Professional Documents
Culture Documents
Main Market of the London Stock Exchange (symbol HOIL) and an Exchangeable Share listed on the Toronto Stock Exchange (symbol HOC) and London Stock Exchange (HOX). The Company currently focuses on operations in Africa, the Middle East and Russia.
Overview
01 Highlights 02 Chairmans Statement 04 Chief Executives Review 08 Q&A 10 Operations Review 10 Uganda 12 Kurdistan Region of Iraq 14 Russia 16 Oman 18 Democratic Republic of Congo 20 Malta 22 Mali 24 Pakistan 26 Tanzania
Financial Review
28 Creating value
Financial Statements
53 Consolidated Balance Sheets 54 Consolidated Income Statements 55 Consolidated Statements of Recognised Income and Expense 56 Consolidated Cash Flow Statements 57 Notes to Consolidated Financial Statements 93 Glossary of Technical Terms
Board of Directors
36 Directors and Senior Management
List of Advisers
38 Advisers
Corporate Governance
39 44 48 52 Corporate Governance Report Remuneration Report Directors Report Auditors Report to the Shareholders
www.heritageoilltd.com
FORWARD-LOOKING INFORMATION Except for statements of historical fact, all statements in this document including, without limitation, statements regarding production estimates and future plans and objectives of Heritage and the Group are forward-looking statements that involve various risks and uncertainties. There can be no assurance that such statements will prove to be accurate; actual results and future events could differ materially from those anticipated in such statements. Factors that could cause actual results to differ materially from anticipated results include risks and uncertainties such as: risks relating to estimates of reserves and recoveries; production and operating cost assumptions; development risks and costs; the risk of commodity price fluctuations; political and regulatory risks; and other risks and uncertainties as disclosed under the heading Risk Factors in the Prospectus and elsewhere in the Groups documents filed from time-to-time with the London Stock Exchange and other regulatory authorities. Further, any forwardlooking statement is made only as of a certain date and the Company undertakes no obligation to update any forward-looking statement or statements to reflect events or circumstances after the date on which such statement is made or reflect the occurrence of unanticipated events, except as may be required by applicable securities laws. New factors emerge from time to time, and it is not possible for management of the Company to predict all of these factors and to assess in advance the impact of each such factor on the Companys business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statement.
Head Office and Directors Business Address: 28-30 The Parade, St Helier, Jersey, JE1 1BG, Channel Islands Tel +44 1534 873000 Fax +44 1534 873344
Principal Canadian Office: 260 Petex Building, 600 - 6 Ave SWCalgary, Alberta, T2P 0S5 Canada Tel: +1 403 234 9974 Fax: +1 403 261 1941
Dushanbe
IRAN
Mosul
Erbil Suleimaniah
Kirkuk
Kabul
Islamabad
Block 8
RUSSIA
Baghdad
Sanjawi
OMAN
New Delhi
PAKISTAN
IRAQ
Basrah
Ras Al Khaimah
Dubai
U.A.E.
The Group was one of the first companies to execute a PSC in the Kurdistan Region of Iraq with the award of the Miran licence in October 2007. The licence covers approximately 1,015 square kilometres and contains the large Miran structure which provides the possibility of multiple reservoir targets. The Miran structure lies within 55 kilometres of the giant Kirkuk oilfield, with remaining reserves estimated to be in excess of 10 billion bbls, and 30 kilometres from the Taq Taq field, on which recent wells have tested 44-50 degree API oil at flow rates of between 15,000 and 37,000 bopd. Seismic acquisition commenced in the second quarter of 2008 and the first high-impact well is planned for the second half of this year.
Russia
The Zapadno Chumpasskoye licence is located in the West Siberian province of Khanty-Mansiysk. The approximately 200 square kilometres licence, which expires in September 2024, contains a field originally discovered in 1997. Twelve wells have been drilled in the licence, nine prior to the Groups acquisition in 2005. Since commencement of production on 14 May 2007, production has averaged 331 bopd for the period ended 31 December 2007 and has since climbed to approximately 800 bopd. The field is located close to well-developed infrastructure.
Pakistan
The Group was awarded a 60% participating interest in the onshore Sanjawi Block (number 3068-2) in Zone II (Baluchistan), Pakistan in November 2007. This exploration licence has a gross area of 2,258 square kilometres. A number of oil seeps occur to the south of the licence, which is encouraging for the development of an oil play.
Oman
Block 8 is located offshore Oman and contains the Bukha field, which commenced production of gas, condensate and LPG in 1994, and the West Bukha field. Wet gas is produced in the Bukha field through an unmanned platform and channelled onshore via a 34 kilometre pipeline. Revenue is generated from selling both the condensate and LPG from the Bukha field. The West Bukha field is located approximately 20 kilometres from the Bukha field and straddles the Iranian border. Development of this field is progressing, with first production anticipated in the third quarter of 2008.
Where we operate
S I C I LY
Tunis Siracusa (Syracuse)
KENYA D. R. C. TANZANIA
Block 7 Block 11 Dodoma BLOCK 1
MALI
Latham Kimbiji Kisangire Lukoliro
M A LTA
TUNISIA
Valetta
Area 2
BLOCK I
BLOCK II Heritage
BLOCK 3A Heritage
Area 7 Bamako
Tarbulus (Tripoli)
Malta
The Group entered L I Ba PSC with the Maltese into Y A Government for a 100% interest in Areas 2 and 7 in the south eastern offshore region of Malta in December 2007. The licences are situated approximately 80 kilometres (Block 2) and 140 kilometres (Block 7) from the south eastern Maltese coast in water depths of approximately 300 metres. Initial seismic interpretation, based on the current extensive data set of almost 3,500 kilometre acquired after 2000, has identified numerous potential prospects. The work programme will commence in 2008.
Mali
The Group is the operator with the right to earn a 75% working interest in each of Blocks 7 and 11 by financing 100% of the minimum work programme, which includes seismic and one well over the next two years. The two licences are located within the Gao Graben. The Graben has been delineated by various surveys since the early 1970s, including over 2,000 kilometres of 2D seismic and a comprehensive gravity and magnetic survey. Tilted fault-blocks have been identified along with the presence of some 4,000 metres of sediments in the geological section. Previous drilling in the Gao Graben has encountered oil and gas shows.
Tanzania
The Group announced in April 2008 that it had signed documentation to farm-in to four exploration licences in Tanzania. The licences, known as the Kimbiji, Latham, Kisangire and LukoliroAreas, cover approximately 25,000 square kilometres and are held under two production sharing agreements. In order to earn the working interests, the Group will fund all seismic and drilling costs of the required work programmes during the initial exploration phases. An oil seep and recent gas discovery in a neighbouring concession area indicates the presence in the region of a working hydrocarbon system that is generating both oil and gas.
DRC Blocks I and II, in the Albert Basin, adjacent to Ugandan Blocks 2 and 3A, are held under a single PSC, signed in July 2006, with the Government of DRC. The initial exploration term is five years, during which time seismic data will be acquired and exploration wells drilled. Work will commence following the receipt of a Presidential Decree. With the proximity of the DRC licences to the Uganda licences in the Albert Basin, there should be cost benefits from sharing certain operating, capital and infrastructure development costs, including the development and construction of a potential international export pipeline to Mombasa on the east coast of Kenya.
Uganda
Blocks 1 and 3A are located in the Albert Basin in Uganda, straddling the border with the DRC. The Group has maintained interests in Uganda since 1997. Eight exploration and appraisal wells have been drilled successfully in the basin since the beginning of 2006 and all encountered oil bearing reservoirs, with two of the wells testing over 12,000 bopd. The Groups Kingfisher-1 well in Block 3A spud in August 2006 and was drilled to a total depth of 3,195 metres, the limit of the rigs operational capability. Four intervals were tested successfully in the Kingfisher-1 well, resulting in an overall cumulative flow rate of 13,893 bopd. Multi-well drilling programmes are scheduled, commencing with the Kingfisher-2 well in Block 3A which spud at the end of April 2008. The Groups 50% working interest share of the mean risked resources from Blocks 3A and 1 in Uganda is estimated at 462 MMboe (gross 923 MMboe).
Highlights
The last 15 months have been outstanding for the Group with successful exploration in Uganda and the listing on the London Stock Exchange. 2008 should be a pivotal year for the Group. The Company has the resources and team to achieve strong growth in the size and value of its energy assets.
Operational Kingfisher-1 well in Block 3A in Uganda tested at 13,893 bopd from four intervals First production from the Zapadno Chumpasskoye field in Russia Miran Block Production Sharing Contract awarded in the Kurdistan Region of Iraq Expanded portfolio of significant licence awards and farm-ins in Mali, Malta, Pakistan and Tanzania in the last six months 110% increase in annual production from continuing operations to 129,900 barrels of oil Total reserves and resources increased to 626 MMboe Financial Primary listing on the Main Market of the London Stock Exchange completed on 31 March 2008 Over $350 million of funds raised in 2007; $165 million by way of a convertible bond issue and $186 million from the issue of shares Strong balance sheet with cash of $230 million at 31 December 2007
2007 was a year of substantial success for the Group both operationally and financially. Our accomplishments are a result of our consistent focus on the swift appraisal and timely execution of key opportunities.
Chairmans Statement
Social Responsibility
Progress
In many of our activity areas we are committed to implementing a wide range of community projects, including public health, education, environmental awareness, public facility and community relations based programmes. In these endeavours, our involvement is not simply limited to providing funds. We actively work with communities to build trust and ensure that community needs are carefully considered when the projects are planned and implemented.
Although we have been active in Uganda since 1997, our achievements over the last two years have been particularly significant. Our persistence in the face of challenging circumstances is a point of considerable corporate pride that underscores our drive to realise value from the large Uganda land base that we hold. With multi-well drilling programmes planned for Blocks 3A and 1, which commenced with the spud of the Kingfisher-2 well in April 2008, we have lots to look forward to in Uganda over the next few years. In other areas of activity we continued to enjoy success on all fronts. We commenced production in Russia were finally awarded a licence in the Kurdistan Region of Iraq, and have completed farm-ins and secured licences in several new territories. We now have a portfolio of assets with significant scope for success. This, combined with our ability to recruit and
Tribute
For all of our pride in our success, we are mindful of and deeply saddened by the tragic loss of life of Carl Nefdt, the team leader of IMC Geophysical International Limiteds seismic crew in Uganda, on 3 August 2007. Carls memory will be honoured permanently as we are building a school in Uganda that will be dedicated in Carl Nefdts memory and named Carl Nefdt Memorial School.
Board of Directors
I am pleased to welcome General Sir Michael Wilkes KCB, CBE, to the Group. Sir Michael is an outstanding addition to the board as he brings considerable corporate experience, an extensive network of contacts and strong corporate governance experience.
Outlook
Looking forward, as we initiate high-impact drilling programmes in Uganda and the Kurdistan Region of Iraq, our solid working capital position ensures that we can reasonably expect to create additional shareholder value without any near-term expectation of dilution. We believe 2008 will be another exciting year for the Company as we drive our business forward at an accelerating rate and realise the benefits of an increased level of market interest in our activities. Michael J. Hibberd Chairman
Milestones
April 2008: Commencement of drilling of the Kingfisher-2 well in Uganda April 2008: Signed documentation to farm in to four exploration licences March 2008: Dealings commence on the London Stock Exchange February 2008: Completion of Mali documentation for two licences and announcement of Corporate Reorganisation December 2007: Awarded production sharing contract in Malta November 2007: Closing of Equity Financing Raising Cdn $181.5 million October 2007: Awarded production sharing contract in the Kurdistan Region of Iraq May 2007: Commences production and development approval at Zapadno Chumpasskoye Field February 2007: Reports final test results of 13,893 bopd for the Kingfisher-I well in Uganda January 2007: Placement of US$165 million convertible bonds.
The Groups strategy is to generate growth in shareholder value through the development, production and acquisition of a portfolio of oil and gas interests, leveraging off a highly effective network of influential industry, political and institutional relationships.
Africa
The Albert Basin, which straddles the border of Uganda and the Democratic Republic of Congo (DRC), remains the centrepiece of the Groups portfolio. We believe it is a world-class resource with multi-billion barrel reserve potential in land positions that cover in excess of 12,000 square kilometres. In Uganda, the Kingfisher-1 exploration well, completed in March 2007, tested 13,893 bopd from secondary zones. The oil is good quality, light (between 30 and 32 API) and sweet with a low gas-oil ratio and some associated wax. Following completion of a 3D seismic programme over the Kingfisher and Pelican
structures, a more powerful rig, capable of drilling to the primary target, was contracted and commenced drilling the Kingfisher-2 well in April 2008. The deeper target has the potential to add significantly to our asset base. New seismic data acquired in Block 1 during 2007 has led to identification of a number of structures and drilling is expected to commence on these prospects during 2008. Additionally, we have plans to commence drilling on the offshore Pelican structure in Block 3A during 2009. On the DRC side of the Albert Basin, a seismic programme will be undertaken in two blocks on receipt of a Presidential Decree ratifying a Production Sharing Agreement between the Group, Tullow and the Government of the DRC. New initiatives undertaken in 2007 demonstrate our intention to explore new regions with considerable hydrocarbon upside potential. In November we committed to a work programme to acquire a 75% working interest in two licences in Mali, Northwest Africa, which is an under-explored region where seismic data indicates the possibility of potential hydrocarbon-bearing structures. Most recently, in April 2008, we committed to a work programme to acquire interests in four licences in Tanzania, with potential to confirm the presence of a working hydrocarbon system generating oil and gas.
geological and geophysical surveys began in 2006. In October 2007 the Group signed a Production Sharing Contract over the Miran Block in the southern part of the Kurdistan Region of Iraq, which is close to the massive Kirkuk oil field. A 270 kilometre 2D seismic programme has commenced and we plan to begin a high-impact drilling programme later in 2008. Our current estimate is that the Miran structure, with multi-reservoir targets, could contain over 3 billion barrels of oil in place, based on the size of the structure and evaluations from neighbouring fields. The Group will also operate as a 50/50 partner with the Kurdistan Regional Government to construct a 20,000 bpd refinery near the licence area. Kurdistan is considered to be prospective, with less than 10% of the region explored. With a relatively stable, and increasingly secure operating environment, we believe our existing holdings constitute an attractive opportunity for low-cost development of a major resource. In Oman, the Group has a 10% working interest in Block 8, an offshore licence that includes Bukha, a producing gas-condensate field, and West Bukha, a light oil/gas-condensate field, for which commercial production development is proceeding well. An appraisal/development well drilled in West Bukha in late 2006 proved highly successful, testing at flow rates of about 12,750 bopd of light crude oil and 26 MMscf/d of natural gas. Development of the field continued in 2007, with construction of a production platform and pipeline to deliver the petroleum liquids to market via the existing Bukha field system. Commercial production is expected to begin in the third quarter of 2008.
Russia
In Russia, the Group remains active in Western Siberia. This region of Russia accounts for more than 60% of the countrys oil production and provides significant cash-flow opportunities. The Group holds a 95% equity interest in the Zapadno Chumpasskoye licence, which contains the Zapadno Chumpasskoye field. Proved and probable reserves are estimated at 60.5 million barrels net to the Group. Production from the field is projected to reach approximately 16,000 bopd by 2014. A multi-well drilling programme began in April 2007 and pilot production facilities were commissioned in May. At year-end, production was averaging 342 bopd of high-quality crude oil and has since risen to over 800 bopd at the beginning of April 2008.
Mediterranean
In December we executed a Production Sharing Agreement with the Government of Malta for two offshore licences in what we believe is a significant high potential region, which may contain structures analogous to very large developed fields in Libya and Tunisia As CEO, I can assure our shareholders that management is focused on ensuring that all of the Groups strategies and activities are directed to our primary objective of continually increasing shareholder value. Measuring our progress to this goal is reflected in the value and liquidity of our shares, so considerable time was spent examining the most suitable markets for listing.
Middle East
In Iraq, the Group has maintained a presence in the Kurdistan Region of Iraq since 2005. Field
The Group is the operator and holds 50% interests in two licences in the Albert Basin of the Western Rift Valley of Uganda known as Block 1 and Block 3A. Recent exploration activity has focused on the northern part of Block 3A, on the eastern shores of Lake Albert, which straddles the border of Uganda and the Democratic Republic of Congo. Chief Executives Review continued
Our conclusion was that a primary listing on the Main Market of the London Stock Exchange was in the best interests of the Group and our investors. We expect the initiatives we have undertaken will enhance our profile and status amongst European investors and within the oil and gas sector generally. We also expect increased trading liquidity and access to an international market with a broad, relevant peer group and considerable research expertise. Over 99.9% of shareholders voted in favour of the scheme of arrangement and the listing, indicating the overwhelming support for our recommendation. As we move forward with capital programmes on a number of fronts, it is worth noting that we have a strong balance sheet and a demonstrated ability to secure funds to finance operations. In 2007 we raised over $350 million through bond and equity issues, therefore all of our planned programs are proceeding from a position of considerable financial strength.
With our highly experienced management team, our dedicated and professional employees, contractors and advisers, our financial strength, operational expertise and diverse portfolio of opportunities, we believe the Group is well positioned to sustain strong growth in the value of its assets through 2008 and beyond. Thank you for your continuing support. Tony Buckingham Chief Executive Officer
Strategy
The Group aims to continue to generate growth in shareholder value by focusing on highimpact international plays that provide multiple targets with the potential to discover substantial hydrocarbon reserves. The Groups growth strategy is to acquire and invest in, exploration and early development opportunities throughout the world, with a particular emphasis on its core areas of Africa, the Middle East and Russia. To be successful, the Group has developed a highly effective network of influential industry, political and institutional relationships. These enable the Group to gain access to a wide variety of new oil and gas business opportunities.
