12th Jun 2006 07:02
Gulf Keystone Petroleum Ld12 June 2006 12th June, 2006 GULF KEYSTONE PETROLEUM LTD ("Gulf Keystone" or the "Company") PRELIMINARY RESULTS ANNOUNCEMENT Gulf Keystone Petroleum Limited, an independent oil and gas exploration companyoperating in the Republic of Algeria, today announces its preliminary resultsfor the period ending 31 December, 2005. Highlights • Drilling and workover operations on Block 126a resulted in a highly successful well test on the GKS oil discovery and a potential oil discovery on the GRJ structure. • Commerciality formally declared on both the GKS and GKN oil discoveries, development approval and a production licence expected shortly. SONATRACH supporting exploration licence extension to allow completion of GRJ-2. Extension subject to formal approval and gazetting. • Award of eight new blocks onshore in Algeria, as Operator with 75% Working Interest. • Independent estimates of recoverable Resources within the new Hassi Ba Bamou Perimeter and Block 129 contract areas total some 200 mmboe, with further exploration potential of some 450 mmboe. • Full review of strategic options for Algerian portfolio ongoing in conjunction with the Algerian Authorities. • Management team strengthened. Todd Kozel, Chief Executive Officer of Gulf Keystone said: "The key challenges for Gulf Keystone during 2006 are very clearly to secureproduction and cash flow from the discoveries on Block 126a and to significantlyadvance the exploration and appraisal of the newly acquired licences. Also GulfKeystone is now well positioned to focus on the further development of itsbusiness and the expansion of its portfolio, exploiting what it considers to beits particular competitive edge at the point of access for new opportunities inboth Algeria and selected areas of the Middle East and North Africa. We approachthis next phase in the company's development with considerable optimism." Enquiries Gulf Keystone Petroleum: 020 7514 1400Todd Kozel, CEOBill Guest, PresidentJon Cooper, Finance Director Hoare Govett Limited: 020 7678 8000Andrew Foster Tristone Capital Limited: 020 7399 2470Simon Ashby Rudd Citigate Dewe Rogerson: 020 7638 9571Media enquiries: Martin Jackson / George CazenoveAnalyst enquiries: Nina Soonor visit: www.gulfkeystone.com CHAIRMAN'S STATEMENT The year has been one of strong operational focus as we have continued with thedrilling and testing of prospects and existing discoveries on Block 126a andhave begun a comprehensive programme of technical and commercial studies on themajor new acreage holdings acquired by Gulf Keystone Petroleum Limited ("theCompany" or "Gulf Keystone") in Algeria during 2005. These varied activities have now confirmed that the Company has a portfolio ofassets with very significant oil and gas potential. A recent independentassessment of the Company's reserves and resources carried out by RPS EnergyLimited (RPS), and discussed further in the Chief Executive's report, hasconfirmed that the Company's newly expanded portfolio of assets containssignificant oil and gas exploration and development potential. While the results of operational activities on Block 126a have been mixed, theyhave added immeasurably to our understanding of the significant hydrocarbonpotential that exists in this geologically complex area. Commerciality has beenformally declared on the two oil discoveries, GKN and GKS, and a third potentialoil discovery has resulted from the drilling of well GRJ-2, which encounteredthree potentially hydrocarbon bearing intervals, and a test programme is beingdeveloped for this well. Having fulfilled its work commitments on Block 126a, and following conclusion ofthe Second Exploration and Evaluation Period of the licence in April of thisyear, Gulf Keystone has decided to focus exclusively on bringing the GKS and GKNoil fields into production, and on unlocking the productive potential of the GRJoil bearing structure. SONATRACH has notified the Company of its support for theextension to the Block 126a exploration licence, which is necessary to enablethe Company to pursue further work on the GRJ field, however, the extension tothe contract still needs to be formally gazetted. The Company has relinquishedthe remaining exploration acreage on the block. In April 2005, Gulf Keystone was a highly successful bidder in the 6th AlgerianInternational Licencing Round, acquiring exploration and appraisal rights to sixadditional onshore blocks under two separate contracts. A third contract,covering the Ben Guecha Perimeter (Blocks 108 and 128b), also adjacent to theCompany's other Constantine Basin interests, was secured as a result of directnegotiation with SONATRACH and the Algerian Ministry of Energy and Mines. Thiscontract has been signed by all relevant parties and we now await the formalgazetting of this award. These awards have increased Gulf Keystone's acreage holdings from one blockcovering 5,830 sq km to nine blocks now covering some 27,400 sq km. The Companyhas been awarded Operatorship of all eight new blocks and holds 75% of theworking interest with its partner SONATRACH holding the remaining 25% workinginterest. The Company has already commenced detailed technical and commercialstudies on these new blocks with the intention of acquiring further 2D and 3Dseismic data, and commencing appraisal and workover activities on discoveriesalready made on the licences, as soon as practicable. I am delighted to report that Gulf Keystone has continued to strengthenradically its management team by recently recruiting individuals onto the Boardand the Executive team with very significant international upstream experiencein the financial, commercial and technical areas in particular. In this regard,Bill Guest took on the position of President of the Company in November 2005while in March 2006 Jon Cooper