KMG EP Annual Report 2011

KazMunaiGas Exploration Production releases its Annual Report for 2011

Astana, 27 April 2012. JSC KazMunaiGas Exploration Production has published today its Annual Report for 2011*. The report is posted on the Company's website at www.kmgep.kz.

Further, the Company provides below the extracts from its Annual Report in unedited full text as required in accordance with DTR 6.3.5 (1)

* Information presented in this annual report is as of April 16, 2012.

CHAIRMAN'S AND CHIEF EXECUTIVE'S STATEMENT 

Last year was a difficult one for JSC KazMunaiGas Exploration Production. A series of complex events in 2011 ledus to make adjustments to the Company's short term operations while remaining true to the previously defined longer term development strategy through to 2020.

In terms of profitability the Company completed 2011 with good results, earning around 1.4 billion U.S. dollars for shareholders. Earnings per share however declined by 9% compared to 2010. The doubling of export customs duty rates from January 2011 was one of the factors which adversely affected the profitability of the Company. The key factor, however, was the decline in oil production and consequently in exports. Consolidated production by KMG EP in 2011 amounted to just over 12.3 million tonnes (250 thousand barrels per day), which was 7% less than in 2010.

The main factor influencing the decline in production was labour unrest at the Uzenmunaigas (UMG) production facility. The protest began in May 2011 with several people going on hunger strike and a few hundred workers stopping work in their support. The strikers' demands for higher wages were not endorsed by the trade union, as they contradicted the Collective Labour Agreement signed in March 2011. Official government and judicial bodies repeatedly confirmed the illegal status of the strike.

This led to a prolonged confrontation between the Company's management and the striking workers, and increased social tensions in the region, especially in the town of Zhanaozen. The situation was complicated by the fact that a similar protest was taking place at JSC Karazhanbasmunai (KBM).

Early in 2012, in response to the government's suggestion to re-employ workers laid-off at UMG and KBM, the Board of Directors of KMG EP decided to create two new service companies - for transportation and drilling - with a total staff of about 2,000 people. These will provide services to KMG EP and other companies operating in the Mangistau region. The two new companies created in January 2012 are "Drilling Operations Management," based in Zhanaozen and "Managing Technological Transport and Wells Maintenance" formed in the city of Aktau.

The new management of the Company has revised its approach to its operating activities in the field to take into account the new circumstances. Recognizing the key role of staff relations, management intends to carry out a systematic awareness-raising programme, and create a system of non-material motivation. The aim is to make the payment system more transparent and to involve employees more actively in the process of improving the Company's performance. In addition, management intends to use a more systematic approach to improving occupational safety, health and environmental protection programmes.

Considerable effort will also be focused on the modernization of production facilities. At Uzenmunaigas, for example, the Company plans to start building a new service center to service 1000 machines and two new units for preparing the special liquids needed for shutting down wells. It also plans a diagnostics and repair centre for underground equipment.

The new, modern service centers and workshops are expected to improve service quality for the fleet of special vehicles and equipment and improve the quality of well sealing liquid. This should lengthen the operating time between servicing of wells, raise the level of industrial and environmental safety, and help to stabilize and even increase oil production.

In order to give the new production facilities a certain autonomy in the conduct of their industrial and economic activities they have been organized as joint stock companies, 100% owned by KMG. This will provide for the necessary management responsibility on the ground, increase the level of transparency in corporate activities and comply with modern standards of corporate governance.

The Company's main medium and long term priorities remain those set out in its Strategy-2020document. The Board of Directors and management remain committed to this Strategy and the objectives that were outlined at the time of the IPO in 2006. In the course of 2011, the Company took several steps towards achieving these goals.

The Company significantly expanded its exploration portfolio in 2011, for example. It acquired a 50% stake in development of the Fedorovsky unitwhose hydrocarbon reserves are estimated at 133.6 million barrels. Last year the Company also bought the right to explore the Karpovsky North block, which is located near Fedorovsky in Western Kazakhstan. Prospective recoverable resources of the Karpovsky North block areestimated at 240 million barrels of oil equivalent. The geographical proximity of these two blocks will enable the Company to create and utilise a jointinfrastructure.

KMG EP also purchased four exploration contracts from the National Company KazMunayGas in 2011. These are the Temir block, Teresken, Karaton - Sarkamys and territory adjacent to Uzen and Karamandybas. Total geological resources of all the blocks are about 1.5 bn barrels of oil equivalent. In the event of successful exploration, they will increase the recoverable reserves of the company in the medium term, including the Uzen and Emba groups of fields.

The acquisition of these assets has increased the quality of the Company's exploration portfolio. This is consistent with the Company's overall development strategy, which is focused on organic reserves growth through active exploration.

In addition, KMG EP has signed a memorandum with the parent company on its possible involvement in several offshore blocks in the Caspian Sea. In this way the Company gained access to the geological, physical, financial and economic data on a number of oil and gas projects. These include marine blocks Zhambyl, Ustyurt (Dead Kultuk) Zhenis, Godin, C-1 and C-2, as well as Urikhtau. The company has conducted a feasibility study of these projects and their commercial attractiveness andmade ​​a relevant proposal to the National Company KazMunaiGas.

At the end of 2011 the Company also completed the preferred shares buy out program, whereby it acquired more than two million shares worth over 37 billion tenge. This program has considerably stimulated the stock market in Kazakhstan, accounting for a significant share of transactions. In addition, KMG has started buying back common shares on the Kazakhstan Stock Exchange and GDRs on the London Stock Exchange. By doing this the management has demonstrated its confidence in the value and future prospects of the Company.

KMG EP is strongly placed to continue implementing its development strategy through exploration, acquisitions and investments in oil and gas assets. The Company's financial stability is reinforced by its high standards of corporate governance. Among the major strengths of the Company's corporate governance analysts note the experience of its independent directors in balancing the influence of the majority shareholder, and monitoring of management. Analysts also note the Company's high level of transparency, active investor relations work and the significant amount of voting rights held by KMG EP's shareholders.

Despite some existing difficulties, the Company looks to the future with confidence. Through establishing a close and continuing dialogue with the workforce of the newly created joint stock companies,the management, with the support of the Board of Directors, expects to continue to ensure efficient operation of the Company for the benefit of all shareholders.

Lyazzat Kiinov

Chairman of the Board of Directors

Alik Aidarbayev

Chief Executive Officer

(Chairman of the Management Board)

CORPORATE GOVERNANCE INFORMATION

CORPORATE GOVERNANCE CODE COMPLIANCE

This section of the Annual Report has been prepared in compliance with the requirements of the FSA's (Financial Services Authority) Disclosure and Transparency Rules (DTR 7.2) (Corporate Governance Statements).

As an overseas company with GDRs admitted to the Official List of the United Kingdom Listing Authority, the Company is not required to comply with the UK Code on Corporate Governance (the UK Code). However, in accordance with DTR 7.2 it is required to disclose in its Annual Report whether or not it complies with the corporate governance code of the Republic of Kazakhstan and the actual principles of corporate governance, which being applied in addition to the practices to be observed in accordance with applicable laws of the Republic of Kazakhstan. In addition, the Company shall specify where its actual governance practices differ from those set out in the UK Code.

The Directors recognize the importance of the corporate governance and support the development of high corporate governance standards in the Company. The Company intends to develop and implement corporate governance practices which impose additional obligations on the Company than those required under legislation of Kazakhstan.

KAZAKHSTAN CORPORATE GOVERNANCE CODE AND COMPANY'S CORPORATE GOVERNANCE CODE

Corporate governance best practice in Kazakhstan is set out in the Kazakhstan Corporate Governance Code. This Code is based on the best international practices in the area of corporate governance and Recommendations on Application of Corporate Governance by Kazakhstan Joint Stock Companies, approved by the Securities Market Expert Council of the National Bank of the Republic of Kazakhstan in September 2002. The Code was approved by the Financial Institutions' Association of Kazakhstan in March 2005 and by the Board of Issuers in February 2005.

Throughout 2011 the Company has complied with the provisions of the Code on Corporate Governance of Kazakhstan in all material respects.

