Half-yearly report financials

14th Aug 2007 11:41

Oilexco Incorporated14 August 2007 14 August 2007 OILEXCO INCORPORATED INTERIM REPORT As at and for the three and six month periods ended June 30, 2007 MANAGEMENT DISCUSSION AND ANALYSIS Further to the announcement of yesterday, the following is management'sdiscussion and analysis ("MD&A") of the operating and financial results ofOilexco Incorporated ("Oilexco" or the "Company") for the three and six monthsended June 30, 2007. The information is provided as of August 13, 2007. Thethree and six month results have been compared to the same periods of 2006. Thisdiscussion and analysis should be read in conjunction with the Company's auditedconsolidated financial statements for the year ended December 31, 2006, togetherwith the accompanying notes, and the December 31, 2006 MD&A and AnnualInformation Form. These documents and additional information about Oilexco areavailable on SEDAR at www.sedar.com . This discussion and analysis contains forward-looking statements relating tofuture events or future performance. In some cases, forward-looking statementscan be identified by terminology such as "may", "will", "should", "expects","projects", "plans", "anticipates" and similar expressions. These statementsrepresent management's expectations or beliefs concerning, among other things,future operating results and various components thereof or the economicperformance of Oilexco. The projections, estimates and beliefs contained in suchforward-looking statements necessarily involve known and unknown risks anduncertainties, including the business risks discussed in the MD&A and AnnualInformation Form as at and for the years ended December 31, 2006 and 2005, whichmay cause actual performance and financial results in future periods to differmaterially from any projections of future performance or results expressed orimplied by such forward-looking statements. Accordingly, readers are cautionedthat events or circumstances could cause results to differ materially from thosepredicted. Barrel of oil equivalent (BOE) volumes are reported at 6:1 with 6 MCF = 1 BOE.All amounts are presented in thousands of United States of America ('US")dollars ("$") unless otherwise noted. BUSINESS OF THE COMPANY Oilexco is an oil and gas exploration and production company headquartered inCalgary, Alberta, active in the United Kingdom ("UK"). All of the Company'sproducing, development and exploration properties are located in the UK CentralNorth Sea. In June 2007 oil production commenced from the Company's firstoperated offshore field developments, the 100% owned Brenda and 70% owned Nicolfields. The Company plans to remain focused on maintaining efficient productionoperations at operated fields and an active exploration/development program onboth its 100% owned and joint venture properties. Effective December 31, 2006,the Company sold 100% of its shares of Oilexco America, Inc. Accordingly, the USoperation results are presented as discontinued operations in the consolidatedfinancial statements and MD&A for the three and six months ended June 30, 2006.The Company's common shares are listed for trading on the London Stock Exchange("LSE") and the Toronto Stock Exchange ("TSX") under the symbol OIL. OVERALL PERFORMANCE Production began from the Company's Brenda/Nicol fields in the UK Central NorthSea in June 2007. Oilexco holds a 100% equity interest in the Brenda field,Block 15/25b, and a 70% equity interest in the Nicol field, Block 15/25a.Initial production was through three horizontal production wells at Brenda and asingle horizontal production well at Nicol. In July the fourth horizontalproduction well at Brenda was successfully completed. This well was placed onproduction at the beginning of August. Production from the Brenda and Nicolfields was suspended for 15 days in July due to shut down of the BalmoralFloating Production Vessel for maintenance. The Company estimates productionfrom the Brenda/Nicol fields five combined horizontal production wells willaverage approximately 30,000 barrels per day during the first full year ofproduction. It is estimated that annual decline rates for Brenda and Nicol willbe approximately 25%, which is typical for these reservoirs in the UK North Sea. In June the Company made a multizone light oil discovery at its 40% ownedHuntington prospect located in Block 22/14b. The discovery well 22/14b-5 wasdrilled to a total depth of 13,325 feet. Oil bearing reservoir sands wereencountered in the Paleocene Forties at a depth of 8,960 and in the UpperJurassic Fulmar at a depth of 12,750 feet. Significant oil columns wereintersected in both intervals; 98 and 130 feet of oil bearing reservoir sandswere intersected in the Paleocene Forties and the Upper Jurassic Fulmar sandsrespectively. Both intervals were subsequently drill stem tested. The drill stem test of the Paleocene Forties sand flowed 41(o) API oil up to amaximum rate of 5,577 bbls/d, and associated gas at an estimated rate of 3.4MMcf/d through a 72/64 inch choke with a flowing tubing pressure of 395 psi through50 feet of perforations from 8,975 feet to 9,025 feet. There was no water orsand produced during the test. Flow rates were severely restricted by the testequipment used for the test. The drill stem test of the Upper Jurassic Fulmarsand flowed 39(o) API oil up to a maximum rate of 4,624 bbls/d, and associatedgas at a rate of 1.6MMcf/d through a 64/64 inch choke with a flowing tubingpressure of 310 psia through 101 feet of perforations across the entire 130 feetof oil bearing Fulmar sand. There was no water or sand produced during the test.Flow rates were restricted by the test equipment used for the test. Furtherappraisals of the Huntington oil accumulations are planned for the fourthquarter 2007 using one of Oilexco's two semi-submersible drilling units. The Company made an application during the period to the UK Department of Tradeand Industry for an out of round License on Block 22/3a. This Block is locatedimmediately east of the Company's 100% owned Block 22/2b, which is the locationof the Shelley Paleocene Forties oil appraisal/development project. At the endof July the Company was offered 100% of an Oil and Gas Production Licence onBlock 22/3a, which it has accepted. The terms of the licence require the Companyto file a field development plan within two years of the award. The addition ofthis licensed area will allow the Company to fully define the ultimate extent ofthe Shelley oil accumulation. Appraisal drilling at Shelley in the fourthquarter of 2006 defined the west boundary of the oil accumulation in Block 22/2b. The Ocean Guardian is currently conducting drilling operations to define thenorth, south and eastern extent of the accumulation. These areas will beaccessed with high angle well bores from a surface location at the boundarybetween the two blocks. Additional surface locations may be required to reachthe ultimate boundaries of the accumulation. During the period the Company drilled a dry hole at its Laurel Valleyexploration prospect located in Blocks 14/28a, 14/29b and 14/23. The well wasplugged and abandoned at a total depth of 8,655 feet after failing to intersecthydrocarbons in the prospective horizons. Oilexco paid 75% of the drilling coststo earn a 45% equity interest in the blocks. The nature of the Laurel Valleyexploration prospect was one of higher risk given that there were no previousdiscoveries made on the property. While Oilexco occasionally engages in suchhigher risk exploration prospects, it maintains its current strategy ofprimarily drilling on properties that contain undeveloped discoveries, whichwill comprise the majority of its exploration and appraisal budget for theremainder of 2007. The Company's second semi-submersible drilling unit commenced operations undercontract to the Company in June. The Ocean Guardian had originally beenforecasted to come on contract in April but was delayed by operationaldifficulties experienced by the unit's previous operator. The Ocean Guardian iscontracted to the Company until June 2009. It will join the Company's othercontracted semi-submersible the Sedco 712, which is contracted to March 2010. In June the Company entered into an engagement letter with the Royal Bank ofScotland plc ("RBS") to increase the Company's Borrowing Base Facility from $275million to $500 million. The proposed increase in the Borrowing Base Facilitywill be used for additional developments of the Company's properties in the UKNorth Sea. The proposed increase is subject to a number of conditions andrequires approval from the Company's syndicate of lending institutions lead byRBS. On July 6, 2007 the Company signed with RBS an Amendment and RestatementAgreement in respect of the Pre-Development Facility. The agreement increasesthe total facility amount up to £100 million (approximately $200.9 million atJune 30, 2007) from the previous total of £40 million (approximately $80.4million at June 30, 2007), and extends the maturity date until January 31, 2009from the previous date of January 31, 2008. In April Company closed an Over-Allotment Option related to an underwrittenprospectus offering initiated in the first quarter of 2007. Oilexco issued anadditional 2,250,000 common shares at C$7.82 ($6.75 as at the transaction date)for gross proceeds of approximately $15.2 million. The total gross proceeds ofthe Offering, including the Over-Allotment Option, was approximately $114.9million from a total of 17,250,000 common shares issued at C$7.82 per share. Thefunds from this offering will be used for the Company's appraisal, evaluationand exploration programme in the North Sea and for general working capitalpurposes. The Company anticipates it will fund future exploration, appraisal anddevelopment activities, as well as general and administrative expenses, from acombination of internally generated cash flow and debt facilities. However, theCompany may elect to issue additional shares to raise funds should opportunitiesarise that require equity funds. On the 29th of June the Company's common shares commenced trading on the mainmarket of the LSE, and ceased trading on the AIM market of the LSE on the samedate. The common shares of the Company trade on the LSE as a primary listing.The Company elected to pursue a primary listing in the United Kingdom ("UK")through the facilities of the LSE as a reflection of its shareholder base, themajority of which is located