joined as Finance Director for Gulf KeystonePetroleum Limited and Iain Patrick joined as Director of Commercial and LegalAffairs for Gulf Keystone Petroleum (UK) Limited. We very much welcome them onboard. As the team expands and continues to build its reputation within Algeria as askilled and technically competent Operator and Partner, Gulf Keystone is nowincreasingly well placed to concentrate on expanding its business developmentstrategy. Such a strategy will inevitably be focused, first and foremost, onbuilding its competitive position in Algeria. The Company is however, alsobeginning to focus actively, in parallel, on other selected areas within theNorth Africa and Middle East region where it considers that it has a competitiveedge at the point of access as a result of its existing regional relationships. Finally, I am delighted to acknowledge the strong and highly collaborativeworking relationship that the Company continues to enjoy in Algeria with itshost, the Ministry of Energy and Mines, and partner SONATRACH and we lookforward to building and developing these relationships further to our mutualbenefit. I remain however acutely aware of the need for us to continue to beable to translate these excellent relationships into specific deliverables. Weare also conscious of the need to demonstrate the viability of, and growthpotential associated with the Company's strategy. One of the key challenges that Gulf Keystone and other operators in Algeria havefaced during 2005 has been the increasing cost of and access to goods andservices. This obviously reflects the current state of the global service marketparticularly in Algeria and has for example hindered the Company fromconsidering some of the more radical reservoir stimulation activities on Block126a that it contemplated at the time of licence acquisition. The Company ishowever taking important steps to ensure that those services required in supportof its future programme of activities within its expanded portfolio can beaccessed on a timely and cost effective basis. I would like to thank all those employed by the Company, whether in Bermuda,Algeria, London or elsewhere, for their significant efforts over the past year,and I now very much look forward to being able to report progress towardsdemonstrating the potential of, and crystallising the value from, the Company'sdiverse portfolio of assets. Roger ParsonsNon-executive Chairman CHIEF EXECUTIVE OFFICER'S STATEMENT I am pleased to be able to report on the activities of Gulf Keystone over thepast year. On the operational side, significant focus has been placed on the drilling andtesting of prospects and existing discoveries on Block 126a and on thematuration and finalisation of development plans for the GKS and GKN oildiscoveries. In parallel, a major technical and commercial effort has beenundertaken to increase our understanding of the hydrocarbon resource potential,and economic potential, of the three further contract areas awarded in 2005, andto progress plans for the further exploration and appraisal of these areas. The Block 126a 2005 drilling campaign consisted of the drilling of two wells,exploration well RTBW-1 and appraisal well GRJ-2, and the drilling of asidetrack to an existing well, GKS-3. The well workover campaign consisted ofthe re-entry and stimulation of wells GKS-2 and GRJ-1. The results, which arediscussed in more detail below, were mixed but have enabled the Company toprogress its plans for the commercialisation of oil discoveries on the Block126a and have added immeasurably to our understanding of this geologicallycomplex area. The above programme marks the completion of all work obligationson Block 126a. One of the key achievements of 2005 was the award of three additional contractareas in Algeria. The areas awarded to Gulf Keystone include the Hassi Ba Hamou(HBH) perimeter, containing 5 blocks and located in the Eastern Timimoun Basinto the north of BP's In Salah field, and Blocks 108, 128b and 129, located inthe Constantine Basin. Preparation of exploration and appraisal plans for theselicences are well underway. Gulf Keystone is Operator of, and holds 100% of the interest available toforeign partners in, all of its Algerian licence interests. Given the rapidexpansion of its portfolio during the year, and ahead of the next round ofexploration and appraisal activity, the Company's recent focus has been firstlyon the full technical review and inventorisation of its portfolio ofdiscoveries, prospects and leads, secondly the potential introduction ofstrategic partners to complement and accelerate its exploration and appraisalefforts, and thirdly the expansion of its management team. I'm pleased to beable to report good progress on a number of fronts. With regard to the technical review of the portfolio, and of the newly awardedlicences in particular, RPS Energy Limited recently and independently estimatedthat for the HBH perimeter and Block 129 alone, gross recoverable hydrocarbonvolumes for the licences total 201.7 million barrels of oil equivalent ("BestEstimate" or Mean case). These resources include a significant gas discovery inthe HBH licence and certain oil discoveries in Block 129. Under the new AIMguidelines, these volumes are categorised as "Contingent Resources" (beingexisting discoveries of oil and gas that require further technical or commercialevaluation). In addition, RPS confirm in these two contract areas, and in the retained areaof Block 126a, the presence of 23 undrilled prospects and leads which, at the "Best Estimate" (Mean) unrisked level, contain potential gross recoverablereserves for the licences ("Prospective Resources") of 473.1 million barrels ofoil equivalent. On a risked basis, this equates to 70.8 mmboe. Furtherdiscoveries and prospectivity have been recognised by SONATRACH and