Heritage Oil Plc
TSX : HOC
LSE : HOIL

Heritage Oil Plc

April 19, 2011 02:00 ET

Heritage Oil Announces Results for the Year Ended 31 December 2010

CALGARY, ALBERTA--(Marketwire - April 19, 2011) -

THIS PRESS RELEASE IS NOT FOR DISTRIBUTION TO UNITED STATES NEWSWIRE SERVICES OR FOR DISSEMINATION IN THE UNITED STATES.

Heritage Oil Plc (TSX:HOC)(LSE:HOIL) ("Heritage" or the "Company"), an independent upstream exploration and production company, announces its results for the twelve months ended 31 December 2010. All figures are in US dollars unless otherwise stated.

2010 Operational Highlights

  • Discovered the largest gas field in Iraq in the last 30 years
  • Highly productive Jurassic reservoir intervals tested in the Miran West-2 well at a restricted cumulative flow rate of over 75 million cubic feet per day ("MMscfd")
  • Estimated gross P90-P50 in-place volumes of 6.8–9.1 Trillion Cubic Feet ("TCF"), with a P10 upside of 12.3 TCF for Miran West
  • Management estimates Heritage has mean net risked contingent and prospective resources in Miran West and Miran East of 744 million barrels of oil equivalent ("MMboe"), based on a 75% working interest
  • Miran development options being considered with first export production targeted for 2015 using planned regional infrastructure
  • Achieved nearly a twelvefold increase in contingent resources from 53 MMbbls to 605 MMboe following the successful testing of hydrocarbons
  • Completed 3D seismic acquisition offshore Tanzania; data currently being processed
  • Further development work in Russia, production increased 65% in 2010

2010 Financial Highlights

  • Completed the disposal of interests in Block 3A and Block 1, Uganda, (the "Ugandan Assets") for which Tullow Uganda Limited ("Tullow") paid a cash consideration of $1.45 billion, including $100 million for a contractual settlement, and Heritage received and retained $1.045 billion
  • Cash at year end of $598 million
  • Special dividend of 100 pence per share paid in August 2010

Outlook

  • Rig contract to drill Miran West-3 well signed in April, well scheduled to spud July 2011
  • Exploration drilling to commence on Miran East in Q4 2011
  • 3D seismic data being processed for Tanzania with a view to establishing a drilling location
  • Mali 2D seismic data currently being acquired with a well expected to be drilled in early 2012
  • Malta 2D seismic data to be acquired during summer 2011
  • Well in Pakistan planned for H2 2011
  • Development options being reviewed for Kurdistan which include a phased development for oil, condensate and gas
  • First horizontal well to be drilled in Q2, 2011, in the Zapadno Chumpasskoye Field, Russia, which should help to provide a material increase in production

Tony Buckingham, Chief Executive Officer, commented:

"The sale of the Ugandan Assets in 2010 has provided Heritage with a strong balance sheet for activities within the current portfolio and the ability to appraise further opportunities to generate value for shareholders. We remain active across the portfolio with seismic programmes and drilling planned for 2011, including a multi-well exploration and appraisal drilling programme in Kurdistan commencing in July. In addition, we are progressing with discussions with the Kurdistan Regional Government for the fast-track development of the Miran Field."

Notes to Editors

  • Heritage is listed on the Main Market of the London Stock Exchange and is a constituent of the FTSE 250 Index. The trading symbol is HOIL. Heritage has a further listing on the Toronto Stock Exchange (TSX:HOC).
  • Heritage is an independent upstream exploration and production company engaged in the exploration for, and the development, production and acquisition of, oil and gas in its core areas of Africa, the Middle East and Russia.
  • Heritage has a producing property in Russia and exploration projects in the Kurdistan Region of Iraq, the Democratic Republic of Congo, Malta, Pakistan, Tanzania and Mali.
  • All dollars are US$ unless otherwise stated.

If you would prefer to receive press releases via email please contact Jeanny So (jeanny@chfir.com) and specify "Heritage press releases" in the subject line.

CHIEF EXECUTIVE'S REVIEW

The sale of our Ugandan Assets in 2010 reconfirms our ability to monetise assets at the appropriate stage of a project. It also provided us with the opportunity to pay out a special dividend of 100 pence per share in August 2010, which, from investor feedback, was well received. This payout has still left Heritage with a year-end cash position approaching $600 million, excluding monies relating to the tax dispute in Uganda. The decision to exit Uganda was taken with recognition that the very large multi-billion dollar investment required to develop the Albert Basin and the related infrastructure was beyond our existing resource capabilities. We believe this sale, which generated cash of $1.45 billion, of which Heritage received and retained $1.045 billion, constituted one of the largest completed oil deals in Sub-Saharan Africa. Monetisation of these assets demonstrates the continued success of Heritage's strategy of gaining a first mover advantage, supported by sound decision making and technical and operating expertise. Our balance sheet remains strong following the sale of the Ugandan Assets and we continue to actively appraise many new opportunities with the potential of generating value for shareholders.

Global equity markets remained volatile in 2010, with debt issues causing markets to decline sharply before rebounding in the second half of the year. Oil prices remained steady in the range of $70–$80 per barrel over the year. However, towards the end of the year demand growth, particularly in emerging markets, coupled with concerns over a cold winter caused oil prices to strengthen. Oil prices have risen sharply since year-end following escalating instability in North Africa and the Middle East. Heightened instability in the world means that there should be further opportunities for oil companies, such as Heritage, which have an excellent appreciation of political and security risk and are nimble and able to operate safely and responsibly in challenging locations.

The oil sector continues to face many future challenges. In 2010, the spectre of environmental, health and safety and operational issues rose to prominence with the unfortunate incident in the Gulf of Mexico. Heritage recognises that its business approach is reliant on its approach to CSR matters, which includes health and safety and the environment. Our track record in both is very good. We have operated in Kurdistan for over one million man hours without incident.

As a matter of course we review our systems continually to ensure that our operations are consistently carried out to the highest international standards. The health and safety of our employees and contractors, and of those living around the areas where we operate is of paramount importance to us. We had no environmental spills or incidents and have not incurred any warnings or fines relating to our environmental management during 2010.

EXPLORATION OPERATIONS

Kurdistan

The Miran West-2 well commenced drilling in November 2009 as an appraisal well for carbonate reservoirs encountered in the Miran West-1 well. After commencing drilling, additional seismic data was acquired which indicated that the Miran West-2 location was optimally located to drill to deeper exploration targets. Accordingly, the Miran West-2 well was deepened and reached a total depth of 4,426 metres in November 2010 after which a series of tests were conducted. In January 2011, we announced the discovery of a major gas field with oil and condensate.

Following completion of the test programme, hydrocarbon volumes of the Miran Field have been re-evaluated. Management currently estimates in-place volumes for the Miran West structure to have a P90–P50 range of 6.8–9.1 TCF, with an upside P10 potential of 12.3 TCF of gas with a P90–P50 range of 42–71 MMbbls of condensate and 53–75 MMbbls of oil. Miran East has an additional estimated P90–P50 gas in-place range of 0.6–0.9 TCF with a P10 upside of 1.3 TCF. We believe Miran to be the largest gas field discovered in Iraq in the last 30 years. We are delighted to have discovered such a large hydrocarbon accumulation, one of the largest within Kurdistan, and to have had incredible success on this wildcat acreage with our first two wells.

Most importantly, a gas field of this size is a commercial discovery and we are considering many different development options including deliveries to local markets in Kurdistan and exports to Turkey and to the European market via the proposed Nabucco Pipeline. Discussions with the Kurdistan Regional Government (the "KRG") over the fast-tracked phased development of the Miran Field have continued. The KRG has outlined their favoured development options for gas utilisation and the initial priority will be to satisfy local gas demand by supplying produced gas on commercial terms to local power stations and other end-users in the Sulymaniyah region in 2013. Early production of the gas will also result in early associated condensate and oil production. This will then be followed by the export of gas to Turkey/Europe and full production of the oil and condensate zones enabling full development of the field.

Management believes that there is further potential for condensate and gas which we will appraise with our accelerated drilling programme which will begin in July with the Miran West-3 well. This will take an estimated 160 days to drill and test and is targeting the flanks of the Jurassic structure, with the benefit of the current 3D seismic survey. The well will appraise the Upper and Lower Cretaceous reservoirs whilst drilling to its primary Jurassic objective, with an estimated total depth of approximately 3,800 metres. On completion of this well the rig will move to drill the Miran West-4 appraisal well. A second rig is being sourced to drill the Miran East-1 exploration well in the fourth quarter of this year, at which point we will have two rigs operating in country.

Additionally, deeper potential remains in the Miran Field as a target in the Triassic was not reached in the Miran West-2 well, since this proved to be beyond the operating capability of the rig.

We were expecting to discover a multi-phase hydrocarbon province with gas and condensate in the deeper horizons and oil in the shallower Cretaceous zones and while drilling, there were shows throughout the Cretaceous consistent with liquid hydrocarbons. However, on test, the Lower Cretaceous produced liquid rich gas which resulted in a reduction in the overall estimated oil resources of the field. Management now estimates, based on initial evaluation of the well, that Heritage has mean risked contingent and prospective resources in Miran West and Miran East of 744 MMboe, based on a 75% working interest, thereby increasing mean net contingent risked resources from 53 MMbbls to 605 MMboe. The KRG has a back-in right which could, if exercised, reduce Heritage's working interest to 56.25%.

We are currently acquiring 730 square kilometres of 3D seismic across the Miran Block to help define further appraisal drilling locations to exploit the fracture networks. This is the largest ever 3D seismic programme undertaken, to date, in Kurdistan. We will be analysing the data in separate tranches to expedite understanding of the structures. In addition, we will also be acquiring 180 kilometres of 2D seismic across the Block in the summer of 2011 to define other potential prospects.

Tanzania

Acquisition of 300 square kilometres of 3D seismic data offshore Tanzania commenced in 2010 and was completed in January 2011. The data is currently being processed which should help to establish a location for drilling. East Africa has become a hot-spot in recent months as there have been many significant gas discoveries made offshore Tanzania and in neighbouring Mozambique. This is significant as the possibility of an export LNG terminal moves much closer with each new discovery.

Other Exploration Assets

Work programmes are progressing across the remainder of Heritage's exploration asset portfolio. Acquisition of approximately 500 kilometres of 2D seismic data has commenced in Block 11 in Mali with a view to establishing a drilling location for early 2012. In Malta, Heritage is planning the acquisition of 1,000 kilometres of 2D seismic data this summer. Finally, in Pakistan, we plan to commence drilling on the Zamzama North licence when the challenges presented by last year's floods are overcome which we estimate will be in the second half of this year.

PRODUCTION OPERATIONS

Russia

Our Zapadno Chumpasskoye Field is located in Western Siberia. Production during the year averaged 542 bopd which is an increase over the previous year of 65%. In 2010, well P14, an exploration well drilled in 1976, was re-entered and relogged but work was suspended due to spring breakup and access difficulties. Further development work is being undertaken in 2011 and a horizontal well should commence drilling in May 2011. This is the first horizontal well to be drilled in the licence and it is hoped that this will lead to a material increase in production.

CORPORATE

In December 2009, a Sale and Purchase Agreement (the "SPA") was executed with ENI International B.V. ("Eni") to sell Heritage's 50% working interests in Blocks 1 and 3A in Uganda (the "Ugandan Assets"). In January 2010, Tullow Uganda Limited ("Tullow") exercised its right of pre-emption on the same terms and conditions as agreed with Eni. The transaction completed on 26 July 2010.

On completion, Tullow paid a cash consideration of $1.35 billion and an additional contractual settlement amount of $100 million, of which Heritage has received and retained $1.045 billion. An additional, approximately $405 million, was in part deposited with the Government of the Republic of Uganda ("Government") and in part held in escrow pending resolution of a tax dispute with the Ugandan Revenue Authority (the "URA"). Heritage's position, based on comprehensive advice from leading tax experts in Uganda, the United Kingdom and North America, is that the disposal of the Ugandan Assets is not taxable in Uganda.

On 15 April 2011, Heritage and its wholly owned subsidiary Heritage Oil and Gas Limited ("HOGL") received Particulars of Claim filed in the High Court of Justice in England by Tullow seeking $313,447,500 for alleged breach of contract as a result of HOGL's and Heritage's refusal to reimburse Tullow in relation to a payment made by Tullow of $313,447,500 on 7 April 2011 to the URA. Heritage and HOGL believe that the claim has no basis and will vigorously and robustly defend it. Heritage and HOGL have also reserved their other rights against Tullow and against Government.

On 15 April 2011, HOGL sent a request to Tullow, as a co-signatory to the escrow account with Standard Chartered Bank for the release of $283,447,000, plus interest to HOGL. HOGL contends that, consequent on Tullow's admission that its payment of $313,447,500 to the URA has discharged HOGL's alleged tax liability, funds no longer need to be held in escrow.

