to the Group's operations because no Group companies operate any loyalty programmes.
Urals Energy Public Company Limited
Consolidated Statements of Changes in Shareholders' Equity
(presented in US$ thousands)
2. Summary of Significant Accounting Policies (Continued)
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 non-current 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 joint venture 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 does not expect the amendments to have any material effect on its consolidated financial statements.
Cost of an Investment in a Subsidiary, Jointly Controlled Entity or Associate-IFRS 1 and IAS 27 Amendment (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 joint venture 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 recognised in profit or loss rather than as a recovery of the investment. The amendments will not have an impact on the Group's consolidated financial statements.
Other new standards or interpretations. The Group has not early adopted the following other new standards or interpretations:
IFRIC 11, IFRS 2 - Group and Treasury Share Transactions (effective for annual periods beginning on or after 1 March 2007);
IFRIC 12, Service Concession Arrangements (effective for annual periods beginning on or after 1 January 2008) Have not been endorsed by the European Union;
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) Have not been endorsed by the European Union.
Unless otherwise described above, the new standards and interpretations are not expected to significantly affect the Group's financial statements.
Urals Energy Public Company Limited
Consolidated Statements of Changes in Shareholders' Equity
(presented in US$ thousands)
2. Summary of Significant Accounting Policies (Continued)
Reclassifications and adjustments. Certain reclassifications and adjustments have been made to 2006 amounts to conform to 2007 presentation. The table below discloses the amounts before and after reclassification or adjustment. Management believes that the current presentation is preferable to that presented in prior years.
| As originally reported | Following reclassification or adjustment | |
| At 31 December 2006 | ||
| Deferred tax assets | - | 1,799 |
| Deferred tax liabilities | 111,787 | 113,586 |
| Intangible assets | - | 1,141 |
| Other non-current assets | 16,073 | 14,932 |
At 31 December 2006, management adjusted to record separately deferred tax liabilities and deferred tax assets for the amount of deferred tax assets which relate to individual subsidiaries and which should not offset deferred tax liability of other subsidiaries, as there is no concept of consolidation of tax profits in the Russian tax code.
At 31 December 2006, management combined intangible assets with other non-current assets. This was subsequently reclassified to disclose intangible assets separately
.
Urals Energy Public Company Limited
Consolidated Statements of Changes in Shareholders' Equity
(presented in US$ thousands)
3 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.
Accounting for extractive industry activity. The Group follows a policy similar to the successful efforts method of accounting for oil and gas properties. Property acquisitions, successful exploratory wells, all development costs and support equipment and facilities are capitalised. Unsuccessful exploratory wells are charged to expense at the time the license area is determined to be non-productive. Production costs and overheads are included in the cost of inventory as incurred and all exploration costs are capitalised as exploration and evaluation assets. Acquisition costs of unproved properties, exploration and evaluation costs are evaluated periodically and any impairment assessed is charged to expense.
The Group calculates depreciation, depletion and amortisation of capitalised costs of oil and gas properties using the unit-of-production method for each field based upon proved developed reserves for exploration and development costs, and total proved reserves for acquisitions of proved properties. For this purpose, the oil and gas reserves of key fields have been determined based on estimates of mineral reserves determined in accordance with internationally recognised definitions and independently assessed by internationally recognised petroleum engineers. The present value of the estimated costs of dismantling oil and gas production facilities, including abandonment and site restoration costs, are recognised when the obligation is incurred and are included within the carrying value of property, plant and equipment, and therefore subject to amortisation thereon using the unit-of-production method. Changes in estimates of reserves can result in significant changes in depletion expense.
Related party transactions. In the normal course of business, the Group enters into transactions with its related parties. Judgement is applied in determining if transactions are priced at market or non-market interest rates, where there is no active market for such transactions. The basis for judgement is pricing for similar types of transactions with unrelated parties and effective interest rate analyses.
Assumptions to determine amount of provisions. In determining amounts of provisions, management uses all information available to determine whether it is probable that an event will result in outflows of resources from the Group. Significant judgement is used to estimate the amounts of provisions, including such factors as the current overall economic conditions, specific customer, counterparty or industry conditions and the current overall legal and tax environment. Changes in any of these conditions may result in adjustments to provisions recorded by the Group.
Useful lives of property, plant and equipment. Items of property, plant and equipment are stated at cost less accumulated depreciation. The estimation of the useful life of an item of property, plant and equipment 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. Fair value of the call and put options related to acquisition of interest in Taas (Note 4) was assessed by a professional independent appraiser using a Monte Carlo valuation model.
Urals Energy Public Company Limited
Notes to the Consolidated Financial Statements
(in US dollars, tabular amounts in US$ thousands, except as indicated)
3 Critical Accounting Estimates and Judgements in Applying Accounting Policies (Continued)
Fair values of acquired assets and liabilities. Since its inception, the Group has completed several significant acquisitions (Notes 4 and 6). 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 advise as to the fair values of acquired assets and liabilities. Changes in any of the estimates subsequent to the finalization of acquisition accounting may result in losses in future periods.
Deferred income tax asset recognition. Deferred tax assets represent income taxes recoverable through future deductions from taxable profits. Deferred income tax assets are recorded on the Group's consolidated balance sheet to the extent that realisation of the related tax benefits is probable. In determining future taxable profits and the amount of tax benefits that are probable in the future, management makes judgements and applies estimation based on recent years' taxable profits and expectations of future taxable income.
Liquidity. These consolidated financial statements have been prepared under the going concern assumption (see Note 23).
Urals Energy Public Company Limited
Notes to the Consolidated Financial Statements
(in US dollars, tabular amounts in US$ thousands, except as indicated)
4 Investments in joint venture
Acquisition of equity interest of 35.3% in Taas Yuraykh Neftegazdobycha ("Taas") In December 2007, the Group acquired a 35.329% stake in OOO Taas Yurayakh 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.
The acquisition price comprised $490.0 million paid in cash plus 22,738,034 shares of Urals Energy Public Company Limited issued to Finfund Limited (hereinafter referred to as "the Seller"), which was equivalent to $93.3 million on the date of the transaction.
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 from 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 a result of the acquisition of the interest in Taas, the Group recognized a $208.7 million gain representing the excess of the estimated fair value of net assets acquired over the purchase price. Management attributes this difference to the desire of the Seller to obtain support in the development of Taas and to partially exit the business.
Urals Energy Public Company Limited
Notes to the Consolidated Financial Statements
(in US dollars, tabular amounts in US$ thousands, except as indicated)
4 Investments in joint venture (Continued)
As the acquisition of the interest in Taas was finalised in late December 2007, the Group's share in the operational results of Taas were not material to the Group in 2007. Below is a table outlining the fair values of identifiable assets and liabilities acquired as well as detail on the components of purchase price.
| Fair values at acquisition (net to the Group) | |||
| Assets | 933,619 | ||
| Liabilities | (22,186) | ||
| Net assets | 911,433 | ||
| Call option for 4.2% of Taas | 5,103 | ||
| Put option for 10.5% of Taas | (118,657) | ||
| Excess of the Group's share in net assets over purchase consideration | 208,713 | ||
| Purchase consideration | |||
| Cash paid | 490,000 | ||
| Consideration in stock | 93,304 | ||
| Transaction costs | 5,862 | ||
| Total investments in joint venture | 911,433 |
Significant assumptions included in the option valuation model 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 | 3 years |
| Correlation coefficient | N/A | 75% |
5 Loan receivable
Other long-term investments represent a long-term loan of $2.3 million issued by UEPCL to Taas, as part of the SPA. This loan was used to pay organisation fees for a $600.0 million project finance loan facility provided by Savings Bank of Russian Federation ("Sberbank") for the development of the SRB field. The loan bears interest of 12% and matures in February 2015. The fair value of the loan approximates its carrying value at the balance sheet date. These loans are considered to be fully performing at 31 December 2007.