Q&A
Our commitment to transparency and accountability begins at the top. In the following Q&A, Tony Buckingham takes the opportunity to answer questions that have been asked frequently by shareholders.
Q: What for you were the highlights of 2007? 2007 was a year of substantial success for the Group both operationally and financially. The principal operational highlights included the Kingfisher-1 well in Block 3A, Uganda which tested at 13,893 bopd and the award of the Miran licence in the Kurdistan Region of Iraq. Administratively, the focal point was our corporate reorganisation that resulted in the Ordinary Shares of a newly incorporated company, Heritage Oil Limited, being listed on the Main Market of the London Stock Exchange (LSE). This was completed on 31 March 2008. Q: Why did you decide on a London listing? We believed that the reorganisation and listing on the LSE were in the best interests of the Group. A number of significant advantages were indentified, which include: Investors on the LSE typically give high values for exploration companies in our peer group, especially those with high-impact drilling programmes African exploration companies listed on the LSE typically trade at a much higher enterprise value to potential resource barrel ratio than on the TSX
The Company can be more readily peer group reviewed on the LSE Increased research coverage and international awareness. On average, companies listed on the LSE are covered by more analysts than those listed on the TSX. We are already seeing this benefit as five analysts currently cover us, compared to one in 2007 We expect to see increased liquidity on the LSE compared to the TSX. What are the key components of your strategy? We aim to continue to generate growth in shareholder value by focusing on high impact international plays that provide multiple targets with the potential to discover substantial hydrocarbon reserves. The Groups growth strategy is to acquire and invest in exploration and early development opportunities throughout the world, with a particular emphasis on its core areas of Africa, the Middle East and Russia, using our highly effective network of influential industry, political and institutional relationships.
What are the Companys strengths? The Companys competitive strengths include: Our ability to secure a portfolio of highimpact international plays Experienced and responsive management and technical teams with a proven track record of finding valuable oil discoveries Our significant position in the Albert Basin of Uganda Our diversified portfolio of assets Our demonstrated success as a first-mover in acquiring assets in territories such as Uganda and the Kurdistan Region of Iraq Our proven track record of creating value through asset sales.
What do you believe are the main near-term priorities for the Company? In the near-term, the main priorities for the Group are to continue to drive the business forward by evaluating the prospects in Blocks 3A and 1 in the Albert Basin, Uganda, so that we can exceed the reserves threshold required to justify investment in a development programme and an export pipeline. Additionally, we need to complete the high-impact exploration campaign in the Kurdistan Region of Iraq, as well as commence operations in exciting new territories where we have been awarded or farmed-in to licences. What do you perceive as the major risks to the Company? There are a number of risks which can affect any international exploration, development and production company, hence effective risk management is critical to continuing to achieve our goals. The Group mitigates its risks by maintaining a portfolio of assets in a variety of stages of development in different countries. The Company continually assesses any risks to ensure that sufficient policies and procedures are in place. The key risks affecting the business were summarised in the Directors Report.
How would you describe the culture at Heritage? We have a highly responsive management system which encourages all staff to participate and build the Company. All key members of staff are motivated to continue to generate shareholder value. We have an enviable record of attracting and retaining experienced employees. Finally, do you have a message for shareholders? We have made tremendous progress since I was appointed CEO in October 2006. Due to the strong support of our shareholders, the dedication of our employees, our welldefined strategy and our proven ability to discover valuable oil and gas reservoirs, we are convinced that we can realise our aspirations. Unforeseen events excluded, we believe that the Group will continue to be a fast growing exploration and production company.
Recent oil discoveries in the Albert Basin have made it one of the most significant new basins to be discovered onshore in Sub-Saharan Africa in decades. Eight exploration and appraisal wells have been drilled successfully in the basin since the beginning of 2006, and all have encountered oil bearing reservoirs, with two of the wells testing at over 12,000 bopd. Operations Review
Uganda
In 1997 the Group became the first oil and gas company to actively explore in Uganda in almost 60 years, with the award of a licence covering the original Block 3 in the Albert Basin of Western Uganda. The Albert Basin is located in the western arm of the East African Rift Valley, straddling the border with the Democratic Republic of Congo (DRC). The Group farmed out 50% of the licence to Energy Africa (now owned by Tullow) in 2001. The original Block 3A was re-configured and re-licenced in 2004 for a term of six years. Block 3A now covers an area of 2,024 square kilometres. Block 1, which is located to the north, has an area of 3,659 square kilometres and was also awarded in 2004. Recent oil discoveries in the Albert Basin have made it one of the most significant new basins to be discovered onshore in Sub-Saharan Africa in decades. Eight exploration and appraisal wells have been drilled successfully in the basin since the beginning of 2006, and all have encountered oil bearing reservoirs, with two of the wells testing at over 12,000 bopd. The Kingfisher-1 well, the Groups first well on Block 3A, was drilled between August 2006 and March 2007 to a depth of 3,195 metres. The drilling rig did not have the operational capacity to reach the deeper primary target. The well tested successfully over four intervals in secondary targets, for an overall cumulative flow rate of 13,893 bopd of light, sweet crude oil. The oil is between 30o and 32o API, with a low gas-oil ratio and some associated wax. The sandstone reservoirs, totalling a thickness of 54 metres, exhibited very high permeabilities of up to 3,000 milliDarcies. A rig capable of drilling to the primary target has been contracted and commenced drilling the Kingfisher-2 well in April 2008. This well will further appraise the existing secondary targets and explore the deeper zones. Management believes that the deeper target has the potential to transform the Company, with an independently evaluated gross un-risked P10 resource estimate of approximately 700 million barrels. A 325 square kilometres 3D seismic survey was carried out on Block 3A over the Kingfisher and neighbouring Pelican structures during the summer of 2007. Initial interpretation confirms that the Kingfisher structure has an aerial extent of approximately 45 square kilometres. The data also identifies a number of appraisal/ development targets within the Kingfisher structure which will require planning for a multiwell drilling programme from land locations and on Lake Albert. Drilling of the Pelican prospect and work on other prospects in the lake identified by recent seismic programmes is planned to commence in the first quarter of 2009. The Group also holds a 50% operating interest (in partnership with Tullow) in Block 1, at the northern end of Lake Albert, covering an area of 3,659 square kilometres. A 2D seismic survey carried out in 2007 identified a number of relatively shallow structures with amplitude anomalies. Oil is known to have migrated into Block 1, as evidenced by the active oil seep at Paraa, within the block. This oil seep, together with the presence of amplitude anomalies, supports the potential presence of hydrocarbons within the block.
Licence
Date Awarded
Heritage Equity
Partners
Operator
Block 1 Block 3A
3,659 2,024
50% 50%
Tullow Tullow
Heritage Heritage
An exploration drilling programme on Block 1 is planned to commence in or after the summer of 2008, concentrating on shallower targets in the southern part of the block.
SUDAN
LEGEND
Permits Albert Graben Heritage PSA Oil Wells Country Border Prospect Oil Field
RPS Energy has estimated that the gross risked recoverable contingent and prospective resources in Blocks 3A and 1 are as follows:
Gross Risked Recoverable Resources (MMstb)
BLOCK 5 Neptune
BLOCK 1 Heritage
p90 280
p50 793
p10 1,731
Mean 923
D. R. C.
BLOCK 2 Tullow
The Group holds a 50% working interest, however, the Government of Uganda has a back-in right which could, if exercised, reduce the Groups working interest to 42.5%
BLOCK 3A Heritage
UGANDA
LEGEND
Blue Mountains
+Licence Boundary +
BLOCK 4A Open 0
Heritage PSA International Border
D. R. C +
50km
Lake Albert
Waraga-1 Ngassa-1 Mputa-2
D. UG R. C AN ON DA GO
+
BLOCK 4B Dominion
Pelican Prospect
+
B A M S E
Nzizi-1 Nzizi-2
E N
Kingfisher-1
+
N
+
T
Block 3A
Turaco -3
rt be n Al abe Gr
RWANDA
Diagramatic representation of Kingfisher drilling
Rwenzori Mountains
UGANDA
+
+ Block 3C Open
As an early entrant in exploration of the Kurdistan Region of Iraq, the Group is strongly positioned to benefit from development of this significant hydrocarbon-prone region the Miran Block covers an area of 1,015 square kilometres, including a potentially very large untested anticline.
Licence
Date awarded
Heritage Equity
Miran Block
1,015
October 2007
100%
Satellite image of Miran Structure
4500E
4600E
IRAN
Demir Dagh
MIRAN
Taq Taq
3600N
3600N
Kirkuk
Suleimaniah
I R A Q I K U R D I S TA N
Jambur Kor Mor
3500N 3500N
0 50km
Pulkhana
LEGEND
Gilabat 1 Injana 5 Chia Surkh 2 Qamar
Oil Fields Gas Fields Gas Condensate Field Prospect
IRAQ
4400E 4500E
Heritage PSA
4600E
From May 2007 to 31 December 2007, production averaged 331 bopd and has since increased, as a result of bringing further wells into production, to a current level of approximately 800 bopd.
Russia
The Western Siberia Region of Russia, which accounts for approximately 60% of Russias total crude oil production, is an example of the Groups strategy of acquiring assets in both highly-prospective and established hydrocarbon-prone parts of the world. Since 2005, the Group has held a 95% equity interest in ChumpassNefteDobycha Limited, a Russian company whose sole asset is the Zapadno Chumpasskoye Licence. This licence, which expires in 2024, is in the hydrocarbon-rich West Siberian province of Khanty-Mansiysk, approximately 100 kilometres from the city of Nizhnevartovsk and in the area of the regions prolific Samotlor oil field, which makes it accessible to existing development production infrastructure and facilities. The licence covers an area of about 200 square kilometres and contains the Zapadno Chumpasskoye field discovered in 1997. A total of nine wells were drilled on the licence prior to 2005, and the Group has drilled a further three wells. The producing reservoir is a Late Jurassic sandstone at a depth of approximately 2,700 metres, and is the same producing horizon present in a number of neighbouring fields. In 2006 the Group acquired 2D seismic data covering an area of 200 kilometres, began constructing pilot production facilities and reentered the existing well #226. Three additional wells were drilled, production facilities were commissioned and production commenced in May 2007. From May 2007 to 31 December 2007, production averaged 331 bopd and has since increased, as a result of bringing further wells into production, to a current level of approximately 800 bopd. The crude is light and sweet, 42o API crude oil, with moderate gas-tooil ratios. RPS Energy has independently estimated that the Zapadno Chumpasskoye field contains proved and probable reserves of 60.4 million barrels of oil net to the Group. Net Present Value, discounted at 10%, is US$234.9 million net to the Group. Large-scale commercial development of this field is planned, with production projected to reach some 16,000 bopd by 2014. Total gross development costs of the field are estimated at over $400 million and are expected to be incurred up to 2015, with peak expenditures expected in 2009 and 2010.
Net working Net Net interest entitlement present reserves interest value
MMboe MMboe $Millions
23.1
20.7
Licence
Date Awarded
Heritage Equity
Operator
Zapadno Chumpasskoye
95%
Heritage
60.4
The Groups Russian expansion strategy is to acquire development licences at attractive prices when the potential is seen to generate early cash flow and production. In order to pursue this strategy, the Group established a jointly owned company with TISE Holding Company, TISE-Heritage Neftegas, in 2007. The other shareholders of TISE Holding Company include Concord, Zarubejneft, Zarubejneftegas (a wholly-owned Gazprom subsidiary), Technopromexport and Zarubejstroymontaj. TISE-Heritage Neftegas functions to appraise and target for acquisition oil and gas opportunities in Russia and internationally.
WESTERN
ZAPADNO CHUMPASSKOYE LICENCE
S I B E R IA
4 226 2 3
10km
LEGEND
Heritage Licence Fields Oil Pipelines Gas Pipelines Exploration & Appraisal Well
Development of the West Bukha field commenced in 2007 and is ongoing. Drilling of the West Bukha 3 well commenced in April 2008. It is planned to re-enter the West Bukha 2 well and complete it as a producer First commercial production is anticipated in the third quarter of 2008.
Oman
The Group acquired a 10% interest in Block 8 offshore of Oman in 1996. Other joint venture partners are RAK Petroleum (the operator) with a 40% interest and LG International with a 50% interest. The Block 8 licence area covers 423 square kilometres and contains the Bukha gascondensate field, which is located 40 kilometres offshore in the Straits of Hormuz in around 90 metres of water, and the West Bukha discovery, which is approximately 20 kilometres away to the north west. The Group has net entitlement interest proved and probable reserves of 1.7 million barrels of oil equivalent liquids and gas in Oman, independently certified by RPS Energy. The Bukha field has been producing gas and condensate from two wells since 1994. Wet gas is produced through an unmanned platform and channelled via a 34 kilometre pipeline to an onshore processing plant in Ras Al Khaimah, operated by the state gas company, Rakgas. Revenue is generated from selling the condensate and LPG. Overall, gross production of liquids from the Bukha field declined by 14% to 1,585 bopd in 2007, which is in line with expectations for this mature asset. Gas condensate is stored, for subsequent lifting when logistically economic quantities are accumulated, and sold to a third party under an annual contract. LPG is sold to Rakgas and residual gas is sold by Rakgas to local cement factories. The Company is not paid directly for gas production from the Bukha field, but will receive revenue from gas production from the West Bukha field. The West Bukha discovery in Block 8 represents a significant potential future field development. The field is partially located in Block 8 in Oman, but a significant area of the structure is in neighbouring Iranian waters, where it is known as Hengam. In May 2006, the West Bukha-2 appraisal/ development well spud, targeting Cretaceousage carbonates (the same formations as at Bukha) in a large, gas-condensate accumulation. The well test produced a combined flow-rate from zones tested (Ilam/Mishrif/Mauddud and Thamama) of approximately 12,750 bopd and 26 MMscf/d. The oil was light (approximately 42 API). Development of the West Bukha field commenced in 2007 and is ongoing. Drilling of the West Bukha 3 well commenced in April 2008. It is also planned to re-enter the West Bukha 2 well and complete it as a producer. Facilities design work has been completed. A platform and pipeline are to be installed to deliver petroleum fluids to markets in Ras Al Khaimah via the existing Bukha system. First commercial production is anticipated in the third quarter of 2008.
Licence
Date Awarded
Heritage Equity
Operator
Block 8
423
April 1985
10%
1.7
RPS Energy has estimated net working interest reserves, net entitlement interest and net present value to the Company of West Bukha and Bukha as at 31 December 2007, using money of the day prices, discounted at 10%, as follows:
Net working Net Net interest entitlement present reserves interest value
MMboe MMboe $Millions
Salakh
IRAN
Gavarzin Qeshm Island
Straits of Hormuz
BLOCK 8
West Bukha Field Bukha Field
Mubarek Field
OMAN
Ras Al Khaimah
LEGEND
Heritage PSA Oil Fields Gas Fields
U.A.E
Dubai
Gas Condensate Field Oil & Gas Well Pipelines Processing Plant International Border
100km
OMAN
Annual Report and Accounts 2007 Heritage Oil Ltd 17
The Group holds a 39.5% non-operating interest in two blocks in the Albert Basin Blocks I and II on the DRC side of the border. These blocks cover more than 6,000 square kilometres, including the entire western or DRC side of Lake Albert The combination of licences in both the DRC and Uganda gives the Group a very strong acreage position in a highly prospective sedimentary basin. Operations Review continued
BLOCK 1 Heritage
BLOCK 2 Tullow
Ngassa-1 Mputa-2 Waraga-1 Mputa-1 Mputa-4 Mputa-3 Nzizi-1 Nzizi-2
Kingfisher-1
LEGEND
Permits Heritage PSA Albert Graben Country Border Oil Well
UGANDA
BLOCK V Dominion
BLOCK 4B Dominion
Licence
Date Awarded
Heritage Equity
Partners
Block I Block II
3,825 2,634
Signed July 2006 (awaiting presidential decree) Signed July 2006 (awaiting presidential decree)
39.5% 39.5%
The licences cover almost 18,000 square kilometres Primary targets are Lower Eocene and Cretaceous carbonates that are already recognised as major hydrocarbon producing plays in the central part of the Mediterranean.
Malta
Malta is a small island nation in the Mediterranean Sea with a population of 400,000. It is situated to the south of Sicily, north of Libya and east of Tunisia and is comprised of an archipelago of seven small islands encompassing 316 square kilometres in area. It is a member of the European Union and stable politically. On 14 December 2007, the Group entered into a PSC with the Maltese Government for a 100% interest in Areas 2 and 7 in the south eastern offshore region of Malta. The licences cover almost 18,000 square kilometres and are situated approximately 80 kilometres (in the case of Area 2) and 140 kilometres (in the case of Area 7) from the south eastern Maltese coast in water depths of approximately 300 metres. Initial seismic interpretation, based on the current extensive data set of almost 3,500 kilometres acquired after 2000, indicates the presence of a variety of potential prospects. Primary targets are Lower Eocene and Cretaceous carbonates that are already recognised as major hydrocarbon producing plays in the central part of the Mediterranean. The licences are under-explored. Only one well has been drilled in Area 2 (Medina Bank 1, 1980). The well was drilled to a depth of 1,225 metres and failed to reach the target horizons, estimated to be at 1,500 to 4,500 metres, but did encounter gas shows in porous, fractured carbonates. The work programme has commenced with the re-interpretation of existing seismic, which will be followed by the acquisition of a further 2D seismic programme and a drilling programme during the next three years.