GulfKeystone in Blocks 108 and 128b and these are currently under review. Block 126a GKN/GKS development Operational activity on the GKN and GKS discoveries included the workover ofwell GKS-2 and the drilling of a sidetrack on well GKS-3. Well GKS-2, wasre-entered and stimulated. Production testing of the well resulted in a measuredflow rate of 4,586bopd and 4.61 million cubic feet of gas per day. Well GKS-3 was originally drilled in 2003 and completed with a perforated liner.The GKS-3 sidetrack, drilled in 2005, allowed further testing and acidstimulation of the Ras Toumb and Cenomanian intervals. These intervals proved tobe tight and non-productive. The well was suspended pending evaluation offurther stimulation techniques. Gulf Keystone has submitted a "Final Discovery Report" with a development planfor the GKN field and has made an "Early Production Licence" application for theGKS field. These discoveries are located in a geologically complex area, hencethe development of reserves will be phased - data from each phase being utilisedto optimise, and confirm the economic viability of, the subsequent phase. TheGKN field is already linked by a pipeline to production facilities at Ras Toumb,and the GKS discovery well, GKS-2, is situated within 2.4 km of this pipeline.Gulf Keystone is proposing to tie GKS-2 into the GKN pipeline, following acapacity upgrade, and carry out extended well testing in order to assess theultimate recovery of the well and provide insight to the optimum mechanism foraccessing the remaining GKS field reserves. The oil recovered during theextended well test will be marketed with the GKN production. The drilling of asecond development well on the GKN discovery, GKN-4, is planned as part of thefirst phase of the GKN development, following receipt of a production licence,as is the acquisition of a small (c. 150 sq km) 3D seismic survey. Approval forthe GKN/GKS development project was temporarily delayed due to the recentintroduction of legislation limiting the flaring of gas. However, the Companyhas now submitted to SONATRACH a viable plan to utilise the associated gasproduced with the oil from both fields which is presently under active review.The Company believes that development approval and a production licence will begranted shortly. GRJ Oil Discovery Well GRJ-1, drilled in 2003, was re-entered and tested during 2005. However,only small quantities of oil were recovered under test with no sustainableproduction being achieved. This further illustrates the challenges that havebeen experienced in Block 126a where widespread oil has been encountered butsufficient connectivity between the wellbore and fractures within the reservoirhas not always been achievable from initial operations. The well was suspendedpending evaluation of various options for stimulating the reservoir andachieving the necessary connectivity. Data from well GRJ-2, drilled in 2005, which was analysed by third partyconsultants, indicated that there are three separate potential reservoirintervals which may have the potential to contain hydrocarbons. Given the poorproductivity of some previous wells, it was decided to defer testing of thiswell until the optimal test programme could be designed and agreed betweenSONATRACH and Gulf Keystone and suitable equipment could be made available inAlgeria. Progress is being made towards finalising a testing strategy. The Company has applied for an 8 month licence extension from the Algerianauthorities in respect of the GRJ discovery in order to complete the testing ofwell GRJ-2 which, in the case of success, the Company expects would be thesubject of a production licence application. Hassi Ba Hamou perimeter (Blocks 317b, 322b, 347b, 348, 349b) The HBH perimeter, covering an area of 18,380 sq km, contains one existing gasfield, HBH, confirmed by the drilling of three wells by SONATRACH and a numberof undrilled leads and prospects. The initial seismic and well data set acquired by the Company in connection withthe licence award included data relating to the HBH-1 discovery well and aportion of the 4,069 km of 2D seismic data previously acquired by SONATRACH.Since then, the Company has acquired from SONATRACH a substantially enhanceddata set, including important log and well test data from a successful appraisalwell HBH-3 and a substantial quantity of additional seismic data. This has enabled the Company to carry out a full technical and economic reviewof the contract area and identify a potential gas resource base which ismaterially larger than was identifiable at the time of licence award. RPS, aspart of their recent independent review of Gulf Keystone's reserves andresources, estimate that the HBH Field contains recoverable gas reserves of 995bcf. (These are classified as "Contingent Resources", pending commercializationof gas, and represent the "Best Estimate" or Mean case). RPS also confirmed aminimum of four undrilled leads and prospects containing a further potential1,935 bcf in place Mean unrisked case). The Company's ongoing technical analysisof the HBH perimeter is continuing to identify significant additionalhydrocarbon prospectively. Gulf Keystone intends to appraise the existing HBH discovery and drill twoexploration wells during the first three year phase of the contract. It had, inaddition, intended to acquire 100 sq km of 3D seismic and 400 km of 2D seismicas part of this initial programme. However, given the significantly enhancedprospectivity of the HBH perimeter, a potential increase in that programme tosome 2,000 km of 2D seismic and 500 sq km of 3D seismic during this initialphase, is under consideration. Ben Guecha (Blocks 108/128b) The primary focus of SONATRACH and Gulf Keystone (the "JV partners") on the BenGuecha permit will be the further development of the existing Ras Toumb oilfield and the