The Company has adopted the Code on Corporate Governance of Kazakhstan as its own Code, amended to include certain provisions of the UK Code. The amendments adopted by the Company impose additional obligations on KMG EP in respect of corporate governance. The Company believes that these additional amendments will significantly strengthen the corporate governance practices applied by the Company. KMG EP also takes into consideration other provisions of the UK Code and will seek to improve its standards of corporate governance in the future.

Additional provisions of the Code on Corporate Governance of the Company in addition to the requirements of applicable laws of the Republic of Kazakhstan (namely, the Code on Corporate Governance of the Republic of Kazakhstan) are as follows:

·; Additional principles of corporate governance were introduced:

o Principle of independent activities of the Company.

o The principle of responsibility.

·; Some of the corporate governance principles are supplemented by various provisions, such as:

o Social Policy principles.

o Provisions regarding relationship with shareholders.

o Division of responsibility between the Chairman of the Board of Directors and the Chief Executive Officer (CEO).

o The provisions describing the role of the Chairman of the Board of Directors.

o Requirement of a minimum number of independent directors.

o Additional provisions governing the criteria for establishing the "independence" of independent directors.

o Provisions on access to information and professional development for directors of the Company.

o Provisions governing the principles of directors' remuneration.

o Provisions concerning treatment of inside information.

The copy of the Code on Corporate Governance of the Company along with description of the Company's practices on corporate governance are available on KMG EP's website.

DIFFERENCES BETWEEN THE CODE ON CORPORATE GOVERNANCE OF THE COMPANY AND PROVISIONS OF THE UK CORPORATE GOVERNANCE CODE

Below are the main differences between the Code on Corporate Governance of the Company and provisions of the UK Code.

·; According to the UK Code, the Directors should meet without the Chairman of the Board of Directors present at least annually to appraise the Chairman's performance and on such other occasions as are deemed appropriate. In addition, according to the UK Code the evaluation of the Board of Directors' should be externally facilitated at least every three years.

The KMG EP's Code on Corporate Governance has no such requirements. Throughout 2011, the Independent Non-Executive Directors met seven times without the Chairman of the Board to discuss the following issues: development of the updated Company's strategy; acquisition projects for oil and gas assets in the Republic of Kazakhstan and abroad, relations of the Company with its major shareholder, Company's insurance programme, further participation of the Company in petrochemical projects, cash funds management and observance of the Treasury Policy, internal audit and control matters, election to the Board of Directors and to the Management Board, Succession Policy.

No official evaluation of the activity of the Chairman of the Board of Directors was made by the Directors. The Board's activity was evaluated by an external independent consultant.

·; According to the provisions of the UK Code the Chairman should on appointment meet the independence criteria set out therein.

The Code on Corporate Governance of the Company does not contain the provision on independence of the Chairman of the Board of Directors, and, in the opinion of the Directors, the Chairman would not meet the criteria of independence stated in the respective provisions of the UK Code or the Company's Code on Corporate Governance.

The Audit Committee Provision specifies that the Chairman of the Board of Directors must not be a member of the Audit Committee, notwithstanding such an option in the UKCode. This difference is intentionally included in the Audit Committee Provision as the Chairman of the Board of Directors is the representative of the major shareholder.

·; According to the UK Code at least half of the Board of Directors, excluding the Chairman, should comprise of Independent Non-Executive Directors. On the other hand, the Code on Corporate Governance and the Charter of the Company specify that Independent Non-Executive Directors shall make at least one third of the Board of Directors.

In 2011 the Board of Directors consisted of 8 members, including the Chairman and three Independent Non-Executive Directors: Philip Dayer, Paul Manduca and Edward Walshe.

According to the Charter of the Company a number of key issues, including related-party transactions, shall be approved by a majority of the Independent Non-Executive Directors. The Charter of the Company is available for review at the corporate website.

·; The UK Code also states that the Board shall appoint one of the Independent Non-Executive Directors to be the Senior Non-Executive Director.

The Board of Directors did not appoint the Senior Non-Executive Director in a view of the current shareholder structure of the Company. The requirement on appointment of the Senior Non-Executive Director will be subject for consideration from time to time.

o According to the UK Code the Chairman is responsible for setting the board's agenda and ensuring that adequate time is available for discussion of all agenda items, in particular strategic issues.

The Code on Corporate Governance of the Company does not contain similar provisions, however in practice this requirement is complied with in all material respects.

o According to the UK Code the Chairman should ensure that the directors continually update their skills and the knowledge and familiarity with the company required to fulfil their role both on the board and on board committees. Further the chairman should regularly review and agree with each director their training and development needs.

The Code on Corporate Governance of the Company has no such requirements and during 2011 these requirements were not complied with in all material respects.

o According to the UK Code the Chairman, if necessary, should ensure that the company maintains contact as required with its principal shareholders about remuneration.

This requirement is not contained in the Code on Corporate Governance of the Company. In practice, remuneration issues are subject to approval by the Company's major shareholder - NC KMG.

o The UK Code states that the Chairman should ensure that the views of shareholders are communicated to the board as a whole and that the Chairman should discuss governance and strategy with major shareholders. .

This requirement is not contained in the Code on Corporate Governance of the Company. Nevertheless, during 2011 the Chairman ensured that the views of the major shareholder - NC KMG was communicated to the Board of Directors as a whole, and also facilitated negotiations on governance issues and strategy of the Company with the major shareholders - NC KMG .

o The UK Code states that Non-Executive Directors should scrutinise the performance of management in meeting agreed goals and objectives and monitor the reporting of performance. They should satisfy themselves on the integrity of financial information and that financial controls and systems of risk management are robust and defensible.

The Code on Corporate Governance of the Company imposes similar requirements to all members of the Board of Directors.

o The UK Code provides that the Non-Executive Directors are responsible for determining appropriate levels of remuneration of executive directors and have a prime role in appointing and, where necessary, removing executive directors, and in succession planning.

The Code on Corporate Governance of the Company does not contain this requirement. During 2011 the Executive Director - General Director - was appointed and resigned following the decision instigated by the major shareholder of the Company - NC KMG.

·; The UK Code states that all Directors should be re-elected by the shareholders on an annual basis.

The Code on Corporate Governance of the Company does not contain this requirement. During the election of the members of the Board of Directors in 2011 requirements of the UK Code were not complied.

·; The UK Code provides that the Board of Directors is responsible for determining the nature and extent of the significant risks it is willing to take in achieving its strategic objectives.

This requirement is not included in the Code on Corporate Governance of the Company. However this annual report provides certain information on risk factors facing the Company.

·; The UK Code provides that the Audit Committee should also review the Company's internal financial controls and, unless expressly addressed by a separate board risk committee composed of independent directors, or by the board itself, to review the company's internal control and risk management systems; The audit committee should review arrangements by which staff of the company may, in confidence, raise concerns about possible improprieties in matters of financial reporting or other matters.

The Code on Corporate Governance of the Company does not contain these requirements. The Company does not have a separate Risk Committee; therefore the Audit Committee of the Board of Directors carries out these functions according to the provisions of the Committee. More detailed information on the Audit Committee of the Board of Directors evaluation may be found further in this report.

·; According to the UK Code the Directors should include in the annual report explanation of the basis on which the Company generates or preserves value over the longer term (the business model) and the strategy for delivering the objectives of the Company.

The Code on Corporate Governance of the Company does not contain such a requirement. This annual report does provide some explanation of the basis on which the Company generates or preserves value over the longer term (the business model) and the strategy for delivering the objectives of the Company in the business outlook section.

DIRECTORS' RESPONSIBILITY STATEMENT

In accordance with the Code on Corporate Governance of the Company, the Board of Directors and the Management Board shall be responsible for the fair presentation of the Company's annual report and financial statements.

In compliance with the UKLA Disclosure and Transparency Rules, each of the Directors (as stated on pages 12-15 hereof), confirms that to the best of his or her knowledge:

·; the financial statements prepared in accordance with the International Financial Reporting Standards (IFRS), give a true and fair account of the Company's assets, liabilities, and financial position, the results of its financial and economic activities and those of the subsidiary enterprises included in the consolidated Company's balance sheet taken as a whole; and

·; the management report includes a fair review of the development and performance of the business and the financial position of the Company and its joint obligations in the matter of subsidiary enterprises, together with the description of the principal risks and uncertainties they face.