S I C I LY
Siracusa (Syracuse)
Tunis
MS-B1 Valetta 1 Lampuko 1 Gozo 1 Madonna Taz-Zejt 1ST1 Naxxar 2 Alexia 1 Alexia 2 MS-A1
M A LTA TUNISIA
Valetta
Malta 1
Aqualta 1
Medina Bank 1
Area 2 Area 7
Sfax
Tama 1
LEGEND
Block boundary Area of seismic coverage Exploration Well Oil & Gas shows International Border
0 0 25 50 100km 50m
A-001A-NC087
Tarbulus (Tripoli)
L I B YA
Licence
Date awarded
Heritage Equity
Area 2 Area 7
9,190 8,778
100% 100%
The two licences are located in the east of the country within the Gao Graben, a Mesozoic basin that management considers geologically similar to other Mesozoic interior-rift basins within North Africa, such as the Muglad Basin of Sudan, the Doba Basin of Chad, and Tertiary basins such as the Albert Basin of Uganda.
Mali
Mali is a large (1.24 million square kilometres) land-locked country in North-West Africa, with a population of 12 million. The terrain is mostly flat to rolling sand-covered northern plains, with rugged mountainous terrain in the north and east and savanna in the south. Mali is among the poorest countries in the world, with 65% of its land area desert or semi-desert and with economic activity largely confined to the riverine area irrigated by the Niger. The Group is the operator and has the right to earn a 75% working interest in each of Blocks 7 and 11 by financing 100% of the minimum work programme over the next two years, estimated to be a minimum of $14 and $15 million. The blocks cover a gross area of over 72,000 square kilometres and are located onshore in the Gao Basin. The Groups partner is Mali Oil Developments SARL, a wholly-owned subsidiary of Centric Energy Corporation. The two licences are located in the east of the country within the Gao Graben, a Mesozoic basin that management considers geologically similar to other Mesozoic interior-rift basins within North Africa, such as the Muglad Basin of Sudan, the Doba Basin of Chad, and Tertiary basins such as the Albert Basin of Uganda. The Graben has been delineated by various surveys conducted since the early 1970s, including over 2,000 kilometres of 2D seismic and a comprehensive gravity and magnetic survey. This data shows the presence of tilted fault-blocks, and indicates the presence of approximately 4,000 metres of sediments in the geological section. Previous drilling in the Gao Graben has encountered oil and gas shows. The Tin Bergoui water well, which lies approximately 30 kilometres to the west of Block 11, was drilled to a depth of 350 metres, encountered oil and gas shows in a number of horizons, indicating the potential for a working hydrocarbon system. The Group will proceed with a comprehensive programme of seismic acquisition and reprocessing to support selection of initial drilling locations.
14 24
12
10
20
6 24
LEGEND
Heritage PSA
22
MALI
Atouila-1
A L G E R I A
22
20
0 0 100 50 200km 100m
20
Yarba-1
Block 7
Kidal
In Tamat-1 18
18
Timbuktu
16
Tahabanat-1
M A U R I TA N I A
Block 11
Tin Bergoui-1
Gao
16 Ansongo-1
14 SENEGAL
Kayes
N I G E R
14
12
Bamako Sikasso
BURKINA FASO
Ouagadougou
NIGERIA BENIN
2 4
12
G U I N E A
14 10 12 10 8
TO
6 IVORY COAST
GHANA
4 2 0
10
Licence
Date Awarded
Heritage Equity
Partners
Operator
Block 7 Block 11
39,804 32,810
75% 75%
Heritage Heritage
The block is considered highly prospective due to the presence of oil seeps to the south of the licence. The block is dominated by a series of broad east-west trending surface features including the Dabbar and Warkan Shah anticlines.
Pakistan
The Indus Valley civilisation, one of the oldest in the world and dating back at least 5,000 years, spread over much of what is presently Pakistan. During the second millennium B.C., remnants of this culture fused with the migrating IndoAryan peoples. The area underwent successive invasions in subsequent centuries from the Persians, Greeks, Scythians, Arabs (who brought Islam), Afghans, and Turks. Pakistan today covers some 800,000 square kilometres with a population of approximately 168 million. Pakistan has proved oil and gas reserves reported to be in the region of 289 million barrels and 760 billion cubic metres, respectively. The Group was awarded a 60% participating interest in the Sanjawi Block (number 3068-2) in Zone II (Baluchistan) in November 2007, and has been appointed as operator. This onshore exploration licence covers a gross area of 2,258 square kilometres and encompasses a variety of terrains ranging from relatively flat desert and cultivated valley floors to rugged hill country. The block is considered highly prospective due to the presence of oil seeps to the south of the licence. The block is dominated by a series of broad east-west trending surface features including the Dabbar and Warkan Shah anticlines. These are large structures, the Dabbar anticline being some 300 square kilometres in area. These features will be examined as potential targets for drilling.
72
TA J I K I S TA N
LEGEND
Heritage PSA Oil Fields Gas Fields Gas Condensate Field International Border Gas pipeline Oil pipeline Refined product pipeline
CHINA
A F G H A N I S TA N
Kabul Peshawar Islamabad
32
0 0 100 50 200km 100m
Khattan
PA K I S TA N
Savi Ragha-1 Dhodak Sanjawi
32
Lahore
Quetta
Zarghuri South-1
Khattan
Ind us
New Delhi
IRAN
INDIA
24
Licence
Date Awarded
Karachi
Heritage Equity
Partners
Operator
24
Sanjawi Permit
2,412
November 2007
60%
Heritage
The Group has four licences with a gross area of over 25,000 square kilometres. The Company is very pleased to have secured these land positions which have been identified as having highly desirable exploration potential.
Tanzania
Tanzania is a large (0.9 million square kilometres) country in East Africa stretching over 1,000 kilometres from the Indian Ocean to the Western Rift Valley, with a population of approximately 40 million. In April 2008, the Group signed documentation to farm-in to four exploration licences (Latham, Kimbiji, Kisangire and Lukuliro Areas) in Tanzania. The Kimbiji and Latham Areas cover approximately 9,300 square kilometres and are held under one PSA, whilst the Kisangire and Lukuliro Areas cover approximately 16,100 square kilometres and are held under another PSA. The Latham and Kimbiji Areas, covering 5,056 square kilometres and 4,298 square kilometres respectively, encompass onshore (1,881 square kilometres), near shore (2,981 square kilometres), and deep water (4,491 square kilometres) areas. The PSA was awarded to Petrodel Resources Ltd (Petrodel) by the Tanzanian Government in September 2006 with exploration periods of four years, followed by extensions of four years and three years respectively, with the right to a development licence with a term of 25 years. Under the terms of the farm-in agreement with Petrodel, the Group has the right to earn a 70% working interest in the Kimbiji Area, and a 29.9% working interest in the Latham Area, by funding all seismic costs of the required work programmes on both blocks, comprising the acquisition of both 2D and 3D seismic data, and the drilling of two exploration wells within the Kimbiji Area. The Group will be appointed operator upon drilling the second exploration well in the Kimbiji Area. The onshore Kisangire and Lukuliro licences were originally awarded to Dominion Oil & Gas Limited (Dominion) in May 2005, with an exploration period of four years, followed by one extension of four years, a further extension of three years and the right to a development licence with a term of 25 years. Under the terms of the farm-in agreement with Dominion, the Group has the right to initially earn a working interest of 55% in both the Kisangire and Lukuliro licences. In order to earn the working interests, the Group will fund all costs to acquire a minimum of 150 kilometres of 2D seismic data and the costs of the first commitment well. The Group also has an option to earn an additional working interest of 15% thereby increasing its participating interest to 70% by funding 87.5% of the costs of a second well. The minimum exploration expenditure required under the PSA during the first exploration period, which includes seismic acquisition and the drilling of two wells, is US$10 million. All four licences are close to the recent Mkuranga-1 gas discovery which was drilled in 2007, and reportedly flowed gas at a rate of 20 mmcf/d from an Upper Cretaceous reservoir. This well is located approximately 25 kilometres to the east of the Kisangire Area. The large Songo Songo producing gas field is located to the south-east of the Areas. The Wingayongo oil seep is present in the Kisangire Area, indicating the presence in the region of a working hydrocarbon system that is generating both oil and gas. Previous seismic data acquired in the Areas, combined with encouraging hydrocarbon shows in wells drilled in the licences, identifies the Areas as a highly desirable exploration province. The farm-ins are expected to close in the second quarter of 2008, subject to certain conditions precedent, including customary governmental approvals, which are expected to be met.
Licence
Date Awarded
Heritage Equity
Partners
Operator
As we move forward with capital programmes on a number of fronts, it is worth noting that we have a strong balance sheet and a demonstrated ability to secure funds to finance operations. In 2007 we raised over $350 million through bond and equity issues, therefore all of our planned programmes are proceeding from a position of considerable financial strength. Financial Review
Creating Value
2006 2007 Change
Production Sales volume Average realised price Petroleum and natural gas revenue Drilling services revenue Loss from continuing operations Income from discontinued operations Net loss Net loss per share basic and diluted Net cash outflow from operating activities of continuing operations Total cash capital expenditures continuing operations Year end cash balance Net (debt) cash Gearing ratio (net debt divided by total equity)
Selected operational and financial data
387 214 50.36 3.9 2.9 (40.8) 12.4 (28.4) (0.13) (12.7) 28.5 46.9 (57.2) 57.0
356 333 30.53 3.7 (83.2) (83.2) (0.37) (2.5) 75.3 230.1 13.7
(8%) 56% (39%) (5%) (104%) (193%) (185%) 80% 164% 391%
Pursuant to a reorganisation, Heritage Oil Limited became the parent company of the Group on 31 March 2008. Prior to that time, the parent company of the Heritage Group was Heritage Oil Corporation. Accordingly, for this years annual report, the financial statements presented in this report and the related financial information are derived from Heritage Oil Corporation.
Average daily production declined by 8% from 387 bopd to 356 bopd. This decline resulted from the sale of the Kouakouala field working interest in the Congo on 12 December 2006, offset by first production from the Zapadno Chumpasskoye field in Russia in May 2007.
Revenue
Petroleum and natural gas revenue decreased by 5% to $3.7 million, due to lower condensate sales from Oman, offset by revenue from Russian production. Condensate sales from the Bukha field in Oman decreased by 56% to $1.6 million, with condensate of 11,199 barrels held in inventory for sale in 2008 (2,844 barrels at 31 December 2006 for sale in 2007). First production from Russia commenced in May 2007 generating revenue of $1.7 million during the period ended 31 December 2007. The average realised price of $30.53 in 2007 was 39% lower than the previous year due to changes in product mix, with sales in Russia being sold to the domestic market. There were no third party drilling services revenues realised in 2007 compared with $2.9 million in 2006. Drill rig revenue is generated from the Groups 50% share of Eagle Drills sales to third parties. In 2006, Eagle Drill was a drilling contractor for the operator of Block 2 in Uganda.
options granted or approved in 2007. If share-based compensation expenses are excluded, net general and administrative expenses increased from $7.5 million in 2006 to $12.2 million in 2007. This increase resulted from the following factors: Growth of the Group. The Group has employed additional staff and appraised and undertaken operations in new territories; Increased travel expenses supporting higher levels of activity in the Groups core areas; and Expenses in 2007 relating to the corporate reorganisation and subsequent listing on the London Stock Exchange. In 2007, the Group capitalised $10.3 million (2006: $1.7 million) of general and administrative costs relating to exploration and development activities, including share-based compensation of $9 million (2006: $0.7 million). Depletion, depreciation and amortisation expenses increased by 36% to $1.9 million in 2007, principally due to depletion of the field in Russia and an increase in corporate assets subject to depreciation. The carrying value of the drilling rig was written down to its estimated fair value in 2007, resulting in a charge of $1.8 million. Exploration expenditures expensed in the period and not capitalised decreased by 11% from $6.1 million in 2006 to $5.4 million in 2007. Exploration expenditure in 2006 principally related to activities in the Kurdistan Region of Iraq ($3.6 million) and in Oman ($1.7 million). Exploration expenditures in 2007 related mainly
to activities in the Kurdistan Region of Iraq of $2.3 million and potential new ventures in Russia of $1.5 million. In December 2006, the Group disposed of its assets in Congo. The results of operations in Congo were therefore classified as discontinued operations. The gain on disposal of discontinued operations and earnings from discontinued operations amounted to $12.4 million in 2006. In 2007, the Group recognised a gain on disposal of its shares in subsidiaries of $1.1 million. The Groups 65% equity interests in Pipelay and Naturalay Technologies were sold for consideration of 605,000 common shares in SeaDragon Offshore Limited. Interest income of $2.6 million in 2007 was $1.3 million higher than in 2006 as a result of higher average cash balances and higher average interest rates. Cash and cash equivalents are typically held in interest bearing treasury accounts. Cash generating this income was raised by a private placement of shares for gross proceeds of $186.4 million (Cdn$181.5 million) in November 2007 and the issue of $165 million, 8%, unsecured, convertible bonds in February 2007. In the first quarter of 2007, the Group redeemed the 550 outstanding 10%, unsecured convertible bonds, issued in March 2006, for total proceeds of $82.5 million plus accrued interest. This resulted in a loss of $7.2 million on redemption, net of transaction costs.
Operating results
Petroleum and natural gas operating costs increased to $2.9 million in 2007, due primarily to commencement of production in Russia in May 2007. Drilling rig operating expenses in 2007 reduced significantly, due to the lack of third party drilling activity in Uganda. General and administrative expenses increased from $8.6 million in 2006 to $41.3 million in 2007, due principally from higher share-based compensation expenses relating to stock
Convertible bonds are separated into liability and derivative liability components (being the bondholders conversion option) and each component is recognised separately. The change in the fair value of the convertible bonds conversion options, which is primarily due to the performance of HOCs share price, resulted in a loss of $24.9 and $21.3 million in 2006 and 2007, respectively. Other finance costs increased from $4.6 million in 2006 to $10.7 million in 2007, from the issue of unsecured convertible bonds ($60 million in March 2006 and $165 million in February 2007), that lead to higher interest and accretion expenses. The Group recognised an unrealised gain in the fair value of its investment in Afren plc (Afren) warrants of $0.2 million in 2006 and $0.9 million in 2007. The Group holds 1,500,000 warrants in Afren, received as partial consideration from the sale of Heritage Congo Limited in 2006. The Groups net loss in 2007 was $83.2 million, compared to $28.4 million in 2006. In 2007 the basic and diluted loss per share from continuing operations and net basic and diluted loss per share were $0.37, compared to basic and diluted loss per share from continuing operations of $0.19 and net basic and diluted loss of $0.13 in 2006.
Cash used in operating activities of continuing operations was $2.5million in 2007 compared to $12.7 million in 2006. Total cash capital expenditures in 2007 were $75.3 million compared to $28.5 million in 2006. The following work was undertaken in 2007: In Uganda, work programmes were accelerated following the discovery of a new hydrocarbon system in the Albert Basin. Following the completion of drilling and testing of the Kingfisher-1 well in the first quarter of 2007, which production tested 13,893 bopd, a series of 2D and 3D and seismic programmes were acquired in Blocks 3A and 1. These programmes have identified a number of targets which can be drilled in 2008 and beyond; An exploration and appraisal drilling programme commenced in the Zapadno Chumpasskoye field in Russia and an early production system was installed and commissioned, resulting in first production in May 2007; The development of the West Bukha field in Block 8, Oman continued during 2007; and During the second half of 2007, the Group acquired new prospective areas through farm-ins and licence awards in the Kurdistan Region of Iraq, Malta, Mali and Pakistan. Cash inflow from discontinued operations was $21.3 million in 2006 (2007: $nil). The Group achieved a net increase in cash and cash equivalents during 2007 of $182.5 million.
At 31 December 2007, the Group had a working capital surplus of $212.2 million, including cash and cash equivalents of $230.1 million. The Group raised cash of over $350 million in 2007. $165 million was raised in February 2007 by the issue of 8%, unsecured convertible bonds, of which $82.5 million plus accrued interest was used to redeem an existing 10% convertible bond and the remainder was available for general corporate funding purposes. Gross proceeds of $186.4 million (Cdn$181.5 million) were received in November 2007 from an issue of 3,000,000 Common Shares by HOC at a price of Cdn$60.50 per share. In October 2007, the Group received a loan of $9.5 million to refinance the acquisition of a corporate jet. Interest on the loan is at a rate of LIBOR plus 1.6%.
Capital structure
The Groups financial strategy has been to fund its capital expenditure programmes and any potential acquisitions by selling non-core assets, reinvesting funds from operations, using existing treasury resources, finding new credit facilities and, when considered appropriate, either issuing unsecured convertible bonds or equity. The Group had net cash of $13.7 million at 31 December 2007 compared with net debt of $57.2 million at 31 December 2006 and a gearing ratio of 57%.