Urals Energy Public Company Limited
Notes to the Consolidated Financial Statements
(in US dollars, tabular amounts in US$ thousands, except as indicated)
6 Acquisitions of subsidiaries
Acquisition of OOO Oil Company Dulisma and OOO Lenskaya Transportnaya Kompaniya. In April 2006, the Group acquired 100% stakes in OOO Oil Company Dulisma ("Dulisma") and OOO Lenskaya Transportnaya Kompaniya ("LTK"). The purchase consideration comprises cash and cash equivalents paid of $148.0 million. Dulisma holds exploration and production licenses in Irkutsk expiring in 2019. A net loss of $2.4 million associated with Dulisma and LTK were included in the Group's results for the year ended 31 December 2006.
The table below presents the fair values of 100% of Dulisma's and LTK's assets and liabilities as of the date of acquisition. Aggregate amounts are presented due to the acquisition of LTK being individually immaterial. No information on the IFRS carrying values before the acquisition is available as Dulisma and LTK did not prepare IFRS financial statements prior to acquisition.
| Fair values at acquisition | |||
| Cash and cash equivalents | 61 | ||
| Accounts receivable and prepayments | 2,842 | ||
| Other current assets | 1,378 | ||
| Oil and gas properties and equipment | 241,711 | ||
| Short-term borrowings and current portion of long-term borrowings | (399) | ||
| Other current liabilities | (18,523) | ||
| Deferred income tax liability, non-current | (55,738) | ||
| Net assets | 171,332 | ||
| Excess of the Group's share in net assets over purchase consideration | (35,448) | ||
| Purchase consideration | 135,884 | ||
| Less: cash and cash equivalents of subsidiaries acquired | (61) | ||
| Outflow of cash and cash equivalents on acquisition | 135,823 |
Included within oil and gas properties and equipment acquired with Dulisma and LTK were property acquisition costs with a fair value of $153.1 million that were not subject to depletion pending the results of management's assessment of the economic viability of the properties. Additionally, included within oil and gas properties and equipment acquired with Dulisma and LTK were property acquisition costs with a fair value of $35.4 million that are being depleted over total proved reserves.
Management attributes the excess of the Group's share in net assets acquired over purchase consideration to the foreign seller's interest in exiting the Russian market and its lack of interest in investing the required resources to develop the license as well as uncertainties over the timing and conditions for using the planned pipeline connecting Dulisma's operations to commercial markets.
The remaining amount of $0.447 million of excess of net assets acquired over purchase price in the Group's consolidated income statement for 31 December 2006, related to the acquisition of OOO Nizhneomrinskaya Neft, an entity extracting crude oil, for a total consideration of $3.532 million. The cash and cash equivalents of subsidiary acquired were $2.056 million as of the date of acquisition.
Urals Energy Public Company Limited
Notes to the Consolidated Financial Statements
(in US dollars, tabular amounts in US$ thousands, except as indicated)
6 Acquisitions of subsidiaries (Continued)
Summary combined financial information. The following table sets forth summary combined financial information for the year ended 31 December 2006 that is presented to provide information to evaluate the financial effects of the acquisitions of Dulisma and LTK as if they had occurred on 1 January 2006.
| Group | Dulisma | Adjustments | Summary | ||||
|
| results |
| And LTK |
| and elimination | combined | |
| Total revenues | 169,590 | 4,390 | (2,968) | 171,012 | |||
| Profit (loss) for the year | 34,422 | (2,904) | 2,449 | 33,967 | |||
The summary combined financial information should not be construed to represent consolidated financial information. Group results include the activities of the acquired entities from the respective acquisition dates through 31 December 2006. Total revenues and profit (loss) for the period for Dulisma and LTK comprise the respective entities' results for the full year, including the period prior to acquisition, without adjustments for intercompany transactions or fair values. Adjustments and eliminations include the following: (a) intercompany eliminations were recorded; (b) adjustments to eliminate results of the period included both in the Group results and the respective entities' results for the full year; and (c) corresponding adjustments for income taxes were recorded. However, no adjustments were made to adjust interest expense for borrowings used to finance these acquisitions.
7 Non-current assets held for sale
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 $93.2 million subject to a possible working capital adjustment that management believes will be insignificant. As part of the sale and purchase agreement, CNPSEI was also included in the list of assets to be disposed; however, this transaction was not complete by the date of these financial statements being subject to some unfulfilled condition precedent. Management believes that this transaction will be completed during 2008; therefore, CNPSEI is also classified with assets held for sale.
Non-current assets classified as held for sale are stated at their carrying amount, being lower than fair value less costs to sell. No impairment of the assets was necessary as a result of the decision to sell these subsidiaries.
Below is a breakdown of assets and liabilities of non-current assets classified as held for sale.
| 31 December 2007 | |
| Cash and cash equivalents | 379 |
| Accounts receivable and prepayments | 2,166 |
| Current income tax prepayments | 288 |
| Inventories | 3,313 |
| Property, plant and equipment | 126,052 |
| Intangible assets | 262 |
| Deferred tax assets | 726 |
| Other non-current assets | 177 |
| Total non-current assets held for sale | 133,363 |
| Accounts payable and accrued expenses | 2,515 |
| Income tax payable | 1 |
| Other taxes payable | 3,099 |
| Advances from customers | 57 |
| Long-term borrowings | 41 |
| Dismantlement provision | 2,638 |
| Deferred tax liability | 19,126 |
| Total liabilities directly associated with non-current assets classified as held for sale | 27,477 |
Urals Energy Public Company Limited
Notes to the Consolidated Financial Statements
(in US dollars, tabular amounts in US$ thousands, except as indicated)
7 Non-current assets held for sale (Continued)
During the years ended 31 December 2007 and 2006 these assets had the following cash flows.
| 31 December: | |
| 2007 | |
| Operating cash flows | 15,298 |
| Investing cash flows | (6,109) |
| Financing cash flows | - |
| Total cash flows | 9,189 |
8 Accounts Receivable, Prepayments and Cash and cash equivalents
| 31 December: | ||
| 2007 | 2006 | |
| Prepaid taxes | 13,566 | 4,740 |
| Advances to suppliers | 2,044 | 4,857 |
| Recoverable taxes including VAT | 9,301 | 8,255 |
| Receivables from related parties (Note 25) | 5,767 | 2,897 |
| Trade accounts and notes receivable (net of provision of $0.664 million and $0.640 million at 31 December 2007 and 2006, respectively) | 3,079 | 1,755 |
| Other | 5,014 | 2,213 |
| Total accounts receivable and prepayments | 38,771 | 24,717 |
Included in total accounts receivable and prepayments are $7.1 million and $3.9 million at 31 December 2007 and 2006, respectively, denominated in US dollars.
Receivables from related parties consist of short term loans to employees and shareholders of which $3.7million is secured by real estate owned by an employee. Trade accounts receivable arises primarily from sales to ongoing customers with standard payment terms, Other primarily relate to short-term prepaid expenses, which will be expensed during 2008 and overpaid amounts to customs and tax authorities, which will be returned to the Group in cash or will be used to off-set future payments.
Changes in the provision for impairment of trade accounts and notes receivable relates only to translation difference as follows:
| 31 December: | ||
| 2007 | 2006 | |
| At 1 January | 640 | 586 |
| Effect of currency translation | 24 | 54 |
| At 31 December | 664 | 640 |
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 24 for credit risk disclosures).
8 Accounts Receivable and Prepayments (Continued)
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 $1.0 million and $0.1 million at 31 December 2007 and 2006, respectively were past due but not impaired. These relate to the only contractor AMNGR, who is a neighboring company to Arcticneft and sells crude oil to the Group. The majority of the liability is for sold petroleum products, and was collected in 2008. The ageing analysis of these past due but not impaired trade and other receivables are as follows:
Included within financial assets the amounts of past due but not impaired was:
| At 31 December: | ||
| 2007 | 2006 | |
| Up to 90 days past-due | - | 111 |
| 91 to 360 days past-due | 994 | - |
| Total past due but not impaired | 994 | 111 |
At 31 December 2007, included within cash and cash equivalents was $17.9 million (GBP 8.8 million) of funds, which were invested in the Morgan Stanley Liquidity Funds at year-end to earn interest on available funds.