in the UK, as well recognizing the Company's UKNorth Sea Operating focus. The company continues to maintain a primary listingof its common shares on the TSX. Oilexco finished the second quarter in excellent financial condition which isreflected in the Company's balance sheet. Total assets at the end period were$890.0 million, up from $611.3 million from the year ending December 31, 2006.Current assets increased at the end of the period to $176.3 million compared to$95.5 million as at December 31, 2006. Property, plant and equipment alsoincreased at the end of the period to $653.6 million compared to $467.7 millionas at December 31, 2006. The increase was due to expenditures related to thedevelopment of the Brenda/Nicol field, and expenditures on exploration andappraisal drilling conducted on the Company's other properties. Property, plantand equipment will continue to increase in future periods as the Company now hastwo semi-submersible drilling units working full time under long term contractin addition to development projects at Ptarmigan and Shelley. Total liabilities for the Company increased to $427.4 million at the end of theperiod, up from $322.7 million as at December 31, 2006. Current liabilities atthe end of the period increased to $137.9 million, up from $114.4 million as atDecember 31, 2006. The increase in current liabilities are due to an increase inaccounts payables which are primarily related to increased expenditures foroffshore drilling reflecting an increase in the day rate at the end of March onthe Sedco 712 to $225,000 per day from $140,000 per day and the commencement ofthe contract for the Ocean Guardian, and an increase in the current portion oflong term bank debt. Long term debt increased at the end of the period to $266.9million from $193 million at December 31, 2006 reflecting the completion of theBrenda/Nicol field developments Shareholders' equity at the end of the periodincreased to $462.5 million from $288.5 million as at December 31, 2006. Thereasons for the increase relate to an underwritten prospectus offering in whicha total of 17.25 million shares were issued for gross proceeds of approximately$108 million, and gains on translation of consolidated financial statements intoreporting currency. The Company experienced net income of $25.7 million for the period compared to anet loss of $17.8 million for the same period one year ago. Basic net income pershare for the period was $0.12 and diluted net income per share was $0.11compared to a loss per share of $0.09 basic net income and a loss per share of$0.09 diluted net income for the same period a year ago. The primary reason forthe increase in net income was the increase in oil and gas sales as a result ofthe commencement of production from the Brenda/Nicol fields. Revenue for theperiod was $40.7 million compared to $2.3 million for the same period a yearago. Revenues for the Company are anticipated to increase the next quarterreflecting a full quarter of oil production from the Brenda/Nicol fields.Expenses were $16.0 million for the period compared to $20.2 million for thesame period a year ago. General and administrative expenses for the period were$6.8 million compared to $2.2 million for the same period a year ago. Thisincrease was due to costs associated with the listing of the Company's shares onthe main market of the LSE and increased staff levels in the Aberdeen andCalgary offices in addition to the opening and staffing of a London corporateoffice. It is anticipated that general and administrative costs will continue toincrease as additional staff is added to facilitate the Company's growth plans.Operating costs were $6.0 million for the period compared to $1.1 million forthe same period a year ago. The increase is a result of the apportionment ofcosts to Oilexco related to increased production from the Brenda/Nicol fieldsthat is processed at the Balmoral Floating Production Vessel. It is anticipatedthe total operating costs will increase as total production increases in thenext quarter. Depletion, depreciation and accretion costs were $12.3 million forthe period compared to $1.5 million for the same period in 2006 because of theproduction from the Brenda/Nicol fields. Depletion costs are expected toincrease next quarter because of the anticipated increase in total productionfor the next quarter. Interest and bank charges for the period were $5.2 millioncompared to nil for the same time period in 2006, due to increased chargesassociated with the Company's credit facilities. The Company experienced a net decrease in cash of $36.2 million for the periodcompared to a net decrease in cash of $39.6 million for same period a year ago.The decrease in cash was due to an increase in cash used for investingactivities, which were comprised primarily of the completion costs associatedwith the Brenda/Nicol development, drilling activities on the Company's otherproperties and prepayments for equipment being manufactured for futuredevelopments. RESULTS OF OPERATIONS REVENUES ($ 000's) Three Months ended June 30, Six Months ended June 30, 2007 2006 % 2007 2006 % -------- ------- ------- ---- -------- ------ ------- Oil and Gas UK -North Sea 39,170 809 4,742% 40,179 1,397 2,776%Inter-field Tariff 372 268 39% 681 453 50%Interest Income 1,194 1,261 -5% 1,874 2,320 -19% -------- ------- ------- ---- -------- ------ ------- 40,736 2,338 1642% 42,734 4,170 925% Oil and Gas -Discontinued - 281 - - 628 -Operations - United States Other Income -Discontinued - - - - 1 -Operations - United States Total 40,736 2,619 1455% 42,734 4,799 790% -------- ------- ------- ---- -------- ------ ------- Sales of oil and gas in the UK North Sea amounted to approximately $39.2 millionfor the three months and $40.2 million for the six months ended June 30, 2007,compared to approximately $0.8 million and $1.4 million for the same periods in2006. The increase relates to the sale of oil from Brenda and Nicol fields asproduction from these fields was launched in June 2007. The Company also realized income from inter-field tariffs of approximately $0.4million for the three months and $0.7 million for the six months ended June 30,2007, compared to approximately $0.3 million and $0.5 million for the sameperiods of 2006. These represent the Company's interest in tariffs onthird-party oil processed on the Balmoral floating production facility in the UKNorth Sea. The increase relates to higher production volumes in 2007 as comparedto the same periods of 2006. The interest income represents interest on bank accounts and short-term depositsand was higher for the three and six months ended June 30, 2006 compared to thesame periods of 2007 due to the higher average cash balances in 2006. In 2006,the Company had significant cash balances due to funds raised at the end of 2005for the UK North Sea operations. Revenues and other income from US discontinued operations relate to the OilexcoAmerica, Inc. operation, which was sold effective December 31, 2006. PRODUCTION AND PRICES ($ 000's) Three Months Six Months ended June 30, ended June 30, 2007 2006 % 2007 2006 % ------- ------ ------- --- ------ ------ ------- Oil and Gas - BOE/dayUK North Sea 6,274 133 4,617% 3,250 119 2,631%United States -Discontinued - 49 - - 56 -Operations Average Oil and Gas Price $/BOEUK North Sea 68.61 67.01 2% 68.31 64.66 6%United States -Discontinued - 62.50 - - 62.15 -Operations Crude Oil as % ofProductionUK North Sea 99% 97% 1% 99% 98% 1%United States -Discontinued - 92% - - 92% -Operations ------- ------- ------- ---- ------ ------ ------ Average daily production of oil and gas in the UK North Sea increased from 133BOE/day for the second quarter of 2006 to 6,274 BOE/day for the second quarterof 2007 and increased from 119 BOE/day for first the six months of 2006 to 3,250BOE/day for the first six months of 2007. The increase relates to oil productionfrom Brenda and Nicol fields as production from these fields was launched inJune 2007. Average oil and natural gas prices in respect of the UK North Sea operationsincreased by 2% and 6% for the three and six months ended June 30, 2007,compared with the same periods of 2006. The increase is attributable to theincrease in worldwide crude oil prices during the periods under review.Average production and prices of US discontinued operations relate to theOilexco America, Inc. operation, which was sold effective December 31, 2006. OPERATING COSTS ($ 000's) Three Months ended June 30, Six Months ended June 30, 2007 2006 % 2007 2006 % ------- ------- ------- ---- ------- ------- -------Oil and Gas ProductionUK North Sea 6,002 1,133 430% 7,252 2,136 240%United States -Discontinued - 26 - - 67 -Operations ------- ------- ------- ---- ------- ------- ------- 6,002 1,159 418% 7,252 2,203 229% Operating costs $/BOEUK North Sea 10.51 93.85 -89% 12.33 98.83 -88%United States -Discontinued - 5.78 - - 6.66 -Operations ------- ------- ------- ---- ------- ------- ------- Throughout 2006 and the first quarter of 2007 operating expenses from the UKNorth Sea represented the Company's interest in the oil and gas production costsof the Balmoral and Glamis Fields as well as the Company's share of operatingcosts of the Balmoral floating production facility, which was operating belowits capacity. In June 2007, the production of Brenda and Nicol fields waslaunched and accordingly, the total operating costs have increased significantlyby 430% and 240% for the three and six months ended June 30, 2007, as comparedto the same periods of 2006. At the same time, operating costs per BOE decreasedsignificantly to $10.51 and $12.33 per BOE for the three and six months endedJune 30, 2007, respectively, as the launch of production at Brenda and Nicolfields has improved efficiencies of the Balmoral floating production facility.Operating expenses of US discontinued operations relate to the Oilexco America,Inc. operation, which was sold effective December 31, 2006. GENERAL AND ADMINISTRATIVE ($ 000's) Three Months ended June 30, Six Months ended June 30, 2007 2006 % 2007 2006 % ------- ------- --------- ---- ------- ------- ------- General andAdministrative 6,819 2,237 205% 9,304 4,169 123%Employment as atJune 30 36 25 44% 36 25 44% ------- ------- --------- ---- ------- ------- ------- The increase in general and administrative expenses in 2007 compared with 2006,relate mainly to the addition of new employees and consultants at the HeadOffice in Calgary, Oilexco North Sea