A thorough risk assessment of business processes was undertaken in 2006 which identified key financial risks relating to financial reporting. A system of internal controls was designed and tailored to ensure key risks are appropriately addressed and to provide assurance regarding the reliability of financial reporting and preparation of financial statements. Risk and internal controls are continually assessed. One weakness has been identified, concerning accounting for complex transactions from the transition from Canadian GAAP to IFRS, although the Company seeks third party advice to mitigate against this weakness as disclosed on page 42. The Group maintains insurance policies in accordance with industry standards. The Group believes that the level of insurance cover it maintains is adequate based on various factors such as the cost of the policies, industry standard practice and the risks associated with the exploration and development of oil and gas properties in the countries in which it operates. The Group does not insure against political risk and, therefore, provides shareholders with full exposure to the risks and rewards of investing in its territories. The Group maintains a detailed financial model which allows the Company to plan future operating and capital activities in the most efficient manner. Paul Atherton Chief Financial Officer
Reserves
RPS has certified that as of 31 December 2007, the Groups net working interest reserves and value, using money of the day prices, discounted at 10%, were as follows: Working interest reserves represent the proportion of future production, before deducting government share of that production, attributable to the Groups participating interests. Entitlement reserves represent the Groups share of future production net of government share in that production under the terms of the relevant PSAs. Government share is impacted inter alia by assumptions as to future oil prices. The Groups PSAs all provide for the Operators costs to be substantially recovered via a priority allocation of oil production (Cost Oil). As oil prices increase, so the amount of Cost Oil required to recover past costs reduces, thereby reducing the joint ventures share of production and so entitlement reserves, although the potential future monetary value of those reserves is increased. Proved Probable Additional
25.3 40.5
24.2 38.0
33.0 233.4
65.8
62.2
266.4
Total gross reserves and net reserves attributable to the Groups properties are summarised below:
Light and Medium Crude Oil (Mmbs) Oil Equivalent (Mmboe)
Gas (Bcf)
NGLs (Mmbs)
Net Net Net Net Net entitleNet entitleNet entitleNet entitleworking ment working ment working ment working ment interest interest interest interest interest interest interest interest reserve reserve reserve reserve reserve reserve reserve reserve
23.96 38.54
23.61 37.62
0.74 4.01
0.52 1.00
1.20 1.33
0.46 0.22
26.50 42.50
24.15 38.02
62.50
61.23
4.75
1.52
2.53
0.68
69.00
62.17
Economic valuation of reserves and resources are linked to a long-term price forecast for Brent. The Base Case (US$/bbl Money of the Day) price forecasts, used for all valuations presented in this report, are set out below:
US$/bbl, MOD
Resources
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 onwards
85.0 82.0 80.0 78.0 77.0 77.3 78.8 80.4 82.0 83.7 85.3 87.0 88.8 90.6 +2% p.a.
RPS certified that the Group had a 50% working interest share of the mean risked working interest prospective resources from Blocks 3A and 1 in Uganda of 462 MMboe (923 MMboe gross) as at 31 December 2007. The Government of Uganda has a back-in right which could, if exercised, reduce the Groups working interest to 42.5%.
The Group has always been committed to responsible and respectful conduct towards the diverse communities in which it operates, believing that it is only through such an approach to business incorporating economic, environmental and social initiatives that the Groups sustainable development will be achieved. Corporate Social Responsibility
Community
Over the past five years the Group has implemented a wide range of community projects, including public health, education, environmental, public facility, and community relations based programmes. In all of these, the Groups involvement was not simply to provide funds, but to actively work with the communities in order to build trust and ensure that both the needs of communities and those of the Group were considered when the projects were planned. For example, in Uganda the Group has worked closely with local communities in Rwebisengo Bundibugyo District and Buhuka Hoima District, to build and rehabilitate roads and valley dams, drill community water wells and construct cattle dipping tanks. The Group has constructed and repaired fencing around a number of schools such as Makondo Primary School in the Bundibugyo District and invested
Environment
access for villagers to local markets; Drilling community water wells; provision of medical supplies & health checks; Building of cattle dipping tanks and valley dams; Sponsorship of school sportswear & equipment; Sponsorship of various community aid & womens projects; including a community radio station and the Watoto Child Care project.
The Group is committed to protecting the environment and where a project may have an impact on the environment an Environmental Impact Assessment is usually conducted. This identifies potential impacts and what appropriate mitigation measures can be put in place. The mitigation measures are made operational by drawing up an Environmental Management Plan, which is followed by monitoring the effectiveness of the measures taken to protect the environment or allow its self renewal.
Educational Projects Building the Carl Nefdt Memorial School in Sponsorship of local individuals to universities; Sponsorship of civil servants to attend
courses on oil legislation and contract terms and to the East African Petroleum Conference. Buhuka;
Environmental Incidents
The Group attaches great responsibility to its emergency response plans which are instituted in case of any environmental incidents. The directors place considerable confidence in the effectiveness of the Groups environmental incident reporting procedures. To date, the Group has not been subject to any material environmental incidents. The Groups objective is to minimise its impact on the environment and to undertake a series of community, conservation and education projects in certain countries in which it operates. Respect for the environment and active engagement with local communities are fundamental to the business of the Group.
Safety
The Group operates in difficult and hazardous environments and the safety of its people is absolutely paramount at all times. As an organisation the Group wants to eliminate accidents and injuries to people in all aspects of its business. It recognises that this is a difficult goal but strives to succeed.
Above: Construction of the Carl Nefdt Memorial School. Below: Presentation of motorbikes to the Uganda Wildlife Service.
10
6. General Sir Michael Wilkes, KCB, CBE, aged 67 Non Executive Director General Sir Michael Wilkes retired from the British Army in 1995 as Adjutant General and Middle East Adviser to the British Government. As Adjutant General, Sir Michael was the most senior administrative officer within the Army and a member of the Army Board. During his distinguished career, he has seen active service across the world while also commanding at every level from Platoon to Field Army including commanding the 22 Special Air Service Regiment and serving as the Director of Special Forces. Sir Michael is the Non Executive Chairman of Cyberview Technology Ltd and a Non Executive director of the Stanley Gibbons Group, both of which are listed on AIM. In addition he holds non executive positions on a number of private companies including Britam Defence and Trico Ltd and chairs the Advisory Board of PegasusBridge Fund Management Limited, a homeland security company. He joined the Group on 18 March 2008. 7. Brian Smith, aged 55 VP Exploration Mr. Smith has 30 years experience in the oil industry. He initially worked as an exploration geologist for Exxon in the North Sea and Gulf of Mexico. He subsequently joined Enterprise Oil where he managed various exploration projects in the Far East and Eastern Europe. He joined the Group in 1997.
8. Stephen Kobak, aged 53 VP Production Russia and CIS Stephen Kobak, a qualified engineer, has 27 years of experience in oil and gas production operations, reservoir studies and asset development. The companies he has worked for include ESSO, Shell International and Khanty Mansiysk Oil Corporation in Western Siberia, where he held senior management positions guiding technical and operations activities. He has extensive international experience working in Russia, the Far East, Middle East and Canada. Mr. Kobak joined the Group in 2007. 9. Armen Sahakian, aged 69 VP Business Development Mr. Sahakian received his Ph.D. in geology from Harvard University. He has more than 30 years experience in the oil industry and has held senior management positions in business development and international petroleum negotiations. Among the companies and institutions he has worked for include Conoco, Hispanoil, Partex-CPS, OMV and the World Bank, where he served as petroleum advisor on the Oil and Gas Divisions financed petroleum projects.
10. James Baban, aged 56 General Manager, Kurdistan Mr. Baban has over 30 years experience in the upstream oil and gas industry. He is a Chartered Engineer and a Fellow of The Energy Institute in the United Kingdom and has previously worked for Petro-Canada, Burlington Resources, Veba Oil, BP & BG. Mr. Baban has extensive skills in the development and management of international offshore and onshore projects, having worked in the Middle East, Far East and North Africa. Mr. Baban joined the Group in 2005.
List of Advisers
Company Secretary Woodbourne Secretaries (Jersey) Limited Ordnance House 31 Pier Road St Helier Jersey JE4 8PW Channel Islands Ordnance House 31 Pier Road St Helier Jersey JE4 8PW Channel Islands 28-30 The Parade St Helier Jersey JE1 1BG Channel Islands 34 Park Street London W1K 2JD United Kingdom JPMorgan Cazenove Limited 20 Moorgate London EC2R 6DA United Kingdom McCarthy Ttrault Registered Foreign Lawyers & Solicitors 2nd Floor 5 Old Bailey London EC4M 7BA United Kingdom McCarthy Ttrault LLP Suite 3300 421 7th Avenue S.W. Calgary, Alberta T2P 4K9 Canada Principal Bankers of the Company Independent Petroleum Engineering Consultants to the Company Jersey Legal Advisers to the Company Mourant du Feu & Jeune 22 Grenville Street St Helier Jersey JE4 8PX Channel Islands KPMG LLP U.K. 8 Salisbury Square London EC4Y 8BB United Kingdom
Auditors of Heritage Oil Corp KPMG LLP Canada National Suite 3300 Commerce Court West 199 Bay Street Toronto, Ontario M5L 1B2 Canada Registrars of the Company Computershare Investor Services (Channel Islands) Limited Ordnance House 31 Pier Road St Helier Jersey JE4 8PW Channel Islands Standard Bank (Europe) Bank of Scotland (Europe) Barclays Bank RPS Energy Goldsworth House Denton Way Goldsworth Park Woking, Surrey GU21 3LG United Kingdom Bell Pottinger Group 6th Floor, Holborn Gate 330 High Holborn London WC1V 7QD United Kingdom
Financial Advisers
Press Agents
The directors recognise the importance of maintaining good corporate governance practices and are committed to applying the highest industry standards of business ethics, health and safety, environment, risk management and corporate and social responsibility throughout the Company. To this end, the Board will be putting in place policies and procedures within which it will conduct its activities along with working practices and a business culture to ensure openness and full accountability. As described below, the Company intends in due course to comply with the June 2006 Combined Code of Corporate Governance as issued by the UK Financial Reporting Council (the Code) in all material respects.
Board of Directors
The initial Board comprises six directors which include a non-executive Chairman, two executive directors and a further three non-executive directors (as noted below). The Chairman and two of the non-executive directors are deemed to be independent under the terms of the Code. All of the directors bring either extensive experience of the oil industry or a broad range of business, commercial and corporate governance experience, to the Board. The executive directors have close involvement with the operations of the business through their operational roles. The biographies of the Board are set out on pages 36 and 37. The Board is accountable to shareholders for the creation and delivery of strong sustainable financial performance, guidance, perspective and long-term shareholder value. In doing this, the Board must ensure the effectiveness of the system of internal controls including effectively managing and considering the commercial risks and financing needs, the disposal of businesses, assessing the most appropriate balance between acquisition led growth and organic growth. In practice, these corporate governance and stewardship obligations require individual directors and the Board to be constantly evaluating and challenging the Companys business strategy to ensure they identify areas where improvements can be made or where new opportunities exist so that the strategies remain appropriate and relevant to the Companys business. In order to ensure that the Company complies with its obligations as a listed company, the Board must also have responsibility for communications with shareholders, health and safety policy and the review of the Companys management and financial performance. Further details of compliance with these obligations are set out below. The main Committees to which the Board delegates certain of its responsibilities are the Audit, Remuneration and Nominations Committees. Further details of these Committees and their activities can be found later in this report and also in the Directors Remuneration Report on pages 44 to 47.
The Board was not formed until 2008 and therefore did not meet during the 2007 financial year under review. The Board will meet sufficiently regularly to discharge its duties during 2008 by way of formal Board meetings as well as ad hoc meetings. The frequency of these meetings and the production of a formal schedule detailing matters specifically reserved for its decision and those that will be delegated to management have yet to be determined. Such details and information, together with the levels of individual attendances at Board meetings, will be provided and reported upon next year. The Board intends to utilise the Groups existing system for identifying, evaluating and managing the significant risks faced by the Company and its system of internal control. This system is designed to manage, rather than eliminate, the risk of failure to achieve business objectives and can only provide reasonable and not absolute assurance against material misstatement or loss. The Board will continue to review and improve its system of internal controls. The Company Secretary is a corporate entity based in Jersey that will deal with normal statutory compliance. The Company, the Board and its Committees will be serviced by the Company Secretary or its nominee. The other duties that would normally be carried out by the Company Secretary such as the provision of information flows to the Board, will be dealt with by either the Chairman or Company Chief Financial Officer or their nominee. In terms of corporate governance issues, the Board will be advised by McCarthy Ttrault Registered Foreign Lawyers & Solicitors in London. The Board will monitor the provision of Company Secretarial duties and take any action as appropriate to ensure its requirements are met. The appointment or removal of the Company Secretary will be a matter for the Board as a whole. As part of the Listing, all non-executive directors executed letters of appointment on 28 March 2008 setting out their respective terms of appointment including their expected time commitment which has been agreed and confirmed with them. The letters are available for inspection and further details can be found in the Directors Remuneration Report on pages 44 and 47. The directors are aware of their responsibilities and feel able to raise any concerns at Board meetings which are minuted accurately in the Board meeting minutes. The Board will adopt a formal procedure on this in due course. As required by the Code, the Company maintains Directors and Officers Liability insurance cover, in respect of any legal action taken against the directors, which is reviewed annually.
The Board is satisfied that its composition will ensure that no individual or group of individuals will dominate the decision-making process and that there will soon be a strong presence on the Board of both executive and non-executive directors.
The Board considers John McLeod and General Sir Michael Wilkes are independent in character and judgement and free from relationships or circumstances which may affect their judgement. On appointment, the Chairman was also considered to be independent. Albion Energy Limited (Albion), the Companys largest shareholder and Anthony Buckingham entered into a relationship agreement with the Company on 28 March 2008 (the Relationship Agreement) as part of the Listing. The purpose of the Relationship Agreement was to ensure that transactions and relationships between the Group, Albion and Anthony Buckingham were at arms length and on normal commercial terms. The Relationship Agreement prescribes that at all times, the Board shall be comprised of a majority of directors who are all independent of Anthony Buckingham. Gregory Turnbull does not meet the independence criteria set out by the Code as he is a partner of McCarthy Ttrault LLP, the Canadian advisers to the Company. As noted above, one of the main areas of non-compliance with the Code is the appointment of the Chairman as a member of the Audit Committee which is considered necessary due to his financial background. The Board will look to appoint another non-executive director, so that the fundamental areas of non-compliance with the Code are rectified.
Board Committees
As mentioned above, the Board has three Committees, being the Remuneration, Audit and Nominations Committees. The duties of these Committees are set out in formal terms of reference that were adopted by the Board on 18 March 2008 and are available on the Company website. The Committee memberships will be refreshed regularly.
Internal controls
The Committee will give due consideration to laws and regulations, provisions of the Code and the requirements of the Listing Rules. It will also have responsibility for reviewing the effectiveness of the Companys system of internal controls and risk management systems. The Board has taken into account the relevant provisions of the Code in formulating the systems and procedures in operation in the Company. It currently maintains a system of internal control as Heritage Oil Corporation was previously subject to compliance with relevant rules and regulations in Canada (Multilateral Instrument 52-109 of the Canadian Securities Administrators). A further review of the system of internal control will be undertaken prior to the publication of the 2008 annual report.
The Board is aware of the need to conduct regular risk assessments to identify any deficiencies in the controls currently operating over all aspects of the Company. A formal risk assessment will be conducted on an annual basis on internal controls to cover material controls, both financial and operational, and risk management systems. A report by exception will also be made on any material changes during the year. The Board recognises the need for effective high level internal controls and for evaluating and managing the risks of the Company. Such matters will be addressed with the Board at its formal Board meetings, ad hoc discussions or via the whistle-blowing policy currently in place (see below). Financial reporting procedures were reviewed as part of the Listing process and a Board memorandum was prepared. Having considered the findings, the directors were able to confirm that the financial reporting procedures established provided them with a reasonable basis to make proper judgments on the financial position and prospects of the Company on an ongoing basis. However, one weakness was noted, that the preparation of the Groups consolidated IFRS financial information is a fairly complex task requiring IFRS-experienced accounting personnel and involving the recording of complicated and non-routine transactions that are technical in nature. There is an increasing demand for a limited number of IFRS-experienced accounting personnel who also have knowledge of Canadian GAAP as more Canadian companies prepare financial statements on the basis of IFRS or other international standards. Furthermore, HOC, as a listed entity in Canada, has historically prepared its consolidated financial information according to Canadian GAAP and applied Canadian corporate practice and financial reporting procedures such that there can be no guarantee that the Group will not face difficulties in preparing consolidated IFRS financial information or in applying its new UK financial reporting procedures in all circumstances in the future. Any of the above factors could materially adversely affect the Groups business, results of operations, financial condition and prospects. However, in any event, the Group does consult with third-party experts from time to time on technical matters in relation to recording items in its financial statements and the nature of its financial reporting procedures and notwithstanding the above, the directors believe that the Groups financial systems, which have been reviewed by its professional advisers, are sufficient to ensure compliance with the requirements of the Disclosure and Transparency Rules published by the FSA from time to time as a listed entity. The directors recognise the need to maintain financial reporting procedures, to review them on an ongoing basis and to adapt them to changing circumstances and will use the Board memorandum as a basis for further developing the Board processes.
Remuneration Committee
The initial members of the Remuneration Committee are John McLeod (Chairman), Michael Hibberd and General Sir Michael Wilkes. All the members are independent non-executive directors. The Chief Executive and external advisers may also be invited to attend. Further information on the Committee can be found in the Directors Remuneration Report on pages 44 to 47. It is intended that the Remuneration Committee will meet at least once a year and have responsibility for making recommendations to the Board on the framework, or broad Company policy, for the remuneration of the Chairman and the specific remuneration packages including pension rights, and any compensation payments for each of the executive directors, the senior management and such other members of the executive management as it is designated to consider. The Committee will also ensure compliance with the Code and Companies Act 1985 (as amended by the Companies Act 2006) in this respect. No director may be involved in any decisions as to their own remuneration.