9 Inventories
| 31 December: | ||
| 2007 | 2006 | |
| Crude oil | 8,818 | 6,910 |
| Oil products | 2,269 | 1,700 |
| Materials and supplies (net of allowances of $0.397 million and $1.217 million at 31 December 2007 and 2006, respectively) | 32,799 | 18,069 |
| Total inventories | 43,886 | 26,679 |
Inventory provision
| 31 December: | ||
| 2007 | 2006 | |
| At 1 January | 1,217 | 854 |
| Additional provisions | - | 275 |
| Reversal of previously booked provisions | (882) | - |
| Effect of currency translation | 62 | 88 |
| At 31 December | 397 | 1,217 |
The largest part of the reversal of the previously booked provision relates to the electric power transformers, which were in stock for over 4 years and management had no plans to use them in the future. During 2007 as a result of technical review of the power generating facilities in Petrosakh and review of the electric power transformers in stock, management decided to use those electric power transformers for the upgrade of the existing power supply units. Therefore, the previously booked provision for these units was reversed in these financial statements. The cost to put this inventory in working condition is not material.
Urals Energy Public Company Limited
Notes to the Consolidated Financial Statements
(in US dollars, tabular amounts in US$ thousands, except as indicated)
10. Property, Plant and Equipment
|
| Oil and gas properties | Refinery and related equipment | Buildings | Other Assets | Assets under construction | Total |
| Cost at | ||||||
| 1 January 2006 | 266,137 | 8,984 | 2,048 | 5,131 | 14,754 | 297,054 |
| Translation difference | 35,034 | 838 | 330 | 341 | 4,837 | 41,380 |
| Business combinations | 209,473 | - | 2,629 | 1,216 | 31,437 | 244,755 |
| Additions | 5,060 | - | - | - | 39,546 | 44,606 |
| Capitalised borrowing costs (Note 16) | - | - | - | - | 861 | 861 |
| Transfers | 28,322 | 57 | 59 | 4,729 | (33,167) | - |
| Changes in estimates of dismantlementprovision (Note 17) | 146 | - | - | - | - | 146 |
| Impairment | - | - | - | - | - | - |
| Disposals | (2,112) | - | - | (1,055) | (1,176) | (4,343) |
| 31 December 2006 | 542,060 | 9,879 | 5,066 | 10,362 | 57,092 | 624,459 |
| Translation difference | 39,822 | 720 | 369 | 952 | 4,822 | 46,658 |
| 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 |
Urals Energy Public Company Limited
Notes to the Consolidated Financial Statements
(in US dollars, tabular amounts in US$ thousands, except as indicated)
10 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 2006 | (8,317) | (502) | (222) | (528) | - | (9,569) |
| Translation difference | (1,312) | (64) | (33) | (71) | - | (1,480) |
| Depreciation, depletion and amortization | (16,950) | (518) | (380) | (1,034) | - | (18,882) |
| Disposals | 883 | - | - | 389 | - | 1,272 |
| 31 December 2006 | (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) |
|
| Oil and gas properties | Refinery and related equipment | Buildings | Other Assets | Assets under construction | Total |
| Net Book Value at | ||||||
| 31 December 2006 | 516,364 | 8,795 | 4,431 | 9,118 | 57,092 | 595,800 |
| 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 |
Urals Energy Public Company Limited
Notes to the Consolidated Financial Statements
(in US dollars, tabular amounts in US$ thousands, except as indicated)
10.. Property, Plant and Equipment (Continued)
Included within oil and gas properties at 31 December 2007 and 2006 were exploration and evaluation assets:
| Cost at 31 December 2006 | Additions | Transfers to tangible part of Oil and Gas properties | Disposals: Impairment loss | Translation difference | Cost at 31 December 2007 | |
| Exploration and evaluation assets, excluding assets held for sale | ||||||
| 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 |
| Subtotal | 249,233 | 8,417 | (2,813) | (28,407) | 19,043 | 245,473 |
| Exploration and evaluation assets held-for-sale | 66,890 | 207 | - | - | 4,873 | 71,970 |
| Total cost of exploration and evaluation assets | 316,123 | 8,624 | (2,813) | (28,407) | 23,916 | 317,443 |
| Drilling and exploration wells | ||||||
| - Group, excluding assets held for sale | 2,743 | 7,035 | - | (7,035) | 199 | 2,942 |
| - Assets held for sale | - | - | - | - | - | - |
| Licenses | ||||||
| - Group, excluding assets held for sale | 246,490 | 1,382 | (2,813) | (21,372) | 18,844 | 242,531 |
| - Assets held for sale | 66,890 | 207 | - | - | 4,873 | 71,970 |
Cash flows associated with exploration and evaluation assets during the years ended 31 December 2007 and 2006 were as follows:
| Year ended 31 December: | ||
| 2007 | 2006 | |
| Cash flows used in operating activities | 8,624 | 5,060 |
| Cash flows used in investing activities | - | 153,094 |
| Total cash used for exploration and evaluation of assets | 8,624 | 158,154 |
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 $2.4 million (including $2.1 million recorded within assets held for sale) and $2.3 million at 31 December 2007 and 2006, respectively, are included in the cost of oil and gas properties. The Group has estimated its liability based on current environmental legislation using estimated costs when the expenses are expected to be incurred.
Urals Energy Public Company Limited
Notes to the Consolidated Financial Statements
(in US dollars, tabular amounts in US$ thousands, except as indicated)
10. Property, Plant and Equipment (Continued)
During 2007 the Group completed drilling the first exploration well on the Nadezdinskiy license block. The results of testing of this well did not confirm commercial quantities of hydrocarbons. According to its terms, the license expired 1 January 2008. Since exploration was not successful, the Group did not apply for the extension of the license and let it expire. As a result of unsuccessful exploration of that license block, the Group impaired the investment costs as well as exploration and evaluation expense assets, which resulted in a $28.3 million charge in the statement of income and expenses. There are no additional commitments associated with the expiration of the license.
Additionally, at 1 January 2008, four other minor licenses, which were part of the Urals Nord block, expired. The Group did not allocate any values to those licenses, and they were transferred back to the state. Since no works were performed on those areas, the Group did not incur any dismantlement or site restoration obligations.
Also, included in the $31.0 million impairment of property, plant and equipment was an impairment of proved oil and gas properties in Chepetskoye NGDU in the amount of $2.7 million due to revision of the reserves according to the independents reserve report prepared by DeGolyer & MacNaughton at 31 December 2007.
At 31 December 2007 and 2006, property, plant and equipment with a carrying net book value of nil and $134.4 million, respectively, were pledged as collateral for the Group's borrowings.
11.Intangible assets
Included with in intangible assets were cost associated with purchase and installation of the software, which was completed during 2007.
| 2007 | 2006 | |
| Cost at | ||
| 1 January | 1,149 | 27 |
| Translation difference | 206 | 39 |
| Additions | 1,149 | 1,083 |
| Disposals | (3) | - |
| Transfers to property, plant and equipment | (24) | - |
| 31 December | 2,477 | 1,149 |
| Including assets-held-for sale | 331 | |
| Accumulated amortisation at | ||
| 1 January | (8) | - |
| Translation difference | (39) | (1) |
| Additions | (353) | (7) |
| Disposals | 1 | - |
| 31 December | (399) | (8) |
| Including assets-held-for sale | (69) | |
| Net-book value at 31 December | 2,078 | 1,141 |
| Including assets held-for-sale | 262 | - |
12 Other Non-Current Assets
|
| 31 December: | |
| 2007 | 2006 | |
| Advances to contractors and suppliers for CAPEX | 19,649 | 12,474 |
| Other deferred costs | - | 2,458 |
| Total other non-current assets | 19,649 | 14,932 |
Urals Energy Public Company Limited
Notes to the Consolidated Financial Statements
(in US dollars, tabular amounts in US$ thousands, except as indicated)
13 Accounts Payable and Accrued Expenses
|
| 31 December: | |
| 2007 | 2006 | |
| Accounts payable for loan organisation fees | 10,000 | - |
| Trade payables | 5,710 | 1,620 |
| Accounts payable for CAPEX | 4,103 | 4,371 |
| Wages and salaries | 1,035 | 1,167 |
| Interest payable | 967 | 15 |
| Accounts payable for investment in joint venture | 589 | - |
| Advances from and payables to related parties (Note 25) | 113 | 863 |
| Other payable and accrued expenses | 880 | 1,997 |
| Total accounts payable and accrued expenses | 23,397 | 10,033 |
Total accounts payable and accrued expenses in the amount of $19.2 million and $3.3 million at 31 December 2007 and 2006, respectively, are denominated in US dollars. The fair value of the loan approximates its carrying amount at the balance sheet date.