Limited's office in Aberdeen and a newoffice in London, which is the result of continuous development of the Company'sUK North Sea operation. Additionally, the general and administrative expensesfor the second quarter of 2007 include an accrual of approximately $1.8 millionfor national insurance charges in the UK in respect of stock options granted toUK employees as well as expenses related to the Company obtaining a listing onthe London Stock Exchange main market of approximately $1.6 million. DEPLETION, DEPRECIATION AND ACCRETION ($ 000's) Three Months ended June 30, Six Months ended June 30, 2007 2006 % 2007 2006 % ------ ------ -------- --- ------ -------- ------- Depletion,Depreciation and 12,337 1,459 746% 12,783 2,324 450%Accretion (DD&A)Depletion,Depreciation and - 25 - - 54 -Accretion (DD&A) -DiscontinuedOperationsDD&A $/BOE 21.61 120.77 -82% 21.73 107.50 -80%DD&A $/BOE -Discontinued - 5.56 - - 5.35 -Operations ------ ------ -------- --- ------ -------- ------- The significant increase in DD&A of 746 % and 450% for the three and six monthsof 2007, compared to the same periods in 2006, relates entirely to the launch ofproduction from Brenda and Nicol fields. Additionally, DD&A includes anaccretion expense with respect to Asset Retirement Obligations ("ARO"), whichfor the UK North Sea operation amounts to approximately $0.1 million perquarter. DD&A of US discontinued operations relate to the Oilexco America, Inc.operation, which was sold effective December 31, 2006. IMPAIRMENT OF PROPERTY, PLANT AND EQUIPMENT ($ 000's) Three Months Six Months ended June 30, ended June 30, 2007 2006 % 2007 2006 % ------ ------ ----- ------ ------ ------ -------Impairment ofProperty, Plant andEquipment - - - - 12,471 - ------ ------ ----- ------ ------ ------ ------- To assess the impairment of oil and gas properties and equipment, the Companyperforms a ceiling test calculation on a quarterly basis. As at June 30, 2007 noimpairment was recognized. In the first quarter of 2006, an impairment of approximately $12.5 million wasrecognized primarily in relation to unsuccessful exploratory wells drilled atPalomino and Joy, compared to the fair value of proved and probable reserves ofthe Balmoral field. Brenda and Nicol, the Company's major development project atthat time, was subject to a separate impairment test, resulting in noimpairment. FOREIGN EXCHANGE ($ 000's) Three Months Six Months ended June 30, ended June 30, 2007 2006 % 2007 2006 % ------ ------ ------ --- ------- ------- --------Foreign ExchangeGain/(Loss) 20,151 561 3,492% 19,489 (294) -6,729% ------ ------ ------ --- ------- ------- -------- The Company's foreign exchange gains and losses relate mainly to the fluctuationof the Canadian dollar against the British pound and US dollar. In the secondquarter of 2007 and 2006, the Company experienced foreign exchange gains ofapproximately $20.2 million and $0.6 million, respectively, while the cumulativesix months results showed a foreign exchange gain of $19.5 million in 2007 and aforeign exchange loss of $0.3 million in 2006. These results reflect the factthat in the second quarter of 2007, as well as during the whole first half of2007, the Canadian dollar strengthened against the British pound andstrengthened significantly against the US dollar. In the first quarter of 2006 the Canadian dollar weakened against the Britishpound and was fairly stable against the US dollar, while in the second quarterthe Canadian dollar weakened against the British pound but strengthenedsignificantly against the US dollar, The functional currency is the Canadian dollar for Oilexco Incorporated. Inaccordance with Canadian GAAP requirements, the consolidation is performed inCanadian dollars, the functional currency, and than translated into US dollars,the reporting currency for the Company. STOCK-BASED COMPENSATION ($ 000's) Three Months Six Months ended June 30, ended June 30, 2007 2006 % 2007 2006 % ------ ------ ------- ----- -------- ------ -------Stock-BasedCompensation 1,217 7,683 -84% 3,810 8,271 -54%Expense ------ ------ ------- ----- -------- ------ ------- A compensation expense of approximately $1.2 million and $3.8 million has beenrecognized for the three and six months ended June 30, 2007, respectively, as aresult of stock options granted to employees and consultants to acquire commonshares at an exercise price as follows: • January 11, 2007 -100,000 stock options at C$7.04 ($6.11) per share; • February 6, 2007 - 625,000 stock options at C$8.58 ($7.30) per share; • April 2, 2007 - 120,000 stock options at C$8.56 ($7.32) per share; • May 15, 2007 - 220,000 stock options at C$9.45 ($8.33) per share. Exercise prices for stock options granted are determined by the closing marketprice on the date of the grant or, if the Company is in a black-out period atthe time of the grant, then the closing market price 48 hours after thedissemination of information which ends the black out period. All stock options vest immediately on the date of grant. Fair value of eachoption granted is estimated on the date of grant using the Black-Scholes optionpricing model (assumptions used for the model are discussed in the notesaccompanying the Company's unaudited consolidated interim financial statementsas at and for the three and six month periods ended June 30, 2007). UNREALIZED LOSS ON DERIVATIVES ($ 000's) Three Months Six Months ended June 30, ended June 30, 2007 2006 % 2007 2006 % -------- ------ ------ -------- ------- -------- ------ Unrealized Loss on 4,504 8,287 -46% 7,955 18,657 -57%Derivatives -------- ------ ------ -------- ------- -------- ------ The Company has in place a collar agreement with the Royal Bank of Scotland("RBS") in order to secure its future cash flow by limiting the Company'sexposure to downward fluctuations in the price of crude oil. As a result of anincrease in oil prices as at June 30, 2007 and 2006 (as compared to January 25,2006 when the collar was signed) a mark-to-market valuation of respective putsand call options included in this collar resulted in an unrealized loss onderivatives of approximately $8.0 million and $18.7 million being recognized forthe six months ended June 30, 2007 and 2006, respectively. This is a non cashitem that does not affect the Company's existing cash flow. INTEREST AND BANK CHARGES ($ 000's) Three Months Six Months ended June 30, ended June 30, 2007 2006 % 2007 2006 % -------- ----- ------ --- ----------- ------- -----Interest and BankCharges 5,225 - - 11,011 - - -------- ----- ------ --- ----------- ------- ----- Interest and bank charges of approximately $5.2 million and $11.0 million forthe three and six months ended June 30, 2007 relate mainly to the SeniorFacility utilized to cover Brenda and Nicol development costs. During the firsttwo quarters of 2006 interest expense was capitalized into the Brenda and Nicolprojects. INCOME TAX PROVISIONS ($ 000's) Three Months Six Months ended June 30, ended June 30, 2007 2006 % 2007 2006 % ------ -------- ------ --- ------- ------ ------ Current Income Tax 317 - - 519 - -Future Income TaxRecovery (1,261) - - (10,887) - - ------ -------- ------ ---- ------- ------ ------ Current income tax of $0.3 million and $0.5 million for the three and six monthsended June 30, 2007, respectively, relates to a 30% UK income tax on non-ringfence activities, which, for the Company, includes interest on cash and bankdeposits as well as foreign exchange gains or losses on cash denominated inforeign currencies. The future income tax recovery of $1.3 million and $10.9 million for the threeand six months ended June 30, 2007, respectively, relates entirely to the UKoperation and represents mainly the expenditure supplement claim available tothe Company in 2007 in respect of prior years' eligible expenditures. NET INCOME OF DISCONTINUED OPERATIONS ($ 000's) Three Months Six Months ended June 30, ended June 30, 2007 2006 % 2007 2006 % ------- -------- ---- --- ----- ----- ---- Income ofDiscontinued - 147 - - 348 -Operations - United States ------- -------- ---- ---- ------ ------ ---- Net income of discontinued operations relate to the Oilexco America, Inc.operation, which was sold effective December 31, 2006. NET LOSS AND CASH FLOWS FROM OPERATING ACTIVITIES ($ 000's) Three Months Six Months ended June 30, ended June 30, 2007 2006 % 2007 2006 % ------ ------- ------ ---- ------ ------- ---------- Net Income/(Loss)before 25,727 (17,900) 244% 20,476 (44,152) 146%DiscontinuedOperationsNet Income/(Loss)after 25,727 (17,753) 245% 20,476 (43,804) 147%DiscontinuedOperationsCash (Used in)Operating (3,097) (1,883) 64% (9,613) (4,096) 135%Activities ------ ------- ------ ---- ------ ------- ---------- In the second quarter of 2007 the Company recognized net income of approximately$25.7 million compared to a net loss before discontinued operations ofapproximately $17.9 million in the second quarter of 2006. The magnitude of thisincrease in the Company's results of approximately $43.6 million resulted mainlyfrom: • an increase in sales of approximately $38.3 million due to Brenda/ Nicol production; • an increase in foreign exchange gain of approximately $19.6 million; • a decrease in stock-based compensation expense of approximately $6.4 million; • a decrease in unrealized loss on derivative contracts of approximately $3.8 million; and • the recognition of UK related current and future income taxes of approximately net $1.0 million. The above increase was compensated by: • the increase of approximately $10.8 million in DD&A and increase in operating costs of approximately $4.9 million due to launch of Brenda/Nicol production in June 2007; • recognition of interest expense of approximately $5.2 million (the interest was capitalized in first two quarters of 2006); and • the increase of approximately $4.6 million in general and administrative expenses, mainly due to the addition of new employees and consultants as well as an accrual for UK employee's related costs and expenses related to the London Stock Exchange listing. Cash used in operating activities for the three and six month periods ended June30, 2007 increased by 64% and 135%, respectively as compared to the same periodsin 2006. The increasing trend relates mainly to the increase in general andadministrative expenses which resulted from continuous development of theCompany's UK North Sea operation. The Brenda/Nicol production did not have asignificant impact on the Company's cash flow from operating activities