STRUCTURE OF THE BOARD OF DIRECTORS

As of December 31, 2011, the Board of Directors consisted of eight members, including:

At the extraordinary general shareholders' meeting on 31March 2011, ​​the following decisions were made:

·; to terminate the powers of member of the Board of Directors of the Company, Tolegen Dzhumadovich Bozzhanov;

·; to elect Sisengali Utegaliyev as a member of the Board of Directors of the Company.

Based on results of the Annual general meeting of shareholders on 5 May 2011 the following decisions were made:

·; to terminate the powers of  member of the Board of Directors of the Company, Kenzhebek Niyazovich Ibrashev;

·; To elect Alik Aidarbayev to the Board of Directors. The Board of Directors elected Alik Aidarbayev as the Chairman of the Board of Directors of the Company.

On 22 December 2011, the Chairman of the Management Board (General Director) of the Company, Askar Balzhanov resigned. Alik Aidarbayev, who until that time acted as the Chairman of the Management Board of Directors, was elected the Chairman of the Board (General Director) of KMG EP.

On February 27, 2012, at the extraordinary general shareholders' meeting, it was decided to terminate the powers and election of Askar Balzhanov and to elect Lyazzat Kiinov as a new member of the Board of Directors.

On 13 March 2012 pursuant to resolution of the Board of Directors, Mr. Lyazzat Kiinov was elected as Chairman of the Company's Board of Directors.

The Board of Directors of KMG EP as of 13 March 2012:

·; Lyazzat Kiinov Chairman of the Management Board of NC KazMunayGas, Chairman of the Board of Directors

·; Alik Aidarbayev CEO, Chairman of the KMG EP Management Board (General Director)

·; Yerzhan Zhangaulov General Manager for Legal Affairs of NC KazMunayGas

·; Asiya Syrgabekova Chief Financial Officer of NC KazMunayGas

·; Sisengali Utegaliyev Deputy General Director of JSC KazTransOil

·; Paul Manduca Independent Non-Executive Director of KMG EP

·; Edward Walshe Independent Non-Executive Director of KMG EP

·; Philip Dayer Independent Non-Executive Director of KMG EP

In accordance with the Code of Corporate Governance of the Company, the Board of Directors established the fact of the independence of the directors and believes that Philip Dayer, Paul Manduca and Edward Walshe are independent in character and in making decisions. The Board of Directors found that there were no relationships or circumstances which had or could have a significant impact on independent solutions of these directors.

STRUCTURE OF THE MANAGEMENT BOARD 

In 2011 the Management Board of the Company consisted of senior executives, including Director General and his deputies.The members of the Management Board as of 31 December 2011 are listed below:

During 2011 on the basis of decisions of the Board of Directors the following changes were made in the composition of the Management Board:

·; On 5 May 2011 it was decided to elect Bagitkali Biseken as a member of the Management Board (Deputy Director for Operations).

·; On 22 December 2011 it was decided to terminate the powers of General Director (Chairman of the Management Board), Askar Balzhanov, and elect Alik Aidarbayev as the General Director (Chairman of the Management Board).

RESPONSIBILITY OF THE BOARD OF DIRECTORS AND THE MANAGEMENT BOARDResponsibilities between the Board of Directors, Management Board and Director General of the Company are allocated in accordance with the Charter of the Company, Sections 12 and 13.The Board of Directors is responsible to shareholders for effective management and proper control over the activities of the Company and acts in accordance with the approved decision making system. The most important functions of the Board of Directors is to identify areas of strategic development and policy of the Company, making decisions about potential acquisitions of oil and gas assets and other significant issues. The Board, in turn, is responsible for developing an action plan to implement these functions and for the daily operational activities of the Company. The Board reports to the Board of Directors for the state of progress towards the objectives of the Company.The Board of Directors meets on a regular basis and as necessary. During 2011 the Board of Directors held 20 meetings, including seven meetings - withvoting in person, 10 sessions - with absentee voting, and three meetings - via telephone conferencing.

During the year the Board of Directors considered, among other things, the following issues:

·; Purchasing oil and gas assets by the Company: 100% share in JSC "Karpovsky Severniy", a 50% share in the company "Ural Group Limited" (Block Fedorovskiy), 100% right to use subsoil under the four contracts for exploration of hydrocarbons in the Republic of Kazakhstan (Temir, Teresken, Karaton, Sarkamys)

·; Program for repurchase of common shares of the Company

·; Risk Management Policy

·; Company's Risk Insurance Program

·; Approving budgets and business plans of the Company

·; Adoption of the Strategic Map of the Company for 2011

·; The policy of sponsorship and charitable assistance of the Company

·; Preliminary approval of the Company's consolidated financial statements for the previous year

·; Issues of relationships with affiliated entities - subsidiaries of NC KMG

·; Conclusion of transactions by the Company of related parties

·; Matters within the competence of the supreme bodies of subsidiaries

·; Issues of Compliance

·; Policy on securities transactions

·; Disclosure Policy

·; Observance of the law of the United Kingdom on corruption (UK Bribery Act)

·; Election of the Chairman of the Board of Directors

·; Formation of committees of the Board of Directors

·; Issues of labour collectives

·; Election of the Director General (Chairman of the Management Board) and members of the Management Board

·; Determining the amount of salaries and conditions of remuneration and bonuses of the members of the Management Board

·; Report of the Board of Directors and Management Board for 2010

·; Report on assessment of performance of the Board of Directors for 2010

·; Review of plans and reports of the Internal Audit Service, the status of implementation of the recommendations of the Internal Audit Service

·; The final performance of key performance indicators (KPIs) of the Management, Head of Internal Audit Service and Corporate Secretary of the Company

·; Hiring and staffing issues of the Internal Audit Service and Corporate Secretary

·; Providing options in accordance with the Option Program

The Board of Directors in 2011 approved the following documents:

·; The rules of compensation of employees.

·; Risk management policy

·; Policy on securities transactions

·; Disclosure policy

·; Internal documents regulating internal audit

·; Changes and additions to Cash management policy

·; Provisions on affiliates of subsidiaries of the Company.

The Board of Directors also reviewed and recommended to the General Meeting of shareholders to make amendments to the Charter of the Company.

Presence of members of the Board of Directors and committee members at meetings of the Board of Directors and committees.

The Management Board is an executive authority and regulates the Company's current activities. In 2011 46 meetings of the Board of the Company were held on a regular basis and as necessary.In 2011 the Board of Directors of the Company considered the following key issues related to the Company's operating activities:

·; transactions on participation in share acquisition and 100% right to subsoil use in a number of Kazakhstan oil and gas companies were approved;

·; the project for Company's participation in the public licensing round in Vietnam was approved;

·; projects to assess the acquisition of 100% participation share in a number of foreign companies were approved to be implemented;

·; the medium-term production program of JSC "EP "KazMunaiGas" for 2011-2013 was approved;

·; the production plan of JSC "EP "KazMunaiGas" for 2011 -2015 was approved;

·; the related party transaction - the merger agreement between JSC "EP "KazMunaiGas" and LLC "NSC" was approved;

·; the production plan of JSC EP KazMunaiGas for 2012-2016 was approved;

·; the 2012 budget and the business-plan for 2012-2016 were approved;

·; a number of procedures regulating internal operations of the Company in accordance with the Integrated Management Standards was approved.

The Management Board also makes decisions on other issues of the Company's operations, not pertaining to the exclusive competence of the General Meeting of Shareholders, the Board of Directors and Officials of the Company.

AUDIT COMMITTEE

MEMBERS OF THE AUDIT COMMITTEE

In 2011, this Committee was composed of only independent directors, namely, Paul Manduca (Chairman), Philip Dayer and Edward Walshe. Appointments to the Audit Committee are made for the three years period which may be extended by the Board of Directors not more than for two additional three years periods, provided that the members of the Audit Committee are independent.

NUMBER OF MEETINGS

For 2011 the Audit Committee held nine meetings. The Chairman of the Audit Committee shall make decisions on frequency and timing of meetings of the Committee. The number of meetings is determined in accordance with the requirements to the duties of the Committee. At the same time at least four meetings per year must be held, which should coincide with key dates of the cycle of preparation of financial reporting and audit of the Company (when audit plans of internal and external auditors are prepared, and when the interim financial statements, preliminary announcements and the annual report approach to completion).