On 27 August, 2010, Heritage returned approximately $490 million to shareholders and Bondholders through a 100 pence per share special dividend. The remainder of Heritage's funds, $598 million excluding amounts related to the Uganda tax dispute, will be allocated between accelerating work programmes on our existing asset portfolio and potential acquisitions.

Heritage's strategy of first mover advantage, supported by sound decision making and technical and operating expertise, has proven to be successful. Since listing in 1999 on the Toronto Stock Exchange, Heritage has achieved a remarkable return to shareholders of 10,276% to 31 December 2010. Our management team is closely aligned in interests to our shareholders, through its 30% shareholding, and is dedicated to continuing to achieve superior performance during the next decade.

OPPORTUNITIES

Heritage has been reviewing a substantial number of corporate and asset opportunities to position itself to continue to generate value for shareholders. We are firmly focused on upstream opportunities that will create value through a balanced international portfolio of production, development and high impact exploration.

CORPORATE SOCIAL RESPONSIBILITY

The framework of our CSR policy continues to evolve and in 2010 we established a Board level CSR Committee. One of the important responsibilities of this new committee is to review community involvement regularly. We believe that our active, ongoing involvement in community projects in the areas where we operate is fundamental in developing and maintaining strong relationships within these regions.

During 2010, we spent a total of approximately $946,000 on CSR related activities. During the first half of 2010 we continued with our programmes in Uganda with the completion of the water gravity system in Hoima, providing clean water to over 6,000 villagers across five villages and with our support for the Carl Nefdt School.

Our community programmes in both Kurdistan and Tanzania are progressing with the benefit of the framework developed from our experience in Uganda.

Kurdistan

Our current activities in this region are focused on supporting local education, healthcare and assisting the development of local infrastructure. We pay an annual fee to the KRG towards environmental costs and for the training of local staff. During 2010, our initiatives in local schools have benefited approximately 250 teachers and pupils. Furthermore, we have undertaken work in the region to help repair some of the main access roads to villages near our operations.

Tanzania

Our activities in this region have focused on supporting the local health services. In June 2010, we made a donation to the Baobab Maternity Hospital in Dar es Salaam where a new maternity hospital is urgently needed. The government has donated land for the hospital and will provide support in terms of salaries, supplies and equipment. The donation has been provided to contribute towards the construction, management and service delivery of the Baobab Maternity Hospital. The expectation is that every year this hospital will save thousands of lives, reduce the spread of HIV/AIDS and prevent the occurrence of disabilities. Currently, reproductive health services in Dar es Salaam are insufficient and do not meet the needs of the hundreds of daily births. Consequently, maternal and newborn death rates are very high and much of this suffering can be prevented.

Pakistan

In light of the unprecedented floods in Pakistan, Heritage committed $72,000 to a disaster relief fund and immediate relief to those most affected in our Zamzama North licence area.

OUTLOOK

Heritage has a strong balance sheet with which to pursue opportunities to create further value for our shareholders. I believe that 2011 will be Heritage's busiest year ever as we accelerate work programmes in our current portfolio and also look for new opportunities.

As always, I am very grateful to our management team, employees and supportive Board for their dedication and contribution to the remarkable progress made by Heritage this past year.

Finally, to our shareholders, thank you for your continued support and interest in Heritage.

Anthony Buckingham
Chief Executive Officer

FINANCIAL REVIEW

The sale of our Ugandan Assets has left Heritage with a strong balance sheet for 2011.

Selected operational and financial data

20102009Change
Productionbopd54232965%
Sales volumebopd53936846%
Average realised price$/bbl25.520.226%
Petroleum revenue$ million5.02.785%
Loss from continuing operations$ million(44.2)(36.8)(20%)
Gain/(loss) from discontinued operations$ million1,267.2(2.5)n/a
Net profit/(loss)$ million1,223.0(39.3)n/a
Special dividend per sharePence per share100n/a
Total cash capital expenditures$ million(119.0)(104.1)
Year end cash balance$ million598.3208.1

CORPORATE PERFORMANCE

Production and sales volumes

2010 petroleum revenue was generated from the Zapadno Chumpasskoye Field in Russia, following the disposal of our Oman operations, with effect from 1 January 2009.

Average daily production increased by 65% from 329 bopd in 2009 to 542 bopd in 2010. This increase resulted from a full year of production in 2010 compared to 2009 where the field was temporarily shut in at the beginning of the year due to unfavourable domestic market conditions in Russia. In addition, three well workovers were undertaken in 2010 which further contributed to increased production.

The difference between the production volumes and sales volumes is due to the change in the oil inventory balance during the year.

Revenue

Petroleum revenue increased by $2.3 million (85%) to $5.0 million in 2010. This increase comprised:

  • $1.25 million from an increase in sales volumes that increased from 368 bopd in 2009 to 539 bopd in 2010; and
  • $1.05 million from an increase in average commodity prices from $20.15/bbl in 2009 to $25.51/bbl in 2010.

Operating results

Petroleum operating costs increased by 38% to $2.1 million in 2010, due to higher crude oil production. However, the average operating cost per produced barrel of oil decreased from $11.12/bbl in 2009 to $10.64/bbl in 2010.

Production tax in Russia increased from $1.3 million in 2009 to $2.6 million in 2010 as a result of both higher production volumes and increased average commodity prices in 2010 used in the calculation of production tax.

General and administrative expenses increased from $18.7 million in 2009 to $29.8 million in 2010. This is due, principally, to uncompleted corporate transaction expenses, arbitration settlement costs to be paid to a former director and higher legal and transportation expenses.

If share-based compensation expenses are excluded, net general and administrative expenses increased from $15.6 million in 2009 to $26.6 million in 2010. In 2010, the Group capitalised $6.7 million (2009 – $7.6 million) of general and administrative costs relating to exploration and development activities, including share-based compensation of $1.1 million (2009 – $2.1 million).

Acquisition expenses of $7.1 million in 2009 represent one-off expenses relating to the aborted acquisition of Genel Energy International Limited ("Genel Energy"). In November 2009, Heritage announced that it had terminated all discussions and consequently expensed all costs incurred with respect to the planned acquisition of Genel Energy.

Depletion, depreciation and amortisation expenses increased by 23% to $2.1 million in 2010, due to higher production volumes. Net depletion, depreciation and amortisation expenses per barrel reduced from $14.24/bbl in 2009 to $10.67/bbl in 2010.

Exploration expenditures expensed in the year, and not capitalised, increased from $0.2 million in 2009 to $2.8 million in 2010. Exploration expenditures in 2010 related principally to potential new ventures in Africa and South America.

In 2010, the Group recognised an impairment of intangible exploration and evaluation assets of $10.5 million (2009 – nil) comprised of two elements. Following changes in future plans, management decided to write-down to nil expenditure of $1.6 million incurred with respect to interests in Block 1 and 2 in the Democratic Republic of Congo (the "DRC"). Additionally, after a technical review management decided to write-off expenditures of $8.9 million incurred with respect to the Kisangire and Lukuliro licence areas in Tanzania.

In 2010, the Group recognised an impairment write-down of property, plant and equipment of $1.9 million (2009 – $2.9 million) relating to a reduction in the fair value of an aircraft due to unfavourable economic conditions.

In 2010, interest income was $3.0 million (2009 – $0.6 million). Cash and cash equivalents are typically held in interest bearing treasury accounts. This increase in interest income is primarily due to an increase in cash and cash equivalents balances in 2010 in comparison with 2009.

At 30 June 2009, the carrying value of investments in unlisted securities (shares of SeaDragon Offshore Limited ("SeaDragon") was written down to nil following completion of a financial reorganisation by SeaDragon and resulted in an impairment write-down of $2.4 million in 2009. It is not possible to determine whether any of the original investment will be recoverable in the near future.

Other finance costs decreased from $4.3 million in 2009 to $3.0 million in 2010, due primarily to Bondholders exercising their conversion rights in respect of $30.6 million of convertible bonds in 2009 and forgoing the right to earn any interest. This had a full year's impact on other finance costs in 2010 compared with only a partial year impact in 2009. Additionally, the level of interest costs capitalised in 2010 was higher than 2009 due to an increased capitalisation rate resulting from increased convertible bonds accretion costs following a $2.4 million payment of consent fees in January 2010 to Bondholders.

In 2010, the Group had foreign exchange gains of $1.8 million compared to a $1.0 million loss in 2009. The gain is primarily as a result of revaluation of the British pounds denominated liability to pay the special dividend. The liability for special dividends was outstanding between the date of the special dividend announcement and date of payment.

Heritage recognised an unrealised gain of $0.9 million in 2010 (2009 – $1.0 million), in the fair value of its investment in Afren plc ("Afren") warrants. The gain or loss is determined by the performance of the share price of Afren. Heritage holds 1,500,000 warrants in Afren with an exercise price of £0.60 per warrant, received as partial consideration from the sale of Heritage Congo Limited in 2006. The warrants have a term until 22 December 2011. At 31 December 2010, Afren's share price was £1.48 per share.

Heritage's loss from continuing operations in 2010 was $44.2 million, compared to $36.8 million in 2009. The adjusted loss from continuing operations in 2010 was $31.3 million compared to $21.2 million in 2009 if certain non-cash items (share-based compensation expense, impairment of intangible exploration and evaluation assets, property, plant and equipment impairment write-down, impairment of investment in unlisted securities, foreign exchange gains/losses and unrealised gain on revaluation of Afren warrants) and the one-off aborted acquisition costs are excluded.

Disposals

On 18 December 2009, Heritage announced that the Company and HOGL had entered into a SPA with Eni for the sale of the Ugandan Assets and on 17 January 2010, Tullow exercised its rights of pre-emption. The sale of the Ugandan Assets completed on 26 July 2010; Tullow paid cash of $1.45 billion, including $100 million from a contractual settlement, of which Heritage received and retained $1.045 billion.

The URA contends that income tax is due on the capital gain arising on the disposal and it raised assessments amounting to $404,925,000 prior to completion of the disposal. Heritage's position, based on comprehensive advice from leading legal and tax experts in Uganda, the United Kingdom and North America, is that no tax should be payable in Uganda on the disposal of the Ugandan Assets.

In order to allow the disposal to proceed, the Group agreed with Tullow a mechanism to provide Government with security over the disputed amounts through depositing some of the proceeds with the URA and placing a further amount in escrow.

Tullow paid cash consideration of $1.35 billion and an additional contractual settlement amount of $100 million. On closing, Heritage deposited $121,477,000 with the URA, amounting to 30% of the disputed tax assessment of $404,925,000. $121,477,000 has been classified as a deposit in the balance sheet at 31 December 2010. A further $283,447,000 has been retained in escrow, pursuant to an agreement between HOGL, Tullow and Standard Chartered Bank pending resolution between Government and HOGL of the tax dispute. Including accrued interest an amount of $286,603,000 is classified as restricted cash in the balance sheet at 31 December 2010.

In August 2010, the URA issued a further income tax assessment of $30 million representing 30% of the additional contractual settlement amount of $100 million. HOGL disputed this assessment and no provision has been made for this amount. There is a tax tribunal ongoing in Uganda, and HOGL continues to review options to recover monies held in relation to the Ugandan tax dispute which could include arbitration in London.

Although disputes of this nature are inherently uncertain, the Directors believe that the monies on deposit and held in the escrow account will ultimately be recovered by Heritage.

As at 31 December 2010 a working capital adjustment with respect to the disposal of the Ugandan Assets of $13.6 million was owed by Tullow. This was paid in March 2011.

On 15 April 2011, Heritage and its wholly owned subsidiary HOGL received Particulars of Claim filed in the High Court of Justice in England by Tullow seeking $313,447,500 for alleged breach of contract as a result of HOGL's and Heritage's refusal to reimburse Tullow in relation to a payment made by Tullow of $313,447,500 on 7 April 2011 to the URA. Heritage and HOGL believe that the claim has no basis and will vigorously and robustly defend it. Heritage and HOGL have also reserved their other rights against Tullow and against Government.

On 15 April 2011, HOGL sent a request to Tullow, as a co-signatory to the escrow account with Standard Chartered Bank for the release of $283,447,000, plus interest to HOGL. HOGL contends that, consequent on Tullow's admission that its payment of $313,447,500 to the URA has discharged HOGL's alleged tax liability, funds no longer need to be held in escrow.

The results of operations in Uganda and Oman have been classified as discontinued operations. The gain from discontinued operations in Uganda was $1,267.2 million in 2010 compared to the loss from discontinued operations of $1.8 million in 2009. The loss on disposal of discontinued operations in Oman was $0.7 million in 2009. The gain from discontinued operations in Uganda of $1,267.2 million may be summarised as follows:

Year ended 31 December 2010
$ million
Consideration received
Cash consideration and amount to settle contractual dispute1,450.0
Working capital adjustments13.6
Total1,463.6
Less:
Carrying amount of net assets sold and expenses(196.4)
Gain on disposal of discontinued operations1,267.2

In 2010, the basic and diluted loss per share from continuing operations was $0.15 and $0.30 respectively, compared to the basic and diluted loss per share from continuing operations of $0.13 in 2009.