for thesecond quarter of 2007 as it was launched only in June 2007. LIQUIDITY AND CAPITAL RESOURCES Total net proceeds from financing activities in the first half of 2007 amountedto approximately $194.0 million and represent: • Net proceeds from the shares issued further to a short form prospectus of approximately $93.4 million; • Net proceeds from the shares issued further to over-allotment of approximately $14.3 million; • Proceeds from stock options exercised during the first half of 2007 of approximately $2.8 million; and • Net proceeds from the Senior Facility and Pre-Development Facility of approximately $83.5 million. On March 12, 2007, the Company closed a short form prospectus offering of15,000,000 common shares issued at C$7.82 per share ($6.68 as at the date of thetransaction) for gross proceeds of approximately $99.7 million. The Agent waspaid 6% commission fee. The terms of the offering provided for a 15% over-allotment option which wasexercised, and on April 4, 2007, a further 2,250,000 common shares were issuedat C$7.82 per share ($6.75 as at the date of the transaction) for additionalgross proceeds of approximately $15.2 million. The Company has the following bank facilities in place, all with the Royal Bankof Scotland ("RBS"): Balance Balance Interest rate per annum Maturity Date Available outstanding --------------------------------------------------------------------- Senior Facility $ 275,000 $ 265,486 LIBOR + 2.0 % Dec.31, 2010Pre-Development Facility 200,920 70,322 LIBOR + 3.0 - 5.5 % Jan. 31, 2009 Overdraft 3,000 - LIBOR + 1.5 % On demand ----------------------------------------------------------------------- Senior Facility Under the terms of the Senior Facility agreement, the use of initial cash flowfrom Brenda/Nicol production is limited to expenses and costs related to Brendaand Nicol fields. Once the development project is completed, cash flow fromBrenda/Nicol becomes "free" for the Company's use. The agreement provides forthe project to be completed after 1.56 million barrels of oil have beenrecovered (net to the Company) from Brenda/Nicol, or 120 days of sustainedproduction of 13,000 barrels per day has been achieved. The Company expectsBrenda/Nicol project completion at the end of the third quarter of 2007. On July 8, 2007, the Company entered into an engagement letter with RBS toincrease the borrowing base of its Senior Facility from $275 million to USD $500million subject to various conditions and approval of the banking syndicate. TheCompany is currently working closely with RBS to finalize the terms of thisextension. Pre-Development Facility On February 26, 2007, a Pre-Development Credit Facility ("Pre-DevelopmentFacility") was signed with RBS for £40 million (approximately $80.4 million atJune 30, 2007). The Pre-Development Facility is repayable at any time subject tocertain conditions and matures on January 31, 2008. The interest rates are basedon LIBOR plus a margin of 4% per annum. The interest is payable on interestperiods elected by the Company for each drawing (each such interest period to beone, two, three or six months in duration) and interest must be paid at the endof the selected interest period. The Pre-Development Facility is subordinated tothe existing Senior Facility. The Pre-Development Facility is secured by asecond ranking charge over the assets of Oilexco North Sea Limited, a guaranteefrom Oilexco Incorporated and a second ranking charge over OilexcoIncorporated's shares in Oilexco North Sea Limited. On July 6, 2007, an Amendment and Restatement Agreement in respect of thePre-Development Facility was signed with RBS. The agreement extends both theamount of funds available under this facility up to £100 million (approximately$200.9 million at June 30, 2007) and the maturity date until January 31, 2009. The interest rates are still based on LIBOR plus a margin, however, the marginis applied as follows: • for first £40 million - 3% per annum • £40 million - £70 million - 4% per annum • £70 million - £100 million - 5.5% per annum The proceeds from the above sources as well as cash available at the beginningof the six month period ended June 30, 2007 were used to finance the Company'sactivities in the UK North Sea, which amounted to approximately $202.6 million.As at June 30, 2007, the Company had 216,497,827 outstanding common shares, aswell as 500,000 outstanding common share purchase warrants and 18,910,000outstanding common share stock options. Assuming all warrants and stock optionsoutstanding as at June 30, 2007 are exercised, the Company would realiseadditional gross proceeds of approximately $54.9 million. As at June 30, 2007, the Company had cash of approximately $65.5 million, networking capital of approximately $38.3 million and long-term debt of $270.4million. COMPARATIVE BALANCE SHEET ITEMS ($ 000's) June 30, March 31, % June 30, December 31, % 2007 2007 2007 2006 Cash 65,473 101,608 -36% 65,473 81,951 -20%Current 176,276 144,547 22% 176,276 95,460 85%AssetsProperty,Plant andEquipment 653,649 522,302 25% 653,649 467,704 40%CurrentLiabilities 137,940 124,061 11% 137,940 114,440 21%Long-term 270,384 200,082 35% 270,384 196,732 37%DebtShare 409,561 394,116 4% 409,561 297,384 38%CapitalShareholders'Equity 462,525 386,043 20% 462,525 288,519 60% --------- ---------- ------ --------- ------ ----------- As indicated in the table above, all of the items on the balance sheet, exceptfor cash, have increased in both the second quarter and the first half of 2007,as the Company continued to develop its operations in the UK North Sea. LONG-TERM FINANCIAL LIABILITIES As at June 30, 2007, the total outstanding balance of bank loans amounted toapproximately $335.8 million and consisted of: • approximately $265.5 million in respect of the Senior Facility (including approximately $68.9 million payable within one year); and • approximately $70.3 million in respect of Pre-Development Facility. The Company has in place a capital lease agreement to purchase a pump and othermanifold related subsea equipment with a total value of approximately $4.7million. The respective lease obligation amounted to approximately $4.3 millionas at June 30, 2007 (including approximately $0.9 million payable within oneyear). In addition, the Company recognized the mark-to-market value of its derivativecontracts which resulted in an accounting liability of approximately $12.3million as at June 30, 2007. These derivative contracts represent a collaragreement with RBS, which was entered into by the Company in order to secure theCompany's future cash flow and to enhance the repayment of the loan facilitywith RBS by limiting its exposure to downward fluctuations in the price of crudeoil. CONTRACTUAL OBLIGATIONS Payments Due by Period-------------- ------- ---------- ------- ------- ---------($ 000's) Total Less than 1 Year 1-3 Years 4-5 Years After 5 Years-------------- ------- ---------- ------- ------- ---------Long term BankLoans 335,808 68,885 228,679 38,244 -Capital 4,273 911 2,033 1,329 -LeaseDrillingContracts 555,375 221,835 333,540 - -FloatingProductionVessel 370,000 - 159,568 140,352 70,080Contractors 90,482 79,230 11,252 - -UKCS 20,854 667 1,647 4,573 13,967LicencesOffice Lease 5,885 967 2,218 1,971 729---------- ------- ---------- -------- -------- ---------TotalObligations 1,382,677 372,495 738,937 186,469 84,776---------- ------- ---------- -------- -------- --------- Long term bank loans represent the balance outstanding as at June 30, 2007 ofthe Senior Facility and Pre-Development facility, which the Company has in placewith RBS. Pursuant to the Senior Facility agreement, loan repayment obligations arerequired to reduce the amount borrowed to an amount no greater than theborrowing base. The amount of the borrowing base may fluctuate over time due tochanges in oil prices and reserves booked by the Company. Accordingly, for eachbalance sheet date, the repayment timing is estimated based on the most recentre-determination of the borrowing base, and thus may change in the future.The capital lease obligation relates to an agreement to purchase a pump andother manifold related subsea equipment, which the Company entered into in 2006.Included in drilling contracts is the Company's obligation with respect to twodrilling units: • Oilexco North Sea Limited has in place contracts with Transocean Offshore (North Sea) Ltd. ("Transocean") for the provision of the Sedco 712 semi-submersible drilling unit until March 23, 2010. As at June 30, 2007 the Company's obligations for the next 33 months under these contracts with Transocean amounted to approximately $308.3 million. • In December 2006, Oilexco North Sea Limited entered into a contract with Diamond Offshore Drilling ("Diamond") for the provision of Ocean Guardian, a semi-submersible drilling unit. The Company has contracted Ocean Guardian for a one year period commencing June 2007, with an option to extend the contract for another year. This option was exercised in March 2007. As the result the Company's obligations for the next 23 months under this contract with Diamond amounted to approximately $247.1 million. On April 27, 2007, the Company signed an agreement with Sevan Production UK (awholly-owned subsidiary of Sevan Marine ASA) for charter of the floatingproduction vessel "Sevan 3" to be installed in mid 2008 on the Shelley field.The fixed term of the contract is five years with an extension option for anadditional five years. The respective commitments under the fixed term amount toapproximately $370 million. The Company's commitments in respect of contractors relating to sub-sea work todevelop the Brenda and Nicol fields amounted to approximately $30.4 million asat June 30, 2007. Contractual commitments related to other development work andequipment amounted to approximately $60.1 million as at June 30, 2007.Further to licenses granted to Oilexco North Sea, the Company is committed topay license fees of approximately $20.8 million during the next nine years inrespect of its share in North Sea Blocks. The Company is currently pursuing projects/contracts that will requireadditional financing. The Company has enjoyed a positive working relationshipwith its primary bankers and has access to capital frequently as required. Inthe future, in order to meet its ongoing obligations, the Company intends torely on internally generated cash flow, bank financing, farm-outs, exercise ofexisting warrants and stock options, and