14 Advances from customers
| 31 December: | ||
| 2007 | 2006 | |
| Petraco | 32,011 | 30,233 |
| Galaform | 22,407 | - |
| Other | 761 | 680 |
| Total advances from customers | 55,179 | 30,913 |
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, prepayments shall be made in one or more advances against specified future deliveries of agreed volumes of crude oil to be sold to Petraco. The total aggregate amount of all prepayments outstanding at any given time shall not exceed the lower of 70% of the estimated value of the aggregate estimated deliveries under the off-take contract for the next succeeding eight month period, or $50.0 million. Each individual prepayment advance must be reimbursed by the specified future deliveries which must occur within eight months from the date of the relevant advance. All prepayment amounts outstanding as of 1 January 2009 shall be reimbursed in full before any additional prepayments may be requested or made, provided that following the full reimbursement of such outstanding prepayments, additional prepayments may be requested and made thereafter through expiration of the agreement in July 2012. The agreement does not have any financial covenants but does contain cross-default provisions in the event the Group is in default of any of its other borrowing agreements. Interest on the prepayments accrues at LIBOR plus 4.75% 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. Subsequent to the year-end the maximum borrowing base was increased to $60.0 million, the period of the deliveries was reduced to six months and interest rate was increased by 25 basis points.
An additional drawdown of $10.0 million from Petraco was received in April 2008.
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 is secured with the domestic crude oil deliveries from the resources of Dinyu, CNPSEI, Michayuneft, Nizhneomrinskaya Neft and Chepetskoye NGDU. The prepayment is due to be settled starting from November 2008 and should be fully repaid in April 2009.
Subsequent to delivery in May 2008, the Group repaid RR 374.6 million ($15.8 million) of the Galaform prepayment.
Urals Energy Public Company Limited
Notes to the Consolidated Financial Statements
(in US dollars, tabular amounts in US$ thousands, except as indicated)
15 Taxes
Income taxes for the years ended 31 December 2007 and 2006 comprised the following:
|
| Year ended 31 December: | |
| 2007 | 2006 | |
| Current tax expense | 2,423 | 2,434 |
| Release of income tax provision | (1,097) | (3,730) |
| Deferred tax (benefit) | (9,215) | (1,988) |
| Income tax (benefit) | (7,889) | (3,284) |
Below is a reconciliation of profit before taxation to income tax charge (benefit):
| Year ended 31 December: | ||
| 2007 | 2006 | |
| Profit before income tax | 105,902 | 31,138 |
| Theoretical tax charge at the statutory rate of 24 % | 25,416 | 7,473 |
| Excess of net assets acquired over purchase price | (50,091) | (8,615) |
| Utilisation of previously unrecognised tax loss carry forward | (1,623) | (781) |
| Unrecognised tax loss carry forward for the year | 425 | 396 |
| Reversal of unused income tax provision | (1,097) | (3,730) |
| Effect of tax penalties | 9 | 164 |
| Other non-deductible expenses | 19,072 | 1,809 |
| Income tax (benefit) | (7,889) | (3,284) |
Urals Energy Public Company Limited
Notes to the Consolidated Financial Statements
(in US dollars, tabular amounts in US$ thousands, except as indicated)
15 Taxes (Continued)
The movements in deferred tax assets and liabilities during the years ended 31 December 2007 were as follows:
|
| 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 held for sale | 1,925 | - | - | - | - |
| Net deferred tax assets classified as held for sale | 726 | - | - | - | - |
|
| 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 liability | (112,961) | (7,901) | 8,526 | - | (113,586) |
| Net deferred tax liability of the Group, excluding that classified as held for sale | (93,835) | - | - | - | - |
| Net deferred tax liability classified as held for sale | (19,126) | - | - | - | - |
Urals Energy Public Company Limited
Notes to the Consolidated Financial Statements
(in US dollars, tabular amounts in US$ thousands, except as indicated)
15 Taxes (Continued)
|
| 2006 | Recognized in equity for translation differences | Credited (charged) to the income statement | Effect of acquisitions | 2005 |
| Deferred tax liabilities | |||||
| Inventories | - | - | - | - | - |
| Deferred tax assets | |||||
| Property, plant and equipment | 250 | 3 | 72 | 175 | - |
| Receivables | 3 | - | 3 | - | - |
| Dismantlement provision | 411 | 7 | 13 | 391 | - |
| Tax losses | 1,135 | 72 | 423 | - | 640 |
| Net deferred tax assets | 1,799 | 82 | 511 | 566 | 640 |
|
| 2006 | Recognized in equity for translation differences | Credited (charged) to the income statement | Effect of acquisitions | 2005 |
| Deferred tax liabilities | |||||
| Property, plant and equipment | (114,638) | (7,750) | 1,720 | (55,988) | (52,620) |
| Inventories | (124) | (9) | (25) | - | (90) |
| Payables | (75) | (19) | 238 | (3) | (291) |
| Other taxable temporary differences | (39) | (8) | 82 | - | (113) |
| Deferred tax assets | |||||
| Receivables | 252 | 19 | (32) | 110 | 155 |
| Dismantlement provision | 388 | 24 | 171 | 3 | 190 |
| Payables | 459 | 36 | 63 | - | 360 |
| Inventories | 130 | 12 | (87) | 91 | 114 |
| Other deductible temporary differences | 61 | 110 | (653) | 49 | 555 |
| Net deferred tax liability | (113,586) | (7,585) | 1,477 | (55,738) | (51,740) |
Urals Energy Public Company Limited
Notes to the Consolidated Financial Statements
(in US dollars, tabular amounts in US$ thousands, except as indicated)
15 Taxes (Continued)
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 2007 and 2006, deferred tax assets of $12.6 million and $4.8 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 asset to be utilised. Accumulated tax losses were $119.0 million and $35.5 million at 31 December 2007 and 2006 respectively; of which $114.2 million in 2007 and $26.5 million in 2006 can be carried forward indefinitely. The remaining $4.8 million of the accumulated tax losses at 31 December 2007 expire in 2017 and of the remaining $9.0 million at 31 December 2006, $6.0 million were reversed during 2007, and $3.0 million will expire in 2016.
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 2007 and 2006, the estimated unrecorded deferred tax liabilities for such differences were $1.7 million and $1.4 million, respectively. Unremitted earnings amounted to $34.4 million and $28.6 million at 31 December 2007 and 2006, respectively
Other taxes payable at 31 December 2007 and 2006 were as follows:
| 31 December: | ||
| 2007 | 2006 | |
| Unified production tax | 1,901 | 5,583 |
| Value added tax | 268 | 374 |
| Other taxes payable | 731 | 1,296 |
| Total other taxes payable | 2,900 | 7,253 |
Tax provisions
| 2007 | 2006 | |
| Tax provision at 1 January | 2,367 | 1,987 |
| Effect of acquisitions: | ||
| VAT | - | 108 |
| Other | - | 22 |
| Accrual (release) of tax provision: | ||
| Excise tax (Note 19) | (1,717) | 1,367 |
| VAT (Note 20) | (137) | (757) |
| Other (Note 20) | (75) | (554) |
| Effect of currency translation | 91 | 194 |
| Tax provisions at 31 December | 529 | 2,367 |
During 2007 the Group was successful in defending its position in the courts regarding tax claims as a result of tax audits in Arcticneft for the period 2003-2007. After winning the cases in all courts, management decided to reverse those provisions. Additionally, management downgraded the probability of similar tax risks in other periods. That reversal resulted in $1.8 million of income in the consolidated income statement.