Nomination Committee
The majority of the Board have previously served as directors of Heritage Oil Corporation and they were judged on their merit before being appointed to the Board. Future re-elections of directors will be subject to satisfactory performance and refreshing of the Board. Neither the Chairman nor any other director have any other significant appointments and no executive director holds any appointments of FTSE 100 companies. The initial members of the Nomination Committee are Michael Hibberd (Chairman), General Sir Michael Wilkes and Anthony Buckingham. The majority of the members are independent non-executive directors and Anthony Buckingham is the Chief Executive. External advisers may also be invited to attend meetings as and when required. It is intended that the Committee will meet at least once a year and will have responsibility for making recommendations to the Board on its composition (including the skills, knowledge and experience), structure and size and that of its Committees, as well as on retirements and appointments of additional and replacement directors taking into account the challenges and opportunities facing the Company. A number of the Code provisions relating to the Nomination Committee are not relevant at this early stage of the Companys Listing. The requirements of the Code are included in the Terms of Reference and in due course, processes will be adopted to implement these in practice to ensure compliance with all aspects of the Code.
Performance evaluation
The Chairman will also ensure meetings are held with non-executive directors without the executive directors present. The non-executive directors shall also meet led by a senior independent director and without the Chairman present, at least once a year, in order to evaluate the Chairmans performance.
Whistle-blowing policy
The Company has implemented a whistle-blowing policy and information has been sent to all employees advising them that they can raise concerns in confidence about possible wrongdoing by contacting the Chairman of the Audit Committee. In addition, whistle-blowing is an agenda item at Board and Audit Committee meetings and will be reviewed by the Audit Committee and appropriate action taken.
Re-election
In accordance with the Companys Articles of Association no director will resign and be subject to re-election by shareholders at the forthcoming Annual General Meeting. Thereafter, one third or the nearest to one third of the directors shall retire at subsequent Annual General Meetings.
Remuneration Report
In line with the Boards commitment to applying the Combined Code in the fullness of time, the Company has adopted the fundamental principles of good governance relating to directors remuneration as set out in the 2006 Combined Code on Corporate Governance (the Code). This Report has been prepared in accordance with the provisions of Companies Act 2006 and Listing Rules of the Financial Services Authority.
Remuneration Committee
The Company set up a Remuneration Committee (the Committee) on 18 March 2008 shortly prior to its listing on the London Stock Exchange on 31 March 2008 (the Listing). As a result of its recent Listing, a number of elements in the Code are not applicable at this early stage; however the Board and the Committee will use their best endeavours to implement these during the course of the next 12 months or so. The members of the Committee are John McLeod (Chairman), Michael Hibberd and General Sir Michael Wilkes. The Committee will meet at least once a year. The Chief Executive and external advisers will be invited to attend meetings but will not take part in the decision making process. The Committees main responsibilities will be to: Advise on remuneration policy for the Chairman, executive directors and senior executives; Assess and determine total rewards available to the executive and non-executive directors; Determine policy and scope for pension rights and any compensation payments and ensure compliance with the Code in this respect. Make recommendations to the Board for its approval and that of shareholders on the design of future long-term incentive plans and make recommendations for the grant of options to executives under such plans. It is the Companys intention over time to provide executive rewards in line with the Association of British Insurers and the National Association of Pension Funds guidelines, whilst maintaining an internationally competitive position. This will be done in association with independent consultants. Such consultants will also advise the Company on remuneration and sector issues and have no connection with the Company. The Remuneration Committee has clearly defined terms of reference which were adopted by the Board on 18 March 2008 and are available on the Companys website. No director will be involved in deciding their own remuneration.
a) Service agreements
The executive directors service agreements with the Company are for no fixed term. In normal circumstances, the agreements may be terminated by the Company giving not less than 24 months notice and the director giving six months notice. These arrangements were in place during their time as executive directors of Heritage Oil Corporation and have been inherited by the Company. The Board feels that these notice periods were appropriate to recruit and retain the executive directors, and whilst it has no present intention of changing them, it will keep them under review. In the event of a change of control of the Company, if the executive directors resign or the Company terminates their appointment within 24 months of such an event, they will each be entitled to an immediate payment in lieu of notice of a sum equivalent to three times their annual salary. In addition, they will be entitled to a payment of $75,000 in the event they are asked to resign from the Board of Heritage Oil Corporation in any event other than as a result of a change of control. The Company also may terminate the agreements and make payments in lieu of notice. Currently the executive directors service contracts do not provide for mitigation in the event of early termination. The executive directors do not have service contracts with any Group subsidiary.
24 months 24 months
6 months 6 months
The executive directors will also be entitled to an annual performance related bonus determined by the Committee. It is expected that approximately half of the executive directors remuneration will be fixed and the remaining will be performance related. In addition, they are entitled to the benefits of private medical insurance, life insurance and executive participation in the Companys retirement and welfare benefit scheme. Both executive directors are entitled to allowances of 100,000 (Anthony Buckingham) and 77,500 (Paul Atherton) to cover their living expenses. Their salaries will be subject to regular review by the Committee and it is anticipated that the first review will take place towards the end of 2008. The executive directors do not have any other significant appointments, nor do they hold any appointments of FTSE 100 companies. The Board does not expect this to change but will keep it under review and report any changes in the future.
In addition, they will each receive an additional fee of 2,000 (or such other amount as the Board in its sole discretion deems appropriate) for each additional day worked in excess of the agreed 20 days per annum. The level of non-executive directors fees is governed by the Companys Articles of Association and any changes will be subject to shareholder approval. The non-executive directors terms of appointment may be terminated by each party giving three months notice in writing. Michael Hibberd and George Turnbull will be entitled to a change of control bonus of $75,000 plus a pro-rata amount of their previous years bonus multiplied by a stock price performance factor in the event that Heritage Oil Corporation changes control. With the exception of General Sir Michael Wilkes, all the non-executive directors will be entitled to a payment of $75,000 in the event they are asked to resign from the Board of Heritage Oil Corporation in any event other than as a result of a change of control. General Sir Michael Wilkes received a payment of 50,000 on joining the Board of the Company. No other director received this form of payment on joining the Board of the Company.
Michael Hibberd George Turnbull John McLeod General Sir Michael Wilkes
Non-executive directors will not participate in the Companys pension arrangements or the Companys future long-term incentive plans. In addition, neither the Chairman nor any other non-executive director hold appointments of any FTSE 100 companies.
On Listing, the directors (including non-executive directors) held the following options under the Replacement Scheme:
Director No of Ordinary Shares under option Exercise price per Ordinary Share1
Vesting periods
Expiry date
Michael Hibberd Anthony Buckingham Paul Atherton Gregory Turnbull John McLeod
1
150,000 750,000 250,000 500,000 9,129,510 500,000 1,250,000 1,125,000 500,000 150,000 300,000 150,000 100,000 300,000 150,000
0.81 1.43 2.45 0.48 1.43 2.45 0.48 1.43 2.45 0.48 1.43 2.45 0.48 1.43 2.45
23 June 2006 23 June 2008 14 December 2006 14 December 2008 21 December 2007 21 December 2009 20 May 2005 20 May 2007 14 December 2006 14 December 2008 21 December 2007 21 December 2009 20 May 2005 20 May 2007 14 December 2006 14 December 2008 21 December 2007 21 December 2009 20 May 2005 20 May 2007 14 December 2006 14 December 2008 21 December 2007 21 December 2009 20 May 2005 20 May 2007 14 December 2006 14 December 2008 21 December 2007 21 December 2009
23 June 2011 14 December 2011 21 December 2012 20 May 2010 14 December 2011 21 December 2012 20 May 2010 14 December 2011 21 December 2012 20 May 2010 14 December 2011 21 December 2012 20 May 2010 14 December 2011 21 December 2012
The final exercise prices were converted into pounds sterling on Listing using the exchange rate in effect on that date.
The highest and lowest mid-market prices of HOCs shares during the period were 0.81 and 3.33 respectively after taking into account the effects of the corporate re-organisation. The mid market price of the Companys shares at 31 December 2007 is not available due to its recent Listing. Further details of the Replacement Scheme can be found on page 46 of this Report The directors interests in the Ordinary Shares of the Company on Listing as shown below:
At 31 March 2008
Michael Hibberd Anthony Buckingham(1) Paul Atherton Gregory Turnbull John McLeod General Sir Michael Wilkes
Note: 1: Mr Buckinghams Ordinary Shares include the Ordinary Shares held by Albion Energy Ltd, the Companys major shareholder which is owned and controlled by Mr Buckingham.
Approval
The Directors Remuneration Report has been approved by the Board of directors of the Company. Signed on behalf of the Board of Heritage Oil Limited John McLeod Remuneration Committee Chairman 30 April 2008
Directors Report
The directors of Heritage Oil Limited (the Company) submit their report together with the consolidated audited financial statements of Heritage Oil Corporation (HOC) for the year ended 31 December 2007 for the Company and its subsidiaries (the Group). The Company was incorporated subsequent to the year-end as part of a reorganisation of the Group which is discussed in more detail below.
Reorganisation
The Company was incorporated on 6 February 2008 in Jersey under the Companies (Jersey) Law 1991, as amended (the Jersey Companies Law) to become the ultimate holding company of the Group. It changed its status to a public company on 25 February 2008 in preparation for the listing of its Ordinary Shares on the Main Market of the London Stock Exchange (the LSE) on 31 March 2008 (the Listing). The Companys registered office is in Jersey. Prior to the Listing, the holding company of the Group was HOC, a Canadian registered company whose common shares (Common Shares) were traded on the Toronto Stock Exchange (TSX). As part of the Listing, the Group was reorganised and HOC became an indirect whollyowned subsidiary of the Company (the Reorganisation). The Reorganisation culminated in the Common Shares being de-listed from the TSX and a new class of exchangeable shares being created and issued by HOC (Exchangeable Shares). Holders of Common Shares could exchange their Common Shares for either Ordinary Shares of the Company (Ordinary Shares) which are traded on the LSE or for Exchangeable Shares of HOC that are traded on both the LSE and the TSX. Further details of the Listing and Reorganisation can be found in the prospectus dated 28 March 2008 (the Prospectus) and available on the Companys website at www.heritgageoilltd.com.
Capital structure
The Company has two classes of shares, namely the Ordinary Shares and the special voting share of HOC (the Special Voting Share). Its subsidiary HOC has one class of shares, being the Exchangeable Shares. The Ordinary Shares and the Special Voting Share carry no right to fixed income. The Ordinary Shares have a right to one vote at general meetings whilst the holders of Exchangeable Shares have rights through the Special Voting Share held by the trustee of the Voting and Exchange Trust to one vote at general meetings for every Exchangeable Share on the same basis as if they had exchanged them for Ordinary Shares. For clarity, the Voting and Exchange Trust is a Canadian trust that holds the Special Voting Share for the benefit of the registered holders of the Exchangeable Shares pursuant to the terms of a Voting and Exchange Trust Agreement dated 27 February 2008. The issued share capital of the Company and total voting rights of the Company are as follows: 250,513,032 Ordinary Shares of the Company are issued and outstanding, which constitutes 98.3% of the total voting rights of the Company; and 4,431,120 Exchangeable Shares of HOC are issued and outstanding, which constitutes 1.7% of the total voting rights of the Company. The directors interests in the Ordinary Shares, Exchangeable Shares and options granted under the employee share scheme are set out in the Directors Remuneration Report on pages 44 to 47.
Major shareholders
The Company was not incorporated until 6 February 2008. In accordance with Rule 5 of the Disclosure and Transparency Rules, the shareholders listed below have notified the Company of their interests in the Ordinary Shares of the Company as at 29 April 2008:
Name Ordinary Shares held % Held1
Albion Energy Limited Capital Research and Management Company Lansdowne Partners Limited Firebird Global Master Fund, Ltd Harrier Holdings Ltd re LCAM
1 2
Includes voting rights attaching to the Special Voting Share as well as the Ordinary Shares. Number of Ordinary Shares held by both Albion Energy Limited and Anthony Buckingham.
Albion Energy Limited (Albion) and Anthony Buckingham entered into a relationship agreement with the Company on 28 March 2008 (the Relationship Agreement) as part of the Listing. The purpose of the Relationship Agreement was to ensure that transactions and relationships between the Group, Albion and Anthony Buckingham were at arms length and on normal commercial terms.
Directors
The following directors held office:
Appointment dates
Michael Hibberd Anthony Buckingham Paul Atherton Gregory Turnbull John McLeod General Sir Michael Wilkes
18 March 2008 25 February 2008 6 February 2008 18 March 2008 18 March 2008 18 March 2008
With the exception of General Sir Michael Wilkes, all the directors were previously and continue to be directors of HOC. William Kaufmann is the other director of HOC. With regard to retirement and re-election of directors, the Company is governed by its Articles of Association, the Combined Code of Corporate Governance and the Jersey Companies Law. It has not been appropriate to carry out an evaluation of the Board of directors at this stage, however, the effectiveness and time commitment of each of the individual directors was taken into consideration at the time of their initial appointments as directors of the Company which included, where relevant, their prior service as directors of HOC. Biographical information on all the directors can be found on pages 36 and 37.
Registrar
The Companys share registrar is Computershare Investor Services (Channel Islands) Limited, Ordnance House, 31 Pier Road, St Helier, Jersey JE4 8PW Channel Islands.
Employees
As at 31 December 2007, the Group had 89 employees (including full-time contractors, consultants and executive directors) based in the following locations: Russia Kurdistan Region of Iraq UK Uganda 41 5 14 21 South Africa Switzerland Canada 4 3 1
Additional risk factors were all also identified and further information on these, and the significant risk factors above, can be found in the Prospectus. The above risk factors (and the additional risk factors identified in the Prospectus) could materially adversely affect cash flows to an extent that the Group may, in certain circumstances, need to obtain further debt or equity financing after 28 March 2009.
Agreements
The Takeovers Directive (Interim Implementation) Regulations 2006 requires the Company to disclose whether there are any significant agreements to which it is a party that take effect after, or terminate upon, a change of control of the Company following a takeover bid and the effects of such agreements. The Company confirms that it has not entered into such agreements since its Listing.
Going concern
After making due enquiries, the directors have made an informed judgment at the time of approving the Financial Statements, that there is a reasonable expectation that the Group has adequate resources to continue in operational existence for the foreseeable future. For this reason, the directors continue to adopt the going concern basis in preparing the Financial Statements. Approved by the Board on 30 April 2008
Anthony Buckingham
Chief Executive Officer 30 April 2008
We have audited the consolidated balance sheets of Heritage Oil Corporation as at December 31, 2007 and 2006 and the consolidated statements of income, recognized income and expense, and cash flow for the years then ended. These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of the Company as at December 31, 2007 and 2006 and the results of its operations and its cash flows for the years then ended in accordance with International Financial Reporting Standards.
Chartered Accountants
Calgary, Canada April 28, 2008
Notes
ASSETS Non-current assets Intangible exploration assets Intangible development costs Property, plant and equipment Other financial assets Current assets Inventories Prepaid expenses Trade and other receivables Cash and cash equivalents
10 11 12 13 14 15
54,767,332 102,862,754 1,574,039 32,187,098 64,225,918 914,558 5,044,201 89,443,027 172,132,873 98,921 199,465 531,273 447,271 9,839,506 6,759,261 46,861,146 230,089,323 57,330,846 237,495,320
146,773,873 409,628,193
LIABILITIES Current liabilities Trade and other payables Borrowings Non-current liabilities Borrowings Derivative financial liability Provisions
16 17 17 23 18
63,124,843 154,253,701 27,997,140 36,739,990 62,322 170,899 91,184,305 191,164,590 42,726,467 193,193,432 24,580,984 217,672,243 2,637,058 43,178,359 15,508,425 (67,657,170) 42,726,467 193,193,432
104,047,406 216,434,761
SHAREHOLDERS EQUITY ATTRIBUTABLE TO EQUITY HOLDERS OF THE CORPORATION Share capital 19 Reserves 20 Retained earnings (deficit) 20
The notes are an integral part of these consolidated financial statements. Approved by the Board of Directors
Anthony Buckingham
Director
William Kaufmann
Director
Notes
7 1e 12 9
3,938,512 2,895,727 6,834,239 723,611 2,291,585 8,628,127 627,005 1,351,987 6,066,977 19,689,292
3,709,503 3,709,503 2,897,603 38,360 41,271,960 (931,913) 1,892,290 5,415,696 1,799,762 52,383,758 1,077,132
Expenses Petroleum and natural gas operating Drilling rig operating General and administrative Foreign exchange losses (gains) Depletion, depreciation and amortisation Exploration expenditure Impairment of property, plant and equipment Gain on disposal of subsidiaries
Finance income (costs) Interest income Loss on redemption of liability component of convertible bonds Loss on derivative financial liability relating to convertible bonds Other finance costs Unrealised gain on other financial assets Loss from continuing operations
1,336,351 2,648,691 17 (7,155,622) 1q (24,851,295) (21,279,964) 5 (4,642,126) (10,688,220) 13 195,178 906,643 8 8 1w, 21 (27,961,892) (35,568,472) 9,200,700 3,248,490 12,449,190 (40,816,945) (83,165,595)
Gain on disposal of discontinued operations Earnings from discontinued operations Income from discontinued operations Net loss per share from continuing operations Basic and diluted
Net loss for the year attributable to equity holders of the Corporation
Net earnings per share from discontinued operations Basic and diluted Net loss per share Basic and diluted
Notes
Changes in the fair value of available-for-sale financial assets Exchange differences on translation of foreign operations Net income (expense) recognised directly in equity Net loss for the year Total recognised income and expense for the year
20 20
(4,003)
168,000 434,583
Notes
Cash provided by (used in) Operating activities Net loss from continuing operations for the year Items not affecting cash Depletion, depreciation and amortisation Finance costs accretion expenses Foreign exchange losses (gains) Share-based compensation Loss on redemption of convertible bonds Loss on derivative financial liability Gain on disposal of subsidiaries Gain on other financial assets Impairment of property, plant and equipment (Increase) decrease in trade and other receivables (Increase) decrease in prepaid expenses (Increase) decrease in inventory Increase in trade and other payables Continuing operations Discontinued operations Investing activities Property, plant and equipment expenditures Intangible exploration expenditures Intangible development expenditures Investment in shares Continuing operations Discontinued operations Financing activities Shares issued for cash Share issue costs Convertible bonds Convertible bond issue costs Redemption of convertible bonds Long-term debt Long-term debt issue costs Repayment of long-term debt Increase in cash and cash equivalents Cash and cash equivalentsbeginning of year Foreign exchange gain on cash held in foreign currency Cash and cash equivalentsend of year Non-cash investing and financing activities Supplementary information The following have been included within cash flows from continuing operations for the year under operating activities Interest received Interest paid
The notes are an integral part of these consolidated financial statements.