equity financing as needs arise.However, delays and unexpected outcomes could affect the Company's ability tofinance its operations on terms acceptable to the Company. SUMMARY OF QUARTERLY RESULTS ($ 000's)(Unaudited) Q1/07 Q1/06 Q2/07 Q2/06 Q3/06 Q3/05 Q4/06 Q4/05 Gross 1,318 773 39,542 1,077 1,063 1,409 1,467 1,255Revenue Gross Revenue- - 278 - 226 140 195 80 247DiscontinuedOperations Net Earnings/(Loss) (5,251) (26,051) 25,727 (17,753) 4,667 (10,468) 25,126 (3,349) Per Share ($) (0.03) (0.13) 0.12 (0.09) 0.02 (0.07) 0.13 (0.03) Net Earnings/(Loss) - - 201 - 147 83 144 (729) (23)DiscontinuedOperations Per Share ($) - - - - - - - - For the past quarters up to March 31, 2007, gross revenues related to theBalmoral and Glamis fields in the UK North Sea. In June 2007, production fromthe Brenda/Nicol fields was launched resulting in a significant increase inrevenues for the second quarter of 2007. In the last two quarters of 2005 and first two quarters of 2006, the Companyexperienced net losses. The increasing trend of net losses over this periodmainly reflects the increase in general and administrative expenses. Thesignificantly higher losses for the first and second quarter of 2006 reflect theaccounting for stock-based compensation expenses and unrealized losses onderivatives. In the third quarter of 2006 the valuation of derivatives resultedin a significant unrealized gain, and despite additional interest and taxcharges, the Company experienced earnings in this quarter. Net earnings in thelast quarter of 2006 relate mainly to the recognition of future income taxassets in the UK operation offset partially by foreign exchange losses andinterest charges recognized in the quarter. The net loss in the first quarter of2007 resulted mainly from the recognition of interest expense, stock-basedcompensation expense and an unrealized loss on derivatives, partially offset bya future income tax recovery. Discontinued operations relate to Oilexco America, Inc., sold effectiveDecember, 31 2006. CONTROLS ENVIRONMENT Disclosure Controls and Procedures The Chief Executive Officer and Chief Financial Officer are responsible forestablishing and maintaining the Company's disclosure controls and procedures.They are assisted in this responsibility by the Company's senior managementteam. Disclosure controls and procedures have been designed to ensure thatinformation required to be disclosed by the Company is accumulated andcommunicated to our management as appropriate to allow timely decisionsregarding required disclosure. An evaluation of the design and operatingeffectiveness of the Company's disclosure controls and procedures as of June 30,2007 was performed under the supervision of the Chief Executive Officer andChief Financial Officer and with participation of the Company's seniormanagement. The Chief Executive Officer and Chief Financial Officer haveconcluded, as of the date of this Management's Discussion and Analysis that theCompany's disclosure controls and procedures have been designed and areoperating effectively to provide reasonable assurance that material informationrelated to the Corporation is made known to them by others within theCorporation. It should be noted that while the Company's Chief Executive Officer and ChiefFinancial Officer believe the disclosure controls and procedures provide areasonable level of assurance and are effective, they do not expect that thedisclosure controls and procedures would prevent all errors and fraud. A controlsystem, no matter how well conceived or operated, can provide only reasonable,not absolute, assurance that the objectives of the control system are met.purposes in accordance with Canadian GAAP. An evaluation of the designeffectiveness of the Company's internal controls over financial reporting as ofJune 30, 2007 was performed under the supervision of the Chief Executive Officerand Chief Financial Officer and with participation of the Company's seniormanagement. The Chief Executive Officer and Chief Financial Officer haveconcluded, as of the date of the Management's Discussion and Analysis that theCompany's internal controls over financial reporting have been designed toprovide reasonable assurance regarding the reliability of financial reportingand the preparation of financial statements for external purposes in accordancewith Canadian GAAP. Management does not expect that the internal controls over financial reportingwould prevent all errors and fraud. A controls system, no matter how wellconceived or operated, can provide only reasonable, not absolute, assurance thatthe objectives of the control system are met. There have been no material changes in the design of the Company's internalcontrols over financial reporting that have affected, or are reasonably likelyto materially affect, the Company's internal controls over financial reportingduring the six month ending June 30, 2007. Management has undertaken a thirdparty review of internal controls for disclosure and financial reporting and theCompany is addressing issues as they arise, however, no material changes to suchinternal control systems have been identified to date. CHANGE IN ACCOUNTING POLICIES a) Financial Instruments and Hedging Activities Effective January 1, 2007, the Company adopted the Canadian Institute ofChartered Accountants ("CICA") Section 3855, "Financial Instruments -Recognition and Measurement," Section 3861, "Financial Instruments - Disclosureand Presentation" and Section 3865, "Hedges." The Company has adopted thesestandards prospectively and the comparative interim consolidated financialstatements have not been restated. Financial Instruments The new CICA sections provide standards for recognizing and measuring financialinstruments in the balance sheet and the standards for reporting gains andlosses in the financial statements. Financial instruments are required to bereviewed and classified into the following categories: financial assets andliabilities held for trading, loans and receivables, investments held tomaturity, financial assets available for sale and other financial liabilities.Measurement of the financial instruments is based on their classification. The Company has made the following classifications: • Cash and cash equivalents are classified as financial assets held for trading and are measured at their fair value. Gains and losses related to periodical revaluation are recorded in net income. • Accounts receivable and deposits are classified as loans and receivables and are initially measured at their fair value. Subsequent periodical revaluations are recorded at their amortized cost using the effective interest rate method. • Bank loans, capital lease obligation, accounts payable and accrued liabilities are classified as other liabilities and are initially measured at their fair value. Subsequent periodical revaluations are recorded at their amortized cost using the effective interest rate method. • Derivative contracts currently in place are classified as held for trading and are measured at their fair value. Gains and losses related to periodical revaluation are recorded in net income. Derivative Instruments and Hedges The Company may use derivative financial instruments to manage its exposure tomarket risks resulting from fluctuations in foreign exchange rates, interestrates and commodity prices. The Company does not enter into derivative financialinstruments for trading or speculative purposes. All new derivative contractsare reviewed and the Company may choose to designate a derivative instrument asa hedge and apply hedge accounting if the hedging relationship meets therespective requirements. All existing derivative contracts are designated as held for trading andrecorded at their fair value as at the balance sheet date with any resultingunrealized gain or loss recognized directly in income. A mark-to-marketvaluation is performed by a third party, based on market prices for theparticular derivatives as at the balance sheet date. Embedded Derivatives An embedded derivative is a component of a financial instrument or non-financialinstrument (the "host instrument") of which the characteristics are similar to aderivative. This component needs to be treated as a separate derivative when itseconomic characteristics and risks are not clearly and closely related to thoseof the host instrument. The embedded derivatives are measured at their fairvalue with subsequent changes recognized directly in income. The Company haselected January 1, 2003 as its transition date for accounting for any potentialembedded derivatives. The Company currently has no embedded derivatives and theadoption of this new standard had no impact on the Company's consolidatedfinancial statements. b) Comprehensive income Effective January 1, 2007, the Company adopted Section 1530 of the CICAHandbook, "Comprehensive Income". It describes reporting and disclosurerecommendations with respect to comprehensive income and its components.Comprehensive income consists of net earnings and other comprehensive income("OCI") and represents the change in shareholders' equity, which results fromtransactions and events from sources other than the Corporation's shareholders.These transactions and events include changes in the currency translationadjustment and unrealized gains and losses resulting from changes in fair valueof available financial instruments for sale and the effective portion of thechange in fair vale of any designated cash flow hedges. The adoption of this Section resulted in a new statement, "ConsolidatedStatement of Comprehensive Income", being included as a part of the Company'sconsolidated financial statements. Accumulated Other Comprehensive Income is anew equity category comprised of the cumulative amounts of OCI. c) Accounting Changes Effective January 1, 2007 the Company adopted the revised recommendations ofCICA Handbook section 1506, Accounting Changes. The new recommendations permit voluntary changes in accounting policy only ifthey result in financial statements which provide more relevant and reliablefinancial information. Accounting policy changes must be applied retrospectivelyunless it is impractical to determine the period or cumulative impact if thechange in policy. Additionally, when an entity has not applied a new primarysource of generally accepted accounting principles ("GAAP") that has been issuedbut is not yet effective, the entity must disclose that fact along withinformation