Heritage's net profit in 2010 was $1,223.0 million, compared to a net loss of $39.3 million in 2009. The adjusted net profit in 2010 was $1,225.4 million, compared to a net loss of $23.7 million in the previous year if certain non-cash items (share-based compensation expense, impairment of intangible exploration and evaluation assets, property, plant and equipment impairment write-down, impairment of investment in unlisted securities, foreign exchange gains/losses and unrealised gain on revaluation of Afren warrants) and the one-off aborted acquisition costs are excluded.

In 2010, the basic and diluted earnings per share were $4.25 and $3.57 respectively, compared to the basic and diluted loss per share of $0.14 in 2009.

Cash flow and capital expenditures

Cash used in continuing operating activities was $21.0 million in 2010 compared to $20.7 million in 2009. Total cash capital expenditures, including discontinued operations, in 2010 were $119.0 million which is higher by $14.9 million than in 2009. The following major work programmes were undertaken in 2010:

  • the Miran West-2 well commenced drilling on 26 November 2009 and drilling and testing continued throughout 2010, and into January 2011. The well was drilled to a total depth of 4,426 metres. This resulted in the discovery of a large gas field which management considers to be the largest gas field to be discovered in Iraq in the last 30 years;
  • the acquisition of a 3D seismic survey commenced on the Miran Block in Kurdistan in the fourth quarter of 2010;
  • capital expenditures of $21.7 million in respect of Block 1 and 3A in Uganda;
  • 336 kilometres of 2D seismic were acquired on the Zamzama North licence, Pakistan; and
  • the acquisition of 300 square kilometres of 3D seismic offshore Tanzania commenced in December 2010.

Capital expenditures also included the acquisition of an aircraft for $42.9 million.

Special dividend

On 2 August 2010, Heritage announced the declaration of a special dividend of 100 pence per Ordinary Share of the Company and Heritage Oil Corporation ("HOC", the "Corporation"), the Company's wholly owned subsidiary, also announced a declaration of a special dividend of Cdn$1.62 per Exchangeable Share of HOC, calculated at an exchange rate of £1.00:Cdn$1.62. The special dividend was paid on 27 August 2010.

Following an amendment to the terms of the $165,000,000 8.00% convertible bonds due 2012 (the "Bonds"), the special dividend was also paid to Bondholders and no adjustments were made to the conversion rights under the terms of the Bond (the "Conversion Rights") in respect of any dividend paid or made by the Company. The Company paid a $2.4 million consent fee to Bondholders who voted in favor of the amendment to the terms. Accordingly, the Company agreed to pay the holder of each Bond a pass-through dividend (the "Pass-through Dividend") which is equal to the dividend which would be received by the holder of a number of Ordinary Shares equal to the number of Ordinary Shares to which the Bondholder would have been entitled if it had exercised its Conversion Rights on the record date of 13 August 2010. The aggregate principal amount of bonds outstanding on the record date was $127,100,000. These Bonds are convertible into 27,042,553 Ordinary Shares pursuant to the Conversion Rights and accordingly the Company paid to Bondholders a Pass-through Dividend of £27,042,553 on 27 August 2010.

FINANCIAL POSITION

Liquidity

Heritage had a net increase in cash and cash equivalents in 2010 of $390.1 million. At 31 December 2010, Heritage had a working capital surplus of $969.3 million, including cash and cash equivalents of $598.3 million.

Like most oil and gas exploration companies, Heritage raises financing for its activities from time to time using a variety of sources. Sources of funding for future exploration and development programmes will be derived from inter alia disposal proceeds from the sale of assets, such as the sale of the Company's holdings in Oman in 2009 and the sale of the Ugandan Assets in 2010 (see disposals section of the Financial Review), using its existing treasury resources, new credit facilities, reinvesting its funds from operations, farm-outs and, when considered appropriate, issuing debt and additional equity. Accordingly, the Group has a number of different sources of finance.

Capital structure

Heritage's 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.

On 7 April 2009, the Company completed the sale of Eagle Energy, a wholly owned subsidiary of Heritage, to RAK Petroleum Oman Limited for $28 million, plus a working capital adjustment of $0.4 million.

On 18 June 2009, the Company completed the placing of 25,400,000 new Ordinary Shares at a price of £5.20 per share for gross proceeds of $216,848,944 (£132,080,000). Share issue costs were $11,820,609 (£7,157,379).

On 26 July 2010, the Company completed the disposal of the Ugandan Assets for cash consideration of $1.35 billion and an additional contractual settlement amount of $100 million.

At 31 December 2010, Heritage had net cash of $409.2 million (31 December 2009 – $41.7 million) (cash and cash equivalents less total liabilities) and nil gearing (31 December 2009 – nil) (net debt as a percentage of total shareholders' equity).

Creditors' payment policy

It is the Company and Group's general policy to settle all debts with creditors on a timely basis and in accordance with the terms of credit agreed with each supplier. Average creditor payment days in 2010 were approximately 45 days (2009 – 45 days).

PRIMARY RISKS AND UNCERTAINTIES FACING THE BUSINESS

Heritage's business, financial standing and reputation may be impacted by various risks, not all of which are within its control. The Group identifies and monitors the key risks and uncertainties affecting the Group and runs its business in a way that minimises the impact of such risks where possible.

The primary risks to the business include:

  • Exploration and development expenditures and success rates – the Group has experienced management and technical teams with a track record of finding attractive hydrocarbon discoveries and has a diversified portfolio of exploration, development and production assets. Considerable technical work is undertaken to reduce related areas of risk and maximise opportunities.
  • Factors associated with operating in developing countries, political, fiscal and regulatory instability – the Group maintains close contact with governments in the areas within which it operates and, where appropriate, invests in community projects. Considerable work is undertaken before commencing operations in any new territory. The Group continually reviews fiscal regimes and enters into robust, transparent Production Sharing Contracts on licences.
  • Title disputes – notwithstanding potential challenges in Kurdistan and Malta, the Group believes that it has good title to its oil and gas properties. However, the Group cannot control or completely protect itself against the risk of title disputes or challenges and there can be no assurance that claims or challenges by third parties against the Group's properties will not be asserted at a future date. Naturally, the Group strives to employ the best internal and advisory knowledge available to help to minimise this risk associated with its activities.
  • Oil and gas sales volumes and prices – whilst not under the direct control of the Company, a material movement in commodity prices could impact on the Group. The Group did not hedge oil prices in 2010.
  • Loss of key employees – remuneration packages are regularly reviewed to ensure key executives and senior management are properly remunerated. Long-term incentive programmes have been established.
  • Foreign exchange exposure – generally, it is the Group's policy to conduct and manage its business in US dollars, which is its reporting currency. Cash balances in Group Subsidiaries are primarily held in US dollars but small amounts may be held in other currencies in order to meet immediate operating or administrative expenses or to comply with local currency regulations.

INTERNAL CONTROLS

A system of internal controls was designed and tailored to ensure key risks are addressed appropriately and to provide assurance regarding the reliability of financial reporting and preparation of financial statements. Risk and internal controls are assessed continually. One weakness identified in its financial procedures reporting concerns accounting for complex transactions and the Company ensures that it seeks third party advice to mitigate this weakness.

As part of the internal controls, all transactions with related parties are identified, scrutinised and disclosed in the financial statements appropriately.

Heritage maintains insurance policies in accordance with industry standards. Heritage 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. Heritage does not insure against political risk and, therefore, shareholders have full exposure to the risks and rewards of investing in its territories.

Heritage maintains detailed financial models which allows the Company to plan future operating and capital activities in an efficient manner.

Paul Atherton
Chief Financial Officer
18 April 2011

Financial Information Included in This Announcement

The following information included in this Announcement does not constitute audited financial statements of the Group. The Accounts for the year ended 31 December 2010 have been audited and will be posted on the Group's website. The auditors have issued an unqualified opinion on those Accounts; their report includes an 'emphasis of matter' drawing attention to the disclosures made in the Group financial statements concerning the uncertain outcome of a dispute as to whether or not tax is payable on the disposal of the Group's interests in Uganda (which are reproduced in note 6 below). The following financial information has been extracted from those Accounts.

HERITAGE OIL PLC
CONSOLIDATED INCOME STATEMENT
Years ended 31 December 2010 and 2009
2010
$'000
2009
$'000
Revenue
Petroleum5,0152,705
Expenses
Petroleum operating(2,055)(1,493)
Production tax(2,609)(1,304)
General and administrative (note 22)(29,785)(18,677)
Aborted acquisition expenses(7,142)
Depletion, depreciation and amortisation(2,111)(1,710)
Exploration expenditures (note 2e)(2,818)(202)
Impairment of intangible exploration assets (note 10)(10,535)
Impairment of property, plant and equipment (note 11)(1,854)(2,933)
Operating loss(46,752)(30,756)
Finance income (costs)
Interest income2,967564
Other finance costs (note 7)(2,970)(4,329)
Impairment of investment in unlisted securities(2,353)
Foreign exchange gains/(losses)1,830(1,010)
Unrealised gain on other financial assets (note 12)8961,047
2,723(6,081)
Loss from continuing operations before tax(44,029)(36,837)
Income tax expense (note 8)(197)
Loss from continuing operations after tax(44,226)(36,837)
Gain/(loss) on disposal of discontinued operations (note 6)1,267,211(2,510)
Profit/(loss) for the year attributable to owners of the Company1,222,985(39,347)

The notes are an integral part of these consolidated financial statements.

HERITAGE OIL PLC
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
Years ended 31 December 2010 and 2009
2010
$'000
2009
$'000
Profit/(loss) for the year1,222,985(39,347)
Other comprehensive loss
Exchange differences on translation of foreign operations (note 19)(124)(595)
Cumulative gains on available for sale investments transferred to income statement on impairment of investments.(168)
Other comprehensive loss, net of income tax(124)(763)
Total comprehensive income/(loss) for the year1,222,861(40,110)
Attributable to:
Owners of the Company1,222,861(40,110)
Net loss per share from continuing operations
Basic(0.15)(0.13)
Diluted(0.30)(0.13)
Net earnings/(loss) per share from discontinued operations
Basic4.40(0.01)
Diluted3.70(0.01)
Net earnings/(loss) per share
Basic4.25(0.14)
Diluted3.57(0.14)

The total comprehensive income for the year of $1,222,861,000 (2009 loss – $40,110,000) includes income of $1,267,211,000 (2009 loss – $2,510,000) from discontinued operations (note 6).

The notes are an integral part of these consolidated financial statements.

HERITAGE OIL PLC
CONSOLIDATED BALANCE SHEET
As at 31 December 2010 and 2009
2010
$'000
2009
$'000
ASSETS
Non-current assets
Intangible exploration and evaluation assets (note 10)183,424121,278
Property, plant and equipment (note 11)101,99359,298
Other financial assets (note 12)2,0501,154
287,467181,730
Current assets
Inventories9713
Prepaid expenses746568
Assets of a disposal group classified as held for sale163,415
Trade and other receivables (note 13)20,2402,204
Deposit with URA (note 6)121,477
Restricted cash (note 6)283,603
Cash and cash equivalents (note 14)598,275208,094
1,024,438374,294
1,311,905556,024
LIABILITIES
Current liabilities
Liabilities of a disposal group classified as held for sale12,559
Current tax liabilities (note 8)197
Trade and other payables (note 15)54,08323,277
Borrowings (note 16)896616
55,17636,452
Non-current liabilities
Borrowings (note 16)133,515129,554
Provisions (note 17)389355
133,904129,909
189,080166,361
Net assets1,122,825389,663
SHAREHOLDERS' EQUITY ATTRIBUTABLE TO EQUITY HOLDERS OF THE COMPANY
Share capital (note 18)460,280460,280
Reserves86,67882,547
Retained earnings/(deficit)575,867(153,164)
1,122,825389,663

The notes are an integral part of these consolidated financial statements.

HERITAGE OIL PLC
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY
Year ended 31 December 2010
Share Capital $'000Foreign currency translation reserve $'000Share-based payments reserve $'000Retained earnings/
(deficit) $'000
Equity portion of convertible debt $'000Total equity $'000
Balance at 1 January 2010460,280(816)58,714(153,164)24,649389,663
Total comprehensive income for the year
Profit for the year1,222,9851,222,985
Other comprehensive loss
Exchange differences on translation of foreign operations(124)(124)
Total other comprehensive loss(124)(124)
Total comprehensive income/(loss) for the year(124)1,222,9851,222,861
Transactions with owners, recorded directly in equity
Contributions by and distributions to owners
Dividends to shareholders(451,537)(451,537)
Pass-through dividend to Bondholders(42,417)(42,417)
Share-based payment transactions and exercise of share options4,2554,255
Total transactions with owners4,255(493,954)(489,699)
Balance at 31 December 2010460,280(940)62,969575,86724,6491,122,825

The notes are an integral part of these consolidated financial statements.