exploration for additional oil and gas reserves. SONATRACH'sinterpretation of its previously acquired 4,457 km of 2D seismic on the permitidentified 7 additional prospects and leads, one of which, OSD, SONATRACHcompleted the drilling and logging of an exploration well and temporarilyabandoned the well awaiting testing equipment. The JV partners committed todrill 2 wells on the permit during the initial 3 year phase of the licence, as aminimum work program. The Company acquired 156 sq km of 3D data over the greater Ras Toumb area in2005 and this, together with an enhanced seismic and well data base sincereceived from SONATRACH, has formed the basis of an ongoing full technicalreview of the contract area, the initial results of which have confirmed theprospectivity of the area. Further to the signing of the Production Sharing contract in 2005, theselicences are yet to be ratified by being published in the Algerian officialgazette. While the Company has already commenced a comprehensive work programmeon the licence, the first official three year phase of the licence will notcommence until the contract is ratified. Bottena perimeter (Block 129) Covering an area of 4,368 sq km, the Bottena perimeter is in the SouthConstantine Basin, adjacent to Block 126a and extending towards the Tunisianborder. The licence area contains the Hassi El Kerma (HEK) oil discovery andDjebel Foua gas discovery. SONATRACH recently drilled two additional structureson the permit area, Djebel Darmoun (DDN) (2000) and Hanchir Baaziz (HCZ) (2002)both of which confirmed the presence of oil. Gulf Keystone currently intends to appraise the discoveries HEK and DDN, drillone exploration well and acquire additional 2D and 3D seismic data on theBottena Perimeter. In addition, Gulf Keystone is considering processing andinterpreting the 412 sq km 3D seismic survey that was acquired by SONATRACH overthe DDN discovery in July 2005. It is presently undertaking a full technicalreview of the licence to firm up the prospectivity. Financial Results The Company reports a loss after taxation of $40.8 million (2004: $2.4 million)for the period. This loss is after an impairment charge for Block 126a of $35.1million. The impairment under IFRS 6 was triggered for the Block 126a's groupof cash generating units by the transfer of $24.8 million relating to the GKNand GKS fields from intangible fixed assets to tangible fixed assets, andreflects the decision of the Company not to apply for an extension to the Block126a licence area outside of GKN, GKS and GRJ-2. Capital Expenditure on exploration and evaluation activities was $47 million.At the end of the year the Company had $51.4 million in cash of which $34.7million was pledged against the issue of bank guarantees to SONATRACH. Outlook The key challenges for Gulf Keystone during 2006 are very clearly to secureproduction and cash flow from Block 126a and to radically advance theexploration and appraisal of its newly acquired licences. The Company is now inposition to focus efforts on the further development of its business and theexpansion of its portfolio, exploiting what it considers to be its particularcompetitive edge at the point of access for new opportunities in both Algeriaand other selected areas of the Middle East and North Africa. We approach thisnext phase in the Company's development with considerable optimism. Todd KozelChief Executive Officer CONSOLIDATED INCOME STATEMENT FOR THE YEAR ENDED 31 DECEMBER 2005 Restated NOTES 2005 2004 $'000 $'000Continuing Operations Revenue - - Impairment provision 3 (35,145) -General and administrative expenses (7,325) (4,197)Share option expense (394) (108)Loss from operations (42,864) (4,305) Investment income 2,213 1,928Loss before tax (40,651) (2,377) Tax expense (135) - Loss after tax for the year (40,786) (2,377) Loss per share (cents)Basic and diluted 1 (16.08) (1.72) CONSOLIDATED BALANCE SHEET AS AT 31 DECEMBER 2005 NOTES 2005 Restated 2004 $'000 $'000ASSETS Non-current assets Property, plant and equipment 2 25,594 83Intangible assets 3 28,651 41,708 54,245 41,791Current assetsInventories 3,472 2,485Trade and other receivables 3,386 425Cash and cash equivalents 51,439 89,882 58,297 92,792 Total assets 112,542 134,583 LIABILITIES Current liabilities Trade and other payables 20,291 4,068Tax liabilities 135 -Provisions 2,050Total liabilities 22,476 4,068 Net assets 90,066 130,515 EQUITY Share capital 1,638 1,626Share premium account 135,349 135,349Convertible warrants - 12Share option charge reserve 502 108Exchange translation reserve (57) -Accumulated losses (47,366) (6,580) Total equity 90,066 130,515 CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 2005 Attributable to equity holders of the Group Exchange Share Share Share option Convertible Accumulated Translation Total Capital premium reserve warrants Deficit Reserve Equity $'000 $'000 $'000 $'000 $'000 $'000 $'000 Balance at 1 January 2004 24,493 - - - (5,578) - 18,915 24,493 - - - (5,578) - 18,915- Prior year adjustment re - - - - 1,375 - 1,375overheads capitalised (see note 7)- as restated 24,493 - - - (4,203) - 20,290 Preferred shares private 13,072 - - - - - 13,072placementShare conversion and issue (35,939) 135,349 - - - - 99,410Warrants subscribed - - - 12 - - 12Net loss for the year - - - - (2,377) - (2,377)Balance at 1 January 2005 1,626 135,349 - 12 (7,837) - 129,151- Prior year adjustment re - - - - 1,363 - 1,363overheads capitalised (see note 7)- Prior period adjustment re - - 108 - (108) - -share option expense- as restated 1,626 135,349 108 12 (6,580) - 130,515Employee share option expense - - 394 - - - 394Exchange differences arising on - - - - - (57) (57)translation of overseasoperationsExercise of warrants 12 - - (12) - - -Net loss for the year - - - - (40,786) - (40,786)Balance at 31 December 2005 1,638 135,349 502 - (47,366) (57) 90,066 The exchange rate used in the currency revaluation at year end was British Pound= 1.7361 US Dollar. CONSOLIDATED CASH FLOW STATEMENT FOR THE YEAR ENDED 31 DECEMBER 2005 Restated NOTES 2005 2004 £'000 £'000OPERATING ACTIVITIESCash used in operations 4 (2,132) (5,852)Interest received 2,213 1,928 NET CASH GENERATED/(USED) IN OPERATING ACTIVITIES 81 (3,923) INVESTING ACTIVITIESPurchase of intangible assets (37,663) (25,620)Purchase of property, plant and equipment (804) (43)NET CASH USED IN INVESTING ACTIVITIES (38,467) (25,663) FINANCING ACTIVITIESProceeds on issue of share capital - 112,494NET CASH USED IN FINANCING ACTIVITIES - 112,494 NET (DECREASE)/INCREASE IN CASH AND CASH EQUIVALENTS (38,386) 82,907 CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 89,882 6,975 Effect of foreign exchange rate changes (57) - CASH AND CASH EQUIVALENTS AT END OF YEAR Bank balances and cash 51,439 89,882 CONSOLIDATED FINANCIAL STATEMENTSSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The financial information for the year ended 31 December 2005 has not beenaudited and does not constitute the Company's statutory financial statements.The preliminary report was approved by the Board on 12 June 2006. The statutoryaccounts for the year ended 31 December 2005 have not been reported on by theCompany's auditors. They will be circulated to the shareholders in June 2006 andthe Annual General Meeting is arranged to take place on 15 July 2006. Thecomparative results for the year ended 31 December 2004 are based on the auditedfinancial statements which contained an unqualified audit opinion. Basis of accounting The company is incorporated in Bermuda and it is quoted on the AlternativeInvestment Market of the London Stock Exchange. The financial statements have been prepared in accordance with InternationalFinancial Reporting Standards ("IFRS") for the first time. The disclosuresrequired by IFRS 1 concerning the transition from UK GAAP to IFRS are given innote 6. The financial statements have been prepared under the historical cost accountingrules and on a going concern basis. In common with many exploration companies,the Group raises finance for its exploration and appraisal activities indiscrete tranches to finance its activities for limited periods. Furtherfunding is raised as and when required. When any of the Group's projects moveto the development stage, specific financing may be required to enabledevelopment to take place. The principal accounting policies adopted are set outbelow. At the date of authorisation of these financial statements the followingStandards and Interpretations which have not been applied in these financialstatements were in issue but not yet effective: IFRS 7 Financial instruments: Disclosures; and the related amendment to IAS 1 on capital disclosures IFRIC 4 Determining whether an Arrangement contains a Lease IFRIC 5 Rights to Interest Arising from Decommissioning, Restoration and Environmental Rehabilitation Funds IFRIC 8 Scope of IFRS 2 Share -based Payment IFRIC 9 Reassessment of Embedded Derivatives The Directors anticipate that the adoption of these Standards andInterpretations in future periods will have no material impact on the financialstatements of the Group when the relevant standards come into effect for periodscommencing on or after 1 January 2007. Basis of consolidation The consolidated financial statements incorporate the financial statements ofthe Company and enterprises controlled by the Company (its subsidiaries) made upto 31 December each year. The Group uses the purchase method of accounting forthe acquisition of subsidiaries. The results of subsidiaries acquired or disposed of during the year are includedin the consolidated income statement from the effective date of acquisition orup to the effective date of disposal, as appropriate. Where necessary,adjustments are made to the financial statements of subsidiaries to bring theaccounting policies used into line with those used by other members of theGroup. All intra-Group transactions, balances, and unrealised gains on transactionsbetween Group companies are eliminated on consolidation. Unrealised losses arealso eliminated unless the transaction provides evidence of an impairment of theasset transferred. Leasing Rentals payable under operating leases are charged to income on a straight-linebasis over the term of the relevant lease. Benefits received and receivable as an incentive to enter into an operatinglease are also spread on a straight line basis over the shorter of the period tothe next rent review date and the lease term. Foreign currencies Transactions in currencies other than US Dollars are recorded at the rates ofexchange prevailing on the dates of the transactions. At each balance sheetdate, monetary assets and liabilities that are denominated in foreign currenciesare retranslated at the rates prevailing on the balance sheet date. Non-monetaryassets and liabilities carried at fair value that are denominated in foreigncurrencies are translated at the rates prevailing at the date when the fairvalue was determined. Gains and losses arising on retranslation are included inthe income statement for the period. On consolidation, the assets and liabilities of the Group's overseas operationsare translated at exchange rates prevailing on the balance sheet date. Incomeand expense items are translated at the average exchange rates for each month inthe period. Exchange differences arising, if any, are classified as equity andtransferred to the Group's translation reserve. Such translation differences arerecognised as income or as expenses in the period in which the operation isdisposed of. The functional and presentation currency of the company is dollars as themajority of the Group's transactions are transacted in this currency. Taxation