relevant to assessing the possible impact that application of thenew primary source of GAAP will have on the entity's financial statements in theperiod of initial application. As of January 1, 2008, the Company will be required to adopt two new CICAhandbook requirements, section 3862 "Financial Instruments - Disclosures" andsection 3863 "Financial Instruments - Presentation" which will replace thecurrent section 3861. The new standards require disclosure of the significanceof financial instruments to an entity's financial statements, the risksassociated with the financial instruments, and how those risks are managed. Thenew presentation standard essentially carries forward the current presentationrequirements. The Company is assessing the impact of these new standards in itsconsolidated financial statements and anticipates that the main impact will bein terms of additional disclosures required. As of January 1, 2008 the Company will be required to adopt CICA Handbooksection 1535, "Capital Disclosures", which requires entities to disclose theirobjectives, policies and processes for managing capital, and in addition,whether the entity has complied with any externally imposed capitalrequirements. The Company is assessing the impact of this new standard on itsconsolidated financial statements and anticipates that the main impact will bein terms of additional disclosures required. RESPONSIBILITY STATEMENTS Arthur S. Millholland, a director and the chief executive officer of Oilexco andBrian L. Ward, a director and the chief financial officer of Oilexco, areresponsible for preparing this Report and the related financial statements inaccordance with applicable UK law (including the Disclosure and TransparencyRules of the UK Financial Services Authority ("DTR") and Canadian generallyaccepted accounting principles. Arthur S. Millholland and Brian L. Ward each confirm that, to the best of theirrespective knowledge, (a) the set of financial statements accompanying this Report has been preparedin accordance with Canadian generally accepted accounting principles and gives atrue and fair view of the assets, liabilities, financial position and profit orloss of Oilexco and the undertakings included in the consolidation as a whole,as required by DTR 4.2.4; (b) the interim Management Discussion and Analysis appearing in this Reportincludes a fair review of the information required by DTR 4.2.7 and 4.2.8. Signed "Arthur S. Millholland" Signed "Brian L. Ward"Director Director OILEXCO INCORPORATED Consolidated Balance Sheets As at (unaudited) (in thousands of United States dollars) June 30, December 31, 2007 2006 ------- ---------AssetsCurrent AssetsCash and Cash Equivalents $ 65,473 $ 81,951Accounts Receivable 45,829 9,398Prepaids and Deposits (Note 3) 64,974 4,111 ------- --------- 176,276 95,460 Deferred Financing Costs 4,107 3,705Future Income Tax-Asset (Note 8) 55,925 44,384Property, Plant and Equipment (Note 4) 653,649 467,704 ------- --------- 713,681 515,793 $ 889,957 $ 611,253 ======= ========= Liabilities and Shareholders' EquityCurrent LiabilitiesAccounts Payable and Accrued Liabilities $ 60,181 $ 55,645Capital Lease Obligation 911 828Current Portion of Long Term Bank Loans (Note5) 76,848 57,967 ------- --------- 137,940 114,440 Long Term Bank Loans (Note 5) 266,923 193,321Capital Lease Obligation 3,461 3,411Derivative Contracts 12,263 5,049Asset Retirement Obligations 6,845 6,513 ------- --------- 427,432 322,734 ------- ---------Commitments (Note 7) Shareholders' EquityShare Capital (Note 6) 409,561 297,384Contributed Surplus 30,047 27,208Deficit (31,755) (52,231)Accumulated Other Comprehensive Income 54,672 16,158 ------- --------- 462,525 288,519 ------- --------- $ 889,957 $ 611,253 ======= ========= The accompanying notes form an integral part of these consolidated financialstatements. OILEXCO INCORPORATED Consolidated Statements of Income/(Loss) and Deficit For the Periods Ended (unaudited) (in thousands of United States dollars, except per share amounts) ------ ------- ------- ------- Three months Three months Six months Six months June 30, June 30, June 30, June 30, 2007 2006 2007 2006 ------ ------- ------- -------RevenuesOil and GasSales $ 39,170 $ 809 $ 40,179 $ 1,397Inter-FieldTariff 372 268 681 453InterestIncome 1,194 1,261 1,874 2,320 ------ ------- ------- ------- 40,736 2,338 42,734 4,170 ------ ------- ------- -------ExpensesGeneral andAdministrative 6,819 2,237 9,304 4,169Operating 6,002 1,133 7,252 2,136Depletion,Depreciationand 12,337 1,459 12,783 2,324AccretionImpairment ofProperty,Plant and Equipment - - - 12,471ForeignExchange(Gain)/Loss (20,151) (561) (19,489) 294Stock-BasedCompensation 1,217 7,683 3,810 8,271(Note 6 (c))UnrealizedLoss onDerivatives 4,504 8,287 7,955 18,657Interest andBank Charges 5,225 - 11,011 - ------ ------- ------- ------- 15,953 20,238 32,626 48,322 ------ ------- ------- -------Income/(Loss)Before IncomeTaxes 24,783 (17,900) 10,108 (44,152)andDiscontinuedOperationsCurrent IncomeTaxes (Note 8) (317) - (519) -Future IncomeTax Recovery(Note 8) 1,261 - 10,887 - ------ ------- ------- -------Income/(Loss)BeforeDiscontinuedOperations 25,727 (17,900) 20,476 (44,152)Net Income ofDiscontinuedOperations - 147 - 348 ------ ------- ------- -------NetIncome/(Loss) 25,727 (17,753) 20,476 (43,804) Deficit,Beginning ofPeriod (57,482) (64,271) (52,231) (38,220) ------ ------- ------- ------- Deficit, Endof Period $ (31,755) $ (82,024) $ (31,755) $ (82,024) ====== ======= ======= ======= Basic NetIncome/(Loss)per ShareBefore andAfterDiscontinued Operations(Note 6(d)) $ 0.12 $ (0.09) $ 0.10 $ (0.23) ====== ======= ======= =======Diluted NetIncome/(Loss)per ShareBefore andAfterDiscontinuedOperations(Note 6(d)) $ 0.11 $ (0.09) $ 0.09 $ (0.23) ====== ======= ======= ======= The accompanying notes form an integral part of these consolidated financialstatements. OILEXCO INCORPORATED Consolidated Statements of Accumulated Other Comprehensive Income For the Periods Ended (unaudited) (in thousands of United States dollars, except per share amounts) ------- ------- ------- ------- Three months Three months Six months Six months June 30, June 30, June 30, June 30, 2007 2006 2007 2006 ------- ------- ------- ------- AccumulatedOther $ 20,156 $ 14,456 $ 16,158 $ 14,692ComprehensiveIncome,Beginning ofPeriod OtherComprehensive ------- ------- ------- -------Income:Unrealizedgains/(losses)on 34,516 12,581 38,514 12,345translation ofconsolidatedfinancialstatementsintoreportingcurrency ======= ======= ======= =======AccumulatedOther $ 54,672 $ 27,037 $ 54,672 $ 27,037ComprehensiveIncome,End ofPeriod ======= ======= ======= ======= The accompanying notes form an integral part of these consolidated financialstatements. OILEXCO INCORPORATED Consolidated Statements of Cash Flows For the Periods Ended (Unaudited) (in thousands of United States dollars) Three months Three months Six months Six months June 30, June 30, June 30, June 30, 2007 2006 2007 2006 Cash Flows fromOperatingActivitiesNetIncome/(Loss) $ 25,727 $ (17,900) $ 20,476 $ (44,152)Items Not AffectingCashDepletion,Depreciationand Accretion 12,337 1,459 12,783 2,324Impairment ofProperty,Plant andEquipment - - - 12,471Unrealized(Gain)/Loss onForeign (22,748) (1,165) (23,552) (392)ExchangeNon-cashinterest andBank Charges 472 - 1,478 -Future IncomeTax Recovery (1,261) - (10,887) -Stock-BasedCompensation 1,217 7,683 3,810 8,271UnrealizedLoss onDerivatives 4,504 8,287 7,955 18,657 -------- -------- ------ -------- 20,248 (1,636) 12,063 (2,821)Changes inNon-CashWorkingCapital (23,345) (247) (21,676) (1,275) -------- -------- ------ -------- (3,097) (1,883) (9,613) (4,096) -------- -------- ------ --------Cash Flows fromFinancingActivitiesProceeds fromIssuance ofCommon Shares, 14,923 621 110,521 5,570net of Issue CostsNet Proceedsof Bank Loans 49,886 47,294 83,517 116,502Repayment ofBank Loan - - - (17,831)Decrease/(Increase) inDeferredFinancingCosts - 172 - (4,254)Changes inNon-CashWorkingCapital (97) (419) - (1,140) -------- -------- ------ -------- 64,712 47,668 194,038 98,847 -------- -------- ------ --------Cash Flows fromInvestingActivitiesAdditions toProperty,Plant andEquipment (91,370) (91,302) (143,306) (154,461)Changes inNon-CashWorkingCapital (6,429) 5,878 (59,285) 36,857 -------- -------- ------ -------- (97,799) (85,424) (202,591) (117,604) -------- -------- ------ --------Net Decreasein Cash (36,184) (39,639) (18,166) (22,853) Net Effect offoreignexchange oncash held inforeigncurrencies 49 384 1,688 (129) Net cash flowsofdiscontinuedoperations - 65 - 438 -------- -------- ------ --------Cash and CashEquivalentsBeginning ofPeriod 101,608 131,128 81,951 114,482 -------- -------- ------ -------- Cash and CashEquivalents,End of Period $ 65,473 $ 91,938 $ 65,473 $ 91,938 ======== ======== ====== ======== SupplementalInformation:Interest Paidduring thePeriod $ 896 $ 1,012 $ 4,934 $ 2,053 ======== ======== ====== ========Income TaxesPaid duringthe Period $ - $ - $ 440 $ - ======== ======== ====== ========Term Depositsas at June 30,2007 $ 16,270 $ 9,462 $ 16,270 $ 9,462 ======== ======== ====== ======== The accompanying notes form an integral part of these consolidated financialstatements. NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS AS AT AND FOR THETHREE AND SIX MONTH PERIODS ENDED JUNE 30, 2007 Tabular amounts are presented in thousands of United States dollars ("$") unlessotherwise noted. 1. DESCRIPTION OF BUSINESS Oilexco Incorporated and its wholly owned subsidiary Oilexco North Sea Limited(together "the Company") are involved in the exploration, development andproduction of oil and gas in the UK North Sea. Currently, the Company'sproduction is from Brenda, Nicol, Balmoral and Glamis Fields located in the UKCentral North Sea. Oilexco America, Inc, a second wholly owned subsidiary of Oilexco Incorporatedwas sold effective December 31, 2006, therefore, it has been classified asdiscontinued operations for the presentation of 2006 comparative periods. 