HERITAGE OIL PLC
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY
Year ended 31 December 2009
Share Capital $'000Foreign currency translation reserve $'000Available for-sale revaluation investments reserve $'000Share-based payments reserve $'000Retained deficit
$'000
Equity portion of convertible debt
$'000
Total equity $'000
Balance at 1 January 2009218,284(221)16854,565(113,817)30,642189,621
Total comprehensive income for the year
Loss for the year(39,347)(39,347)
Other comprehensive loss
Exchange differences on translation of foreign operations(595)(595)
Cumulative gains on available for sale investments transferred to income statement on impairment of investments.(168)(168)
Total other comprehensive loss(595)(168)(763)
Total comprehensive loss for the year(595)(168)(39,347)(40,110)
Transactions with owners, recorded directly in equity
Contributions by and distributions to owners
Issue of shares, net205,028205,028
Issue of shares on conversion of bonds34,200(5,993)28,207
Share-based payment transactions and exercise of share options (note 18)2,7684,1496,917
Total transactions with owners241,9964,149(5,993)240,152
Balance at 31 December 2009460,280(816)58,714(153,164)24,649389,663

The notes are an integral part of these consolidated financial statements.

HERITAGE OIL PLC
CONSOLIDATED CASH FLOW STATEMENT
Years ended 31 December 2010 and 2009
2010
$'000
2009
$'000
Cash provided by (used in) operating activities
Net loss from continuing operations for the year(44,226)(36,837)
Items not affecting cash
Depletion, depreciation and amortisation2,1111,710
Finance costs – accretion expenses9984,163
Foreign exchange gains(289)(1,333)
Share-based compensation3,1693,207
Gain on other financial assets(896)(1,047)
Impairment of intangible exploration assets10,535
Impairment of property, plant and equipment1,8542,933
Impairment of investment in unlisted securities2,353
Increase in trade and other receivables(1,124)(333)
(Increase)/decrease in prepaid expenses(178)97
(Increase)/decrease in inventory(84)317
Increase in trade and other payables6,9534,092
Increase in tax payable197
Continuing operations(20,980)(20,678)
Discontinued operations (note 6)(300)
(21,280)(20,678)
Investing
Exercise of third party back-in rights for Miran (note 10)6,738
Property, plant and equipment expenditures(46,946)(3,890)
Intangible exploration expenditures(50,284)(49,643)
(97,230)(46,795)
Discontinued operations
Consideration on disposal (note 6)1,450,00028,199
Transaction related expenses and other(17,397)
Increase in deposit with URA (note 6)(121,477)
Property, plant and equipment expenditures and intangible exploration expenditures (note 6)(21,735)(50,613)
Increase in restricted cash (note 6)(283,603)
908,558(69,209)
Financing
Shares issued for cash216,849
Shares issued for cash, proceeds from exercise of options1,647
Shares issue costs(11,821)
Payment of Bondholder consent fees (note 16)(2,378)
Distribution to shareholders(451,537)
Pass through dividend to Bondholders(42,417)
Repayment of long-term debt(823)(604)
(497,155)206,071
Increase in cash and cash equivalents390,123116,184
Cash and cash equivalents – beginning of year208,09490,620
Foreign exchange gain/(loss) on cash held in foreign currency581,290
Cash and cash equivalents – end of year598,275208,094
Non-cash investing and financing activities (note 24)
Supplementary information
The following have been included within cash flows for the year under operating and investing activities
Interest received2,298593
Interest paid10,47311,738
Aborted acquisition expenses8006,342

The notes are an integral part of these consolidated financial statements.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Reporting Entity

Heritage Oil Plc (the "Company") was incorporated under the Companies (Jersey) Law 1991, as amended (the "Jersey Companies Law") on 6 February 2008 as Heritage Oil Limited. The Company changed its name to Heritage Oil Plc on 18 June 2009. Its primary business activity is the exploration, development and production of petroleum and natural gas in Africa, the Middle East and Russia. The Company was established in order to implement a corporate reorganisation of HOC.

These consolidated financial statements include the results of the Company and all subsidiaries over which the Company exercises control. The Company together with its subsidiaries are referred to as the Group. The key subsidiaries consolidated within these financial statements include inter alia Heritage Oil Corporation, Heritage Oil & Gas Limited , Eagle Energy (Oman) Limited (disposed in 2009 (note 6)), Heritage Oil and Gas (U) Limited, Heritage Energy Middle East Limited, Heritage DRC Limited, Coatbridge Estates Limited, ChumpassNefteDobycha, Neftyanaya Geologicheskaya Kompaniya, Heritage Mali Block 7 Limited, Heritage Mali Block 11 Limited, Begal Air Limited, Heritage Oil & Gas Holdings Limited, Eagle Drill Limited, Heritage Oil & Gas (Switzerland) SA, Heritage Oil International Malta Limited, 1381890 Alberta ULC, Heritage Oil Cooperatief U.A, Heritage Oil Holdings Limited, Darwin Air Limited, Heritage Tanzania Kimbiji-Latham Limited, Heritage Tanzania Kisangire Limited, Heritage Oil Tanzania Limited and Heritage Oil (UK) Limited.

The financial statements were approved by the Board and authorised for issuance on 18 April 2011.

2. Significant Accounting Policies

The principal accounting policies applied in the preparation of these consolidated financial statements are set out below. These policies have been consistently applied to all the years presented, unless otherwise stated.

a) Basis of preparation

The consolidated financial statements have been prepared in accordance with IFRS as adopted by the EU.

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 Company's consolidated financial statements are presented in thousand US dollars unless otherwise stated. US dollars are the Company's functional and presentation currency.

The Group had available cash of $598 million at 31 December 2010, excluding amounts related to the tax dispute with Government. Based on its current plans and knowledge, its projected capital expenditure and operating cash requirements, the Group has sufficient cash to finance its operations for more than 12 months from the date of this report. As for most oil and gas exploration companies, Heritage raises financing for its activities from time to time using a variety of sources. Sources of funding for future exploration and development programmes will be derived from inter alia disposal proceeds from the sale of assets, such as the sale of the Company's holdings in Oman in 2009 and the disposal of the Ugandan Assets in 2010 (note 6), using its existing treasury resources, new credit facilities, reinvesting its funds from operations, farm-outs and, when considered appropriate, issuing debt and additional equity. Accordingly, the Group has a number of different sources of finance available and the Directors are confident that additional finance will be raised as and when needed.

After making enquiries, the Directors have a reasonable expectation that the Group has adequate resources to continue in operational existence for the foreseeable future. Accordingly, they continue to adopt the going concern basis in preparing the Annual Report and Accounts.

The financial position of the Group, its cash flows and liquidity position are described in the Financial Review of this report. In addition, note 3 of the financial statements includes the Group's policies and processes for managing its capital; its financial risk management; and its exposure to foreign exchange risk, commodity price risk, credit risk and liquidity risk.

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 Company's 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 4.

b) Consolidation

The consolidated financial statements incorporate the assets and liabilities of all subsidiaries of the Company as at 31 December 2010 and 2009 and the results of all subsidiaries for the years then ended.

Subsidiaries are all entities, including special purpose entities over which the Company 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 Company controls another entity. Subsidiaries are fully consolidated from the date on which control is transferred to the Company. They are deconsolidated from the date that control ceases.

The purchase method of accounting is used to account for the acquisition of subsidiaries by the Group. The cost of an acquisition is measured as the fair value of the assets given, equity instruments issued and liabilities incurred or assumed at the date of exchange. 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 Group's 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 Company 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 Company.

c) Segment reporting

The Group determines and presents operating segments based on the information that internally is provided to the CEO and CFO, who are the Group's chief operating decision makers.

An operating segment is a component of the Group that engages in business activities from which it may earn revenues and incur expenses, including revenues and expenses that relate to transactions with any of the Group's other components. An operating segment's operating results are reviewed regularly by the Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO") to make decisions about resources to be allocated to the segment and assess its performance, and for which discrete financial information is available.

Segment results that are reported to the CEO and CFO include items directly attributable to a segment as well as those that can be allocated on a reasonable basis. Unallocated items comprise mainly corporate assets, corporate offices expenses and liabilities.

Segment capital expenditure is the total cost incurred during the period to acquire property, plant and equipment, and intangible assets other than goodwill.

d) Joint arrangements

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.

e) Exploration and evaluation expenditures

The Group applies a modified full cost method of accounting for exploration and evaluation ("E&E") costs, having regard to the requirements of IFRS 6 "Exploration for and Evaluation of Mineral Resources". Under the modified full cost method of accounting, costs of exploring for and evaluating oil and gas properties are capitalised on a licence or prospect basis and the resulting assets are tested for impairment by reference to appropriate cost pools. Such cost pools are based on geographic areas and are not larger than a segment. The Group had seven cost pools in 2010 (2009 – eight cost pools); Uganda (discontinued in 2010); Kurdistan; Russia; the DRC; Pakistan; Malta; Mali and Tanzania.

E&E costs related to each licence/prospect are initially capitalised within "Intangible exploration and evaluation assets". Such E&E costs may include costs of licence acquisition, technical services and studies, seismic acquisition, exploration drilling and testing, the projected costs of retiring the assets, if any, and directly attributable general and administrative expenses, but do not include costs incurred prior to having obtained the legal rights to explore an area, which are expensed directly to the income statement as they are incurred.

Where the Company farms-in to licences and incurs costs in excess of its own share of licence costs as consideration, these costs are capitalised as its own share.

Tangible assets acquired for use in E&E activities are classified as property, plant and equipment; however, to the extent that such a tangible asset is consumed in developing an intangible E&E asset, the amount reflecting that consumption is recorded as part of the cost of the intangible asset.

Intangible E&E assets related to each exploration licence/prospect are not depreciated and are carried forward until the existence, or otherwise, of commercial reserves has been determined. The Group's definition of commercial reserves for such purpose is proved and probable reserves on an entitlement basis.

Proved and probable reserves are the estimated quantities of crude oil, natural gas and natural gas liquids which geological, geophysical and engineering data demonstrate with a specified degree of certainty (see below) to be recoverable in future years from known reservoirs and which are considered commercially producible. There should be a 50% statistical probability that the actual quantity of recoverable reserves will be more than the amount estimated as proved and probable and a 50% statistical probability that it will be less. The equivalent statistical probabilities for the proven component of proved and probable reserves are 90% and 10%, respectively.

Such reserves may be considered commercially producible if management has the intention of developing and producing them and such intention is based upon:

  • a reasonable assessment of the future economics of such production;
  • a reasonable expectation that there is a market for all or substantially all the expected hydrocarbon
    production; and
  • evidence that the necessary production, transmission and transportation facilities are available or can be made available.

Furthermore:

(i)Reserves may only be considered proved and probable if producibility is supported by either actual production or a conclusive formation test. The area of reservoir considered proved includes (a) that portion delineated by drilling and defined by gas-oil and/or oil-water contacts, if any, or both, and (b) the immediately adjoining portions not yet drilled, but which can be reasonably judged as economically productive on the basis of available geophysical, geological and engineering data. In the absence of information on fluid contacts, the lowest known structural occurrence of hydrocarbons controls the lower proved limit of the reservoir.
(ii)Reserves which can be produced economically through application of improved recovery techniques, such as fluid injection, are only included in the proved and probable classification when successful testing by a pilot project, the operation of an installed programme in the reservoir, or other reasonable evidence (such as, experience of the same techniques on similar reservoirs or reservoir simulation studies) provides support for the engineering analysis on which the project or programme was based.

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.

f) Property, plant and equipment

i) Development and production assets

The Group had one interest at the development and production stage during the years covered by these financial statements: Russia.

Development and production assets are accumulated on a field-by-field basis and represent the cost of developing the commercial reserves discovered and bringing them into production, together with the E&E expenditures incurred in finding commercial reserves transferred from intangible E&E assets as outlined above, the projected cost of retiring the assets and directly attributable general and administrative expenses.

The net book values of producing assets are depleted on a field-by-field basis using the unit of production method by reference to the ratio of production in the year to the related proved plus probable reserves of the field, taking into account estimated future development expenditures necessary to bring those reserves into production.

An impairment test is performed whenever events and circumstances arising during the development or production phase indicate that the carrying value of a development or production asset may exceed its recoverable amount. The aggregate carrying value is compared against the expected recoverable amount of the cash generating unit, generally by reference to the present value of the future net cash flows expected to be derived from the production of commercial reserves. The cash generating unit applied for impairment test purposes is generally the field, except that a number of field interests may be grouped as a single cash generating unit where the cash flows generated by the fields are interdependent.

ii) 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.

Aircraft are depreciated over their expected useful life of 60 months. Depreciation is charged so as to write-off the cost, less estimated residual value of aircraft 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 with nil residual value. The land is not depreciated.

g) Cash and cash equivalents

Cash and cash equivalents include cash on hand, deposits held at call with banks and other short-term highly liquid investments with original maturities of three months or less. Cash and cash equivalents are stated at amortised cost using the effective interest rate method.

h) Trade and other receivables

Trade and other receivables are recognised initially at fair value and subsequently measured at amortised cost using the effective interest method, less provision for impairment. A provision for impairment of trade receivables is established when there is objective evidence that the Group will not be able to collect all amounts due according to the original terms of the receivables.