RESPONSIBILITIES AND DUTIES OF THE AUDIT COMMITTEE

The Audit Committee is responsible, among other things, for any reports containing financial information of the Company, monitoring risk management and internal control system and for involvement of the auditors of the Company in this process. It also receives information from the Company's Internal Audit Service, which monitors compliance with internal control procedures of the Company. In particular, the Committee deals with issues of compliance with regulatory requirements, accounting standards, applicable rules of the UK Listing Authority (UKLA) and the Kazakhstan Share Exchange (KASE), providing effective system of internal control. The Management Board is also responsible for preliminary approval of the annual financial report. The Audit Committee periodically reviews major transactions on acquisitions and disposals, and addresses any questions that the Management Board may refer to the Audit Committee. Every year at the General meeting of shareholders, the Chairman of the Audit Committee through the Chairman of the Board of Directors shall report the results of the Audit Committee and answer questions related to the activities of the Audit Committee.

ACTIVITIES OF THE AUDIT COMMITTEE IN 2011

·; Financial statements

o reviewed issues on preparation of financial statements in compliance with the IFRS

o quarterly and annual financial statements to be disclosed to the Kazakhstan and London stock exchanges were approved

·; Issues of taxation

·; Internal control and risk management systems

o effectiveness of the internal control and risk management systems was assessed

o the Audit Committee self-assessed its performance

o Insurance program

·; Internal audit

o the plan of the Internal Audit Service was reviewed and approved

o internal audit effectiveness was assessed

o work progress report of the Audit Committee for 2010 was reviewed and approved

• Forecasts of cash flows of the Company

o issues on compliance with cash management policy

o the requirements to consider candidates for the position of chief accountant and deputy chief accountant were approved

·; Compliance

o policy on securities transactions

o disclosure policy

o issues of compliance with the law on corruption Britain (UK Bribery Act)

REMUNERATION COMMITTEE

MEMBERS OF THE REMUNERATION COMMITTEE

In 2011 this Committee was composed of only independent directors in the name of Philip Dayer (Chairman), Paul Manduca and Edward Walshe. Terms of office of the members of the Committee coincide with their terms of office as the members of the Board of Directors.

RESPONSIBILITIES AND DUTIES OF THE REMUNERATION COMMITTEE

The Remuneration Committee is responsible for monitoring the Company's current system of remuneration of the members of the Board of Directors, Director General, members of Management Board and other employees of the Company, including the analysis of the remuneration policy in comparison with other companies.

The Remuneration Committee is also responsible for developing and providing recommendations to the Board of Directors on the principles and criteria for determining the amount and terms of remuneration and compensation to the members of the Board of Directors, Director General and members of the Management Board of the Company and on approving the terms share option plans of the Company and other long-term incentive programs for managers and employees Company.

The Remuneration Committee oversees coordination of the Company's policy of remuneration and current remuneration system of the Company with the development strategy of the Company, its financial situation and the situation on the labour market. The Remuneration Committee oversees provision of adequate information disclosure in respect of remuneration and compensation of members of the Management Board and the Board of Directors of the Company in accordance with the laws of the Republic of Kazakhstan, the Listing Rules and the Company's internal documents.

In addition, the Remuneration Committee monitors implementation of decisions of the General meeting of shareholders with respect to determining the size and order of payment of remuneration of the Board of Directors of the Company.

The Remuneration Committee shall report regularly to the Management Board on its work and also hold annual review on compliance by the Committee of the provision on the Remuneration Committee providing information to the Board of Directors.

ACTIVITIES OF THE REMUNERATION COMMITTEE IN 2011

During 2011 the Remuneration Committee held six meetings. The Committee shall hold meetings as necessary, but not fewer than once every six months. Meetings may be convened at the initiative of the Chairperson of the Committee, or by decision of the Board of Directors.

In 2011, the Remuneration Committee considered issues such as:

·; determining the amount of salaries and conditions of remuneration and bonuses of the members of the Management Board

·; the final performance of key performance indicators (KPIs) of the members of the Board, Head of Internal Audit Service and Corporate Secretary of the Company

·; Remuneration  and approval of KPIs of the members of the Management Board, employees of the Internal Audit Service and Corporate Secretary

·; issues related to the share option program

·; proposals to introduce a system of bonuses based on implementation of cost management projects Total amount of remunerations of independent directors for the year as of December 31, 2011, are listed in the table below:

Other members of the Board of Directors do not receive remuneration as the members of the Board of Directors, but shall be entitled to reimbursement for costs associated with such appointment.

NOMINATION COMMITTEE

In 2011 the composition of the Nomination committee included: Alik Aydarbayev (Chairman of the Committee from 28 June 2011), Askar Balzhanov (Chairman of the Committee until 28 June 2011), Edward Walshe, Paul Manduca and Philip Dayer. The main purpose of the Committee is to increase efficiency and quality of the Board of Directors in selection of professionals to fill positions in the Company, as well as to ensure continuity in changing officers of the Company, to define criteria for selection of candidates for the Board of Directors, Director General, members of the Management Board and Corporate Secretary of the Company. The Nomination committee considers matters related to changing the composition of the Board of Directors and Management Board, with termination of office and appointment of the Corporate Secretary, his/her retirement and appointment of additional and alternate directors.

ACTIVITIES OF THE NOMINATION COMMITEE COMMITTEE FOR 2011

During 2011 the Committee held two meetings, where the following issues were discussed:• Recommendation on electing a member of the Board of Directors

• Recommendation on electing members of the Management Board

STRATEGIC PLANNING COMMITTEE

In 2011 the composition of the Strategic Planning Committee consisted of: Edward Walshe (Chairman), Kenzhebek Ibrashev (up to May 5, 2011), Askar Balzhanov, Alik Aydarbayev (since 28 June 2011).The main purpose of the Committee is to develop and provide recommendations to the Board of Directors on formulation of the priorities of the Company and its development strategy.

ACTIVITIES OF THE COMMITTEE ON STRATEGIC PLANNING FOR 2011

• For 2011 the Committee held five meetings, where issues were discussed:• the strategic map and a list of key performance indicators (KPIs)• acquisition and development opportunities for international development [?]• Functional strategies• Information about the  exploration program of the Company going forward• Participation in the petrochemical project

STAKES OF DIRECTORS AND MEMBERS OF THE MANAGEMENT BOARD

Stakes of directors and members of the Management Board in common, preferred shares and GDRs of the Company, according to information provided by members of the Board of Directors and the Board as of 31 December 2011 are the following:

MAJOR SHAREHOLDERS AND/OR GDR HOLDERS

In accordance with the laws of the Republic of Kazakhstan the list of holders of securities of the Company, who own shares as of 31 December 2011, the number of which must be reported, is presented. This requirement does not apply to holders of GDR, however, the Company considers it necessary to specify the information on that on 30 September 2009, the State Investment Fund of the People's Republic of China Investment Corporation (CIC) announced on acquisition of GDR amounting to about 11% of the shares of the Company in the form of GDRs.

CONTRACTS OF DIRECTORS, LETTER OF APPOINTMENT OF DIRECTORS AND LABOR CONTRACTS OF MEMBERS THE MANAGEMENT BOARD

CONTRACTS WITH DIRECTOR

·; Powers of Tolegen Bozzhanov as a member of the Board of Directors were terminated on 31 March 2011.

·; Sisengali Utegaliyev was elected to the Board of Directors on 31 March 2011.

·; Powers of Kenzhebek Ibrashev as a member of the Board of Directors were terminated on 5 May 2011.

·; Alik Aidarbayev was elected to the Board of Directors on 5 May 2011.

LABOUR CONTRACTS OF MEMBERS OF THE MANAGEMENT BOARDAll the members of the Management Board signed labour contracts with the Company which provide them with accident insurance during travel and expenses during business trips, in accordance with the internal rules of the Company. Except for the foregoing, it is not expected to enter into any other employment agreements with members of the Company's Board of Directors or Management Board members.