2. ACCOUNTING POLICIES The unaudited interim consolidated financial statements follow the sameaccounting policies as the most recent annual audited financial statement,except as noted below. The notes to these unaudited interim consolidatedfinancial statements do not conform in all respects to the note disclosurerequirements of Canadian generally accepted accounting principles ("GAAP") forannual financial statements. Accordingly, these unaudited interim consolidatedfinancial statements should be read in conjunction with the audited consolidatedfinancial statements as at and for the year ended December 31, 2006. a) Financial Instruments and Hedging Activities Effective January 1, 2007, the Company adopted the Canadian Institute ofChartered Accountants ("CICA") Section 3855, "Financial Instruments -Recognition and Measurement," Section 3861, "Financial Instruments - Disclosureand Presentation" and Section 3865, "Hedges." The Company has adopted thesestandards prospectively and the comparative interim consolidated financialstatements have not been restated. Financial Instruments The new CICA sections provide standards for recognizing and measuring financialinstruments in the balance sheet and the standards for reporting gains andlosses in the financial statements. Financial instruments are required to bereviewed and classified into the following categories: financial assets andliabilities held for trading, loans and receivables, investments held tomaturity, financial assets available for sale and other financial liabilities.Measurement of the financial instruments is based on their classification. The Company has made the following classifications: • Cash and cash equivalents are classified as financial assets held for trading and are measured at their fair value. Gains and losses related to periodical revaluation are recorded in net income. • Accounts receivable and deposits are classified as loans and receivables and are initially measured at their fair value. Subsequent periodical revaluations are recorded at their amortized cost using the effective interest rate method. • Bank loans, capital lease obligation, accounts payable and accrued liabilities are classified as other liabilities and are initially measured at their fair value. Subsequent periodical revaluations are recorded at their amortized cost using the effective interest rate method. • Derivative contracts currently in place are classified as held for trading and are measured at their fair value. Gains and losses related to periodical revaluation are recorded in net income. Derivative Instruments and Hedges The Company may use derivative financial instruments to manage its exposure tomarket risks resulting from fluctuations in foreign exchange rates, interestrates and commodity prices. The Company does not enter into derivative financialinstruments for trading or speculative purposes. All new derivative contractsare reviewed and the Company may choose to designate a derivative instrument asa hedge and apply hedge accounting if the hedging relationship meets therespective requirements. All existing derivative contracts are designated as held for trading andrecorded at their fair value as at the balance sheet date with any resultingunrealized gain or loss recognized directly in income. A mark-to-marketvaluation is performed by a third party, based on market prices for theparticular derivatives as at the balance sheet date. Embedded Derivatives An embedded derivative is a component of a financial instrument or non-financialinstrument (the "host instrument") of which the characteristics are similar to aderivative. This component needs to be treated as a separate derivative when itseconomic characteristics and risks are not clearly and closely related to thoseof the host instrument. The embedded derivatives are measured at their fairvalue with subsequent changes recognized directly in income. The Company haselected January 1, 2003 as its transition date for accounting for any potentialembedded derivatives. The Company currently has no embedded derivatives and theadoption of this new standard had no impact on the Company's consolidatedfinancial statements. b) Comprehensive income Effective January 1, 2007, the Company adopted Section 1530 of the CICAHandbook, "Comprehensive Income". It describes reporting and disclosurerecommendations with respect to comprehensive income and its components.Comprehensive income consists of net earnings and other comprehensive income("OCI") and represents the change in shareholders' equity, which results fromtransactions and events from sources other than the Corporation's shareholders.These transactions and events include changes in the currency translationadjustment and unrealized gains and losses resulting from changes in fair valueof available financial instruments for sale and the effective portion of thechange in fair vale of any designated cash flow hedges. The adoption of this Section resulted in a new statement, "ConsolidatedStatement of Accumulated Other Comprehensive Income", being included as a partof the Company's consolidated financial statements. Accumulated OtherComprehensive Income is a new equity category comprised of the cumulativeamounts of OCI. c) Accounting Changes Effective January 1, 2007 the Company adopted the revised recommendations ofCICA Handbook section 1506, Accounting Changes. The new recommendations permit voluntary changes in accounting policy only ifthey result in financial statements which provide more relevant and reliablefinancial information. Accounting policy changes must be applied retrospectivelyunless it is impractical to determine the period or cumulative impact if thechange in policy. Additionally, when an entity has not applied a new primarysource of GAAP that has been issued but is not yet effective, the entity mustdisclose that fact along with information relevant to assessing the possibleimpact that application of the new primary source of GAAP will have on theentity's financial statements in the period of initial application. As of January 1, 2008, the Company will be required to adopt two new CICAhandbook requirements, section 3862 "Financial Instruments - Disclosures" andsection 3863 "Financial Instruments - Presentation" which will replace thecurrent section 3861. The new standards require disclosure of the significanceof financial instruments to an entity's financial statements, the risksassociated with the financial instruments, and how those risks are managed. Thenew presentation standard essentially carries forward the current presentationrequirements. The Company is assessing the impact of these new standards in itsconsolidated financial statements and anticipates that the main impact will bein terms of additional disclosures required. As of January 1, 2008 the Company will be required to adopt CICA Handbooksection 1535, "Capital Disclosures", which requires entities to disclose theirobjectives, policies and processes for managing capital, and in addition,whether the entity has complied with any externally imposed capitalrequirements. The Company is assessing the impact of this new standard on itsconsolidated financial statements and anticipates that the main impact will bein terms of additional disclosures required. 3. PREPAIDS AND DEPOSITS Prepaids and deposits include mainly prepaid capital expenditures, insurance andoperating expenses and can be summarized as follows: June 30, December 31, 2007 2006 ------------ ------------ Prepaid development equipment $ 62,381 $ -Prepaid drilling equipment 693 691Prepaid insurance 1,110 2,777Other 790 643 ------------ ------------ $ 64,974 $ 4,111 ============ ============ Prepaid development equipment as at June 30, 2007 relates to prepayments madefor equipment in respect of Shelley and Ptarmigan development projects. 4. PROPERTY, PLANT AND EQUIPMENT To assess the impairment of oil and gas properties and equipment, the Companyperforms a ceiling test calculation on a quarterly basis. As at June 30, 2007 noimpairment was recognized. The benchmark prices used in the impairment calculation at June 30, 2007 are asfollows: $/Barrel ------ 2007 $ 62.93 2008 65.98 2009 59.54 2010 55.44 2011 52.24Average remainder 54.95 ------- Undeveloped and unproved oil and natural gas properties excluded from thecalculation of depletion and depreciation amounted to approximately $124.2million as at June 30, 2007 ($59.3 million as at December 31, 2006). 5. BANK INDEBTEDNESS The Company has the following bank facilities in place, all with the Royal Bankof Scotland ("RBS"): Balance Outstanding as at Interest rate per Maturity Date Available June 30, 2007 annum SeniorFacility $ 275,000 $ 265,486 LIBOR + 2.0 % Dec.31, 2010Pre-Development Facility 200,920 70,322 LIBOR + 3.0 - 5.5 % Jan. 31, 2009Overdraft 3,000 - LIBOR + 1.5 % On demand Senior Facility Under the terms of the Senior Facility agreement, the use of initial cash flowfrom Brenda/Nicol production is limited to expenses and costs related to Brendaand Nicol fields. Once the development project is completed, cash flow fromBrenda/Nicol becomes "free" for the Company's use. The agreement provides forthe project to be completed after 1.56 million barrels of oil have beenrecovered (net to the Company) from Brenda/Nicol, or 120 days of sustainedproduction of 13,000 barrels per day has been achieved. The Company expectsBrenda/Nicol project completion at the end of the third quarter of 2007. Pre-Development Facility On February 26, 2007, a Pre-Development Credit Facility ("Pre-DevelopmentFacility") was signed with RBS for £40 million (approximately $80.4 million atJune 30, 2007). The Pre-Development Facility is repayable at any time subject tocertain conditions and matures on January 31, 2008. The interest rates are basedon LIBOR plus a margin of 4% per annum. The interest is payable on interestperiods elected by the Company for each drawing (each such interest period to beone, two, three or six months in duration) and interest must be paid at the endof the selected interest period. The Pre-Development Facility is subordinated tothe existing Senior Facility. The Pre-Development Facility is secured by asecond ranking charge over the assets of Oilexco North Sea Limited, a guaranteefrom Oilexco Incorporated and a second ranking charge over OilexcoIncorporated's shares in Oilexco North Sea Limited. On July 6, 2007, an Amendment and Restatement Agreement in respect of thePre-Development Facility was signed with RBS. The agreement extends both theamount of funds available under this facility up to £100 million (approximately$200.9 million at June 30, 2007) and the maturity date until January 31, 2009. The interest rates are still based on LIBOR plus a margin, however, the marginis applied as follows: • for first £40 million - 3% per annum • 40 million - £70 million - 4% per annum • 70 million - £100 million - 5.5% per annum Bank loans balances as at June 30, 2007 can be summarised as follows: June 30, December 31, 2007 2006 -------- ---------Current Portion of Long Term Bank Loans:Current portion of Senior Facility $ 68,885 $ 55,778Accrued Interest 7,963 2,189 -------- --------- $ 76,848 $ 57,967 ======== =========Long Term Bank Loans:Senior Facility $ 196,601 $ 193,321Pre-Development Facility 70,322 - ---------- ----------- $ 266,923 $ 193,321 ========== =========== As at June 30, 2007, aggregate maturities on total long term bank loans of$335.8 million were as follows: • within one year - $68.9 million • 1-2 years - $166.1 million • 2-3 years - $62.6 million • 3-4 years - $38.2 million Pursuant to the Senior Facility agreement, loan repayment obligations arerequired to reduce the amount borrowed to an amount no greater than theborrowing base. The amount of the borrowing base may fluctuate over time,particularly due to changes in oil prices and reserves booked by the Company.Accordingly, for each balance sheet date, the timing of repayment is estimatedbased on the most recent re-determination of the borrowing base and may changein future. 