Urals Energy Public Company Limited
Notes to the Consolidated Financial Statements
(in US dollars, tabular amounts in US$ thousands, except as indicated)
16 Borrowings
Long-term borrowings. Long-term borrowings were as follows at 31 December 2007 and 2006:
| 31 December: | ||
| 2007 | 2006 | |
| BNP Paribas Reserve Based Loan Facility | - | 51,054 |
| BNP Paribas Subordinated Loan | - | 10,570 |
| Other | 29 | 185 |
| Subtotal | 29 | 61,809 |
| Less: current portion of long-term borrowings | - | (20,965) |
| Total long-term borrowings | 29 | 40,844 |
BNP Paribas Reserve Based Loan Facility. In November 2005, the Group entered into a five year, revolving Reserve Based Loan Facility with BNP Paribas, underwritten to a maximum commitment of $100.0 million. The facility was divided into a senior tranche of $59.0 million that bore interest at LIBOR plus 5.0% and a junior tranche of $10.0 million at LIBOR plus 6.25%. The weighted average interest rate of the facility at 31 December 2006 was 11.67%. Both tranches were scheduled to mature in December 2010. The facility was collateralized by liens on property, plant and equipment of subsidiaries and included certain financial and other covenants, including the maintenance of a minimum current ratio and a maximum ratio of total borrowings to EBITDA. In August 2007, the Group fully repaid the Reserve Based Loan.
BNP Paribas Subordinated Loan. In January 2006, the Group obtained a $12.0 million subordinated loan from BNP Paribas (the "Subordinated Loan"). The Subordinated Loan bore interest at LIBOR plus 5.0% (10.73% at 31 December 2006) and was scheduled to be repaid in November 2010. Attached to the Subordinated Loan were warrants to purchase up to two million of the Company's common stock for GBP 3.03. The warrants are exercisable at any time and expire in November 2010. In June 2007, the Group repaid the Subordinated Loan in full.
Warrants. Management estimated the value of the warrants to be $1.75 million at issuance. As the exercise price of the warrants is denominated in a currency other than the Company's functional currency, the warrants are classified as a liability and adjusted to fair value at each reporting date, with the change in fair value recorded within the income statement. As the warrants are exercisable at any time, this amount was originally recorded as current liabilities in the Group's consolidated balance sheet, with a corresponding reduction in the carrying value of the Subordinated Loan. The difference between the carrying value and the face value of the Subordinated Loan is accreted over the term to maturity as interest expense at the effective interest rate of the debt. For the years ended 31 December 2007 and 2006, the change in the fair value of warrants resulted in a gain of $2.2 million and a loss of $1.8 million, respectively.
As part of the agreement reached with BNP Paribas to settle the loan in full, the Group agreed, subject to board approval, to repurchase the warrants issued in connection with the Subordinated Loan at a price equal to 1.02046 times the U.S. dollar to British Pound exchange rate times the higher of either one British Pound or the difference between GBP 3.03 and the average market price of the Company's shares during the period from 19 June 2007 to the date of repurchase. As of June 2008, the Group's Board of Directors has not approved the repurchase of the warrants.
Urals Energy Public Company Limited
Notes to the Consolidated Financial Statements
(in US dollars, tabular amounts in US$ thousands, except as indicated)
16 Borrowings (Continued)
Scheduled maturities of long-term borrowings outstanding were as follows:
| Scheduled maturities at 31 December: | ||
| 2007 | 2006 | |
| One year | - | 20,965 |
| Two to five years | 29 | 40,844 |
| Thereafter | - | - |
| Total long-term borrowings | 29 | 61,809 |
Short-term borrowings. Short-term borrowings were as follows at 31 December 2006 and 2007:
| 31 December: | ||
| 2007 | 2006 | |
| Sberbank acquisition loan | 500,000 | - |
| - loan organization fees | (14,678) | - |
| Sberbank field development loan | 130,000 | - |
| - loan organization fees | (1,415) | - |
| Other | 124 | 2,000 |
| Total short-term borrowings | 614,031 | 2,000 |
Sberbank 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. According to the loan agreement, the loan matures in November 2008. However, if the Group meets certain technical conditions, the loan can be extended until November 2010, repayable in full in one installment. 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 in the consolidated balance sheet and which are being 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 contracted to pay $10.0 million fees to Ashmore Investment Management Limited ("Ashmore"), Taas shareholder, in exchange for a pledge of 10.5% of Ashmore share in Taas to 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 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.
Also, 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 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 are considered to be fully performing at 31 December 2007.
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 $1.625 million (1.25% of the facility amount) which are recorded net against the loan balance in the consolidated balance sheet and which are being amortised over the life of the loan using the effective interest method. If the Group meets certain technical conditions, the loan can be extended for six years with 15 equal quarterly principal installments payable starting May 2010.
The Group pledged 100% of its shares in Dulisma as collateral for its obligations under the loan. Additionally, major shareholders of the Group agreed to pledge UEPCL shares to Sberbank as additional collateral. Management believes that the Group was in compliance with all covenants in the loan agreement as of the date of these financial statements.
Urals Energy Public Company Limited
Notes to the Consolidated Financial Statements
(in US dollars, tabular amounts in US$ thousands, except as indicated)
16 Borrowings (Continued)
Goldman Sachs project finance loan. In January 2007, the Group entered into a new loan agreement to fund the development of the Dulisminskoye field in Irkutsk Region, Eastern Siberia. The debt facility was secured by 100% of the Group's ownership of Dulisma. Loan organisation fees of $4.4 million were recorded net in the consolidated balance sheet and were being amortised over the life of the loan.
The terms of the loan include an interest rate of 725 basis points over the three month LIBOR rate of which LIBOR plus 300 basis points were payable quarterly, with the remainder accruing and being capitalized to loan principal until scheduled maturity in 2011.
Concurrent with entering into the loan agreement, the Group entered into an agreement with Goldman Sachs under which Goldman Sachs agreed to make payments to the Group equal to the cash portion of the interest under the loan agreement from 9 February 2007 to 9 February 2009. The Group paid Goldman Sachs $20.4 million for agreeing to make these payments to the Group as the interest came due. Goldman Sachs assumption of this liability was recognized as a financial derivative asset in the Group's consolidated balance sheet, valued at inception at its fair value of $20.4 million.
The Group recognized interest expense on the principal balance of the loan agreement at the coupon rate of LIBOR plus 7.25% per annum. Amortization of loan organisation fees was also recorded within interest expense. Additionally, at each balance sheet date, the carrying value of the financial derivative was adjusted to its fair value by reference to current market rates for similar instruments. Any change in the fair value of the financial derivative, other than those caused by cash payments received, was recorded within the consolidated income statement.
The loan was fully repaid and the swap agreement terminated in November 2007. As a result of the repayment of this loan and the termination of the swap agreement, the Group incurred expenses of $12.2 million, representing the amount of interest payable at the rate of 7.25 % per annum, calculated on each Interest Payment Date by reference to the amount of the Loan for the period on and from the date of prepayment to 9 February 2009 and discounted at the Make-Whole Discount Rate.
Weighted average interest rate. The Group's weighted average interest rates on short-term borrowings were 14.56% and 11.51% at 31 December 2007 and 2006, respectively.