INTERNAL CONTROL ANDRISK MANAGEMENT

JSC "Exploration Production" KazMunayGas" operates a system of internal control over financial and economic activity. The system is based on firmly-established international practices, such as the COSO Internal Control Framework and COSO Enterprise Wide Risk Management, as well as on the requirements of the Listing Rules of the London Stock Exchange and the UK Combined Code of Corporate Governance. The main objective of the system of internal control is to ensure sustainable development of the Company by identifying, evaluating and managing significant risks to achieve its strategic objectives and to preserve and increase shareholder value. The system of internal control of the JSC includes the Audit Commission, the Committee of the Audit Board, and Risk Management Committee under the Company's management, independent auditor and internal audit service. The existing chain of authority and interaction between elements of the internal control system provides a level of independence necessary for its effective functioning, and in line with best international practice in this area. The Directors confirm that during 2011 the processes that identified, assessed and managed significant risks faced by the Company were in place. In addition, the Directors used an approach that takes into account the risks of creating a system of internal control and reviewing performance.

The key elements of the Company's internal control include:

·; The internal company documents such as financial, operational, administrative policies, policies for managing the funds and other procedures.

·; Constant monitoring of the operating and financial activities and related work in compliance with the safety requirements of the Company.

The Internal Audit Service of the Company provides the Board of Directors with objective information about how effectively the system of internal control of the Company operates. In its work The Internal Audit Service uses a risk-oriented approach which allows identifying and focusing maximum attention on the critical areas of the Company, thereby helping to improve the Company's overall performance and the quality of its corporate governance. The Internal Audit Service reports include recommendations for improving the forms and methods of operation of the system of internal control. The Internal Audit Service monitors the implementation of the recommendations by the Management and reports thereon to the Audit Committee and the Board of Directors. In addition the financial risks information can be found in the Analysis of financial condition and results of financial and economic activities. General information on the risk profile of the Company can be found in the Risk Factors section.

With regard to risk management, the Board established a Committee on risk management and more detailed information on its activities is presented below.

RISK MANAGEMENT COMMITEE

In 2011, the Risk Management Committee conducted its activities under the chairmanship of General Director, Askar Balzhanov. The Committee consists of Head of Risk Management Department, Deputy General Director for Production - Head of Operations Management in Aktau, Deputy General Director for Economics and Finance, Deputy Director of Corporate Development and Asset Management, Managing Director - Financial Controller, Managing Director for Economics and Finance, Managing Director of Legal Affairs, Managing Director of Information Technology, Managing Director of Human Resources and Social Policy, Managing Director of Safety, Health and Environment and Corporate Secretary. Head of Internal Audit participates in meetings of the Committee as an observer.

The main purpose of the Committee is a prompt consideration of risk management issues in the Company. The Committee may make recommendations to the Board on risk management, and monitoring the effectiveness of risk management systems and make recommendations to structural units of the Company to improve the risk management system in order to make business processes more efficient and achieve the strategic goals of the Company.

During the 2011 Risk Management Committee held four meetings where it discussed and made decisions on the following issues:

·; Review and approval of the Risk Management Policies Project

·; Overview on the current status and development plan for the risk management system

·; The status of orders on matters considered at the meeting of the RMC

·; Issue on the list of key positions of JSC KMG EP.

·; Status on the choice of an independent consultant for the Insurance Program of JSC KMG EP.

·; An overview and current status of the risk management system and further plan of RMC meetings

INFORMATION ON TAXATION IN THE UK

The overview given below is based on the UK law and the HM Revenue & Customs practices in force as at the date of this document, both of which are subject to change, possibly with retrospective effect. Except where otherwise stated, the overview discusses only certain UK tax consequences for absolute beneficial owners of shares or GDRs who are (1) considered to be UK residents for tax purposes; (2) considered to be residents for tax purposes in no other jurisdiction; and (3) not in possession of a permanent establishment in the Republic of Kazakhstan to which the holding of shares or GDRs is related ("the UK Holders").

In addition, this overview (1) addresses only the tax consequences for the UK Holders who own shares and GDRs as capital assets and it does not addresses the tax consequences that may apply to certain other categories of the UK Holders, e.g. dealers; (2) assumes that the UK Holder does not, directly or indirectly, control 10% or more of the voting shares of the Company; (3) assumes that a holder of the GDRs is beneficially entitled to the underlying shares and to the dividends on those shares; and (4) does not address the tax consequences for the UK Holders that are insurance companies, investment companies or pension funds.

The following is intended only as a general guide and is not intended to be, nor should be considered to be, legal or tax advice to any particular UK Holder. Accordingly, investors should satisfy themselves as to the overall tax consequences, including, specifically, the consequences under the UK law and HM Revenue & Customs practice, of the acquisition, ownership and disposal of shares or GDRs in their own particular circumstances.

WITHHOLDING TAX

On the assumptions that income received from GDRs is from a non-UK source for tax purposes, it should not be subject to withholding tax in the UK. Dividend payments on shares will not be subject to the UK withholding tax.

TAXATION OF DIVIDENDS

A UK Holder receiving a dividend on shares or GDRs may be subject to the UK income tax or corporation tax, as the case may be, on the gross amount of any dividend paid before the deduction of any Kazakhstan withholding taxes, subject to the availability of any credit for Kazakhstan tax withheld. A UK Holder who is an individual resident and domiciled in the UK will be subject to UK income tax on the dividend paid on shares or GDRs and is entitled to a non-refundable tax credit equal to one ninth of the amount of dividend received. A UK Holder who is an individual resident but not domiciled in the UK and who is entitled to be taxed in the UK on the remittance basis will be subject to the UK income tax on the dividend paid on shares or GDRs to the extent that the dividend is remitted or treated as remitted to the UK, and will also be entitled to a non-refundable tax credit equal to one ninth of the amount of dividend received.

A UK Holder which is a company residing in the UK is not subject to the UK corporate tax on the dividend paid on shares or GDRs, unless certain anti-avoidance rules in the tax law apply.

TAXATION OF DISPOSALS OR DEEMED DISPOSALS

The disposal by a UK Holder of interests in the shares or GDRs may result in a chargeable gain or an allowable loss for the purposes of UK taxation of chargeable gains, depending on the UK Holder's circumstances and subject to any available exemption or relief. A UK Holder who is an individual and domiciled in the UK will generally be liable to UK capital gains tax on chargeable gains made on the disposal of an interest in the shares or GDRs. A UK Holder who is an individual but not domiciled in the UK and who is entitled to be taxed in the UK on the remittance basis will generally be liable to the UK capital gains tax to the extent that the chargeable gains made on the disposal of an interest in the shares or GDRs are remitted or treated as remitted in the UK. In particular, dealings in the GDRs on the London Stock Exchange may give rise to remitted profits that would, therefore, give rise to the UK capital gains tax liability.

An individual holder of shares or GDRs who ceases to be a resident or an ordinarily resident in the UK for tax purposes for a period of less than five full tax years and who disposes of such shares or GDRs during that period may also be liable on returning to the UK to UK tax on capital gains, even though the individual may not be a resident or an ordinarily resident in the UK at the time of the disposal.

A corporate UK Holder will generally be subject to the UK corporation tax on any chargeable gains arising from a disposal of shares or GDRs.

EFFECT OF KAZAKHSTAN WITHHOLDING TAXES

Dividend payments in respect of shares and GDRs are subject to the Kazakhstan withholding tax. A UK Holder, who is an individual, should generally be entitled to a credit for Kazakhstan tax properly withheld from such payments against the income tax liability on such amounts, subject to UK tax rules for calculation of such a credit. A UK Holder, which is a company, is not generally subject to UK corporation tax on the dividend payment and so is not be able to claim credit for any such Kazakhstan withholding taxes.

STAMP DUTY AND STAMP DUTY RESERVE TAX ("SDRT")

Assuming that any document effecting the transfer of, or containing an agreement to transfer, one or more shares or GDRs is neither (i) executed in the UK nor (ii) relates to any property located in the UK, or to any matter or thing done or to be done in the UK (which may include involvement of UK bank accounts in payment mechanism), then no UK ad valorem stamp duty should be payable on such a document.

Even if the document effecting the transfer of, or containing an agreement to transfer, one or more shares or GDRs is (i) executed in the UK and/or (ii) relates to any property located in the UK, or to any matter or thing done or to be done in the UK, in practice it should not be necessary to pay any UK ad valorem stamp duty on this document unless the document is required for any purposes in the UK. If it is necessary to pay the UK ad valorem stamp duty, it may also be necessary to pay interest and penalties associated therewith.