6. SHARE CAPITAL (a) Issued Number Amount ---------------------------- -------- ---- ------ Balance December 31, 2006 197,892,827 $ 297,384 Issued pursuant to a public offering 15,000,000 99,703 Issued pursuant to over-allotment 2,250,000 15,181 Issued pursuant to exercise of stock 1,355,000 2,819 options Contributed surplus on stock options - 1,655 exercised Share issue costs - (7,181) --------------------------- -------- ---- ------- Balance June 30, 2007 216,497,827 $ 409,561 --------------------------- -------- ---- ------- On March 12, 2007, the Company closed a short form prospectus offering of15,000,000 common shares issued at C$7.82 per share ($6.68 as at the date of thetransaction) for gross proceeds of approximately $99.7 million. The Agent waspaid 6% commission fee. The terms of the offering provided for a 15% over-allotment option which wasexercised, and on April 4, 2007, a further 2,250,000 common shares were issuedat C$7.82 per share ($6.75 as at the date of the transaction) for additionalgross proceeds of approximately $15.2 million. (b) Warrants In February 2007, the Company issued 500,000 common share purchase warrants toRBS as part of the Pre-Development Facility consideration. The warrants areexercisable at 3.75 (C$8.55) and expire on February 26, 2009. The fair valueallocated to these warrants using the Black-Scholes option model (with theassumptions as presented below) was approximately $0.7 million. The total fairvalue was included in the income statement as interest and bank charges. 2007 -------- Risk free interest rate 5.45%Weighted average years 2.0Expected volatility 50%Expected dividend yield 0% (c) Stock Options On January 11, 2007, the Company granted 100,000 stock options to its employeesto acquire common shares at an exercise price of C$7.04 ($6.11) per share. Thesestock options vest immediately and expire on January 11, 2012 On February 6, 2007, the Company granted 625,000 stock options to its employeesto acquire common shares at an exercise price of C$8.58 ($7.30) per share. Thesestock options vest immediately and expire on February 6, 2012. On April 2, 2007, the Company granted 120,000 stock options to its employees toacquire common shares at an exercise price of C$8.56 ($7.32) per share. Thesestock options vest immediately and expire on April 2, 2012. On May 15, 2007, the Company granted 220,000 stock options to its employees toacquire common shares at an exercise price of C$9.45 ($8.33) per share. Thesestock options vest immediately and expire on May 15, 2012. Accordingly, a compensation expense of approximately $1.2 million and $3.8million for the above stock options granted has been recognized for the threeand six months ended June 30, 2007, respectively. The fair value of each optiongranted is estimated on the date of grant using the Black-Scholes option pricingmodel with the following assumptions: 2007 ----------- Risk free interest rate 5.45 - 5.50%Weighted average years 5.0Expected volatility 42 - 50%Expected dividend yield 0% Exercise prices for stock options granted are determined by the closing marketprice on the date of the grant or, if the Company is in a black-out period atthe time of the grant, then the closing market price 48 hours after thedissemination of information which ends the black out period. During the six months ended June 30, 2007, 1,355,000 stock options of theCompany were exercised for the proceeds of approximately $2.8 million. TheCompany increased share capital and decreased contributed surplus byapproximately $1.7 million, representing the compensation expense associatedwith those stock options exercised. (d) Income/(Loss) Per Share Data ----------- ---------------------- --------------(in $ Three Months ended Three Months ended000's, June 30, 2007 June 30, 2006except pershareamounts) ----------- ----------------------- -------------- Weighted Per Weighted Per Average Share Average Share Net Shares Net Shares Earnings Outstanding Loss Outstanding ---------- ------- --- ------- --------- ------- Basic $25,727 216,201,069 $0.12 $(17,753) 195,405,051 $(0.09)Optionsassumed - 12,778,839 - - - -ExercisedWarrants - - - - - -assumedExercisedDiluted $25,727 228,979,908 $0.11 $(17,753) 195,405,051 $(0.09) ----------- ---------------------- --------------(in $ Six Months ended Six Months ended000's, June 30, 2007 June 30, 2006except pershareamounts)----------- ----------------------- -------------- Weighted Per Weighted Per Average Share Average Share Net Shares Net Shares Earnings Outstanding Loss Outstanding ---------- ------- ------- --------- ------- ------ Basic $20,476 208,808,904 $0.10 $(43,804) 194,531,895 $(0.23)Optionsassumed - 10,928,834 - - - -ExercisedWarrantsassumed - 21,240 - - - -ExercisedDiluted $20,476 219,758,978 $0.09 $(43,804) 194,531,895 $(0.23)------- ------- ---------- ------- --- ------- --------- ------- Basic and diluted income and loss per share before and after discontinuedoperations was the same for the three and six months ended June 30, 2007 andJune 30, 2006. 7. COMMITMENTS---------------- ------- -------- ------ ------ ------ Total Less than 1 Year 1-3 Years 4-5 Years After 5 Years---------------- ------- -------- ------ ------ ------DrillingContract 555,375 221,835 333,540 - -FloatingProductionVessel 370,000 - 159,568 140,352 70,080Contractors 90,482 79,230 11,252 - -UKCS Licences 20,854 667 1,647 4,573 13,967Office Lease 5,885 967 2,218 1,971 729----------- ------- ---------- -------- -------- ---------TotalObligations 1,042,596 302,699 508,225 146,896 84,776----------- ------- ---------- -------- -------- --------- Drilling Contracts Oilexco North Sea Limited has in place contracts with Transocean Offshore (NorthSea) Ltd. ("Transocean") for the provision of the Sedco 712 semi-submersibledrilling unit until March 23, 2010. As at June 30, 2007, the Company'sobligations for the next 33 months under these contracts with Transoceanamounted to approximately $308.3 million. Oilexco North Sea Limited has in place a contract with Diamond Offshore Drilling("Diamond") for the provision of Ocean Guardian, a semi-submersible drillingunit until May 2009. As at June 30, 2007, the Company's obligations for the next23 months under this contract with Diamond amounted to approximately$247.1million. Floating production vessel On April 27, 2007, the Company signed an agreement with Sevan Production UK (awholly-owned subsidiary of Sevan Marine ASA) for charter of the floatingproduction vessel "Sevan 3" to be installed in mid 2008 on the Shelley field.The fixed term of the contract is five years with an extension option for anadditional five years. The respective commitments under the fixed term amount toapproximately $370 million payable in 2008-2013. Development Commitments The Company's remaining commitments in respect of contractors relating todevelopment of Brenda and Nicol fields amounted to approximately $30.4 millionas at June 30, 2007. Contractual commitments related to Shelly and Ptarmigan development work andequipment amounted to approximately $60.1 million as at June 30, 2007. Other The Company is committed under operating lease agreements for the rental ofoffice space for approximately $5.9 million over the next eight years. 8. INCOME TAX Current income tax of $0.3 million and $0.5 million for the three and six monthsended June 30, 2007, respectively relates to 30% UK income tax on non-ring fenceactivities, which, for the Company, includes interest on cash and bank depositsas well as foreign exchange gains or losses on cash denominated in foreigncurrencies. The future income tax recovery of $1.3 million and $10.9 million for the threeand six months ended June 30, 2007, respectively relates entirely to the UKoperation and represents mainly the expenditure supplement claim available tothe Company in 2007 in respect of prior years' eligible expenditures. CORPORATE INFORMATION Directors AuditorsJohn F. Cowan Deloitte & Touche LLPLondon, Canada Calgary, CanadaW. Fraser Grant Aberdeen, ScotlandWest Vancouver, CanadaWilliam H. Smith QC BankersCalgary, Canada Royal Bank of ScotlandKevin A. F Burke, FCA Aberdeen, ScotlandLondon, United Kingdom London, EnglandArthur S. Millholland Canadian Western BankCalgary, Canada Calgary, CanadaBrian L. Ward Calgary, Canada Legal Counsel McCarthy Tetrault LLP Calgary, Canada London, United KingdomManagement Field Law LLPArthur Millholland Calgary, CanadaPresident and Chief Executive Officer Transfer Agent and RegistrarBrian Ward Computershare Trust Company of CanadaChief Financial Officer Head OfficeGerry Roe Oilexco IncorporatedChief Operating Officer Suite 3200, 715 - 5th Avenue S.W. Calgary, Alberta, Canada T2P 2X6Aleksandra Owad Telephone: (403) 262-5441Chief Accounting Officer Facsimile: (403) 263-3251 Internet: www.oilexco.comRod Christensen Vice President Exploration & Development Michael Cairns London OfficeVice President Corporate Development 70 Jermyn Street St. James, LondonDavid Marshall SW1Y 6NYVice President Operations General Manager, Oilexco North Sea Limited Aberdeen OfficeShare Listing Oilexco North Sea LimitedThe TSX Exchange Balmoral HouseSymbol: 'OIL' 74 Carden PlaceThe London Stock Exchange Aberdeen, ScotlandSymbol: 'OIL' AB10 1UL This information is provided by RNS The company news service from the London Stock Exchange

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