(40,816,945) (83,165,595) 1,892,290 1,351,987 3,619,198 647,453 (153,174) 422,648 1,417,044 31,300,295 7,155,622 24,851,295 21,279,964 (1,077,132) (906,643) (195,178) 1,799,762 5,195,888 (972,251) 84,002 (312,051) (100,544) 142,809 725,738 10,585,162 (12,737,451) (2,490,905) 3,748,853 (8,988,598) (2,490,905)
(12,265,063) (27,236,018) (16,172,102) (48,095,422) (64,931) (386,668) (200,000) (28,823,833) (75,596,371) 17,576,116 (11,247,717) (75,596,371) 26 1,318,945 187,106,476 (10,473,386) 60,000,000 165,000,000 (3,000,000) (6,979,268) (83,022,752) 9,450,000 (314,897) (155,537) (287,759) 58,031,186 260,610,636 37,794,871 182,523,360 8,583,321 46,861,146 704,817 482,954 46,861,146 230,089,323 1,665,998 5,032,919 3,504,866 8,546,840
Heritage Oil Corporation (the Corporation) is incorporated under the Business Corporations Act (Alberta) and its primary business activity is the exploration, development and production of petroleum and natural gas in Africa, Russia, Pakistan and the Middle East. These consolidated financial statements include the results of the Corporation and all subsidiaries over which the Corporation exercises control. The subsidiaries consolidated within these financial statements include inter alia Heritage Oil & Gas Limited, Eagle Energy (Oman) Limited, Heritage Oil and Gas (U) Limited, Heritage Energy Middle East Limited, Heritage DRC Limited, Coatbridge Estates Limited, ChumpassNefteDobycha, Neftyanaya Geologicheskaya Kompaniya, Heritage Oil & Gas (Austria) GesmbH, Heritage Mali Block 7 Limited, Heritage Mali Block 11 Limited, Heritage Energy Holding GesmbH (Austria), Heritage Oil & Gas (Gibraltar) Limited, TISE Heritage Neftegaz, Begal Air Limited, Heritage International Holding GmbH, Heritage Talinskoye GmbH, Heritage Oil & Gas Holdings Limited, Eagle Drill Limited, Heritage Oil (Barbados) Limited, Heritage Oil & Gas (Switzerland) SA, Heritage International Malta Limited and Heritage International Holding (Gibraltar) Limited. On 24 March 2008, the Corporation entered into a corporate reorganisation which resulted in a newly incorporated company, Heritage Oil Limited, becoming the parent company of the Corporation and its current subsidiaries. Further details are provided in Note 27. The Corporations consolidated financial statements are presented in US dollars, which is the Corporations functional and presentation currency. The financial statements were approved by the Board and authorised for issuance on 28 April 2008.
a) Basis of preparation
The consolidated financial statements have prepared in accordance with International Financial Reporting Standards (IFRS). The Corporations first set of financial statements prepared under IFRS were those which included annual 2005 and 2006 and the nine-month periods ended 30 September 2007 as filed for the first time with the UK Listing Authorities. The IFRS 1 disclosures concerning the transition to IFRS 1 can be found in those statements as well as note 28. The consolidated financial statements have been prepared under the historical cost convention, as modified by the revaluation of certain financial assets and liabilities at fair value. The preparation of financial statements in conformity with IFRS requires the use of certain critical accounting estimates. It also requires management to exercise its judgement in the process of applying the Corporations accounting policies. The areas involving a higher degree of judgement or complexity, or areas where assumptions and estimates are significant to the consolidated financial statements, are disclosed in note 3.
b) Consolidation
The consolidated financial statements incorporate the assets and liabilities of all subsidiaries of the Corporation as at 31 December 2006 and 2007 and the results of all subsidiaries for the years then ended. Subsidiaries are all entities (including special purpose entities) over which the Corporation has the power to govern the financial and operating policies, so as to obtain benefits from its activities, generally accompanying a shareholding of more than one half of the voting rights. The existence and effect of potential voting rights that are currently exercisable or convertible are considered when assessing whether the Corporation controls another entity. Subsidiaries are fully consolidated from the date on which control is transferred to the Corporation. They are deconsolidated from the date that control ceases. In this section, the Corporation together with its subsidiaries are referred to as the Group. 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 assets given, equity instruments issued and liabilities incurred or assumed at the date of exchange, plus costs directly attributable to the acquisition. Identifiable assets acquired and liabilities and contingent liabilities assumed in a business combination are measured initially at their fair values at the acquisition date, irrespective of the extent of any minority interest. The excess of the cost of acquisition over the fair value of the Groups share of the net fair value of the identifiable assets, liabilities and contingent liabilities acquired is recorded as goodwill. If the cost of acquisition is less than the fair value of the net assets of the subsidiary acquired, the difference is recognised immediately in the income statement.
Inter-company transactions, balances and unrealised gains on transactions between Group entities (the Corporation and its subsidiaries) are eliminated. For the purposes of consolidation, the accounting policies of subsidiaries have been changed where necessary to ensure consistency with the policies adopted by the Corporation.
c) Segment reporting
The Corporations primary segment reporting format is geographical. A geographical segment is engaged in providing products or services within a particular economic environment, that are subject to risks and returns, that are different from those of segments operating in other economic environments.
d) Joint Ventures
The majority of exploration, development and production activities are conducted jointly with others under contractual arrangement and, accordingly, the Group only reflects its proportionate interest in such assets, liabilities, revenues and expenses.
If commercial reserves have been discovered, the related E&E assets are assessed for impairment on a cost pool basis as set out below and any impairment loss is recognised in the income statement. The carrying value, after any impairment loss, of the relevant E&E assets is then reclassified as development and production assets within property, plant and equipment. E&E assets are assessed for impairment when facts and circumstances suggest that the carrying amount may exceed its recoverable amount. Such indicators include the point at which a determination is made as to whether or not commercial reserves exist. Where the E&E assets concerned fall within the scope of an established full cost pool, the E&E assets are tested for impairment together with all development and production assets associated with that cost pool, as a single cash generating unit. The aggregate carrying value is compared against the expected recoverable amount of the pool, generally by reference to the present value of the future net cash flows expected to be derived from production of commercial reserves. Where the E&E assets to be tested fall outside the scope of any established cost pool, there will generally be no commercial reserves and the E&E assets concerned will be written off in full.
Other assets
Other property, plant and equipment are stated at cost less accumulated depreciation and any impairment in value. The assets useful lives and residual values are assessed on an annual basis. Furniture and fittings are depreciated using the reducing balance method at 20% per year. Land is not subject to depreciation. Drilling rig equipment is depreciated using the unit-of-production method based on 2,740 drilling days with a 20% residual value. The corporate jet is depreciated over its expected useful life of 69 months. Depreciation is charged so as to write off the cost, less estimated residual value of corporate jet on a straight-line basis. Corporate capital assets are depreciated on a straight-line basis over their estimated useful lives. The building is depreciated on a straight-line basis over 40 years.
i) Inventories
Inventories consist of petroleum, condensate, liquid petroleum gas and materials that are recorded at the lower of weighted average cost and net realisable value. Cost comprises direct materials, direct labour and those overheads that have been incurred in bringing the inventories to their present location and condition. Net realisable value is the estimated selling price in the ordinary course of business, less applicable variable selling expenses. Provision is made for obsolete, slow-moving or defective items where appropriate.
k) Investments
The Group classifies its investments in the following categories: financial assets at fair value through the income statement, and available-for-sale financial assets. The classification depends on the purpose for which the investments were acquired. Management determines the classification of its investments at initial recognition. During the years covered by these financial statements the Group did not have any investments classified as loans and receivables or held to maturity investments.
l) Non current assets held for sale (i) Assets held for sale
Non-current assets (or disposal groups) are classified as assets held for sale and stated at the lower of their carrying amount and fair value less costs to sell if their carrying amount will be recovered principally through a sale transaction rather than through continuing use. Non-current assets (including those that are part of a disposal group) are not depreciated or amortised while they are classified as held for sale. Interest and other expenses attributable to the liabilities of a disposal group classified as held for sale continue to be recognised. Non-current assets classified as held for sale and the assets of a disposal group classified as assets held for sale are presented separately, as current assets, from the other assets in the balance sheet. The liabilities of a disposal group classified as held for sale are presented separately, as current liabilities, from other liabilities in the balance sheet.
n) Borrowings
Borrowings are initially recognised at fair value, net of transaction costs incurred. Borrowings are subsequently measured at amortised cost. Any difference between the proceeds (net of transaction costs) and the redemption amount is recognised in the income statement over the period of the borrowings using the effective interest method. Convertible bonds are separated into liability and derivative liability components (being the bondholders conversion option) and each component is recognised separately. On initial recognition, the fair value of the liability component of a convertible bond is determined using a market interest rate for an equivalent non convertible bond. This amount is recorded as a liability on an amortised cost basis using the effective interest method until extinguished on conversion or maturity of the bonds. The fair value of the derivative liability component (see also 1 (q)) is determined using a Black-Scholes option pricing model, and this amount is recorded as a liability. Borrowings are removed from the balance sheet when the obligation specified in the contract is discharged, cancelled or expired. The difference between the carrying amount of a financial liability that has been extinguished or transferred to another party and the consideration paid, including any non-cash assets transferred or liabilities assumed, is recognised in finance income or costs. 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.
o) Borrowing costs
Borrowing costs incurred for the construction of any qualifying asset are capitalised during the period of time that is required to complete and prepare the asset for its intended use or sale. Other borrowing costs are expensed. The capitalisation rate used to determine the amount of borrowing costs to be capitalised is the weighted average interest rate applicable to the Groups outstanding borrowings during the year. For the year ended 31 December 2007, this was 10.70% (31 December 20062.64%).
r) Revenue recognition
Revenue from the sale of petroleum and natural gas is recorded when the significant risks and rewards of ownership of the product is transferred to the buyer. For sales of oil and gas this is usually when legal title passes to the external party. Interest income is recognised on a time proportion basis using the effective interest method. Drilling services revenue relates to the provision of drilling services in respect of the drilling rig.
s) Income taxes
Current income tax is based on taxable profit for the year. Taxable profit differs from profit as reported in the income statement because it excludes items that are never taxable or deductible. The Groups current tax assets and liabilities are calculated using tax rates that have been enacted or substantively enacted by the balance sheet date. Deferred income tax is provided in full, using the liability method, on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the consolidated financial statements. Deferred income tax is determined using tax rates (and laws) that have been enacted or substantively enacted by the balance sheet date and are expected to apply when the related deferred income tax asset is realised or the deferred income tax liability is settled. Deferred tax assets are recognised for deductible temporary differences and unused tax losses only if it is probable that future taxable amounts will be available to utilise those temporary differences and losses. Deferred tax assets and liabilities are offset when there is a legally enforceable right to offset current tax assets and liabilities and when the deferred tax balances relate to the same taxation authority.
v) Share capital
Common Shares are classified as share capital. Incremental costs directly attributable to the issue of new shares or options are shown in equity as a deduction, net of tax, from the proceeds. If the Corporation reacquires its own equity instruments the cost is deducted from equity and the associated shares are cancelled.
2 Risk management
The Groups activities expose it to a variety of financial risks that arise as a result of its exploration, development, production, and financing activities. The Groups overall risk management programme focuses on the unpredictability of financial markets and seeks to minimise potential adverse effects on the Groups financial performance.
The loss for the year would increase/decrease as a result of commodity revenues received.
v) Liquidity risk
Liquidity risk is the risk that the Group will not have sufficient funds to meet liabilities. Cash forecasts identifying liquidity requirements of the Group are produced quarterly. These are reviewed regularly to ensure sufficient funds exist to finance the Corporations current operational and investment cash flow requirements. Management monitors rolling forecasts of the Corporations liquidity reserve on the basis of expected cash flow. The Group had available cash of $230 million at 31 December 2007. Based on its current plans and knowledge, its projected capital expenditure and operating cash requirements, the Group projects available cash at 31 December 2008 of approximately $122 million. The Corporations financial liabilities consist of trade and other payables and borrowings. Trade and other payables are due within 12 months, and borrowings fall due as outlined in note 25.
Total borrowings Less cash and cash equivalents Net debt (cash) Total equity Total capital Gearing ratio
104,047,406 216,434,761 15 (46,861,146) (230,089,323) 57,186,260 (13,654,562) 42,726,467 193,193,432 99,912,727 193,193,432 57% 0%
This decrease in the gearing ratio during 2007 resulted primarily from the issue of shares (note 19).
b) Reserve estimates
Estimates of recoverable quantities of proven and probable reserves include assumptions regarding commodity prices, exchange rates, discount rates, production and transportation costs for future cash flows. It also requires interpretation of complex and difficult geological and geophysical models in order to make an assessment of the size, shape, depth, and quality of reservoirs and their anticipated recoveries. The economic, geological and technical factors used to estimate reserves may change from period to period. Changes in reported reserves can impact asset carrying values and the asset retirement obligation due to changes in expected future cash flows. Reserves are integral to the amount of depletion charged to the income statement and the calculation of inventory. The level of estimated commercial reserves is also a key determinant in assessing whether the carrying value of any of the Groups development and production assets has been impaired.
ii) Derivatives
Derivatives are recognised initially at fair value; attributable transaction costs are recognised in the profit or loss when incurred. Subsequent to initial recognition, derivatives are measured at fair value. Embedded derivatives are separated from the host contract and accounted for separately if the economic characteristics and risks of the host contract and the embedded derivative are not closely related, a separate instrument with the same terms as the embedded derivative would meet the definition of a derivative, and the combined instrument is not measured at fair value through the income statement. The fair value of derivative financial instruments is based on their listed market prices, if available. If a listed market price is not available, then fair value is estimated by discounting the difference between the contractual forward price and the current forward price for the residual maturity of the contract using a risk free interest rate (based on government bonds).
4 Segment information
The Group has a single class of business which is international exploration, development and production of petroleum oil and natural gas. The Group operates in a number of geographical areas based on location of operations and assets, being Russia, Oman, Uganda, DRC, Congo, Kurdistan Region of Iraq, Pakistan, Malta and Mali.
External revenue $ Segment result $ Year ended 31 December 2006 Total Total assets liabilities $ $ Capital additions $ Depreciation, depletion and amortisation $
Russia Oman Uganda1 DRC Congo2 Kurdistan Region of Iraq3 Pakistan Unallocated Corporate
(3,698) 23,395,149 716,322 10,439,341 428,129 46,537,931 (51,552) 35,468 12,449,190 5,157,646 (3,556,202) (715,776) (37,634,168) 61,208,338
External revenue $
Segment result $
Capital additions $
Russia Oman Uganda1 DRC Kurdistan Region of Iraq Pakistan Malta Mali Unallocated Corporate
1 2 3
1,717,717 (2,653,941) 46,384,681 2,874,575 1,991,786 1,027,069 13,817,039 331,379 (38,359) 92,398,347 6,036,508 1,296,220 (2,273,220) 1,622,934 (311,778) 952,406 (32,846) 6,517,779 (159,947) 213,145 2,648,691 (78,722,573) 246,425,642 207,192,299 6,358,194 (83,165,595) 409,628,193 216,434,761
24,306,477 4,408,453 32,993,911 710,751 1,622,934 952,406 6,517,779 213,146 11,765,343 83,491,200
Uganda includes exploration activity as well as revenue and operating profit from drilling services. Revenues and expenses from Congo have been included as discontinued operations in the income statement. Kurdistan Region of Iraq information was not a separate geographic segment as defined in note 1(e) until October 2007. However, information was presented for clarity.
Exploration expenditures in respect of E&E assets relate to pre-licence costs which are expensed in accordance with IFRS 6.