As the GDRs relate to the securities expressed in a currency other than sterling, no "bearer instrument" stamp duty should be payable on either the issue of the GDRs or any transfer of the securities transferable by means of the GDRs.

Assuming that the shares are neither (i) registered in the UK register nor (ii) paired with shares issued by a company incorporated in the UK, no SDRT should be paid in respect of any agreement to transfer shares or GDRs.

YEAR 2011 OPERATING AND FINANCIAL REVIEW

The following document is intended to assist the understanding and assessment of trends and significant changes in the Company's results and financial condition. In this document, the consolidated financial statements presented are those of the Company. This review is based on the consolidated financial statements of the Company and should be read in conjunction with those statements and the accompanying notes. All the financial data and discussions thereof are based upon financial statements prepared in accordance with IFRS.

Overview

KazMunaiGas Exploration Production Joint Stock Company ("the Company" or "KMG EP") is engaged in the exploration, development, production, processing, export of hydrocarbons and the acquisition of oil and gas assets. The Company's core operations are oil and gas properties located in the Pre-Caspian, Mangistau, Southern Torgai basins. The Company's majority shareholder is JSC National Company KazMunaiGas (NC KMG), the wholly state-owned joint stock company which represents the state's interests in the Kazakh oil and gas industry. The Company conducts its core production activities at 47 oil and gas fields, including "Uzenmunaigas" ("UMG"), which consists of 2 fields, "Embamunaigas" ("EMG"), which consists of 40 fields and "Kazakh Gas Refinery" LLP which consists of 5 fields. The Company also has a 50% interest in the oil and gas production joint venture Kazgermunai LLP, CCEL, Ural Group Limited BVI ("UGL") and a 33% interest in its associate PetroKazakhstan Inc.

Company is carrying out onshore exploration in the areas of Liman, Taisoigan, R-9, Karaton-Sarkamys, Uzen and Karamandybas, Fedorovskiy block ("UGL"), Karpovskiy Severniy ("Karpovskiy Severnyi JSC"), Temir, Teresken, Zharkamys Eastern -1 ("KMG EP Exploration assets") andalso holds 35% interest in the BG Group operated license in the United Kingdom Central North Sea - the production license which contains the White Bear prospect.

The Company's total 2011 oil production, together with the share of its joint ventures and its associate company, was approximately 12,341k tonnes or 250kbopd. This includes oil derived from its 50% share in JV Kazgermunai LLP, its 50% share in ÑÑEL and its 33% stake in PetroKazakhstan Inc. The stake in UMG and EMG produced 159kbopd with a further 41kbopd from PetroKazakhstan Inc., 32kbopd from JV Kazgermunai LLP and 18kbopd from CCEL.

Further details of the above joint ventures and associate are given in the section entitled: Overview of Associate and Joint Ventures Operations. Elsewhere in this Operating and Financial Review the discussion is limited to the core assets (UMG, EMG and 100% subsidiaries) of the Company unless indicated otherwise.

Business Environment and Outlook

Macroconomic factors affecting the Company's financial performance for the 2011 under review include movements in crude oil prices, domestic inflation, and foreign exchange rates, particularly the tenge-US dollar rate.

Business Environment for 2011

The average Brent price in 2011 was US$111.26 per barrel; an increase of US$32.07 per barrel year on year.

Most of the Company's revenues, financial assets and borrowings are denominated in US dollars, while most of the Company's operating expenses are denominated in tenge. Company manages currency risk by reducing or increasing the share of financial instruments denominated in US dollars in its portfolio.

Tenge-US dollar exchange rates and domestic inflation, as measured by the consumer price index ("CPI") were as follows:

The tenge appreciated against the US dollar from average 147.35 KZT/US$ in 2010 to 146.62 KZT/US$ in 2011. The inflation rate in 2011 was 7.4% compared to 7.8% in 2010.

Production Activity

Production of crude oil from core assets in 2011 was 7,900k tonnes which is 10% lower than in 2010.

The main reason for the decrease in production of crude oil is a significant number of absences of production staff at UMG during May-August period of 2011, which disrupted normal well servicing and well workover operations. In addition, a number of emergency power cuts in the field, caused by severe weather conditions during 2011 decreased average daily production.

As of January 1, 2012, the number of wells operated by the company was 5,912 production and 1,603 injection wells. Including of 3,637 production and 1,154 injection wells in UMG and 2,275 production and 449 injection wells in EMG. The majority of the Company's existing oil fields are at a mature stage of development, characterized by high water content and declining oil production. The Company engages in production drilling, work-over operations and enhanced recovery operations in order to mitigate the natural production decline and achieve its oil production targets.

In 2011 UMG drilled and put into operation 172 wells (122 oil producing, 50 injection), 14 more than in 2010. Oil production generated by new wells rose to 186k tonnes compared to 149k tonnes in 2010. The workover of 769 wells provided an incremental production of 389k tonnes. In 2011 at UMG as a result of 150 well operations for hydro-fracturing, an additional 223k tonnes were produced.

In 2011 EMG drilled and put into operation 65 wells (63 oil producing, 2 injection), 8 more than in 2010. Oil production generated by new wells rose to 71k tonnes compared to 58k tonnes in 2010. The workover of 297 wells provided an incremental production of 73k tonnes. At EMG as a result of 10 well operations for hydro-fracturing, an additional 16k tonnes were produced.

(1) Including crude oil production of NBK LLP in 2011

Exploration Activity

During2011 the Company conducted seismic surveys in the amount of KZT2.3 billion. The exploratory drilling expenditures were KZT8.2 billion(1), including KZT2.6 billion allocated to disposal of 7 dry exploratory wells and KZT1 billion to disposal of 4 appraisal wells.  In 2012, the Company plans to carry out seismic works in the amount of KZT2.1 billion and exploratory drilling at KZT23.5 billion(1).Increase of expenses for exploration activity in 2012 mainly associated with the start of exploratory drilling on the White Bear structure and drilling of 2 exploratory wells on the JSC "Karpovskiy Severniy" acquired in 2011.

During 2011 the Company carried out exploration works in the blocks Liman, R-9, Taisoigan, Karaton-Sarkamys, Uzen-Karamandybas, Novobogatinsk Western, Temir, Teresken, Zharkamys Eastern-1, Fedorovskiy and White Bear area and appraisal works in the S. Nurzhanov, Prorva Western, Eastern Makat fields.

At Liman block, the analysis of 3D seismic data of 165 sq. km on the Novobogat South Eastern structure was finished. At well G-3 with a projected depth of 1,400m the drilling was halted at 1,250m. The well is in the stage of third object testing. Third object testing has indicated oil production facility at the level of 36 tonnes/day. Well G-4 was drilled to a depth of 1,650m. Due to absence of productive reservoirs according to geophysics and borehole core data the well has been abandoned.

In 2012 on Liman block, for the discovered oil deposits of Novobogat SE to be delineated, 2 exploratory wells of 1,600m and 1,400m will be drilled to track post-salt Midle-Triassic deposits. Apart from that, based on 3D seismic results to analyze the potential of 2 prospects, 2 subsalt wells with a depth of 2,500m will be drilled.

At R-9 block, the analysis of 3D seismic data for 224 sq. km on structure Shokat was completed. The drilled wells 100 (Esbolai), 100 (Masabai), 102 (Kyzylkala), 100 (Kamyskol North) and 100 (Kamyskol South) with depth of 9236m were abandoned for geological reasons. 

Due to negative drilling results in 2011, it was decided that all exploration efforts are cancelled in 2012 and detailed feasibility study is made on whether any further work should be done within the block.

At Taisoigan block, the analyses of 3D seismic data for 150 sq. km on Uaz and Kondybai fields were finished. In 2011 drilling of exploration wells 13, 20 at the Kondybai field and well 1 (Bazhir) completed and all wells were abandoned for geological reasons without lowering the production casing.

At the block Taisoigan exploration drilling is planned for 1 well with planned depth of 1300m on the Uaz area in order to identify oil and gas in Triassic sediments. Seismic 3D-MOGT works for 86 sq. km is planned to be performed on Bazhir structure (eastern wing) to revise geological model and discover new targets in Triassic deposits.