Under current Bermuda laws, the Group is not required to pay taxes in Bermuda oneither income or capital gains. The Group has received an undertaking from theMinister of Finance in Bermuda exempting it from any such taxes at least untilthe year 2016. Algeria currently imposes no taxes on corporate income or capital gains The tax currently payable is based on taxable profit for the year earned in theUnited Kingdom by the Group's subsidiary. Taxable profit differs from netprofit as reported in the income statement because it excludes items of incomeor expense that are taxable or deductible in other years and it further excludesitems that are never taxable or deductible. The Group's liability for currenttax is calculated by using tax rates that have been enacted or substantivelyenacted by the balance sheet date. There is no deferred tax provided as there are no material timing differenceswhich give rise to such a balance. Property, plant and equipment other than oil and gas interests Property, plant and equipment are stated at historical cost. Depreciation isprovided at rates calculated to write each asset down to its estimated residualvalue evenly over its expected useful life as follows:- Fixtures and equipment - 20% straight line Intangible assets other than oil and gas Intangible assets, other than oil and gas assets, have finite useful lives andare measured at cost and amortised over their expected useful economic lives asfollows:- Computer software - 33% straight line Intangible and tangible non current assets - oil and gas interests The Group adopts the full cost method of accounting for its oil and gasinterests. Under the full cost method of accounting all costs relating to theexploration for and development of oil and gas interests, whether productive ornot, are accumulated and capitalised as non-current assets. These costs, whichare initially classified as intangible non-current assets during the explorationand evaluation phase, are only carried forward to the extent that they areexpected to be recouped through the successful development of an area or whereactivities in an area have not yet reached a stage which permits reasonableassessment of the existence of economically recoverable reserves. Costs dealt with in this way include seismic data, licence acquisition costs,technical work, exploration and appraisal drilling, general technical supportand directly attributable administrative and overhead costs. In 2003 and 2004 not all of the directly attributable administrative andoverhead costs were capitalised in line with the Group's policy. In order torectify this, these costs have been capitalised and the opening balancesrestated. These adjustments are set out in note 7. Costs are transferred to depreciable pools within property, plant and equipmentupon declaration of commerciality or upon cessation of exploration on eachlicense and amortised over the life of the area according to the rate ofdepletion of the economically recoverable costs. Any proceeds arising from thesale or farm-out of assets are deducted from the relevant cost pool. Depreciation and depletion of costs in depreciable pools is provided under theunit of production method which uses the estimated commercial reserves in thecost pool and the sum of the total costs in the pool and any further anticipatedcosts to develop such reserves. Impairment of tangible and intangible non-current assets At each balance sheet date, the Group reviews the carrying amounts of itstangible and intangible assets to determine whether there is any indication thatthose assets have suffered an impairment loss. If any such indication exists,the recoverable amount of the asset is estimated in order to determine theextent of the impairment loss (if any). Where the asset does not generate cashflows that are independent from other assets, the Group estimates therecoverable amount of the cash-generating unit to which the asset belongs. Anintangible asset with an indefinite useful life is tested for impairmentannually and whenever there is an indication that the asset may be impaired. Recoverable amount is the higher of fair value less costs to sell and value inuse. In assessing value in use, the estimated future cash flows are discountedto their present value using a pre-tax discount rate that reflects currentmarket assessments of the time value of money and the risks specific to theasset for which the estimates of future cash flows have been adjusted. If the recoverable amount of an asset (or cash-generating unit) is estimated tobe less than its carrying amount, the carrying amount of the asset(cash-generating unit) is reduced to its recoverable amount. An impairment lossis recognised as an expense immediately, unless the relevant asset is carried ata revalued amount, in which case the impairment loss is treated as a revaluationdecrease. Inventories Inventories relates to materials acquired for use in exploration activities.These are valued at the lower of cost and net realisable value. Warrants Proceeds in respect of convertible warrants subscribed are shown as a reserveand upon issue of the shares, the proceeds are transferred to share capital. Financial instruments The Group's financial instruments comprise cash together with various items suchas other receivables and trade payables etc, which arise directly from itsoperations. The main purpose of these financial instruments is to provideworking capital Financial assets and financial liabilities are recognised on the Group's balancesheet when the Group has become a party to the contractual provisions of theinstrument. Trade receivables Trade receivables do not carry any interest and are stated at their nominalvalue as reduced by appropriate allowances for estimated irrecoverable amounts. Financial liabilities and equity Financial liabilities