Urals Energy Public Company Limited
Notes to the Consolidated Financial Statements
(in US dollars, tabular amounts in US$ thousands, except as indicated)
16 Borrowings (Continued)
Interest expense and income. Interest expense and income for the years ended 31 December 2007 and 2006, respectively, comprised the following:
| Year ended 31 December: | ||
|
| 2007 | 2006 |
| Short-term borrowings | ||
| Sberbank | ||
| - interest at coupon rate | 8,505 | - |
| - accretion of issuance costs | 1,689 | - |
| BNP Paribas | 58 | - |
| Bank Zenit | - | 129 |
| Other short-term borrowings | - | 44 |
| Total interest expense associated with short-term borrowings | 10,252 | 173 |
| Long-term borrowings | ||
| BNP Paribas Subordinated Loan | ||
| - interest at coupon rate | 628 | 1,125 |
| - commitments and break up cost | 26 | - |
| - accretion of issuance costs and discount associated with warrants | 1,694 | 381 |
| BNP Paribas Reserve Based Loan Facility | ||
| - interest at coupon rate | 2,303 | 6,521 |
| - commitments | 610 | 263 |
| - accretion of issuance costs | 2,132 | 529 |
| 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 | 8,819 |
| Finance leases | 272 | 162 |
| Less capitalised borrowing costs | (3,576) | (861) |
| Change in dismantlement provision due to passage of time (Note 17) | 438 | 166 |
| Interest on advance from Petraco Oil Company Limited | 4,310 | 1,181 |
| Other interest | 170 | 170 |
| Total interest expense | 47,648 | 9,810 |
| Interest income | ||
| JP Morgan Liquidity Fund | (76) | (635) |
| Related party loans issued (Note 25) | (146) | (130) |
| Sberbank promissory notes | (343) | - |
| Bank deposit | (2,052) | (571) |
| Other | (5) | (23) |
| Total interest income | (2,622) | (1,359) |
| Total finance costs | 45,026 | 8,451 |
The capitalisation rates used to determine the amount of borrowing costs eligible for capitalisation were 13.5% and 10.7% in 2007 and 2006, respectively.
Urals Energy Public Company Limited
Notes to the Consolidated Financial Statements
(in US dollars, tabular amounts in US$ thousands, except as indicated)
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: | ||
| 2007 | 2006 | |
| Opening dismantlement provision | 3,327 | 813 |
| Translation difference | 264 | 126 |
| Assumed in business combination | - | 1,643 |
| Additions | 13 | 433 |
| Disposals | (206) | - |
| Changes in estimates | 250 | 146 |
| Change due to passage of time | 438 | 166 |
| Closing dismantlement provision | 4,086 | 3,327 |
| - Dismantlement provision of the Group, excluding the portion classified as liabilities directly associated with non-current assets classified as held for sale | 1,448 | - |
| - Dismantlement provision classified as liabilities directly associated with non-current assets classified as held-for-sale | 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
At 31 December 2007, authorized ordinary shares were 300 million, each having a par value of 0.0025 Cypriot pounds, of which 175.1 million and 118.1 million were issued and outstanding at 31 December 2007 and 2006, respectively. In January 2008, the par value of shares was redenominated into US dollars at $0.0063 per share.
| Number of shares (thousand of shares) | Share capital | Share premium | ||
| Balance at 1 January 2006 | 86,911 | 460 | 201,355 | |
| Shares issued for cash | 31,089 | 173 | 194,879 | |
| Exercise of options | 113 | - | 125 | |
| Share-based payment - restricted stock |
| - | - | 5,089 |
| Balance at 31 December 2006 | 118,113 | 633 | 401,448 | |
| Shares issued for cash | 32,857 | 205 | 116,396 | |
| Shares issued for payment of investment in Taas | 22,738 | 143 | 93,163 | |
| Shares issued under restricted stock plans | 811 | 5 | (5) | |
| Early vested shares issued under restricted stock plans | 602 | 4 | (4) | |
| Share-based payment related to restricted stock plans | - | - | 9,898 | |
| Share-based payment related to early vesting | - | - | 4,215 | |
| Balance at 31 December 2007 |
| 175,121 | 990 | 625,111 |
Urals Energy Public Company Limited
Notes to the Consolidated Financial Statements
(in US dollars, tabular amounts in US$ thousands, except as indicated)
18 Equity (Continued)
Shares issued for cash. In May 2006, the Group completed a private placement for 31,088,976 of its shares. Proceeds from the issuance totalled $195.1 million, net of transaction costs of $14.0 million.
In December 2007, the Group completed a private placement for 32,857,000 of its shares. Proceeds from the issuance totalled $116.6 million, net of transaction costs of $9.2 million. Subsequent to year-end 2007, Morgan Stanley, the Group's nominated adviser, executed an option for 10% of overallotment of UEPCL shares in the amount of 1,643,000 shares. Proceeds from the overallotment issuance totalled $6.2 million net of transaction costs of $0.2 million.
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 5% 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 during 2007 145,952 restricted stock awards were forfeitured as a result of retirement of certain managers of the Company. Also, of the initially granted in 2007 restricted stock of 3,075,393 shares, 75,275 granted shares were cancelled as a result of retirement of certain employees of the Company.
The total costs associated with the restricted stock granted during the years ended 31 December 2007 and 2006 were $20.1 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 2007 and 2006, $14.1 million and $5.0 million, respectively, of expense related to share-based payments were recognized in the consolidated statements of income. Such expense for the year ended 31 December 2007 includes $4.2 million of expense related to restricted stock granted to certain members of the Group's executive management, who resigned during 2007. As part of the severance agreement with those employees, all unvested restricted stock grants which they held were immediately vested.
As of 31 December 2007, the number of unvested restricted stock grants and their respective vesting dates are presented in the table below.
| Date of Grant | January 2007 | January 2008 | January 2009 | January 2010 | January 2011 | Total |
| Unvested Restricted Stock Granted as of 31 December 2006 | 811,105 | 260,625 | 260,625 | - | - | 1,332,355 |
| Restricted Stock Granted in 2007 | - | 979,791 | 1,025,131 | 1,025,127 | 45,344 | 3,075,393 |
| Forfeitured in 2007 | - | (98,068) | (98,068) | (25,091) | - | (221,227) |
| Vesting in 2007 | (811,105) | - | - | - | - | (811,105) |
| Early vesting in 2007 as part of Separation Agreement | - | (388,760) | (388,757) | (284,506) | - | (1,062,023) |
| Total Restricted Stock Granted as of 31 December 2007 | - | 753,588 | 798,931 | 715,530 | 45,344 | 2,313,393 |
Urals Energy Public Company Limited
Notes to the Consolidated Financial Statements
(in US dollars, tabular amounts in US$ thousands, except as indicated)
18 Equity (Continued)
At 31 December 2007, restricted stock grants for 1,413,307 shares were fully vested and issued. At 31 December 2006, no restricted stock grants were vested.
Subsequent to 31 December 2007, the Group issued 1,380,509 shares which included early vesting of grants of 459,821 shares to the retired employees as part of severance payments and issue of 753,588 shares as a result of normal vesting of previously issued restricted stock grants. Also, this amount includes 167,100 shares acquired by the former CFO as part of grant of option given at the time of IPO 2005.
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. In these consolidated financial statements the fair value of this option was evaluated at $0.007 million. 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 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 $0,125 million on 1 August 2006 and of $0,125 million 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 $0.120 million, of which $0.023 and $0.057 million were recognized within selling, general and administrative expenses in 2007 and 2006, respectively, with respect to this award. The full amount of the award was recognized over its vesting period.
During the years ended 31 December 2007 and 2006, respectively, nil and 113 thousand shares were issued as a result of execution of the award. The option was executed in full in February 2008, when the Group issued 167,000 shares to the former officer.
Urals Energy Public Company Limited
Notes to the Consolidated Financial Statements
(in US dollars, tabular amounts in US$ thousands, except as indicated)
18 Equity (Continued)
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:
| 2007 | 2006 | |
| Balance at 1 January | 118,112,135 | 86,910,546 |
| Shares issued for cash | 1,260,269 | 18,142,335 |
| Shares issued for payment of investment in Taas | 1,121,328 | - |
| Shares issued under restricted stock plans | 606,663 | - |
| Early vested shares under restricted stock plans | 318,660 | - |
| Exercise of options | - | 46,896 |
| Weighted average number of ordinary shares in issue (thousands) | 121,419,055 | 105,099,777 |
| Year ended 31 December: | ||
| 2007 | 2006 | |
| Profit attributable to equity holders of the Company | 113,722 | 34,308 |
| Weighted average number of ordinary shares in issue (thousands) | 121,419 | 105,100 |
| Basic earnings per share ($ per share) | 0.94 | 0.33 |
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. The diluted earning per share for 2007 and 2006 were 0.82 USD per share and 0.31 USD per share respectively.
