Preliminary Results

27 March 2012

VOLGA GAS PLC

Preliminary results for the year ended 31 December 2011

Volga Gas plc ("Volga Gas", the "Group" or the "Company"), the oil and gas exploration and production group operating in the Volga Region of European Russia,is pleased to announce its preliminary unaudited annual results for the year ended 31 December 2011.

FINANCIAL

·; Group average production increased 93% to 2,147 barrels of oil equivalent per day (2010: 1,115 bopd).

·; Revenues increased 118% to US$28.6 million (2010 US$13.1 million).

·; EBITDA up 256% to US$8.9 million (2010 US$2.6 million).

·; Net loss of US$1.1 million (2010: net loss of US$16.9 million).

·; Operating cash flow before working capital of US$7.6 million (2010 US$5.5 million), after offsetting US$3.1 million of gas sales for loan repayments (2010: nil).

·; US$10.1 million in cash at 31 December 2011 (US$26.6 million at 31 December 2010).

KARPENSKIY LICENCE AREA

Supra-Salt (Uzenskoye oil field)

·; Average production during 2011 was 1,178 bopd (2010: 1,115 bopd).

·; Sustained underlying reservoir performance.

·; Unsuccessful sidetrack on Uzen #9 well.

VOSTOCHNY MAKAROVSKOYE ("VM")

·; Long term testing of the production wells on the VM field continued during 2011.

·; The wells have now been tied in to the Dobrinskoye gas processing plant.

·; Upgrade of the gas processing facility is under way, with full time production expected in Q3 2012.

·; Workover of VM well #30 during H1 2012 to add a third production well to the field.

DOBRINSKOYE

·; Group acquired OOO Gazneftedobycha ("GND") in April 2011, gaining as a result 100% ownership of the producing Dobrinskoye field and 100% ownership of the Dobrinskoye Gas Plant.

·; Since acquisition to 31 December 2011, production from Dobrinskoye has averaged 5.4 mmcf/d gas and 426 bpd of condensate, or 1,326 boepd.

·; Sidetrack during H1 2012 of well #22 on Dobrinskoye aims to restore production to higher levels.

UROZHAINOYE 2 LICENCE AREA

·; Drilling of the Yuzhny Romanovskaya-1 ("YR#1") exploration well in the Urozhainoye-2 licence area. The well is currently at a depth of 3,900 metres, close to potential main target horizons.

CURRENT TRADING AND OUTLOOK

·; Current production of approximately 2,500 boepd.

·; Domestic market conditions in Q1 2012 have constrained oil and condensate sales, but net wellhead prices remained firm at over US$50 per barrel.

·; Principal focus on start of full time production from VM.

Mikhail Ivanov, Chief Executive of Volga Gas, commented:

"2011 was a transformational year for Volga Gas. A significant event during the year was the acquisition of GND which gave us a new production stream and, most importantly, ownership of the gas processing facility which will be used to process gas from our VM gas/condensate field development. Our key strategic aim for 2012 is to bring the VM field into full time production which will provide a significant lift in revenues and cash flows and a platform for future growth for Volga Gas.

"We remain positive about the potential for growth, both in reserves and production from our five licences. However, we are also seeking value accretive opportunities beyond our existing licence areas, as we build a focused exploration and production business."

For additional information please contact:

Editors' notes:

Volga Gas is an independent oil and gas exploration and production company operating in the Volga region of European Russia. The company has 100% interests in its five licence areas.

The information contained in this announcement has been reviewed and verified by Mr. Mikhail Ivanov, Director and Chief Executive Officer of Volga Gas plc, for the purposes of the Guidance Note for Mining, Oil and Gas companies issued by the London Stock Exchange in June 2009. Mr. Mikhail Ivanov holds a M.S. Degree in Geophysics from Novosibirsk State University. He also has an MBA degree from Kellogg School of Management (Northwestern University). He is a member of the Society of Petroleum Engineers and has 18 years of experience in the sector.

Availability of report and accounts

The Group's full report and accounts will be dispatched to shareholders as soon as is practicable. Copies will also be available on the Company's website www.volgagas.com and on request from the Company at, Ground Floor, 17-19 Rochester Row, London SW1P 1QT.

 Chairman's Statement

2011 has been a transformational year for Volga Gas, with the acquisition of OOO Gazneftedobycha ("GND") allowing the Company to conclude the long running legal and commercial differences with Trans Nafta and enable the Group to proceed with the final stages of preparation for production from the Group's largest field, Vostochny Makarovskoye.

The production side of the business continued to perform well in 2011 and with the additional production acquired with GND, the Group reported significant increases in revenues, EBITDA and operating cash flow.

The strong cash flow has enabled the Group to repay a significant proportion of the loans that were inherited with GND, while maintaining a strong financial position, with cash balances of over US$10 million at the end of the year.

The cash generating capability of the fields was also an important factor in the Group's ability to secure its first commercial debt facility which was signed post the year end on 26 March 2012. This facility will provide the necessary financial flexibility to support the Group's short and medium term investment strategy which will further drive production growth in 2012 and 2013.