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, depletion 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.

j) 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".

i) Financial assets at fair value through the income statement

Financial assets held for trading are carried at fair value with changes in fair value recognised in the income statement. A financial asset is classified in this category if acquired principally for the purpose of selling in the short-term. Derivatives are classified as held for trading unless they are designated as hedges.

Gains or losses arising from changes in the fair value of the "financial assets at fair value through the income statement" category are presented in the income statement within "Unrealised gain/(loss) on other financial assets" in the year in which they arise.

ii) Available-for-sale financial assets

Available-for-sale financial assets, comprising principally marketable equity securities, are non-derivatives that are either designated in this category or not classified. They are included in non-current assets unless management intends to dispose of the investment within 12 months of the balance sheet date.

Changes in the fair value of monetary securities classified as available-for-sale (other than impairment losses and foreign exchange gains and losses which are recognised in the income statement) are recognised in equity. Upon sale of a security classified as available-for-sale, the cumulative gain or loss previously recognised in equity is recognised in the income statement.

The Group assesses at each balance sheet date whether there is objective evidence that a financial asset or a group of financial assets is impaired. Measurement is assessed by reference to the fair value of the financial asset or group of financial assets.

k) Non-current assets held for sale and discontinued operations

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.

A discontinued operation is a component of the Group's business that represents a separate major line of business or geographical area of operations that has been disposed of or is held for sale, or is a subsidiary acquired exclusively with a view to resale. Classification as a discontinued operation occurs upon disposal or when the operation meets the criteria to be classified as held for sale, if earlier. When an operation is classified as a discontinued operation, from the comparative income statement is represented as if the operation had been discontinued from the start of the comparative period.

l) Trade and other payables

These amounts represent liabilities for goods and services provided to the Group prior to the end of the financial year which are unpaid.

m) 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 Company reassesses the classification during the life of the convertible bond and reclassifies between liabilities and equity when appropriate.

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.

n) 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 Group's outstanding borrowings during the year. For the year ended 31 December 2010, this was 13.01% (31 December 2009 – 12.10%).

o) Provisions

Asset retirement obligations

Provision is made for the estimated cost of any asset retirement obligations when the Group has a present legal or constructive obligation as a result of past events, it is probable that an outflow of resources will be required to settle the obligation and the amount has been reliably estimated. Provisions are not recognised for future operating losses. Asset retirement obligation expense is capitalised in the relevant asset category unless it arises from the normal course of production activities.

Provisions are measured at the present value of management's best estimate of expenditure required to settle the present obligation at the balance sheet date. The discount rate used to determine the present value reflects current market assessments of the time value of money and the risks specific to the liability.

Subsequent to the initial measurement of the asset retirement obligation, the obligation is adjusted at the end of each year to reflect the passage of time and changes in the estimated future cash flows underlying the obligation. The increase in the provision due to the passage of time is recognised as finance costs whereas changes in the estimated future cash flows are added to or deducted from the related asset in the current period.

p) Revenue recognition

Revenue from the sale of petroleum and natural gas is recognised at the fair value received or receivable and is recorded when the significant risks and rewards of ownership of the product are transferred to the buyer. For sales of oil and gas this is usually when legal title passes to the external party which occurs on shipment of oil and gas to the buyer. Interest income is recognised on a time proportion basis using the effective interest method.

q) 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 as well as those that are taxable or deductible in a different period. The Group's 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 balance sheet 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.

r) Foreign currency translation

Items included in the financial statements of each of the Company's consolidated subsidiaries are measured using the currency of the primary economic environment in which the subsidiary operates (the "functional currency"). The Company's consolidated financial statements are presented in thousand US dollars, which is the Company's functional and presentation currency.

Foreign currency transactions are translated into the respective functional currencies of Group entities using the exchange rates prevailing at the dates of the transactions. Foreign exchange gains and losses resulting from the settlement of such transactions and from the translation at year end exchange rates of monetary assets and liabilities denominated in foreign currencies are recognised in the income statement.

The results and financial position of all the Company's consolidated subsidiaries (none of which has a functional currency that is the currency of a hyperinflationary economy) that have a functional currency different from the presentation currency are translated into the presentation currency as follows:

i)assets and liabilities for each balance sheet presented are translated at the closing rate at the date of that balance sheet;
ii)income and expenses for each year are translated at average exchange rates (unless this is not a reasonable approximation of the cumulative effect of the rates prevailing on the transaction dates, in which case income and expenses are translated at the dates of the transactions); and
iii)all resulting exchange differences are recognised as either income or expense in a separate component of equity.

Foreign currency loans and overdrafts are designated as and are considered to be hedges of the exchange rate exposure inherent in foreign currency net investments and, to the extent that the hedge is effective, exchange differences giving rise to changes in the carrying value of foreign currency loans are also recognised as income or expense directly in equity. All other exchange differences giving rise to changes in the carrying value of foreign currency loans and overdrafts are recognised in the income statement.

When a foreign operation is sold, a proportionate share of the cumulative exchange differences previously recognised in equity are recognised in the income statement, as part of the gain or loss on sale where applicable.

s) Share-based compensation plans

The Group applies the fair value method of accounting to all equity-classified share-based compensation arrangements for both employees and non-employees. Compensation costs of equity-classified awards to employees are measured at fair value of the awards at the grant date and recognised over the periods during which the employees become unconditionally entitled to the options. The compensation cost is charged to the income statement with a corresponding increase in equity. The amount recognised as an expense is adjusted to reflect the actual number of share options that vest.

The compensation cost of equity-classified awards to non-employees is initially measured at fair value of the awards at the grant date and periodically remeasured to fair value until the non-employees' performance is complete, and recognised over the periods during which the non-employees become unconditionally entitled to the options. The compensation cost is charged to income with a corresponding increase to share-based payment reserve.

Dividends declared but not paid out before exercise of the option are recognised only when the exercise price, reduced for the dividends declared, becomes a recognised receivable upon exercise. The obligation to pay the dividends reduces the unrecognised receivable due from the option holder. The dividends are netted against the amount with the proceeds from the exercise price and not recognised as a separate distribution in equity.

Upon the exercise of the award, consideration received is recognised in equity (notes 18).

t) Share capital

Ordinary and Exchangeable 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 Company reacquires its own equity instruments the cost is deducted from equity and the associated shares are cancelled.

u) Earnings per share

Basic earnings per share is calculated by dividing the profit attributable to equity holders of the Company by the weighted average number of Ordinary and Exchangeable Shares outstanding during the financial period. The rights of different classes of shares are the same and therefore economically equivalent. As such, Ordinary and Exchangeable Shares are treated as one class of shares for the earnings per share calculation.

Diluted earnings per share adjusts the figures used in the determination of basic earnings per share to take into account the after income tax effect of interest and other financing costs associated with dilutive potential Ordinary Shares and the weighted average number of shares assumed to have been issued for no consideration in relation to dilutive potential Ordinary Shares.

The if-converted method used in the calculation of diluted earnings per share assumes the conversion of convertible securities at the later of the beginning of the reported period or issuance date, if dilutive.

v) New accounting standards and interpretations

Certain new accounting standards and interpretations have been published that are not mandatory for the year ended 31 December 2010. The Company's assessment of the impact of these new standards and interpretations which have not been adopted is set out below.

i)IFRS 9 Financial Instruments (not yet endorsed for use in the EU) is effective for accounting periods commencing 1 January 2013. The expected impact is still being assessed by management, but is expected to only impact disclosures of the Group.
ii)IAS 24 Related Party Disclosures (endorsed by the EU during 2010) was revised by the IASB in 2009 and is effective for accounting periods beginning on or after 1 January 2011. The changes introduced relate mainly to disclosure requirements for government-related entities, and the definition of a related party, and are not expected to have a significant impact on the disclosures of the Group.
iii)The amendments to IAS 32 "Classification of Rights Issues" (endorsed by the EU in 2009) and IFRS 7 "Disclosures – Transfer of Financial Assets" and IAS 12 "Deferred Tax: Recovery of Underlying Assets" (not yet endorsed by the EU) are effective for accounting periods beginning on or after 1 February 2010, 1 July 2011 and 1 January 2012 respectively. They are not expected to have a significant impact upon the Group's net results, net assets or disclosures.
iv)Improvements to IFRS (endorsed by the EU in February 2011) was issued in May 2010 and contains amendments to several individual accounting standards which are effective for accounting periods beginning on or after 1 July 2010 or 1 January 2011. None of the amendments are expected to have a significant impact upon the Group's net results, net assets or disclosures.

The following IFRIC amendments and interpretations have been issued but are not yet adopted by the Group:

  • Amendments to IFRIC 14 'Prepayments of a Minimum Funding Requirement'.
  • IFRIC 19 'Extinguishing Financial Liabilities with Equity Instruments'.

The amendments and interpretations are effective for accounting periods commencing on or after 1 January 2011 and 1 July 2010 respectively. None of the amendments or interpretations are expected to have a significant impact upon adoption. There is no impact expected from any other standards that are available for early adoption but that have not been adopted.

3. Risk Management

The Group's activities expose it to a variety of financial risks that arise as a result of its exploration, development, production, and financing activities. The Group's overall risk management programme focuses on the unpredictability of financial markets and seeks to minimise potential adverse effects on the Group's financial performance.

a) Financial risk management

i) Foreign exchange risk

Foreign exchange risk arises when transactions and recognised assets and liabilities of the Group entity concerned are denominated in a currency that is not the Company's functional currency. The Group operates internationally and is exposed to foreign exchange risk arising from currency exposures to the US dollar.

There are no forward exchange rate contracts in place at, or subsequent to, 31 December 2010.

At 31 December 2010, if the Canadian dollar had strengthened/weakened by 10% against the US dollar with all other variables held constant, the loss for the year would have been $8,000 (31 December 2009 – $536,000) higher/(lower), mainly as a result of foreign exchange gains/losses on translation of Canadian dollar-denominated general and administrative expenses and cash in bank.

At 31 December 2010, if the Russian rouble had strengthened/weakened by 10% against the US dollar with all other variables held constant, the loss for the year would have been $(761,000) (31 December 2009 – $(557,000) higher/(lower), mainly as a result of foreign exchange gains/losses on translation of Russian rouble-denominated cash in bank and monetary assets and liabilities.

At 31 December 2010, if the GB pound sterling had strengthened/weakened by 10% against the US dollar with all other variables held constant, the loss for the year would have been $611,000 (31 December 2009 – $2,309,000) higher/(lower), mainly as a result of GB pound sterling-denominated general and administrative expenses and foreign exchange gains/losses on translation of GB pound sterling-denominated long-term loan.

At 31 December 2010, if the Swiss franc had strengthened/weakened by 10% against the US dollar with all other variables held constant, the loss for the year would have been $728,000 (31 December 2009 –$(300,000) higher/(lower), mainly as a result of foreign exchange gains/losses on translation of Swiss franc-denominated cash at bank.

ii) Commodity price risk

The Company is exposed to commodity price risk to the extent that it sells its entitlement to petroleum, condensate and liquid petroleum gas production on a floating price basis. The Company may consider partly mitigating this risk in the future.

The table below summarises the impact of increases/decreases of the relevant oil/condensate/LPG benchmark on the Company's loss for the year. The analysis is based on the assumption that commodity prices had increased/decreased by 5% with all other variables held constant:

Year ended 31 December
2010
$'000
2009
$'000
Brent light crude12070
12070

The profit /(loss) for the year would increase/decrease as a result of commodity revenues received.

iii) Interest rate risk

The Group had fixed rate convertible bonds in the years under review, therefore it was not exposed to interest rate risk with respect to this fixed rate borrowing. In January 2005, a wholly owned subsidiary of the Company received a sterling denominated loan of £4.5 million to refinance the acquisition of a corporate office. Interest on the loan was fixed at 6.515% for the first five years and is then variable at a rate of Bank of Scotland base rate plus 1.4% (note 16). In October 2007, a wholly owned subsidiary of the Company received a long-term loan of $9.45 million with a variable rate of LIBOR plus 1.6% (note 16). An increase/decrease of LIBOR by 1% would result in an increase/decrease of the Company's profit /(loss) for the year by $144,000 (31 December 2009 – $85,000).

iv) Credit risk

All of the Company's production in 2009 and 2010 was derived from Russia. In 2009 and 2010 sales were to a maximum of nine customers.

Trade debtors of the Company are subject to internal credit review to minimise the risk of non-payment. The Company does not anticipate any default as it transacts with creditworthy counterparties. No credit limits were exceeded during the reporting years and management does not expect any losses from non-performance by these counterparties.

The Company is also exposed to credit risk in relation to regular joint venture billings which are typically outstanding for one month and in relation to its cash balances held with reputable banks.

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 Company's current operational and investment cash flow requirements.

Management monitors rolling forecasts of the Company's cash position on the basis of expected cash flow.

The Group had available cash of $598 million at 31 December 2010. Based on its current plans and knowledge, its projected capital expenditure and operating cash requirements, the Group has sufficient cash to finance its operations for more than 12 months from the date of this report.