Urals Energy Public Company Limited
Notes to the Consolidated Financial Statements
(in US dollars, tabular amounts in US$ thousands, except as indicated)
19 Revenues
| Year ended 31 December: | ||
| 2007 | 2006 | |
| Crude oil | ||
| Export sales | 134,308 | 117,940 |
| Domestic sales (Russian Federation) | 45,891 | 35,666 |
| Petroleum (refined) products - domestic sales | 12,386 | 14,798 |
| Other sales | 1,526 | 1,186 |
| Total gross revenues | 194,111 | 169,590 |
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 were gain from release of tax risk provision $1.7 million and loss from accrual of tax risk provision $1.4 million recognised in 2007 and 2006, respectively.
20 Cost of Sales
| Year ended 31 December: | ||
| 2007 | 2006 | |
| Unified production tax | 41,509 | 38,901 |
| Impairment of property, plant and equipment (Note 10) | 31,039 | - |
| Depreciation and depletion | 28,974 | 18,721 |
| Cost of purchased products | 21,624 | 9,266 |
| Wages and salaries (including payroll taxes of $3.5 million and $2.6 million for the years ended 31 December 2007 and 2006, respectively) | 21,489 | 16,865 |
| Materials | 7,285 | 6,704 |
| Oil treating, storage and other services | 5,467 | 2,381 |
| Other taxes | 3,214 | 2,210 |
| Rent, utilities and repair services | 1,611 | 1,163 |
| Energy services | 1,377 | 666 |
| Release of other taxes risk provision | (212) | (1,311) |
| Loss on disposal of assets | 893 | 441 |
| Other | 2,311 | 2,252 |
| Change in finished goods | (4,153) | (6,188) |
| Total cost of sales | 162,428 | 92,071 |
Urals Energy Public Company Limited
Notes to the Consolidated Financial Statements
(in US dollars, tabular amounts in US$ thousands, except as indicated)
21 Selling, General and Administrative Expenses
| Year ended 31 December: | ||
| 2007 | 2006 | |
| Wages and salaries | 21,812 | 9,616 |
| Share based payments | 14,113 | 5,087 |
| Professional consultancy fees | 5,309 | 2,348 |
| Office rent and other expenses | 3,440 | 1,556 |
| Transport and storage services | 3,266 | 4,600 |
| Loading services | 2,719 | 1,381 |
| Trip expenses and communication services | 1,824 | 1,249 |
| Audit fees | 1,307 | 879 |
| Directors' fees | - | 60 |
| Other expenses | 5,443 | 2,179 |
| Total selling, general and administrative expenses | 59,233 | 28,955 |
Directors' fees for the years ended 31 December 2007 and 2006 were $0.170 million and $0.185, respectively, and do not include amounts related to share-based payments provided to the Group's directors (Note 25).
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.
Sales and royalty commitments. In accordance with the sale purchase agreement to acquire Petrosakh, the Group agreed to pay a perpetual royalty to the previous shareholders of $0.25 per ton of crude oil produced from the currently unproved off-shore licensed area. There was no production from the area in 2007.
Urals Energy Public Company Limited
Notes to the Consolidated Financial Statements
(in US dollars, tabular amounts in US$ thousands, except as indicated)
22 Contingencies, Commitments and Operating Risks (Continued)
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 2008 and 2067, with the most significant licenses expiring 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.
Management currently does not believe that any of its significant exploration or production licenses are at risk of being withdrawn by the licensing authorities. Additionally, management currently plans to complete all the required exploration or development work, as appropriate, within the timetables established in the 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.
Urals Energy Public Company Limited
Notes to the Consolidated Financial Statements
(in US dollars, tabular amounts in US$ thousands, except as indicated)
Contingencies, Commitments and Operating Risks (Continued)
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.
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 $21.1 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.
Included in the above disclosed amount of possible obligations for uncertain tax positions is $0.8 million for which inspection rights of tax authorities have expired, but which may be challenged by regulatory bodies under certain circumstances. In management's estimate no losses are anticipated from these contingent liabilities.
Insurance policies. The Group insured all of its major assets, including oil in stock, against a variety of risks and purchased insurance in respect of directors and officers insurance, certain personnel, including casualty, medical and travel insurance for losses of up to $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 $102.7 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 obligation 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.
Recent volatility in global financial markets. Since the second half of 2007 there has been a sharp rise in foreclosures in the US subprime mortgage market. The effects have spread beyond the US housing market as global investors have re-evaluated their exposure to risks, resulting in increased volatility and lower liquidity in the fixed income, equity, and derivative markets. The volume of wholesale financing has significantly reduced since August 2007. Such circumstances may affect the ability of the Group to obtain new borrowings and refinance its existing borrowings at terms and conditions that applied to similar transactions in recent periods. Debtors of the Group may also be affected by the lower liquidity situation which could in turn impact their ability to repay their amounts owed. Management is unable to reliably estimate the effects on the Group's financial position of any further possible deterioration in the liquidity of the financial markets and their increased volatility.
Urals Energy Public Company Limited
Notes to the Consolidated Financial Statements
(in US dollars, tabular amounts in US$ thousands, except as indicated)
23 Liquidity
A substantial portion of the Group's consolidated net assets comprise undeveloped mineral deposits requiring significant additional investment. The Group is dependent upon external debt and equity financing to fully develop the deposits and realize the value attributed to such assets. During 2007, the Group attracted $630 million in financing from Sberbank in the form of current borrowings (Note 16). As a result, at 31 December 2007 the Group's current liabilities exceed current assets by $534.0 million. However, according to the Group's borrowing agreements with Sberbank, after completion of several technical condition precedents, Sberbank is obliged to extend the maturity of the $500.0 million borrowings by two years from the original maturity and $130.0 million loan by 5 years from the original maturity. Management believes that those conditions will be successfully met and that the loans' maturities will be extended. In addition to extending the maturity of the Sberbank borrowings, management intends to meet its investing cash flow needs through cash generated from its producing properties and from proceeds from the sale of certain assets (Note 7). In the event such proceeds are insufficient, management believes it has sufficient discretion in its planned capital expenditures to ensure that the Group has sufficient resources to meet its cash needs through 31 December 2008. Accordingly, management believes that the preparation of these consolidated financial statements under the going concern assumption is appropriate.
24 Financial Risks
The accounting policies for financial instruments have been applied to the line items below:
| At 31 December: | ||
| 2007 | 2006 | |
| 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 | 28,400 | 33,082 |
| Trade receivables | 8,846 | 4,652 |
| Total loans and receivables: current assets | 37,246 | 37,734 |
| 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 | 2,264 | - |
| Total loans and receivables | 44,613 | 37,734 |
| Financial liabilities | ||
| Measured at fair value - current liabilities | ||
| Derivative financial instruments | 118,657 | - |
| Warrants classified as liabilities | 1,326 | 3,516 |
| Total current liabilities measured at fair value | 119,983 | 3,516 |
| Measured at amortized cost: current liabilities | ||
| Trade and other payables | 22,362 | 8,866 |
| Short-term borrowings and current portion of long-term borrowings | 614,031 | 22,965 |
| Total current liabilities measured at amortized cost | 636,393 | 31,831 |
| Measured at amortized cost: non-current liabilities | ||
| Long-term borrowings | 29 | 40,844 |
| Total long-term liabilities measured at amortized cost | 29 | 40,844 |
Urals Energy Public Company Limited
Notes to the Consolidated Financial Statements
(in US dollars, tabular amounts in US$ thousands, except as indicated)
24 Financial Risks (Continued)
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.
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.