and equity instruments are classified according to thesubstance of the contractual arrangements entered into. An equity instrument isany contract that evidences a residual interest in the assets of the Group afterdeducting all of its liabilities. Bank borrowings Interest-bearing bank loans and overdrafts are recorded at the proceedsreceived, net of direct issue costs. Finance charges, including premiums payableon settlement or redemption, are accounted for on an accrual basis and are addedto the carrying amount of the instrument to the extent that they are not settledin the period in which they arise. Trade payables Trade payables are not interest bearing and are stated at their nominal value. Equity instruments Equity instruments issued by the company are recorded at the proceeds received,net of direct issue costs. Provisions Provisions are recognised when the Group has a present obligation as a result ofa past event which it is probable will result in an outflow of economic benefitsthat can be reliably estimated. Decommissioning provision The decommissioning provision represents management's best estimate of theGroup's discounted liability when restoring the sites of drilled wells to theiroriginal status. Share-based payments The Group has applied the requirements of IFRS 2 to share option schemesallowing certain employees within the Group to acquire shares of the company.For all grants of share options, the fair value as at the date of grant iscalculated using an appropriate option pricing model and the correspondingexpense is recognised over the expected life of the option. Critical accounting estimates and judgements Estimates and judgements are continually evaluated and are based on historicalexperience and other factors, including expectations of future events that arebelieved to be reasonable under the circumstances. Critical accounting estimates and assumptions The Group makes estimates and assumptions concerning the future. The resultingaccounting estimates and assumptions will, by definition, seldom equal relatedactual results. The estimates and assumptions that have a significant risk ofcausing a material adjustment to the carrying amounts of assets and liabilitieswithin the next financial year are discussed below. Abandonment The Group has estimated that abandonment costs for wells will be $410,000 perwell. It has provided for this amount for GKS-3, RDL-1, GRJ-1, GRJ-2 and GKS-3.The carrying amount in the balance sheet as at 31 December 2005 is $2,050,000. Impairment Review of GKN and GKS The Group employed a modelling specialist, PWX LTD, to calculate the net presentvalue of GKN and GKS based on, and with sensitivities around, a gross productionprofile of 4 mbpd, an oil price of $60bbl and a discount rate of 10%. Thepositive net present value from this model exceeded the carrying value as at 31December 2005 of $24.8 million which was, therefore, transferred from intangibleto tangible assets. NOTES 1 LOSS PER SHARE The calculation of the basic and diluted earnings per share is based on the following data: Earnings 2005 2004 $'000 $'000 Loss for the purposes of basic and diluted loss per share (40,786) (2,377) Number of shares Weighted average number of ordinary shares for the purposes of 253,677,757 138,101,276 basic and diluted loss per share There is no dilutive effect from the options or warrants issued by the company. 2 PROPERTY, PLANT AND EQUIPMENT Restated Restated Oil & Gas Fixtures & Properties Equipment Total $'000 $'000 $'000 At 1 January 2004 Cost - 73 73 - Prior year adjustment re overheads 3 3 capitalised (see note 7) - - As restated - 76 76 Accumulated depreciation - (24) (24) Net book value - 52 52 Year ended 31 December 2004 Opening net book value - 52 52 Additions - 43 43 Depreciation charge - (12) (12) Closing net book value - 83 83 At 31 December 2004 Cost - 119 119 Accumulated depreciation - (36) (36) Net book value - 83 83 Year ended 31 December 2005 Opening net book value - 83 83 Additions - 804 804 Transfer from intangible assets 24,849 - 24,849 Depreciation charge - (142) (142) Closing net book value 24,849 745 25,594 At 31 December 2005 Cost 24,849 923 25,772 Accumulated depreciation - (178) (178) Net book value 24,849 745 25,594 3 INTANGIBLE ASSETS Restated Exploration & Computer Restated evaluation costs software Total $'000 $'000 $'000 At 1 January 2004 Cost and net book value 22,393 - 22,393 - Prior year adjustment re overheads 1,375 - 1,375 capitalised (see note 7) - As restated 23,768 - 23,768 Year ended 31 December 2004 Opening net book value 23,768 - 23,768 Additions 17,940 - 17,940 Closing net book value 41,708 - 41,708 At 31 December 2004 Cost and net book value 41,708 - 41,708 Year ended 31 December 2005 Opening net book value 41,708 - 41,708 Additions 46,808 156 46,964 Transferred to tangible assets (24,849) - (24,849) Impairment write off (35,145) - (35,145) Amortisation charge - (27) (27) Closing net book value 28,522 129 28,651 At 31 December 2005 Cost 63,667 156 63,823 Accumulated amortisation (35,145) (27) (35,172) Net book value 28,522 129 28,651 $24.8 million was transferred from oil & gas exploration and evaluation costs tooil & gas properties within property, plant and equipment during the year. Thistransfer was triggered by the SONATRACH and Gulf Keystone Petroleum Limitedjoint venture management committee i) declaring commerciality of the GKN fieldand sending a recommendation via SONATRACH to the Ministry of Energy and Miningin Algeria endorsing a production license; ii) the anticipated declaration ofcommerciality of GKS and subsequent recommendation via SONATRACH to the Ministryof Energy and Mining in Algeria for the award of an early production license. This transfer, together with the expiry of the exploration license from Block126a and the Groups decision only to focus on