The Company's 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 notes 15 and 16.

b) Capital risk management

The Company's objectives when managing capital are to safeguard the Company's ability to continue as a going concern in order to provide returns for shareholders, benefits for other stakeholders and to maintain an optimal capital structure to reduce the cost of capital. Capital consists of share capital and retained earnings/(deficit) and reserves.

The Company monitors capital on the basis of the gearing ratio. This ratio is calculated as net debt divided by total capital. Net debt is calculated as total borrowings (including "borrowings", "trade and other payables", "liabilities of a disposal group classified as held for sale" and "provisions" as shown in the consolidated balance sheet) less cash and cash equivalents. Total capital is calculated as "equity" as shown in the consolidated balance sheet plus net debt.

Year ended 31 December
2010
$'000
2009
$'000
Total borrowings189,080166,361
Less cash and cash equivalents (note 14)(598,275)(208,094)
Net cash(409,195)(41,733)
Total equity1,122,825389,663
Total capital1,122,825389,663
Gearing ratio0%0%

4. Critical Accounting Estimates, Assumptions and Judgements

In the process of applying the Company's accounting policies, which are described in note 2, management makes estimates and assumptions concerning the future. The resulting accounting estimates will, by definition, seldom equal the related actual results. The estimates and assumptions that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year are discussed below:

a) Recoverability of exploration and evaluation costs

Under the modified full cost method of accounting for E&E costs, certain costs are capitalised as intangible assets by reference to appropriate cost pools, and are assessed for impairment when circumstances suggest that the carrying amount may exceed its recoverable value.

Such circumstances include, but are not limited to:

i)the period for which the entity has the right to explore in the specific area has expired during the period, or will expire in the near future, and is not expected to be renewed;
ii)substantive expenditure on further exploration for, and evaluation of, mineral resources in the specific area is neither budgeted nor planned;
iii)exploration for, and evaluation of, mineral resources in the specific area have not led to the discovery of commercially viable quantities of mineral resources and the entity has decided to discontinue such activities in the specific area; and
iv)sufficient data exists to indicate that, although a development in the specific area is likely to proceed, the carrying amount of the exploration and evaluation asset is unlikely to be recovered in full from successful development or by sale.

This assessment involves judgement as to (i) the likely future commerciality of the asset and when such commerciality should be determined, and (ii) future revenues and costs pertaining to any wider cost pool with which the asset in question is associated, and (iii) the discount rate to be applied to such revenues and costs for the purpose of deriving a recoverable value. Note 10 discloses the carrying amounts of the Group's E&E assets. Consequently, major uncertainties affect the recoverability of these costs which is dependent on the Group achieving commercial production or the sale of the assets. Note 23 discloses contingencies relating to title risks. The Company assessed whether these risks are contingencies or indicators of impairment and concluded that they are contingencies. There are licences that are due for renewal in 2011. The Group is confident they will be renewed.

b) Reserve estimates

Estimates of recoverable quantities of proved 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 Group's development and production assets has been impaired.

c) Fair value of financial instruments

The Group's accounting policies and disclosures require the determination of the fair value of financial instruments. Fair values have been determined for measurement and/or disclosure purposes based on the following methods:

i) Non-derivative financial instruments

These comprise investments in equity and debt securities, trade and other receivables, cash and cash equivalents, loans and borrowings and trade and other payables. Non-derivative financial instruments are recognised initially at fair value plus, for instruments not at fair value through the income statement, any directly attributable transaction costs.

Fair value is calculated based on the present value of future principal and interest cash flows, discounted at the applicable market rate of interest at the reporting date.

ii) Derivatives

Derivatives are recognised initially at fair value; attributable transaction costs are recognised in the income statement 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).

IFRS 7 requires the classification of fair value measurements using a fair value hierarchy that reflects the significance of the inputs used in making the assessments. The fair value hierarchy has the following levels:

  • Level 1: quoted prices (unadjusted) in active markets for identical assets or liabilities
  • Level 2: inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly (i.e. as prices) or indirectly (i.e. derived from prices)
  • Level 3: inputs for the assets or liability are not based on observable market data (unobservable inputs).

5. Segment Information

The Group has a single class of business which is international exploration, development and production of petroleum oil and natural gas. The geographical areas are defined by the Company as operating segments in accordance with IFRS 8 Operating Segments. The Group operates in a number of geographical areas based on location of operations and assets, being Russia, the DRC, Kurdistan, Pakistan, Tanzania, Malta, Mali, Uganda (discontinued) and Oman (discontinued). The Group's reporting segments comprise each separate geographical area in which it operates.

Year ended 31 December 2010
External revenue
$'000
Segment result
$'000
Total assets
$'000
Total liabilities
$'000
Capital additions
$'000
Depreciation and depletion amortisation $'000
Russia5,015(1,892)52,5341,3434,8781,306
DRC(1,645)57
Kurdistan130,38516,59555,143
Pakistan4,619752,375
Tanzania(8,890)22,9258,37611,557
Mali3,0371,018
Malta13,778852,613
Uganda – discontinued operations1,267,21123,444
Total for reportable segments5,0151,254,784227,27826,474101,0851,306
Corporate(31,799)1,084,627162,60642,914805
Elimination of discontinued operations(1,267,211)(23,444)
Total from continuing operations5,015(44,226)1,311,905189,080120,5552,111
Year ended 31 December 2009
External revenue
$'000
Segment result
$'000
Total assets
$'000
Total liabilities
$'000
Capital additions
$'000
Depreciation and depletion amortisation $'000
Russia2,705(1,776)48,9595723,265762
DRC1,68881
Kurdistan(7)80,6126,66037,120
Pakistan1,73453
Tanzania20,4021996,904
Mali2,018769
Malta11,111442,457
Uganda – discontinued operations(1,811)163,41512,55928,487
Oman – discontinued operations(699)500
Total for reportable segments2,705(4,293)329,93920,03479,636762
Corporate(35,054)226,085146,327632948
Elimination of discontinued operations2,510(163,415)(12,559)(28,987)
Total from continuing operations2,705(36,837)392,609153,80251,2811,710

The Group's 2010 revenue of $5,015,000 was from nine Russian based customers. Five customers had purchases for more than 10% of revenue ($502,000). The total revenue relating to these five customers was $4,629,000. The remaining four customers account for revenue of $386,000.

There have been no changes to the basis of segmentation or the measurement basis for the segment result since 31 December 2009. In 2010, an impairment loss relating to Tanzania of $8,890,000 (2009 – nil), the DRC of $1,645,000 (2009 – nil) and corporate of $1,854,000 (2009 – $2,933,000) is included in segmental result.

6. Discontinued Operations

Uganda

On 18 December 2009, Heritage announced that the Company and HOGL had entered into a SPA, with Eni for the sale of the Ugandan Assets and on 17 January 2010, Tullow exercised its rights of pre-emption. The sale of the Ugandan Assets completed on 26 July 2010; Tullow paid cash of $1.45 billion, including $100 million from a contractual settlement, of which Heritage received and retained $1.045 billion.

The URA contends that income tax is due on the capital gain arising on the disposal and it raised assessments amounting to $404,925,000 prior to completion of the disposal. Heritage's position, based on comprehensive advice from leading legal and tax experts in Uganda, the United Kingdom and North America, is that no tax should be payable in Uganda on the disposal of the Ugandan Assets.

In order to allow the disposal to proceed, the Group agreed with Tullow a mechanism to provide Government with security over the disputed amounts through depositing some of the proceeds with the URA and placing a further amount in escrow.

Tullow paid cash consideration of $1.35 billion and an additional contractual settlement amount of $100 million. On closing, Heritage deposited $121,477,000 with the URA, amounting to 30% of the disputed tax assessment of $404,925,000. $121,477,000 has been classified as a deposit in the balance sheet at 31 December 2010. A further $283,447,000 has been retained in escrow, pursuant to an agreement between HOGL, Tullow and Standard Chartered Bank pending resolution between Government and HOGL of the tax dispute. Including accrued interest an amount of $286,603,000 is classified as restricted cash in the balance sheet at 31 December 2010.'

In August 2010, the URA issued a further income tax assessment of $30 million representing 30% of additional contractual settlement amount of $100 million. HOGL disputed this assessment and no provision has been made for this amount. There is a tax tribunal ongoing in Uganda, and HOGL continues to review options to recover monies held in relation to the Uganda tax dispute, which could include arbitration in London.

Although disputes of this nature are inherently uncertain, the Directors believe that the monies on deposit and held in escrow account will ultimately be recovered by Heritage.

As at 31 December 2010, working capital adjustments with respect to the disposal of the Ugandan Assets of $13.6 million was owed by Tullow. This was paid in March 2011.

On 15 April 2011, Heritage and its wholly owned subsidiary HOGL received Particulars of Claim filed in the High Court of Justice in England by Tullow seeking $313,447,500 for alleged breach of contract as a result of HOGL's and Heritage's refusal to reimburse Tullow in relation to a payment made by Tullow of $313,447,500 on 7 April 2011 to the URA. Heritage and HOGL believe that the claim has no basis and will vigorously and robustly defend it. Heritage and HOGL have also reserved their other rights against Tullow and against Government.

On 15 April 2011, HOGL sent a request to Tullow, as a co-signatory to the escrow account with Standard Chartered Bank for the release of $283,447,000, plus interest to HOGL. HOGL contends that, consequent on Tullow's admission that its payment of $313,447,500 to the URA has discharged HOGL's alleged tax liability, funds no longer need to be held in escrow.

The results of the Ugandan operations have been classified as discontinued operations. Gain/(loss) on disposal of discontinued operations as at 31 December 2010 and 2009 is as follows:

Year ended 31 December
2010
$'000
2009
$'000
Gain/(loss) on disposal of discontinued operations1,267,211(1,811)
1,267,211(1,811)

The following table provides additional information with respect to the discontinued operations amounts included in the balance sheet at 26 July 2010.

26 July 2010
$'000
Assets
Non-current assets
Intangible exploration and evaluation assets181,963
Property, plant and equipment472
Total assets182,435
Current liabilities
Trade and other payables3,105
3,105
Non-current liabilities
Provisions269
269
Total liabilities3,374
Net assets179,061

The profit on disposal of discontinued operations has been derived as follows:

Year ended
31 December 2010
$'000
Consideration received
Sales proceeds including contractual settlement1,450,000
Working capital adjustments13,636
Total disposal consideration1,463,636
Add:
Revenue – transitional services agreement1,489
Less:
Carrying amount of net assets sold(179,061)
Other expenses(17,421)
Expenses – transitional services agreement(1,432)
Gain on disposal of discontinued operations1,267,211
Year ended
31 December 2010
$'000
Cash flow from (used in) discontinued operations:
Net cash used in operating activities(300)
Net cash from investing activities1,005,788
Net cash flows from discontinued operations1,005,488

Oman

On 7 April 2009, the Company completed the sale of Eagle Energy, a wholly-owned subsidiary of Heritage, to RAK Petroleum Oman Limited for $28 million, plus a working capital adjustment of $0.4 million. Eagle Energy holds a 10% interest in Block 8, Oman.

The effective date of the transaction was 1 January 2009. The cash consideration of $28 million and a working capital adjustment of $0.4 million have been received. The Company acquired Eagle Energy, which has a 10% interest in Block 8 offshore Oman, in 1996. Block 8 contains the Bukha field which commenced production in 1994 and the West Bukha field which commenced production in February 2009.

The following table provides additional information with respect to the discontinued operations amounts included in the balance sheet at 7 April 2009.

7 April 2009
$'000
Assets
Non-current assets
Intangible exploration and evaluation assets1,051
Property, plant and equipment27,449
28,500
Current assets
Accounts receivable247
Inventories65
312
Net assets28,812

The loss on disposal of discontinued operations has been derived as follows:

7 April 2009
$'000
Consideration received
Sales proceeds28,000
Working capital adjustments390
Total disposal consideration28,390
Less:
Carrying amount of net assets sold(28,812)
Other expenses(277)
Loss on disposal of discontinued operations(699)

7. Other Finance Costs

Year ended 31 December
2010
$'000
2009
$'000
Interest on long-term debt303656
Interest on convertible bonds10,16811,023
Accretion of convertible debt5,2554,111
Accretion of asset retirement obligation4552
15,77115,842
Amount capitalised(12,801)(11,513)
Finance costs expensed2,9704,329

Finance costs are capitalised in various balance sheet categories.

8. Income Tax Expense

Recognised in the income statement:

Year ended 31 December
2010
$'000
2009
$'000
Current tax expense197
Total tax expense197

Current tax expense relates to the profit on operations of the Group's UK subsidiary.

The Group did not recognise any income tax in other comprehensive income or directly in equity. The Group is subject to income taxes in certain territories in which it owns licences or has taxable operations. All of the Group's operating activities are outside of Jersey. In the UK, the tax rate applicable to the Group's operations is 28%. It is the UK government's intention to enact legislation which will reduce the main rate of UK corporation tax to 24% by 2014.