In 2012 on Karaton-Sarkamys block drilling of 1 well with a depth of 3,000 m is expected on Keneral structure and 1 well in the eastern wing of Dosmukhambetovskoe field with a depth of 3,500 m. Apart from that, 390 physical tonnes of magnetotelluric depth sounding works is expected as part of studying the block's geological aspects in 2012 and using the data in comprehensive interpretation of 3D/2D seismic data to enhance the performance of exploratory wells location.

To revise geological model and to determine the perspective of areas on Karaton-Sarkamys block, 160 sq. km of 3D seismic works is planned on structures Severniy, Bulatai and on the northern wing of S. Nurzhanov structure.

At Uzen-Karamandybas block, the drilling of exploratory well on the Bodrai structure with a total planned depth of

2,200 m finished. According to the results 4 objects selected for testing in Middle Jurassic deposits. The well has been abandoned for geological reasons by the results of testing.

To revise geological model of Bodrai structure and other selected structures in the northern and southern parts of the block in 2012, it is planned to conduct 3D-MOGT seismic works and further procession of received data for 715 sq. km.

On Novobogatinsk Western field drilled well 19 with a depth of 2,511m for Permian-Triassic sediments, which is currently in the stage of testing. In 2012 will be drilled the exploratory well 20 with projected depth of 2,600m.

At Zharkamys Eastern-1 in 2011, 610 linear km of 2D seismic and 200 sq. km of 3D seismic works were performed. A presalt well was drilled on Tuskum structure with actual depth of 4,750 m. Currently, the first target is being tested. Acid treatment was also performed for stimulation and the well is currently is being tested.

In 2012 an exploratory well (RÀ-2-Ò) will be drilled with the projected depth of 4,500 m for presalt deposits of Tuskum structure as well as 1,000 linear km of 2D MOGT seismic data processing and re-interpretation along with historical data for the central and western parts of Zharkamys Eastern-1 block.

(1) These amounts do not include the 50% share of the expenditures for exploratory drilling on the block Fedorovskiy (KZT2.5 billion - in 2011 and KZT2.5 billion - in 2012), which are stated as "Investments in joint ventures» in the consolidated statement of financial position of KMG EP.

On the Temir block 975 linear km of 2D seismic data was aquired during the reporting period.

In 2012 on Temir area a gravity survey for 3,500 sq. km is planned with further processing and interpretation.

On the Teresken block, processing and interpretation of 1,000 linear km of 2D seismic data was finished.

In 2012 analysis and summary of 2D seismic processing and interpretation of the results is expected and any further exploration works in the area will be specified.

On the block Fedorovskiy 3 subsalt wells were drilled with total depth of 13,500m, which were transferred to temporary conservation for future testing in 2012. The extension of the test term for drilled wells was due to a gas flaring permission obtained from an authorized body.

Apart from the test of the 3 drilled wells, two wells are expected to be drilled with the projected depths of 4,500m and 5,200m respectively according to Rozhkovskoe field assessment in 2012, which were approved in the 2012 production program. Also planned further processing of 747 sq. km of 3D data and completion of Rozhkovskoe field construction for pilot production.

In December 2011the Company announced the closing of the acquisition of 100% of shares in Karpovskiy Severnyi JSC from GazMunaiOnim in West Kazakhstan region.

In 2012 on Karpovskiy Severniy block it is planned to drill 2 exploratary wells with the projected depth of 5,600m and 5,250m according to contractual obligations, as well as to aquire 335 linear km of 2D seismic works.

In the White Bear area, geological and technical studies were carried out. The program of drilling and testing was approved. Also, it was carried out a partial refund of the area by PL 1722 license.

On the White Bear structure it is planned to drill an exploratory well White Bear West 22/4b-F, with a projected depth of 5,900 meters and acquisition of 3D seismic data on blocks 22/8v, part 22 / 9c for preliminary 106.7 sq. km.

At the S. Nurzhanov field drilling of wells 509 and 707 with a total depth of 5,500 meters was finished. Well 509 is in the stage of testing intervals at 3177-3197m with oil deposit at 47.5 tonnes/day and well 707 was abandoned for geological reasons.

In 2012 it is planned to drill one well for Valanginian deposits in the eastern dome of S. Nurzhanov field with the projected depth of 2,000 m.

At the Western Prorva field the 3,560 m well 402 was drilled, received 108.6 m3/day of oil inflow without water.

In 2012 well 401 with projected depth of 3,500m is expected to be drilled for detailed appraisal works on Triassic deposits.

At the Eastern Makat field well 105 with a depth of 1,501 was drilled for a triassic deposit. The well was abandoned for geological reasons.

According to the approved appraisal works project, well 103 with projected depth of 1,550m is expected to be drilled in 2012.

Planned production activity in 2012

Crude oil production in PB UMG and EMG in 2012 is planned to be 8.6 million tonnes, including 5.8 million tonnes in UMG and 2.8 million tonnes in EMG. In order to ensure this and compensate for the natural production decline in 2012, the Company is planning to drill 156 oil producing wells and 79 injections wells. In addition to well workovers, the Company will apply bottomhole treatment and will bring some inactive wells back on line.

In the first quarter of 2012 the production of EMG and UMG was about 150 thousand tonnes (7%) behind the plan, primarily due to adverse weather conditions in Western Kazakhstan. Given the 1Q 2012 results, the planned oil production targets may be more challenging than previously anticipated. The Company will do everything possible to meet them but the results of 2Q 2012 will serve as an indicator whether KMG EP will need to adjust its 2012 production forecasts.

In order to ensure the planned production, Company has set the beginning of construction of the following objects in the UMG: two workshops on repair and diagnostics (tubing, rods and deep-well pumps), site preparation for the jamming of the liquid with the equipment, car service center for specialized equipment, site collection and other objects.

The construction of these targets would allow:

·; to eliminate the use of defective equipment;

·; to increase time between repairs of wells by reducing the number of well servicing operations due to sucker rod breakage;

·; to enhance production by reducing the number of well servicing operations and downtime of equipment;

·; to raise the level production safety;

·; to improve sanitary and living conditions of rotational workers which would improve the productivity of labour.

In connection with the events on December 16 in the city Zhanaozen, the Board of Directors of the Company in early 2012 decided to establish two service companies in the Zhanaozen and Aktau citites (PSB "UBR" and LLP "UTTiOS"), which will provide employment for more than 2,000 people. The principal activities of service companies is the implementation of repairs of wells and provision of transport services in UMG and other businesses in the region, which will have a positive impact on maintaining current production levels. 

In order to enable service businesses to quickly start their activities, KZT20.6 billion has been allocated, including KZT12.3 billion for operating activities and KZT8.3 billion for capital expenditures. Using these funds in 2012, it is planned to purchase machinery and equipment, as well as to begin construction of two rotational campsand two production bases to service Kalamkas and Karazhanbas fields. Construction of these facilities is necessary for the production activity (workover, transportation services) and provides shift workers with necessary sanitary and living conditions.

In 2012 the capital expenditure of the Company is expected to reach KZT126.5 billion. The Company's budget will be periodically reviewed to reflect changes in the crude oil price, and foreign exchange and inflation rates, among other factors.

Results of Operations

Company prepares financial statements in tenge, amounts shown in US dollars are included solely for the convenience of the user of information at the average exchange rate over the applicable period. Assets and liabilities are translated at the closing rate. Income and expenses are translated at the average exchange rate. See "Business Environment and Outlook".

Key Indexes

Transport Routes

The Company delivers its crude oil through three principal routes: export markets via the pipeline owned by Caspian Pipeline Consortium (CPC) and the Uzen-Atyrau-Samara pipeline (UAS) owned by KazTransOil JSC (in Kazakhstan) and the domestic market, as outlined in the following table:

(1) Converted at 7.36 barrels per tonne of crude oil.

(2) Capital expenditures includes expenditures for exploration and evaluation assets as per consolidated statement of cash flows for the period ending December 31, 2011 (see Company website for a copy)

The relative profitability of the two export routes depends on the quality of oil in the pipeline, the prevailing international market prices and the relevant pipeline tariffs. Specifically, CPC tends to be the more advantageous route owing to the higher quality of crude oil in the CPC pipeline in a higher price oil environment, even after taking into account quality bank payments. It should be noted that the volume of crude oil that can be shipped through the pipelines has to be agreed with the Kazakh Ministry for Oil and Gas (MOG); the Company's ability to allocate export volume to different pipelines is, therefore, limited.