Interest on long-term debt Interest on convertible bonds Accretion of convertible debt Accretion of asset retirement obligation Amount capitalised Finance costs expensed
Net loss before tax Standard tax rate Tax on loss at standard rate Change in statutory tax rate Effective lower tax rates in foreign jurisdiction Expenses not deductible for tax purposes Foreign exchange gains (losses) Effect of tax losses not recognised Current tax charge
(28,367,755) (83,165,595) 34.70% 32.12% (9,843,611) (26,712,789) 468,887 1,165,447 192,485 215,472 7,882,589 22,010,883 84,624 (687,333) 1,215,026 4,008,320
The balance comprises temporary differences attributable to: Available tax losses and deductions Deferred tax asset (unrecognised) 7 Staff costs
16,639,282 16,639,282
24,011,654 24,011,654
The average number of employees (including executive directors) employed by the Group during the year, analysed by category was:
Year ended 31 December 2006 2007
Canada Switzerland Russia United Kingdom Uganda Kurdistan Region of Iraq South Africa Total
3 25 13 21 7 3 72
1 3 41 14 21 5 4 89
Salaries and other short-term benefits Share-based compensation Total employee remuneration
8 Discontinued operations
On 6 June 2006, the Group entered into an agreement to sell Heritage Congo Limited which held all of the Groups interests in the Noumbi Exploration Permit and the Kouakouala A and B licences in the Republic of Congo (Congo) to Afren PLC, subject to a number of conditions precedent and pre-emption rights. During 2006, the Groups partners in the Kouakouala A and B licences exercised their pre-emption rights in respect of the sale of these assets. Accordingly, the Group sold these assets to three separate public entities later in 2006. On 22 November 2006, the Group completed the sale of Heritage Congo Limited, which held a 14% working interest in the Noumbi Exploration Permit, to Afren PLC (Afren) for the following consideration: a) Cash of $21,000,000; and b) 1,500,000 Afren warrants, with a term of five years and an exercise price of 0.60 per share. The fair value of the Afren warrants, determined by using the Black-Scholes model, was $719,380 at the date of sale (note 13). On 18 January 2007, the Group finalised the statement of adjustments relating to the sale of its 25% working interest in the Kouakouala A and 30% working interest in the Kouakouala B licence in Congo to the other partners in the licences, Maurel et Prom and Burren Energy, for the following consideration: a) Cash of $6,052,515; and b) An overriding royalty of 15% over a 30% working interest in the Kouakouala B licence in relation to the Mengo field. The Mengo field is not in production. All of the disposition agreements were completed by 12 December 2006. The gain on disposal of all of the Groups interests in the Congo was $9,200,700 in 2006. As at 31 December 2006, accounts receivable included $5,157,646 relating to the unpaid portion of the sales proceeds, which was received in January 2007. The results of operations in Congo have been classified as earnings from discontinued operations. The following table provides additional information with respect to the amounts included in the earnings from discontinued operations.
Period ended 12 December 2006 $
Revenue Petroleum and natural gas Other Expenses Operating Royalties Depletion, depreciation and accretion
The following table provides additional information with respect to the amounts included in the balance sheet as assets of the disposal group held for sale.
Notes Period ended 12 December 2006 $
Assets Non-current assets Intangible exploration assets Property, plant and equipment Liabilities Current liabilities Trade and other payables Non-current Provisions Net assets
10 12
18
Total disposal consideration Less: carrying amount of net assets sold Gain on disposal 9 Disposals
On 9 March 2007, the Group disposed of its previously consolidated 65% interests in Natural Pipelay Worldwide Limited (NPWL) and Naturalay Technologies Limited (Naturalay) in consideration for 605,000 common shares in a private company named SeaDragon. The fair value of the common shares consideration received of $2,420,000, which was based on the most recent private placement by SeaDragon in October 2006, resulted in a gain of $1,077,132 on the disposal. The Groups CFO is a director and CFO of SeaDragon. Below is an analysis of the assets and liabilities of NPWL and Naturalay as at 9 March 2007, the date of sale completion:
$
Assets Intangible development costs Liabilities Trade and other payables Net assets
The gain on disposal of the previously consolidated subsidiary has been derived as follows:
Consideration received or receivable Fair value of shares Total disposal consideration Gain on disposal of subsidiaries 10 Intangible exploration assets
Notes
Balance-beginning of year Exchange differences Additions Assets transferred to property, plant and equipment Assets transferred to disposal group held for sale Balance end of year
12 8
54,767,332 102,862,754
No assets have been pledged as security. The balances at the end of the years are as follows:
31 December 2006 2007 $ $
Russia Oman Uganda DRC Kurdistan Region of Iraq Pakistan Malta Mali Balance end of year
54,767,332 102,862,754
31 December 2006 2007 $ $
Cost Accumulated amortisation Net book amount Net book amountbeginning of year Additionsinternal development Disposalssale of subsidiaries Net book amountend of year
Intangible development costs, such as personnel and production expenses, are related to the development of the Buoyant Drum Lay System (Pipelay System). As the Pipelay System development was not complete, amortisation had not commenced before the disposal of the subsidiaries.
Petroleum and natural gas interests Drilling and barge equipment Land and building Other
Property, plant and equipment, at cost Accumulated depletion and depreciation Net book amount
Reconciliation of movements during the year Petroleum and natural gas interests Cost-beginning of year Accumulated depletion and depreciation beginning of year Net book amount beginning of year Net book value beginning of year Exchange differences Additions Assets transferred from intangible exploration Assets transferred to discontinued operations Depletion and depreciation Net book amount end of year
10 8
9,952,411 15,039,250 103,065 335,094 14,128,855 14,137,329 1,133,000 9,493,106 (8,638,125) (1,639,956) (929,472) 15,039,250 38,075,307 18,091,216 42,056,745 (3,051,966) (3,981,438) 15,039,250 2,693,618 (171,728) 2,521,890 2,521,890 851,351 (176,013) 3,197,228 3,544,969 (347,741) 3,197,228 11,984,701 (173,973) 11,810,728 11,810,728 (139,178) 11,671,550 38,075,307 3,544,969 (347,741) 3,197,228 3,197,228 (1,799,762) 1,397,466 3,544,969 (2,147,503) 1,397,466 11,984,701 (313,151) 11,671,550 11,671,550 (139,178) 11,532,372
Cost end of year Accumulated depletion and depreciation end of year Net book amount end of year Drilling and barge equipment Cost beginning of year Accumulated depletion and depreciation beginning of year Net book amount beginning of year Net book amount beginning of year Additions Depletion and depreciation Impairment Net book amount end of year
Cost end of year Accumulated depletion and depreciation end of year Net book amountend of year Land and building Costbeginning of year Accumulated depletion and depreciation beginning of year Net book amount beginning of year Net book amount beginning of year Depletion and depreciation Net book amount end of year
Notes
Cost end of year Accumulated depletion and depreciation end of year Net book amount end of year Other Cost beginning of year Accumulated depletion and depreciation beginning of year Net book amount beginning of year Net book amount beginning of year Additions Depletion and depreciation Net book amount end of year
11,984,701 (313,151) 11,671,550 1,176,671 (179,148) 997,523 997,523 1,510,919 (229,372) 2,279,070
11,984,701 (452,329) 11,532,372 2,687,590 (408,520) 2,279,070 2,279,070 11,765,343 (823,640) 13,220,773
Cost end of year Accumulated depletion and depreciation end of year Net book amount end of year
The corporate office which represents the land and building category serves as security for a long-term loan (note 17). The carrying value of the drilling rig was written down to its estimated fair value based on third party quoted sales prices. This resulted in an impairment write down of $1,799,762 recognised in the income statement during the year ended 31 December 2007.
8 9
914,558 914,558
The investment in Afren warrants is classified as held for trading. The investment in unlisted securities represents common shares in a private company named SeaDragon, which is classified as available-for-sale. There were no other disposals (see note 9) or impairment losses on held for trading or available-for-sale financial assets in the reporting years under these financial statements. The fair value of unlisted shares of SeaDragon is based on the most recent private placement of SeaDragon on 26 October 2006. The directors consider that there has been no change in the fair value of these shares since this date.
Trade and other receivables are due within 30 days from the invoice date. No interest is charged on the receivables. The carrying amount of trade and other receivables approximates their fair value. The maximum exposure to credit risk at the reporting date is the fair value of each class of receivable. As of 31 December 2007, trade receivables of $6,759,261 (31 December 2006: $9,839,506) were neither past due nor impaired. These relate to a number of independent customers for whom there is no recent history of default. The ageing analysis of these trade and other receivables is as follows:
31 December 2006 2007 $ $
Up to 3 months 3 to 6 months
46,861,146 230,089,323
Trade and other payables and accrued liabilities comprise current amounts outstanding for trade purchases and ongoing costs. The carrying amount of trade and other payables approximates their fair value.
17 Borrowings
Non-current borrowings Convertible bonds unsecured Non-current portion of long-term debt Long-term debt secured Current Non-current 2006 convertible bonds
54,715,050 137,213,274 8,409,793 17,040,427 63,124,843 154,253,701 147,720 8,409,793 8,557,513 623,640 17,040,427 17,664,067
On 27 March 2006, the Corporation issued 600 unsecured convertible bonds each with a par value of $100,000 for aggregate proceeds of $60,000,000. Issue costs amounted to $3,000,000 resulting in net proceeds of $57,000,000. The bonds bear a coupon rate of 10% per annum and a term of five years and one day. On maturity, any bonds outstanding are redeemed for cash. At the option of the holders, the bonds are convertible, in whole or in part, into Common Shares at a price of US$18.00 per share at any time during the term of the bonds. The Corporation could redeem, in whole or part, the bonds for cash at any time on or before 28 March 2007 at 150% of par value. Pursuant to the bond agreement, the Group is required to maintain an equity to debt, net of cash and cash equivalent, ratio of no less than 0.65:1.00. The proceeds of the bond can be employed for development of the Zapadno Chumpasskoye field in Russia and for general corporate purposes. The bonds included conversion features which in certain circumstances could be settled in cash and so these features represent a derivative financial instrument which is classified as a liability. The fair value of the liability component of the bonds (net of issue costs) was estimated at $53,862,435. The fair value of the derivative financial liability representing the bondholders conversion feature (note 23) (net of issue costs) was estimated at $3,137,565 on 27 March 2006. The difference between the $60,000,000 principal amount due on maturity and the recorded liability component is accreted and recorded as finance costs using the effective interest method. The derivative financial instrument is recorded at fair value with resulting gains and losses recorded in finance income and costs. On 17 January 2007, the Corporation gave notice that it had exercised its option to redeem 550 outstanding bonds at 150% of par value for total proceeds of $82,500,000 plus accrued interest which was paid on 28 March 2007. This resulted in the recognition of a loss of $7,155,622 on the redemption, net of transaction costs, on the recorded liability and derivative liability. Previously, early in 2007, 50 bonds, with a total par value of $5,000,000, had been converted into 277,778 Common Shares. As a result of this conversion, a total amount of $7,104,327 was transferred to Share Capital from the convertible bonds and derivative liability of the convertible bonds.
Long-term debt
In January 2005, a wholly-owned subsidiary of the Corporation received a sterling denominated loan of 4.5 million to refinance the acquisition of a corporate office. Interest on the loan is fixed at 6.515% for the first five years and is then variable at a rate of London Interbank Offered Rate (LIBOR) plus 1.35%. The loan, which is secured on the property, is scheduled to be repaid by 240 installments of capital and interest at monthly intervals, subject to a residual debt at the end of the term of the loan of $3.5 million (1,860,000). The current principal balance outstanding as at 31 December 2007 was $8,519,037 (4.3 million) (31 December 2006: $8,557,513 (4.4 million)). In October 2007, a wholly-owned subsidiary of the Corporation received a loan of $9,450,000 to refinance the acquisition of the corporate jet. Interest on the loan is variable at a rate of LIBOR plus 1.6%. The loan, which is secured on the corporate jet, is scheduled to be repaid by 19 consecutive quarterly installments of principal. Each instalment equals to $117,500 with the final installment being $7,217,500. The Corporation provided a corporate guarantee to the lender.
Fair values
At 31 December 2006 and 31 December 2007, the fair values of borrowings are approximately equal to their carrying amounts as the facilities bear interest at market rates of interest.
18 Provisions
The Groups asset retirement obligation results from net ownership interests in petroleum and natural gas assets including well sites and gathering systems. The Group estimates the total undiscounted inflation adjusted amount of cash flows required to settle its asset retirement obligation to be approximately $573,657, which is expected to be incurred in the period from 2012 to 2024. A cost pool specific discount rate, related to the liability, of 9% was used to calculate the fair value of the asset retirement obligation in 2007 (2006: 10%). A reconciliation of the asset retirement obligation is provided below:
Notes 31 December 2006 2007 $ $
Balance beginning of year Additions Revision (due to change in discount rate) Accretion expense Liabilities transferred to discontinued operations 19 Share capital
5 8
The authorised share capital has unlimited number of Common Shares without par value.
Notes 31 December 2006 Number Amount $ 31 December 2007 Number Amount $
Balance beginning of year Issue of shares Issued on exercise of stock options Issued on conversion of bonds Balance end of year
22 17
22,009,034 24,580,984 3,000,000 175,963,414 52,000 1,079,031 426,715 16,048,814 25,487,749 217,672,243
On 14 November 2007, the Corporation closed an equity offering of 3,000,000 Common Shares which were issued at a price of Cdn$60.50 per Common Share for gross proceeds of $186,436,800 (Cdn$181.5 million) to the Company. Share issue costs were $10,473,386. In addition, Albion Energy Limited sold 3,000,000 Common Shares at a price of Cdn$60.50 per Common Share for gross proceeds of $186,436,800 (Cdn$181.5 million). The ultimate owner of Albion Energy is Mr. Anthony Buckingham, a director and Chief Executive Officer of the Corporation. Subsequent to the year-end there was a 1 for 10 share split that took place as part of the corporate reorganisation described in note 27.
Available-for-sale investments revaluation reserve Foreign currency translation reserve Share-based payments reserve
(4,003)
168,000 430,580
Movements Available-for-sale investments revaluation reserve Balance beginning of year Revaluation Balance end of year Foreign currency translation reserve Balance beginning of year Currency translation differences arising during year Balance end of year Share-based payments reserve Balance beginning of year Compensation costs options issued Transfer to share capital on exercise of options Options forfeited Balance end of year
(4,003) (4,003)
Balance beginning of year Premium on repurchase and cancellation of Common Shares Net loss for the year Balance end of year
The following table summarises the weighted average Common Shares used in calculating net earnings per share:
The weighted average number of shares has been adjusted to reflect the effective 1 for 10 share split that took place as part of the corporate reorganisation described in note 27. The reconciling item between basic and diluted weighted average number of Common Shares is the dilutive effect of stock options and convertible bonds. A total of nil options (31 December 2006: 5,350,000) and 33,617,020 of shares relating to the convertible bonds (31 December 2006: 33,333,333) were excluded from the above calculation, as they were anti-dilutive.
Balance beginning of year Granted Exercised Forfeited Balance end of year Exercisable end of year
Exercise price (Cdn)
19
During the year ended 31 December 2007, the weighted average share price at the date of option exercise was Cdn$46.12 (31 December 2006: Cdn$19.58). The fair value of each stock option grant on the date of grant was estimated using the Black-Scholes option pricing model with the following weighted average assumptions and results. The fair value of stock options is amortised over the vesting year of the option.
Weighted average assumption and results Risk free interest rate (%) Volatility (%) Dividend yield (%) Expected life (years) Grant date fair value (Cdn$) 23 Derivative financial liability
27,997,140
36,739,990
For details of the convertible bond, refer to note 17. The fair value of the convertible bonds conversion option has been estimated using the Black-Scholes option pricing model at each period end, with changes in the fair value of the conversion option recognised in income during the period. The expected life of the conversion option has been adjusted to reflect the bondholders put option and the Corporations redemption option as detailed in note 17.
Total repayments of borrowings Operating leases Other long-term obligations Work programme obligations Total contractual obligations
The Corporation may have a potential residual obligation to satisfy any shortfall in officers and former officers secured real estate borrowings in the event of default, a shortfall on the proceeds from the disposal of the properties and the individuals being unable to repay the balance. The value of the residual obligation was estimated as insignificant.
In many of the countries in which the Group operates, land title systems are not developed to the extent found in many industrial countries and there may be no concept of registered title. Although the Group believes that it has title to its oil and gas properties, it cannot control or completely protect itself against the risk of title disputes or challenges. There can be no assurance that claims or challenges by third parties against the Groups properties will not be asserted at a future date. The Group received a letter from the Iraq Ministry of Oil dated 17 December 2007 stating that the Production Sharing Contract (PSC) signed with the Kurdistan Regional Government (KRG) without the prior approval of the Iraqi government is considered to be void by the Iraqi government as they have stated it violates the prevailing Iraqi law. On the basis of KRG legal advice, the Directors believe that the PSC is valid and effective pursuant to the applicable laws. In addition, the DRC work programme pursuant to the DRC PSC cannot be commenced prior to the grant of a Presidential Decree from the DRC government. There can be no assurance that final approval or ratification will ever be received in respect of the DRC PSC or that the pre-agreed fiscal terms will not be re negotiated at a later date by the DRC Government. Furthermore, the Group received a letter from the chairman of the Management Committee of the National Oil Corporation of Libya dated 28 February 2008 stating that the Block 7 licence area lies within the Libyan continental shelf and a portion of this area has already been licensed to Sirte Oil Company. This letter also demands that the Group refrain from any activities over or concerning the Block 7 licence area and asserts the Libyan governments right to invoke Libyan and international law to protect its rights in the Block 7 licence area. The directors believe that the Libyan governments claims are unfounded.