GKN, GKS and GRJ fields withinBlock 126a has triggered an impairment test under IFRS 6 and IAS 36 for Block126a's Group of cash generating units. $35.1million has been written offintangible fixed assets as a result of this impairment test in relation to theexploration activities on OGZ, RDL and RTBW. The amortisation charge of $27,000 has been included in general andadministrative expenses. RECONCILIATION OF LOSS FROM OPERATIONS TO NET CASH USED IN 2005 2004 OPERATING ACTIVITIES4 $'000 $'000 Loss from operations (42,864) (4,305) Adjustments for Depreciation of property, plant & equipment 142 12 Amortisation of intangibles 27 Impairment of intangibles 35,145 Share based payment expense 394 108 Increase in inventories (987) (1,616) Increase in provision 2,050 Increase in receivables (2,961) (361) Increase in payables 6,922 310 Cash used in operations (2,132) (5,852) 5 BANK GUARANTEES As part of the contractual terms of the Algerian contracts, the Group has givenbank guarantees to SONATRACH of $34.7 million. These are cash backed guaranteeswhich effectively reduce the free cash available that the Group has on itsbalance sheet. That is $6 million for the Bottena ("129 Contract") workprogramme, $15.6 million for the Ben Guecha ("108/128b Contract") work programmeand $13.1 million for the Hassi Be Hamou (Blocks 317b, 322b3, 347b, 348 and349b) work programme. These guarantees are against the exploration andevaluation programmes stipulated in the contracts and are reduced as the workprogrammes are completed. 6 EXPLANATION OF TRANSITION TO IFRS As required by IFRS 1, the impact of the transition from UK GAAP to IFRS isexplained below. The accounting policies set out above have been applied consistently to allperiods presented in this financial information and in preparing an opening IFRSbalance sheet at 1 January 2004 for the purposes of the transition to IFRS. IAS 1 - Presentation of Financial Statements The form and presentation of the UK GAAP financial statements has been changedto be in compliance with IAS 1. IFRS 2 - Share Based Payments Under IFRS 2, share awards are measured at fair value at grant date andrecognised as an expense to the income statement over the expected term. Thefair value of the incentives granted is measured using a stochastic model. Theimpact of this standard on the financial statements of the Group is a $108,000charge to the year ended 31 December 2004 income statement and an equivalentincrease in share option reserve. IAS 7 - Cash Flow Statements The IFRS Cash Flow Statement, prepared under IAS 7, presents cash flows in threecategories; cash flows from operating activities, cash flows from investingactivities and cash flows from financing activities. Other than thereclassification of cash flow into the new disclosure categories, there are nosignificant differences between the Group's Cash Flow Statement under UK GAAPand IFRS. Consequently, no cash flow reconciliations are provided. Purchasesof tangible fixed assets under UK GAAP have been reclassified to purchases ofintangible assets and purchases of property, plant and equipment under IFRS. Details of the adjustments to the Group's financial performance for the yearended 31 December 2004 are set out in the following tables: Restated IFRS 2 Share Restated UK GAAP based payment under IFRS $'000 $'000 $'000 Administrative expenses (4,197) - (4,197) Share option expense - (108) (108) Loss from operations (4,197) (108) (4,305) Investment income 1,928 - 1,928 Loss before tax (2,269) (108) (2,377) Tax expense - - - Loss after tax for the year (2,269) (108) (2,377) Basic and diluted loss per share 1.6c 1.7c Restated IFRS 2 Share Restated UK GAAP based payment under IFRS $'000 $'000 $'000 ASSETS Non-current assets Property, plant and equipment 83 - 83 Intangible assets 41,708 - 41,708 41,791 - 41,791 Current assets Inventories 2,485 - 2,485 Trade and other receivables 425 - 425 Cash and cash equivalents 89,882 - 89,882 92,792 - 92,792 Total ASSETS 134,583 - 134,583 LIABILITIES Current liabilities Trade and other payables 4,068 - 4,068 TOTAL LIABILITIES 4,068 - 4,068 Net assets 130,515 - 130,515 EQUITY Share capital 1,626 - 1,626 Share premium 135,349 - 135,349 Other reserves 12 - 12 Share options charge reserve - 108 108 Accumulated losses (6,472) (108) (6,580) Total equity 130,515 - 130,515 The transition to IFRS has had no effect on cash flow. The UK GAAP figures have been restated for the prior year adjustment per note 7. 7 EXPLANATION OF RETROSPECTIVE CHANGES UNDER IAS 8 In 2003 and 2004 not all attributable administrative and overhead costs werecapitalised according to the Group's policy. The 2004 financial statements havebeen restated to correct this. The effect of the restatement on those financialstatements is summarised below. Effect on 2004 $'000 Increase in intangibles 1,360Increase in tangibles 3Decrease in general and administration expense 1,363Decrease in loss before tax 1,363 Decrease in loss per share 0.98 Effect on period prior to 2004 $'000 Increase in intangibles 1,375Decrease in general and administration expense 1,375Decrease in loss before tax 1,375 Decrease in loss per share 1.53 8 POST BALANCE SHEET EVENT On 9 June 2006 the Group signed loan agreements with GIBCA Limited and FalconPartners Trust, both related parties, to provide an unsecured debt facility inaggregate of $5 million at an interest rate of 7% and for a term of 12 months. Full accounts are due to be posted to Shareholders on Friday 16th June, 2006 andwill be available at the Company's registered office Canon's Court, 22 VictoriaStreet, Hamilton, HM12, Bermuda and on the Company's website(www.gulfkeystone.com) The Annual General Meeting is due to be held at the Company's Algerian office on15th July, 2006 at 12 noon. 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Gulf Keystone Petroleum