The Group has available tax deductions of $17,607,000 (31 December 2009 – $23,857,000) and tax losses of $140,378,000 (31 December 2009 – $125,768,000), of which $103,665,000 expires from 2011 to 2030, and the remaining $36,711,000 (31 December 2009 – $45,128,000) does not have an expiry period. No deferred tax assets have been recognised for the benefit of tax deductions and tax losses because realisation of the deferred tax assets in the foreseeable future is not sufficiently likely.

Factors affecting the current tax charge for the year:

Year ended 31 December
2010
$'000
2009
$'000
Profit/(loss) for the year1,223,182(39,347)
Standard tax rate0%0%
Tax on profit/(loss) at standard rate
Effect of higher tax rates in foreign jurisdiction(5,242)(5,912)
Effective weighted average tax rate0.43%15.03%
Change in statutory tax rate372604
Expenses not deductible for tax purposes1,2651,489
Foreign exchange gains/(losses)1,675(686)
Effect of tax losses not recognised2,1274,505
Current tax charge197
2010
$'000
2009
$'000
The balance comprises temporary differences attributable to:
Available tax losses and deductions33,28131,154
Deferred tax asset (unrecognised)33,28131,154

The tax rate applied in respect of foreign jurisdictions is the local tax rate applicable to the nature of the profits arising.

9. Staff Costs

The average number of employees (including Directors) and consultants employed/contracted by the Group during the year, analysed by category, was:

Year ended 31 December
20102009
Jersey43
Canada55
Russia4040
Europe2727
Uganda3148
Kurdistan2023
Pakistan17
Tanzania1110
Mali1
South Africa78
Total163164

The aggregate payroll expenses of those employees (including Executive Directors) and consultants was as follows:

Year ended 31 December
2010
$'000
2009
$'000
Salaries and other short-term benefits30,11719,759
Share-based compensation4,2565,270
Total employee remuneration34,37325,029
Capitalised portion of total remuneration15,73310,752

Key management compensation was:

Year ended 31 December
2010
$'000
2009
$'000
Salaries and other short-term benefits8,2916,350
Share-based compensation2,9883,355
11,2799,705

See note 22 "Related Party Transactions" for disclosures relating to the arbitration settlement with a former director of HOC.

10. Intangible Exploration and Evaluation Assets

Year ended 31 December
2010
$'000
2009
$'000
At 1 January121,278211,346
Effect of movement in exchange differences(83)(131)
Exercise of third party back-in rights for Miran(6,738)
Additions72,76476,371
Disposal of Oman assets(1,051)
Impairment loss(10,535)
Transfer of assets held for sale(158,519)
At 31 December183,424121,278

No assets have been pledged as security.

The balances at the end of the years are as follows:

Year ended 31 December
2010
$'000
2009
$'000
Russia11,15111,235
DRC1,588
Kurdistan128,93073,786
Pakistan3,9881,613
Malta13,64111,028
Mali3,0131,994
Tanzania22,70120,034
Balance – end of year183,424121,278

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. The risk of title disputes associated with Kurdistan and Malta is described in note 23.

In 2010, the Group recognised an impairment of intangible exploration and evaluation assets of $10,535,000 (2009 – nil) comprised of two elements. Following changes in future plans management decided to write-off expenditure of $1,645,000 incurred with respect to interests in Block 1 and 2 in the DRC. After a technical review management decided to write-off expenditure of $8,890,000 incurred with respect to the Kisangire and Lukuliro licence areas in Tanzania.

Exercise of third party back-in rights

In April 2009, in accordance with the option outlined in the PSC in Kurdistan, the Kurdistan Regional Government ("KRG") nominated a third party participant in the Miran Block. The Company remains the operator with a 75% working interest in the Miran Block and has received the pro-rata share of 25% of all past work programme expenditures and the third party pays its share of future costs. The transaction was completed upon the receipt of approximately $6.7 million in costs incurred by the Group to 31 January 2009. No gain/loss resulted from this transaction and intangible exploration assets reduced by $6.7 million. The KRG and the Group have replaced the agreement under which they had agreed in principle (subject to certain conditions which had not been satisfied) to jointly develop a refinery with an agreement under which the Group has agreed to make payments of up to $35 million from future oil and gas sales from the licence.

11. Property, Plant and Equipment

Petroleum and natural gas interests $'000Drilling and barge equipment $'000Land and buildings $'000Aircraft $'000Other
$'000
Total
$'000
Cost
At 1 January 200971,3683,54511,98512,6392,685102,222
Additions3,2656323,897
Assets transferred from intangible exploration(31,092)(31,092)
Effect of movements in exchange rates(546)(546)
At 31 December 200942,9953,54511,98512,6393,31774,481
Additions4,87842,8506347,791
Disposals(60)(60)
Effect of movements in exchange rates(128)(128)
At 31 December 201047,7453,54511,98555,4893,320122,084
Depletion, depreciation, amortisation and impairment losses
At 1 January 2009(8,519)(2,898)(591)(1,180)(995)(14,183)
Charge for the year(762)(139)(524)(285)(1,710)
Impairment losses(2,933)(2,933)
Disposals3,6433,643
At 31 December 2009(5,638)(2,898)(730)(4,637)(1,280)(15,183)
Charge for the year(1,307)(401)(403)(2,111)
Impairment losses(1,854)(1,854)
Disposals(943)(943)
At 31 December 2010(6,945)(2,898)(730)(6,892)(2,626)(20,091)
Net book value:
At 31 December 200937,35764711,2558,0022,03759,298
At 31 December 201040,80064711,25548,597694101,993

The corporate office, which represents the land and building category, and an aircraft serve as security for long-term loans (note 16).

The carrying value of an aircraft was written down to the fair value less cost to sale of $5.9 million ($8.1 million in 2009) because of a reduction in fair value of an aircraft due to unfavourable economic conditions. This resulted in an impairment write down of $1.9 million ($2.9 million in 2009) recognised in the income statement during the year ended 31 December 2010 and 2009.

12. Other Financial Assets

Year ended 31 December
2010
$'000
2009
$'000
Investment in warrants2,0501,154
2,0501,154

The investment in Afren warrants is classified as held for trading. The estimate of the fair value of the warrants is determined using the Black-Scholes model and relevant market inputs. The fair value measurement of investment in warrants is categorised as Level 2.

13. Trade and Other Receivables

Year ended 31 December
2010
$'000
2009
$'000
Trade receivables81
Receivable from the acquirer of the Ugandan Assets on completion of the disposition (note 6)13,636
Other receivables6,5962,203
20,2402,204

Trade receivables are due within 30 days from the invoice date. Joint ventures billings are typically paid within 30 days from the invoice date. Interest is not normally charged on the receivables. The carrying amount of trade and other receivables approximates to 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 2010, trade and other receivables of $20,240,000 (31 December 2009 – $2,204,000) were neither past due nor impaired. Trade and other receivables relate to a number of independent customers and joint ventures partners for whom there is no recent history of default. The ageing analysis of these trade and other receivables is as follows:

Year ended 31 December
2010
$'000
2009
$'000
Up to 3 months19,4311,800
3 to 6 months365133
6 to 12 months444271
20,2402,204

Trade and other receivables analysed by currency are as follows:

Year ended 31 December
2010
$'000
2009
$'000
US dollars19,9431,816
Russian roubles9349
Swiss francs3063
Canadian dollars19214
GB pounds sterling124
Euros3162
20,2402,204

14. Cash and Cash Equivalents

Year ended 31 December
2010
$'000
2009
$'000
Cash at bank and in hand598,275208,094

Cash at bank and in hand includes cash held in interest-bearing accounts.

15. Trade and Other Payables Due within One Year

Year ended 31 December
2010 $2009 $
Trade payables19,52511,329
Withholding tax accrual8,271
Other payables and accrued liabilities26,28711,948
54,08323,277

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 to their fair value.

16. Borrowings

Year ended 31 December
2010
$'000
2009
$'000
Non-current borrowings
Convertible bonds – unsecured120,468115,277
Non-current portion of long-term debt13,04714,277
133,515129,554
Long-term debt – secured
Current896616
Non-current13,04714,277
13,94314,893

2007 convertible bonds

On 16 February 2007, the Company raised $165 million by completing the private placement of convertible bonds. Issue costs amounted to $6,979,000 resulting in net proceeds of $158,021,000. HOC issued 1,650, $100,000 unsecured convertible bonds at par, which have a maturity of five years and one day and an annual coupon of 8% payable semi-annually on 17 August and 17 February of each year. Bondholders have the right to convert the bonds into Ordinary Shares at a price of $4.70 per share at any time. The number of Ordinary Shares receivable on conversion of the bonds is fixed. The Company had the right to redeem, in whole or part, the bonds for cash at any time on or before 16 February 2008, at 150% of par value. This right was not exercised.

The fair value of the host liability component of the bonds (net of issue costs) was estimated at $140,154,000 on 16 February 2007. The difference between the $165 million due on maturity and the initial liability component is accreted using the effective interest rate method and is recorded as finance costs. As the Company call option meant that conversion feature could be settled in cash in accordance with IAS 32 the conversion was treated as a derivative liability. The fair value of this derivative liability (estimated using the Black-Scholes option pricing model) was $17,867,000 at 16 February 2007 and subsequent gains and losses were recorded in finance income and costs up to the expiry of the Company call option on 17 February 2008. As a result of the expiry of this option, and hence the cash settlement feature, the Company has reassessed the classification of the conversion option and determined that it qualifies to be treated as equity under IAS 32, being an option to convert a fixed amount of cash for a fixed number of shares. Therefore, the fair value of the conversion option was reclassified to equity at that date.

Bondholders have a put option requiring the Company to redeem the bonds at par, plus accrued interest, in the event of a change of control of the Company or revocation or surrender of the Zapadno Chumpasskoye licence in Russia (the "contingent put option"). In the event of a change of control and redemption of the bonds or exercise of the conversion rights, a cash payment of up to $19,700 on each bond will be made to a Bondholder, the amount of which depends upon the date of redemption and market value of shares at the date of any change of control event. The contingent put option has been valued separately. The fair value of the contingent put option has been estimated de minimis by the Company at 31 December 2010 (31 December 2009 – de minimis). The fair value measurement of the contingent put option is categorised as Level 2.

During 2009, Bondholders with $30.9 million of bonds gave notices of the exercise of the conversion rights on 309 bonds. These Bondholders received 6,574,456 Ordinary Shares (note 18). As a result of this conversion, $28,207,000 was transferred to share capital from convertible bonds and accrued liabilities and $5,993,000 was transferred from the equity portion of convertible debt to share capital.

On 18 December 2009, the Company announced it had entered into a SPA for the sale of its Ugandan Assets (note 6). The Company also announced that it would consider returning a portion of the disposal proceeds to shareholders through a special dividend on completion of the proposed transaction. Under the terms and conditions of the bonds, the Company was restricted from making or declaring a dividend or making any other distributions to its shareholders which constitutes on a consolidated basis more than 30% of its earnings for the immediately preceding financial year.

In December 2009, the Company approached Bondholders with the proposal to agree to remove this restriction and to make some other changes in the terms and conditions of the bonds. In considerations the Company proposed to pay to those Bondholders who vote on the proposal the sum of $2,000.00 per $100,000 of bonds held by such Bondholders. The majority of the Bondholders voted in favour of this proposal at a meeting on 31 December 2009 and the restriction of making or declaring a dividend or making any other distributions to shareholders has been removed. On 15 January 2010, the Company paid $2,378,000 to the Bondholders who voted. In accordance with IAS 39, this amendment to the terms and conditions of the bonds does not constitute a redemption and therefore this amount was offset against the convertible bonds liability and will be recognised in the income statement over the period of the borrowings using the effective interest method.

Long-term debt

In January 2005, a wholly owned subsidiary of the Company received a sterling denominated loan of £4.5 million to refinance the acquisition of a corporate office. Interest on the loan was fixed at 6.515% for the first five years and is now variable at a rate of Bank of Scotland base rate plus 1.4%. The loan, which is secured on the property, is scheduled to be repaid by 240 instalments 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 (£1.86 million). The principal balance outstanding as at 31 December 2010 was $6,030,000 (£3.9 million) (31 December 2009 – $6,574,000 (£4.1 million)).

In October 2007, a wholly owned subsidiary of the Company received a loan of $9.45 million to refinance the acquisition of an aircraft. Interest on the loan is variable at a rate of LIBOR plus 1.6%. The loan, which is secured on the aircraft, is scheduled to be repaid by 19 consecutive quarterly instalments of principal. Each instalment equals $118,000 with the final instalment being $7,218,000. The Corporation provided a corporate guarantee to the lender. The additional security of $2,454,000 was paid to the bank on 19 January 2010 to maintain the loan to value ratio specified in the loan agreement.

Fair values

At 31 December 2010, the fair values of borrowings were approximately $120.5 million (31 December 2009 – $115.3 million) for the convertible bonds, $71.1 million (31 December 2009 – $89.2 million) for the equity/convertible element of the convertible bonds and $13.9 million (31 December 2009 – $14.9 million) for the long-term debt.