Capitalised portion of share-based compensation Non-cash property, plant and equipment additions relating to the capitalised portion of share-based compensation Non-cash portion of sales proceeds on disposal of discontinued operations Receipt of warrant as part of the sales proceeds from the disposal of discontinued operations Disposition of subsidiaries Gain on disposal of subsidiaries Receipt of SeaDragon shares as a proceeds for disposal of subsidiaries Receipt of SeaDragon shares as a result of the issuance of the Corporations guarantee for a third partys debt Accrual of payable representing the fair value of the Corporations guarantee issued for a third partys debt 27 Subsequent events
9 9 9
On 24 March 2008, the Corporation entered into a corporate reorganisation which resulted in a newly incorporated company, Heritage Oil Limited (Heritage Jersey), becoming the parent company of the Corporation and its current subsidiaries. Heritage Jerseys corporate head office is now located in the Channel Islands and Heritage Jersey is subject to the Companies (Jersey) Law 1991 (as amended). In connection with the reorganisation, Heritage Jersey listed its ordinary shares (Heritage Jersey Shares) on the Official List of the United Kingdom Listing Authority (the UKLA) and trades on the Main Market of the London Stock Exchange plc (the LSE) (collectively, Admission). The Corporation has delisted its existing Common Shares (Heritage Shares) from the Toronto Stock Exchange (the TSX) and obtained a listing for a new class of exchangeable shares (the Exchangeable Shares) on the TSX. As part of the reorganisation, implemented by way of court-approved plan of arrangement (the Arrangement) under the Business Corporations Act (Alberta), the Corporation split its stock such that each existing Heritage Share was exchanged for either ten Heritage Jersey Shares or ten Exchangeable Shares in accordance with the terms of the Arrangement. On 2 April 2008, the Corporation and Heritage Oil Limited collectively, together with their subsidiaries and affiliates, jointly announced that Articles of Arrangement implementing the previously announced Arrangement involving the Corporation and Heritage Jersey had been filed with the Registrar of Corporations for the Province of Alberta with an effective date of 31 March 2008. As a result, former holders of Common Shares of the Corporation were entitled to either 10 Ordinary Shares of Heritage Jersey or 10 Exchangeable Shares of the Corporation for each Common Share held depending on the elections previously made by such shareholders. Effective at the opening of business on 3 April 2008, the Exchangeable Shares were listed and posted for trading in substitution for the previously listed Common Shares of the Corporation which were delisted at that time. The Exchangeable Shares were also admitted to trading on the Main Market of the LSE on 2 April 2008. Trading of Heritage Jersey shares commenced on the LSE on 31 March 2008.
In connection with this reorganisation Heritage Jersey has agreed that the 2007 convertible bonds outstanding were convertible with shares of Heritage Jersey rather than shares of the Corporation. On 11 April 2008, Heritage Jersey announced signing of documentation to farm-in to two exploration licences in Tanzania. The licences, known as the Kimbiji and Latham Areas are held under one production sharing agreement (PSA). The PSA was awarded by way of a competitive tender process to Petrodel Resources Ltd (Petrodel) by the Tanzanian Government in September 2006 with exploration periods of four years, followed by extensions of four years and three years respectively, with the right to a development licence with a term of 25 years. Under the terms of the farm-in agreement with Petrodel, a wholly-owned subsidiary of Heritage Jersey has the right to earn a 70% working interest in the Kimbiji Area, and a 29.9% working interest in the Latham Area. In order to earn the working interests, Heritage will fund all seismic costs of the required work programmes on both blocks, comprising the acquisition of both 2D and 3D seismic data, and the drilling of two exploration wells within the Kimbiji Area. Heritage will be appointed operator upon drilling the second exploration well in the Kimbiji Area. Total exploration costs for the initial exploration term for the two licences are estimated at approximately $17.5 million for the Kimbiji Area and between $5 million and $12 million for the Latham Area. On 21 April 2008, Heritage Jersey announced the signing of documentation to farm-in to two further exploration licences in Tanzania. The licences, known as the Kisangire and Lukuliro Areas are held under one PSA. Heritage will be appointed as operator. The farm-in agreement and appointment of a wholly-owned subsidiary of Heritage as operator are subject to the approval of the Government of Tanzania. The PSA was originally awarded to Dominion Oil & Gas Limited (Dominion) in May 2005, with an exploration period of four years, followed by one extension of four years, a further extension of three years and the right to a development licence with a term of 25 years. Under the terms of the farm-in agreement with Dominion, Heritage has the right to initially earn a working interest of 55% in both the Kisangire and Lukuliro licences. In order to earn the working interests, Heritage will fund all costs to acquire a minimum of 150 kilometres of 2D seismic data and the costs of the first commitment well. Heritage also has an option to earn an additional working interest of 15% thereby increasing its participating interest to 70% by funding 87.5% of the costs of a second well. The minimum exploration expenditure required under the PSA during the first exploration period, which includes seismic acquisition and the drilling of two wells, is $10 million.
Notes
Previous CGAAP $
IFRS $
Assets Non-current assets Intangible exploration assets Intangible development costs Property, plant and equipment Current assets Inventories Prepaid expenses Trade and other receivables Cash and cash equivalents
32,725,642 32,725,642 1,013,012 (32,306,191) 21,776,906 419,451 24,976 24,976 444,427 55,515,560 119,459 272,168 8,920,963 16,235,523 25,548,113 81,063,673
Liabilities Current liability Trade and other payables Non-current liability Provisions Equity Share capital Reserves Retained earnings
(a)(c)(d)(g)
At the end of the comparative period under previous CGAAP 31 December 2005
Notes
Previous CGAAP $
IFRS $
Assets Non-current assets Intangible exploration assets Intangible development costs Property, plant and equipment Current assets Inventories Prepaid expenses Trade and other receivables Cash and cash equivalents
43,503,704 43,503,704 1,187,371 1,187,371 74,729,540 (49,446,988) 25,282,552 75,916,911 216,474 219,222 1,318,450 8,583,321 10,337,467 86,254,378 (5,943,284) 69,973,627 35,441 35,441 251,915 219,222 1,318,450 8,583,321 10,372,908
(5,907,843) 80,346,535
Liabilities Current liabilities Trade and other payables Borrowings Non-current liabilities Borrowings Deferred tax liabilities Provisions
(f)
4,438,649 248,045 4,686,694 7,520,438 2,346,605 434,849 10,301,892 14,988,586 22,854,418 517,209 47,894,165 71,265,792
(e) (a),(c),(d),(e),(g)
Notes
Previous CGAAP $
IFRS $
841,766 342,359 1,184,125 465,110 196,804 5,249,649 1,170,906 536,093 724,915 8,343,477 330,290 (491,824) (161,534) (7,320,886) 3,521,073 (3,799,813)
841,766 342,359 1,184,125 465,110 196,804 5,706,396 1,170,906 738,630 4,517,411 12,795,257 330,290 (491,824) (161,534)
Expenses Petroleum and natural gas Drilling rig operating General and administrative Foreign exchange losses Depletion, depreciation and amortisation Exploration expenditure Impairment of unproved petroleum and natural gas interest Finance income (costs) Interest income Finance costs
Loss from continuing operations Earnings from discontinued operations Net loss
Reconciliation of cash flow statement for the year ended 31 December 2005
Notes
Previous CGAAP $
IFRS $
Cash provided by (used in) Operating activities Net loss from continuing operations Items not involving cash Depletion, depreciation and amortisation Finance costs accretion expenses Foreign exchange losses Share-based compensation Impairment of unproved petroleum and natural gas properties Increase in trade and other receivables Decrease in prepaid expenses Increase in inventory Increase in trade and other payables Discontinued operations
(7,320,886) 536,093 480,253 625,365 724,915 (258,398) 1,921,678 (98,878) 52,946 (3,336,912) 4,034,035 697,123 (16,289,772) (174,359) (16,464,131) 279,782 (16,184,349) 1,423,011 8,577,350 (876,217) (103,997) 9,020,147 (1,185,123) (7,652,202) 16,235,523 8,583,321
(4,451,780) (11,772,666) 202,537 456,747 (724,915) (4,517,411) (4,517,411) 13,721,708 (9,204,297) 4,517,411 4,517,411 738,630 480,253 1,082,112 (258,398) 1,921,678 (98,878) 52,946 (7,854,323) 4,034,035 (3,820,288) (2,568,064) (9,204,297) (174,359) (11,946,720) 279,782 (11,666,938) 1,423,011 8,577,350 (876,217) (103,997) 9,020,147 (1,185,123) (7,652,202) 16,235,523 8,583,321
Investing activities Property, plant and equipment expenditures Intangible exploration expenditures Development expenditures Discontinued operations
Financing activities Shares issued for cash Long-term debt Purchase of Common Shares for cancellation Repayment of long-term debt
Foreign exchange losses on cash held in foreign currency Decrease in cash and cash equivalents Cash and cash equivalents beginning of year Cash and cash equivalents end of year
At the end of the last reporting period under previous CGAAP 31 December 2006
Notes
Previous CGAAP $
IFRS $
Assets Non-current assets Intangible exploration assets Intangible development costs Property, plant and equipment Deferred financing fees Other financial assets Current assets Inventories Prepaid expenses Trade and other receivables Cash and cash equivalents
Liabilities Current liabilities Trade and other payables Borrowings Non-current liabilities Borrowings Provisions Deferred tax liabilities Derivative financial liability
23,249,854 104,047,406
79,629,903 (36,903,436) 42,726,467 27,865,874 (3,284,890) 24,580,984 2,533,532 103,526 2,637,058 49,230,497 (33,722,072) 15,508,425 79,629,903 (36,903,436) 42,726,467
Notes
Previous CGAAP $
IFRS $
(e) (k) (d)(g) (a) (a) (h) (h) (i) (j) (g)(h) (f)
3,938,512 2,895,727 6,834,239 723,611 2,291,585 8,977,345 798,194 691,011 986,964 14,468,710
3,938,512 2,895,727 6,834,239 723,611 2,291,585 8,628,127 627,005 1,351,987 6,066,977 19,689,292
Expenses Petroleum and natural gas Drilling rig operating General and administrative Foreign exchange losses (gains) Depletion, depreciation and amortisation Exploration expenditure Impairment of unproved petroleum and natural gas Finance income (costs) Interest income Finance costs Loss on derivative liability Unrealised gain on other financial assets
1,767,898 (431,547) 1,336,351 (5,996,553) 1,354,427 (4,642,126) (24,851,295) (24,851,295) 195,178 195,178 (4,228,655) (23,733,237) (27,961,892) (11,863,126) (28,953,819) (40,816,945) 9,950,968 (750,268) 9,200,700 3,248,490 3,248,490 1,336,332 (29,704,087) (28,367,755)
Loss from continuing operations Gain (loss) on disposal of discontinued operations Earnings from discontinued operations Net loss
Reconciliation of cash flow statement for the year ended 31 December 2006
Notes
Previous CGAAP $
IFRS $
Cash provided by (used in) Operating activities Net loss from continuing operations Items not involving cash Depletion, depreciation and amortisation Finance costs accretion expenses Foreign exchange losses Share-based compensation Impairment of unproved petroleum and natural gas properties Gain on other financial assets Loss on derivative financial instruments Increase in trade and other receivables Increase in prepaid expenses Decrease in inventory Increase in trade and other payables Discontinued operations
(11,863,126) (28,953,819) (40,816,945) 691,011 660,976 1,351,987 860,895 (213,442) 647,453 593,837 (171,189) 422,648 1,483,945 (66,901) 1,417,044 986,964 (986,964) (195,178) (195,178) 24,851,295 24,851,295 (972,251) (972,251) (312,051) (312,051) 142,809 142,809 725,738 725,738 (7,662,229) 3,748,853 (3,913,376) (5,075,222) (5,075,222) (12,737,451) 3,748,853 (8,988,598)
Investing activities Property, plant and equipment expenditures Intangible exploration expenditures Intangible development expenditures Discontinued operations
(a)(b)(h) (33,512,387) (a)(b)(h) (386,668) (33,899,055) 17,576,116 (16,322,939) 1,318,945 60,000,000 (3,000,000) (287,759) 58,031,186 37,794,871 8,583,321 482,954 46,861,146
21,247,324 (12,265,063) (16,172,102) (16,172,102) (386,668) 5,075,222 (28,823,833) 17,576,116 5,075,222 (11,247,717) 1,318,945 60,000,000 (3,000,000) (287,759) 58,031,186 37,794,871 8,583,321 482,954 46,861,146
Financing activities Shares issued for cash Convertible bonds Convertible bond issue costs Repayment of long-term debt
Decrease in cash and cash equivalents Cash and cash equivalents beginning of year Foreign exchange gains on cash held in foreign currency Cash and cash equivalents end of year
d) Reversal of impairment
Under IFRS, impairment losses previously recorded are reversed if the conditions giving rise to the impairment have reversed. The reversal of impairment losses was not permitted under Canadian GAAP. The impact on adoption to IFRS at 1 January 2005 is an increase in inventory of $24,976, an increase in property, plant and equipment of $1,656,846, and an increase in retained earnings of $1,681,822. At 31 December 2005, this has resulted in increases in inventory of $35,441, property, plant and equipment of $1,442,748, retained earnings of $1,478,189, and depletion expense for the year of $203,633. At 31 December 2006, this has resulted in increases in inventory of $26,638, property, plant and equipment of $1,071,212, retained earnings of $1,097,850 and depletion expense for the year of $380,339.
e) Share-based payments
Under Canadian GAAP, the Group recognised an expense related to their share-based payments on a straight-line basis through the date of full vesting. Under IFRS, the Group is required to recognise the expense over the individual vesting periods for the graded vesting awards. At 31 December 2005, this has resulted in increases in general and administrative expenses and share-based payments reserves of $456,747, with a corresponding decrease in retained earnings. At 31 December 2006, this has resulted in increases in share-based payments reserves of $107,529, with a corresponding decrease in retained earnings. General and administrative expenses for the year decreased by $349,218.
f) Deferred tax
Under Canadian GAAP, the Corporation recognised a deferred tax liability and corresponding increase in property, plant and equipment associated with its acquisition of Russian properties. However, under IFRS deferred tax is only recognised on the initial recognition of an asset if it is acquired through a business combination. At 31 December 2005 and 31 December 2006, this has resulted in a reduction of property, plant and equipment and deferred tax liability of $2,346,605. There was no impact at 1 January 2005.
g) Depletion policy
Upon transition to IFRS, the Corporation adopted a policy of depleting petroleum and natural gas interests on a units of production basis over proved plus probable reserves. The depletion policy under Canadian GAAP was units of production over proved reserves. The impact on adoption to IFRS at 1 January 2005 is an increase in property, plant and equipment and retained earnings of $789,008. At 31 December 2005, this resulted in increases in property, plant and equipment and retained earnings of $743,642, and depletion expense for the year of $34,734, and a decrease in earnings from discontinued operations of $10,632. At 31 December 2006, this resulted in decreases in property plant and equipment of $233,631, retained earnings of $211,900, and earnings from discontinued operations of $674,905, and increases in inventory of $21,731, and depletion expense for the year of $280,637.
l) Convertible bonds
Under Canadian GAAP, the Corporations convertible bonds were initially recognised with an allocation between equity and liability components based on their relative fair values. IFRS requires the recognition of a liability and an embedded derivative liability representing the bond holders conversion option. The fair value of the derivative financial liability is subsequently measured at fair value at each period end with changes in fair value being recognised in income. At 31 December 2006, this has resulted in increases in derivative financial liabilities of $27,997,140 and a loss on derivative financial liabilities of $24,851,951, and decreases in other contributed equity of $3,145,845, and retained earnings of $24,851,295.
$ API
US dollars unless otherwise stated a specific gravity scale developed by the American Petroleum Institute for measuring the relative density of various petroleum liquids, expressed in degrees barrel barrels barrels per day billion cubic feet barrels of oil equivalent1 barrels of oil equivalent per day Heritage Oil Limited a company, incorporated in Jersey on 6 February 2008 and the ultimate holding company of Heritage and the other group subsidiaries low density, high API hydrocarbon liquids that are present in natural gas fields where it condensates out of the raw gas if the temperature is reduced to below the hydrocarbon dew point temperature of the raw gas the Democratic Republic of Congo gigajoules the Company and all of its subsidiaries Heritage Oil Corporation, incorporated in Canada and a wholly-owned subsidiary of the Company liquid petroleum gas cubic metres thousand barrels million barrels thousands of barrels of oil equivalent millions of barrels of oil equivalent thousand cubic feet thousand cubic feet per day million British thermal units million cubic feet million cubic feet per day million stock tank barrels natural gas liquids
Petroleum
any mineral, oil or relative hydrocarbon (including condensate and natural gas liquids) and natural gas existing in its natural condition in strata (but not including coal or bituminous shale or other stratified deposits from which oil can be extracted by destructive distillation) those additional reserves that are less certain to be recovered than Probable Reserves. It is unlikely that the actual remaining quantities recovered will exceed the sum of the estimated Proved plus Probable plus Possible Reserves
Possible Reserves
Probable Reserves those additional reserves that are less certain to be recovered than Proved Reserves. It is equally likely that the actual remaining quantities recovered will be greater or less than the sum of the estimated Proved plus Probable Reserves Proved Reserves those reserves that can be estimated with a high degree of certainty to be recoverable. It is likely that the actual remaining quantities recovered will exceed the estimated Proved Reserves production sharing contract or production sharing agreement pounds per square inch pounds per square inch absolute Society of Petroleum Engineers pounds per square inch Tullow Oil PLC West Texas Intermediate
condensate
DRC Gj Group Heritage, HOC or Corporation LPG m3 Mbbls MMbbls Mboe MMboe Mcf Mcf/d MMBtu MMcf MMcf/d MMstb NGLs
1: Boes may be misleading, particularly if used in isolation. A boe conversion ratio of 6 Mcf: 1 Bbl is based on an energy equivalency conversion method primarily applicable at the burner tip and does not represent a value equivalency at the wellhead.
Conversion
The following table sets forth standard conversions from Standard Imperial Units to the International System of Units (or metric units).
To Convert From To Multiply By
boes Mcf m3 bbls m3 Feet Metres Miles Kilometres Acres Hectares (Saskatchewan) Hectares (Alberta)
Mcfs m3 Cubic feet m3 bbls oil Metres Feet Kilometres Miles Hectares Acres Acres
6 28.174 35.494 0.159 6.290 0.305 3.281 1.609 0.621 0.405 2.471 2.500
Notes
Notes
Notes