Revenue

The following table shows sales volumes and realized prices:

Crude Oil Sales

The total sales of crude oil in 2011 increased by 19% to KZT708 billion compared to 2010. This was due to a 34% increase in the average sales price. The overall volume of crude oil sales in 2011 were decreased by 11% to 7,656 ktonnes in 2011.

Export - UAS Pipeline

Sales of crude oil exported via the UAS pipeline in 2011 increased by 15% to KZT396 billion owing to the increase of the average realized price by 40% to KZT112,344 per tonne which was partially offset by the decrease of volume exported via the UAS pipeline that declined by 793 ktonnes, or 18%.

The decrease of sales volume in 2011 was caused by a 15% decrease in UMG oil production, or 884 thousand tonnes, in comparison with 2010.

(1) Average sales price under financial statement (realized price), converted at 7.23 barrels per tonne of crude oil.

Export - CPC Pipeline

In 2011 sales of exported crude oil via the CPC pipeline increased by 23% to KZT260 billion in comparisons with 2010. This is due to an increase of 40% to KZT116,239 per tonne in the average realized price and was partially offset by the decrease in volume exported via the CPC which declined by 12%.

Domestic Market - Sales of Crude Oil

Domestic sales of crude oil in 2011 increased by 30% to KZT53 billion, compared with 2010, due to a 22% increase in the average sales price and also by the increase in sales volume by 6% or 115k tonnes.

The following table shows the Company's realized sales prices adjusted for crude oil transport and other expenses:

The difference between the benchmark quote and the realized price of sales mainly comprises freight expenses, port charges, customs fees, certain sales commissions and averaging effects. Averaging effects usually appear because of the difference between the average mean of the quoted price on the sale date and the average published price over the whole period. This difference may be significant on account of the high volatility of oil prices.

(1) The Brent (DTD) quoted price is used as benchmark

(2) Netback results have been corrected for the netting of gross margin on sale of crude oil for KZT1.7 billion produced from Uaz and Kondybay blocks, which have been transferred from an exploration to a development stage fields in accordance with the IFRS 6.

(3) Average realized price by financial report converted at 7.23 barrels per tonne of crude oil

(4) Export customs duty without including a claim of KZT15.2 billion by the decision of the Supreme Court, export customs duty for crude oil export shipments in 2008

Production expenses

The following table presents a breakdown of the Company's production expenses:

Production expenses in 2011 increased by 6% or KZT6.7 billion compared with 2010. This is primarily due to increased expenses for employee benefits, repairs and maintenance, materials and supplies and transportation services.

Employee benefits expenses for 2011 increased by 10% compared with 2010 owing to the increase in salaries of production personnel at production divisions, due to the new compensation plan introduced on June 1, 2010 and also because of indexation of basic tariffs by 7% according to the collective agreement.

Repairs and maintenance expenses during 2011 increased by 7% compared with 2010 mainly due to increase in cost of workovers, which were partially offset by decrease in volumes of work done. The cost of materials mainly increased because of higher prices for materialsin 2011 and also due to increase in expenses for workwear of production personnel according to the collective agreement.

Transportation service expenses increased by 78% mainly due to increase in volume of transport services provided by third parties. This relates to massive absence of production staff at UMG, during which UMG's own transport units were left idle.

Selling, general and administrative expenses

The following table presents a breakdown of the Company's selling, general and administrative expenses:

Selling, general and administrative expenses increased by 9% or KZT7.9 billion compared to 2010. This is primarily due to the increased expenses, for fines and penalties, employee benefits and sponsorship and was partially offset by a decrease in transportation expenses and consulting and audit services expenses.

The increase in fines and penalties is explained by accruals of fines and penalties due to results of Complex Tax Audit for 2004-2005 for total amount of KZT6.6 billion, accrual of fines of KZT2.3 billion for export customs duty, and accrual of an environmental fine of KZT2.6 billion. The environmental fine for burning gas is related to gas flaring at Prorva fields group in the first quarter of 2011.

Employee benefits expenses, including general and administrative personnel of UMG and EMG for 2011 increased by 14% compared with 2010 owing to the increase in salary due to the new compensation plan introduced on June 1, 2010 and the indexation increase of basic tariffs by 7% according to the collective agreement.

The increase in expenditure on social projects is mainly due to fact that Company committed KZT1 billion more funds to finance Uralsk city for restoration after flooding and committed funds to social funds for the social support of Mangystau and Atyrau regions.

The decrease in consulting and audit services expenses is related to the decrease in expenses for consultation for acquisition of new assets.

The decrease in transportation expenses is explained by the drop in volumes shipped for export by 16%. This drop is explained by the decrease in production of crude oil at Uzen field.

Taxes other than on income

The following table presents a breakdown of the Company's taxes other than on income:

Finance Income

Net finance income, including foreign exchange gain for 2011 was KZT24.3 billion, as compared to KZT27.1 billion for 2010. The drop is mainly explained by the decrease in interest income. Interest income decreased due to a reduction in the average rate of interest on deposits, which was partially offset with increase in interest income on debt instrument of NC KMG.

Share of Income in Associate and Joint Ventures

The Company's income from its share in associate and joint ventures in 2011 was KZT84.3 billion compared to KZT56.6 billion in 2010. This increase was mainly due to high crude oil prices during 2011. Share of income from JV Kazgermunai LLP was KZT38.4 billion and from PetroKazakhstan Inc. was KZT45.7 billion. For further details please refer to section: Overview of Associate and Joint Ventures Operations.

Income Tax Expense

The effective tax rate (net of JV's results) increased due to non-deductible expenses increase in 2011, such as amounts of fines and penalties paid on 2004-2005 tax audit results. Also, increase in income tax is explained by submission of additional declarations for 2006-2008 periods due to revision of the position of the Company to the risks identified in the comprehensive tax audit for 2004-2005. 

The income tax expenses in Q4 2011 in comparison with Q4 2010 increased mainly due to significant deductions related to double tax depreciation for full 2010 made in Q4 2010.

Profit for the Period

As a result of the factors mentioned above, in 2011 the Company's profit for the period decreased by 11% to KZT208.9 billion compared to 2010.

Overview of Associate's and JVs Operations

PetroKazakhstan Inc.

PetroKazakhstan Inc.'s key financial and operational indicators are shown below (1):

Crude oil production in 2011 was 5,912k tonnes, which is 2% less than in 2010. For 2011 the Company recognized share income from its investment in PetroKazakhstan Inc. (33% share) of KZT45.7 billion, which is KZT11.5 billion higher than in 2010. Growth is the result of greater crude oil prices and reconsolidation of JSC Turgai Petroleum since August 2010. Increase in operating expenses is also related with reconsolidation of JSC Turgai Petroleum since August 2010. Capital expenses in 2011 were US$373.2 million (KZT54.7 billion). During 2011 the Company received dividends from PKI in the amount of KZT53.2 billion.

(1) Results of Associate's and JVs Operations for 2011 are unaudited.

(2) The excess of sales volume over the volume of crude oil produced is due to the fact that the JSC PKKR buys crude oil from third parties to supply the domestic market.

JV Kazgermunai LLP

JV Kazgermunai LLP's (Kazgermunai) key financial and operational indicators are shown below:

The Company's share (50%) in Kazgermunai oil production in 2011 was 1,500k tonnes. Capital expenditure for the period was US$73.7 million (KZT10.8 billion). The company's share in income of the joint venture agreed to consolidated financial statements of the Company for 2011 is KZT38.4 billion which is KZT15.8 billion greater than in 2010. During 2011 the Company received dividends from Kazgermunai in the amount of KZT36.6 billion.

The increase in operating expenses is mainly due to increase in tax payments (rent tax, MET) and customs duty, which is due to an increase in volumes of oil sent for export. 

The increase in net income is due to higher oil price, optimization of the structure of crude oil supplies and purchases for the purposes of meeting domestic supply requirements (mechanism for substitution of oil).

CCEL

CCEL's key financial and operational indicators are shown below (1):