Urals Energy Public Company Limited
Notes to the Consolidated Financial Statements
(in US dollars, tabular amounts in US$ thousands, except as indicated)
24 Financial Risks (Continued)
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 2007 and 2006 exchange rates):
| At 31 December 2007 | Russian rouble | US dollar | GB pound | Euro | CY pound | 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 | 17,948 | 2,064 | 6 | 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) | 16,593 | 2,064 | 6 | (647,211) |
Urals Energy Public Company Limited
Notes to the Consolidated Financial Statements
(in US dollars, tabular amounts in US$ thousands, except as indicated)
24 Financial Risks (Continued)
| At 31 December 2006 | Russian rouble | US dollar | GB pound | Euro | CY pound | Total | |
| Financial assets | |||||||
| Current | |||||||
| Cash and cash equivalents | 1,530 | 31,520 | 23 | - | 9 | 33,082 | |
| Accounts receivable | 1,755 | 2,897 | - | - | - | 4,652 | |
| Financial liabilities | |||||||
| Non-current | |||||||
| Long-term borrowings | (38) | (40,806) | - | - | - | (40,844) | |
| Current | |||||||
| Accounts payable and accrued expenses | (5,552) | (3,314) | - | - | - | (8,866) | |
| Short-term borrowings and current portion of long-term borrowings | (59) | (22,878) | (28) | - | - | (22,965) | |
| Warrants classified as liabilities | - | - | (3,516) | - | - | (3,516) | |
| Net exposure at 31 December 2006 | (2,364) | (32,581) | (3,521) | - | 9 | (38,457) | |
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 10% change in exchange rates and no changes in the portfolio of instruments and other variables held at 31 December 2007 and 2006, respectively.
| Year ended 31 December: | |||
| Effect on pre-tax profit | Increase in exchange rate | 2007 | 2006 |
| $/RUS | 10% | (56,649) | 1 |
| $/GBP | 10% | 1,659 | (352) |
| $/EUR | 10% | 206 | - |
| $/CYP | 10% | 1 | 1 |
The effect of a corresponding 10% decrease in exchange rate is approximately equal and opposite.
Urals Energy Public Company Limited
Notes to the Consolidated Financial Statements
(in US dollars, tabular amounts in US$ thousands, except as indicated)
24 Financial Risks (Continued)
(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.
(c) Cash flow and fair value interest rate risk
The Group is not significantly exposed to 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 2007 and 2006, the Group's interest rate profiles for interest-bearing financial liabilities were:
| At 31 December: | ||
| 2007 | 2006 | |
| At variable rate | - | 63,624 |
| At fixed rate | 614,060 | 185 |
| Total interest bearing financial liabilities | 614,060 | 63,809 |
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 2007 and 2006 would decrease by the amounts shown below.
| Year ended 31 December: | ||
| Effect on pre-tax profit | 2007 | 2006 |
| Increase by 100 basis point | - | 636 |
The effect of a corresponding 100 basis points decrease in interest rates is approximately equal and opposite.
Urals Energy Public Company Limited
Notes to the Consolidated Financial Statements
(in US dollars, tabular amounts in US$ thousands, except as indicated)
24 Financial Risks (Continued)
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 the only 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 is to ensure that it will always have sufficient liquidity to meet its liabilities when due, under both normal and stressed conditions, without incurring unacceptable losses or risking damage to the Group's reputation. In managing its liquidity risk, management aims to maintain adequate cash reserves and debt facilities, continuously monitoring forecast and actual cash flows and striving to balance cash from operations with the maturity profiles of financial assets and liabilities.
The Group prepares various financial plans (monthly, quarterly and annually) to ensure that the Group has sufficient cash on demand to meet expected operational expenses, financial obligations and investing requirements for a period of 30 days or more. The Group has entered into a number of long-term credit facilities to fund cash requirements of a more permanent nature. Additionally, the Group may consider selling some of the non-core assets or issue additional equity to fund future development or acquisitions.
The following tables summarize the maturity profile of the Group's financial liabilities based on contractual undiscounted payments, including interest payments:
| 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 |
Management expects the maturities of borrowings to be extended (see Note 23).
Urals Energy Public Company Limited
Notes to the Consolidated Financial Statements
(in US dollars, tabular amounts in US$ thousands, except as indicated)
24 Financial Risks (Continued)
| At 31 December 2006 | Less than 1 year | Between 1 and 2 years | Between 2 and 5 years | After 5 years | Total |
| Debt at fixed rate | |||||
| Principal | - | - | 185 | - | 185 |
| Interest | - | - | - | - | - |
| Debt at variable rate | |||||
| Principal | 22,965 | - | 40,659 | - | 63,624 |
| Interest | 15 | - | - | - | 15 |
| Warrants classified as liability | 3,516 | - | - | - | 3,516 |
| Accounts payable and accrued expenses | 8,851 | - | - | - | 8,851 |
| Total financial liabilities | 35,347 | - | 40,844 | - | 76,191 |
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.
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.
Urals Energy Public Company Limited
Notes to the Consolidated Financial Statements
(in US dollars, tabular amounts in US$ thousands, except as indicated)
25 Balances and transactions with Related Party
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 | ||
| 2007 | 2006 | |
| Interest income | 146 | 130 |
| Rental expenses (included in selling, general and administrative expense) | - | 450 |
| Other expenses | 34 | 41 |
| Accounts and notes receivable | 48 | 145 |
| Loans receivable | 5,385 | 2,546 |
| Interest receivable | 334 | 206 |
| Receivables from related parties (Note 8) | 5,767 | 2,897 |
| Loan to Taas (Note 5) | 2,264 | - |
| Advances from and payables to related parties (Note 13) | 113 | 863 |
Compensation to senior management. The Group's senior management team compensation totalled $26.732 million and $12.895 million for the periods ended 31 December 2007 and 2006, respectively, including salary, bonuses and severance payments of $12.891 million and $7.806 million respectively. Stock compensation of $13.841 million and $5.087 million, respectively, and no other compensation was paid for both years. Additionally, included in loans receivable at 31 December 2007 and 2006 were loans receivable of $3,730 and $0.955, respectively from the Group's senior management team. The $0.955 loan was repaid in 2007.
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 $3.743 million, including accrued interest. The loan bears 15% interest and matures on 30 September 2008. The loan is secured against real estate owned by that employee.
Additionally, loans receivable include amounts due by OOO Komineftegeophysica in the amount of $0.866 million, where major shareholders of the Group hold the majority of shares. The loans bear interest from 5% to 15% and are short term in nature. These loans are not secured, however, in the ordinary course of business and on market terms Komineftegeophysica provides geological and geophysical services to the Group companies.
Other loans and receivable balances are short-term in the nature, immaterial individually and expire during 2008.
Urals Energy Public Company Limited
Notes to the Consolidated Financial Statements
(in US dollars, tabular amounts in US$ thousands, except as indicated)
26 Subsequent events
Sale of non-core assets. In April 2008, the Group completed the sale of Dinyu, Michayuneft and Nizhneomrinskaya Neft for $93.2 million subject to a possible working capital adjustment that management believes will be insignificant. For more details please refer to Note 7.
Repayment of the domestic prepayment. Following the sale of assets the Group repaid to Galaform RR 374.6 million of prepayment for crude oil deliveries outstanding at 31 December 2007 thus bringing the balance down to RR 175.4 million. See note 14.
Increase of the export prepayment facility from Petraco. Subsequent to the year-end the maximum borrowing base was increased to $60.0 million, and the period of the deliveries was reduced to six months and base interest rate was increased by 25 basis points to LIBOR plus 500 basis points. An additional drawdown of $10.0 million from Petraco was received in April 2008
Financing of Taas. Subsequent to the year-end the Group provided a long-term financing in the amount of $26.3 million. The loans are unsecured, bears interest of 12% and mature in 2015. These loans were part of the shareholders agreement and were provided by all shareholders in the proportion to holdings at the date of the transaction. These funds were used for purchase of promissory notes and repayment of loans
Overallotment of shares. Following December 2007 private placement of 32,857,000 of the Company's shares, Morgan Stanley, the Group's nominated adviser, executed an option for 10% of overallotment of UEPCL shares in the amount of 1,643,000 shares. Proceeds from the overallotment issuance totalled $6.2 million net of transaction costs of $0.2 million. See Note 18.
Evrofinance Mosnarbank. In February 2008 the Group borrowed $18.0 million from the Evrofinance Mosnarbank to fulfil its obligation to make a loan to Taas in the amount of $18.0 million in accordance with the Joint-venture agreement connected to the acquisition. The loan bore 12% interest and was to mature in August 2008. In May 2008, the loan was repaid in full.