17. Provisions

The Group's 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 $783,000, which is expected to be incurred in the period between 2012 and 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 Uganda and Russia (2009 – 9%) and 10% was used in Kurdistan in 2010 (2009 – 10%).

A reconciliation of the asset retirement obligation is provided below:

Year ended 31 December
2010
$'000
2009
$'000
At 1 January355720
Additions117
Settlement(239)
Revision (due to farm-in, Kurdistan)(38)
Accretion expense (note 7)4552
Transferred to disposal group held for sale(257)
Disposal(11)
At 31 December389355

18. Share Capital

The Company was incorporated under the Jersey Companies Law on 6 February 2008. The Company's authorised share capital is an unlimited number of Ordinary Shares without par value. At incorporation, there was one Ordinary Share issued at $42. On 22 February 2008, a second Ordinary Share was issued at $41.

As part of the Reorganisation described in the 2008 Annual Report and Accounts, the rights of different classes of shares are the same and therefore economically equivalent. As such, Ordinary and Exchangeable Shares were treated as one class of shares for the net earnings/(loss) per share calculation.

Ordinary Shares

Year ended 31 December 2010Year ended 31 December 2009
NumberAmount
$'000
NumberAmount
$'000
At 1 January284,842,830457,697251,858,374215,509
Issue of shares25,400,000205,028
Exchange of Exchangeable Shares for Ordinary Shares57,00049225,000192
Issued on exercise of share options (note 21)785,0002,768
Issued on conversion of bonds6,574,45634,200
At 31 December284,899,830457,746284,842,830457,697

Special Voting Share

Year ended 31 December 2010Year ended 31 December 2009
NumberAmount
$
NumberAmount
$
At 1 January11
Issued during the year
At 31 December11

Exchangeable Shares of HOC each carrying one voting right in the Company

Year ended 31 December 2010Year ended 31 December 2009
NumberAmount
$'000
NumberAmount
$'000
At 1 January3,024,1082,5833,249,1082,775
Exchange of Exchangeable Shares for Ordinary Shares(57,000)(49)(225,000)(192)
At 31 December2,967,1082,5343,024,1082,583
Balance of Ordinary Shares of the Company and Exchangeable Shares of HOC at 31 December287,866,938460,280287,866,938460,280

On 18 June 2009, the Company completed the placing of 25,400,000 new Ordinary Shares at a price of £5.20 per share for gross proceeds of $216,849,000 (£132,080,000) to the Company. Share issue costs were $11,821,000 (£7,157,000).

Special dividend

On 2 August 2010, Heritage announced the declaration of a special dividend of 100 pence per Ordinary Share of the Company and HOC, the Company's wholly owned subsidiary, also announced the declaration of a special dividend of Cdn$1.62 per Exchangeable Share of HOC, calculated at an exchange rate of £1.00:Cdn$1.62. The special dividend was paid on 27 August 2010.

The special dividend resulted in a payment to Bondholders. As disclosed in the announcement of 31 December 2009, certain amendments to the terms of the $165 million 8.00% convertible bonds due 2012 (the "Bonds") were approved by Bondholders. Pursuant to such amendments, no adjustments will be made to the conversion rights under the terms of the Bond (the "Conversion Rights") in respect of any dividend paid or made by the Company; instead, the Company agreed to pay the holder of each Bond outstanding on the record date for such dividend a pass-through dividend (the "Pass-through Dividend") which is equal to the dividend which would be received by the holder of a number of Ordinary Shares equal to the number of Ordinary Shares to which the Bondholder would have been entitled if it had exercised its Conversion Rights on the record date of 13 August 2010.

The aggregate principal amount of Bonds outstanding on the record date was $127,100,000. These Bonds are convertible into 27,043,000 Ordinary Shares pursuant to the Conversion Rights and accordingly the Company paid to Bondholders a Pass-through Dividend of £27,043,000 on 27 August 2010.

19. Reserves

a) Available-for-sale investments revaluation reserve

Changes in the fair value and exchange differences arising on translation of available-for-sale investments such as equities, classified as available-for-sale financial assets, are taken to the available-for-sale investments revaluation reserve (note 2j). Amounts are recognised in the income statement when the associated assets are sold or impaired.

b) Foreign currency translation reserve

Exchange differences arising on translation of a foreign controlled entity are included in the foreign currency translation reserve (note 2r). The reserve will be recognised in the income statement when the net investment is sold.

c) Share-based payments reserve

The share-based payments reserve (note 2s), is used to recognise the fair value of options and LTIP awards issued, but not exercised, to employees.

d) Equity portion of convertible debt

The fair value of the conversion feature of convertible bonds is classified as the equity portion of convertible debt which is included in reserves in the balance sheet.

20. Earnings/(Loss) Per Share

The following table summarises the weighted average Ordinary and Exchangeable Shares used in calculating net earnings per share:

Year ended 31 December
20102009
Weighted average Ordinary and Exchangeable Shares
Basic287,866,938273,117,649
Diluted331,012,512289,643,434

The reconciling item between basic and diluted weighted average number of Ordinary Shares is the dilutive effect of share options, LTIP awards and convertible bonds. A total of nil options (31 December 2009 – nil), nil shares relating to the LTIP (31 December 2009 – nil) and nil shares relating to the convertible bonds (31 December 2009 – 27,042,553) were excluded from the above calculation, as they were anti-dilutive. However, since the Company has made a loss in 2009 for the purposes of calculating diluted loss per share, all potential Ordinary Shares have been treated as anti-dilutive in that year. In calculation of 2010 loss per share from continuing operations 27,042,553 of shares relating to the convertible bonds were excluded from the above calculation, as they were anti-dilutive.

21. Share-Based Payments

Share options

The Company had a stock option plan whereby certain Directors, officers, employees and consultants of the Group have been granted options to purchase Ordinary Shares. Under the terms of the plan, options granted normally vest one third immediately and one third in each of the years following the date granted and have a life of five years.

Ordinary Share options outstanding and exercisable:

Year ended 31 December 2010Year ended 31 December 2009
Number of optionsAverage exercise price (GBP) £Number of optionsAverage exercise price (GBP) £
At 1 January23,597,0101.5224,382,0101.51
Exercised (note 18)(785,000)1.29
Balance – end of year23,597,0101.5223,597,0101.52
Exercisable – at 31 December23,597,0101.5223,597,0101.52
Number of options
Exercise price (GBP)OutstandingExercisableRemaining
life (years)
£0.482,000,0002,000,0000.00
£0.81150,000150,0000.48
£1.08–£1.4317,447,01017,447,0100.95
£2.45–£2.514,000,0004,000,0001.93
23,597,01023,597,0101.03

Following the payment of a special dividend of 100 pence per share in August 2010 (see note 18), stock options holders are entitled to receive £1 per share when an option is exercised.

Heritage was in blackout period during 2010 and so stock option holders could not exercise their stock options. In accordance with the terms of stock option plan, the expiry date of 2,000,000 options which were scheduled to expire in 2010 has been extended and the options have been treated as outstanding and exercisable.

Long Term Incentive Plan ("LTIP")

On 19 June 2008, shareholders at the Annual General Meeting ("AGM") of the Company approved the 2008 LTIP. Under the terms of the plan, the LTIP awards will be in the form of full-value shares (Performance Shares), subject to performance and time-vesting conditions. Eligible employees will normally be considered by the Remuneration Committee for an award once each year. Awards made to the Executive Directors of the Company under the LTIP are called First Awards. Participants in the First Award, however, will not be entitled to any further awards until the 2011 financial year. Awards will normally be made during the period of 42 days following the announcement of year end or half-year financial results. Exceptionally, the First Awards under the plan on 19 June 2008, were permitted to be made within 42 days following approval of the LTIP at the June 2008 AGM.

The plan is intended to apply to Executive Directors and other employees in senior management or leadership roles. By exception, other higher performing and high potential employees may be considered for awards. Participants in the LTIP are not entitled to any further awards under the 2008 Scheme.

The vesting of shares under award are subject to performance conditions agreed by the Remuneration Committee when the award is made. For the First Awards made in 2008 the performance conditions are the relative Total Shareholder Return ("TSR") (capital gain plus dividends) performance of the Company versus that of a comparator group of international oil companies and a requirement for the share price of the Company to have increased by 20% over the vesting period of three years. Furthermore there is an additional holding period of one year following the awards vesting.

The Remuneration Committee, in consultation with executive reward consultants, approved grants of shares to Executive Directors, senior management and other employees in leadership roles under the LTIP. The maximum annual, individual award for participants who are not Executive Directors is 250% of base package (expressed as the "face value" of the shares). The First Award to the Executive Directors is 1,200% of base package for the CEO and 800% of base package for the CFO.

The First Awards vest after three years provided that the performance conditions are met. The awards granted to senior management and other employees in leadership roles are in three tranches that vest after three, four and five years respectively, provided that the performance condition is met at that time.

The awards will vest in line with the following schedule:

Senior management and other employees in leadership role awards
First Awards proportion vestingTSR performance versus comparator group of 18 companies
3rd place and above100% of the award100% of the award
4th place80%100%
5th place50%100%
6th place30%100%
7th place and below0%100%
9th place (median)0%100%
10th place and below0%0%

TSR is measured in comparison to a peer group of 18 oil companies selected based on one of or a combination of size (market capitalisation, revenue, turnover, cash expenditure or a combination thereof), area of operations and country of domicile. The TSR measurement is conducted by independent consultants in discussion with the Remuneration Committee.

Since there are market-related conditions the awards of the shares under LTIP were fair valued using the Monte Carlo model which takes into account the market-based performance conditions which effectively estimate the number of shares expected to vest. No subsequent adjustment is made to the fair value charge for shares that do not vest in the event that these performance conditions are not met. Adjustments are, however, made for leavers. The fair value of the awards is recognised as an employee expense with the corresponding increase in equity. The total amount to be expensed is spread over the vesting period during which the employees become unconditionally entitled to the shares and options.

The table below summarises the main assumptions used to fair value the awards made under the above LTIP and the fair values of the shares granted.

Award dateFirst Awards 19 June 200819 June 200819 June 200819 June 2008
Vesting period3345
Exercise priceNilnilnilnil
Share price at date of grant£3.45£3.45£3.45£3.45
Expected volatility40%40%40%40%
Expected dividend yield0%0%0%0%
Fair value as at grant date£1.55£2.49£2.61£2.70
Number of shares granted3,507,246473,061473,061473,061

The share-based payment recognised with respect to share options and LTIP awards previously granted, in the year ended 31 December 2010 was $4,255,000 (31 December 2009 – $5,270,000) out of which $1,086,000 (31 December 2009 – $2,063,000) was capitalised.

22. Related Party Transactions

During the year ended 31 December 2010, the Company incurred transportation costs of $93,000 (31 December 2009 – $270,000) with respect to the services provided by a company indirectly owned by Mr. Anthony Buckingham, CEO and a Director of the Company.

In 2010, the Company accrued $7.7 million in general and administrative expenses, in relation to an arbitration settlement to a former director of HOC whose services were terminated in 2006. Further arbitration proceedings have been initiated by this individual.

23. Commitments and Contingencies

Heritage's net share of outstanding contractual commitments at 31 December 2010 was estimated at:

Total $'000Less than 1 year $'0001–3 years $'0004–5 years $'000After 5 years $'000
Long-term debt, including interest15,5699308,3276155,697
Convertible bonds, including interest142,39413,957128,437
157,96314,887136,7646155,697
Effect of interest(16,793)(14,221)(1,691)(197)(684)
Total repayments of borrowings141,170666135,0734185,013
Operating leases7,4204766726725,600
Work programme obligations(1)106,48919,95566,53420,000
Total contractual obligations113,90920,43167,20620,6725,600
(1)Work programme obligation includes minimum required financial commitments for the Group to fulfil the requirements of licences and production sharing contracts.

The Company 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 Group's 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 PSC signed with the 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". The Directors believe that the PSC is valid and effective pursuant to the applicable laws.

The Group received a letter from the Chairman of the Management Committee of the National Oil Company 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 government's right to invoke Libyan and international law to protect its rights in the Block 7 licence area. The Directors believe that the Libyan government's claims are unfounded.

24. Non-cash Investing and Financing Activities Supplementary Information

Year ended 31 December
2010
$'000
2009
$'000
Capitalised portion of share-based compensation(1,086)(2,063)
Capitalised portion of interest(12,801)(11,534)
Non-cash property, plant and equipment additions relating to the capitalised portion of share-based compensation13,88713,597

FORWARD-LOOKING INFORMATION:

Except for statements of historical fact, all statements in this news release – including, without limitation, statements regarding production estimates and future plans and objectives of Heritage – constitute forward-looking information 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 its Prospectus and elsewhere in Heritage documents filed from time-to-time with the London Stock Exchange and other regulatory authorities. Further, any forward-looking information is made only as of a certain date and the Company undertakes no obligation to update any forward-looking information 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 Company's 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 information.

Contact Information