The Group has significant proven reserves in its three principal fields, which form the basis of an established and rising profile of production. Our fields are advantageously located and our costs are sufficiently low for us to achieve good returns at oil and gas prices significantly lower than those we currently enjoy. Most importantly, these assets provide a strong platform for the Group to grow in the future, both through successful exploration and by selective value accretive acquisitions.

Volga Gas has identified material exploration prospects within existing acreage that can be tested at low cost. In addition, the deeper sub-salt potential of our licences remains largely untested. Based on the knowledge gained from our first well drilled in 2009-2010, we may consider further sub-salt drilling in the future.

During 2012, the strategic priority of the Group will be to achieve full commercial operation of the Vostochny Makarovskoye field, and to complete projects to enhance production from the Group's other two fields. The Board is also evaluating opportunities to extend the Group's activities into new areas, where we have identified the potential to add significant value and incremental production volumes.

The Board believes that Volga Gas has a strong asset base and the financial and operational capability to develop and extend these assets to provide long term value growth for our shareholders.

Alexey Kalinin

Chairman

Chief Executive's Report

A significant event in 2011 was the acquisition of Gazneftedobycha which brought into the Group's ownership the Dobrinskoye gas processing plant and the Dobrinskoye gas/condensate field. This was the final settlement of the extended commercial and legal disputes between the Group and Trans Nafta and was a key event to enable us to proceed towards full time production from the Vostochny Makarovskoye ("VM") field, which is currently the largest of the Group's fields, and which will utilize the Dobrinskoye gas plant to process its output.

With effect of 1 April 2011, the Group acquired the equity of GND for a consideration of approximately US$1.1 million. At the time of the acquisition, GND had loans outstanding due to Trans Nafta amounting to approximately US$24.4 million. By 31 December 2011, the debt outstanding had been reduced to approximately US$4.2 million, with repayments being made from the cash generated by GND itself as well as from the Group's internal cash resources.

On completion of the acquisition of GND in April 2011, the Group benefitted from an immediate increase of 9.3 million barrels of oil equivalent ("mmboe") in C1/C2 Reserves and a new and profitable stream of production to complement the steady production from the Uzenskoye oil field. This higher level of production, together with sustained healthy sales prices for oil, gas and condensate, enabled the Group to report a 118% increase in sales and a 256% increase in EBITDA.

As detailed in the Operational Review below, the majority of the work done on our existing asset base was focused on management of our two producing fields with the aims of maintaining effective and efficient long term production and of maximizing the ultimate recovery of reserves. In 2011, exploration activity was limited to the drilling of a committed exploration well on the Urozhainoye-2 licence area. By the end of 2011, the well had intersected a secondary target without commercial success, and the decision was taken in December 2011 to continue drilling towards the primary objective at a depth of approximately 4,000 metres. Drilling is currently ongoing.

Our key strategic objective now is to bring the VM field into full time production. Much of the development work was accomplished before 2011. We completed two production wells and installed intra-field pipelines in 2009, and during the second half of 2010 and the majority of 2011, we successfully conducted extended production tests on these two wells.

Following the GND acquisition, we completed the physical connection between the VM field and the gas plant, relocated a partly-built H2S processing unit from the VM field site to the gas plant site, and conducted a series of tests to establish the optimum plan for the necessary modifications to enable the gas plant to process the gas and condensate from VM. In December 2011, the plans for the plant upgrades were finalized and the principal procurement and construction contracts issued. Our aim is to complete the modifications and to commence full time production as soon after that as possible, expected in Q3 2012.

While the immediate strategic objective is to bring our existing assets into production, we have also been active in seeking growth opportunities by acquisition. We remain active in our search for complementary assets to expand our business.

Finance

To date, the Group's investments in exploration and capital expenditure have been funded from equity and cash generated from operational activities. Now that the Group's assets have established a track record of reliable cash generation, the Board has decided that it is an appropriate time to bring bank debt into the capital structure of the Group. As announced separately today the Group has arranged its first debt facility with ZAO Raiffeisen Bank, for a sum of US$10 million, which will be utilized to fund capital expenditures and for general corporate purposes in our Russian operating companies

Current trading

Since the beginning of 2012, production capacity from the Dobrinskoye and Uzenskoye fields has been steady at approximately 2,500 boepd. During January and February 2012, the domestic oil market in Russia has been constrained, with several refineries undertaking early maintenance shut-downs, which has reduced demand and has required the Group to produce below the full capacity of our wells. Since the beginning of March 2012, we have seen more normal conditions return to the market, which has allowed us gradually to bring production from our fields closer to their technical capacities. With oil, gas and condensate sale prices remaining firm since the start of the year and costs remaining relatively low, Volga Gas continues to enjoy positive net operating cash flow.

Outlook

Key activities for 2012 will be the ongoing management and development of existing production across the portfolio. The Group's priority is to bring the VM field into production as soon as possible. On the VM field, an additional well, VM #30, is to be worked over and re-completed with the aim of increasing production capacity. Exploration drilling activity in 2012 includes completion of an exploration well on the Urozhainoy-2 Licence Area, and a shallow exploration well in the Pre-Caspian licence area. The total capital expenditure budgeted for 2012 is US$16.0 million, covering exploration and development drilling and the upgrade to the Dobrinskoye gas plant. This will be funded from a combination of cash flow, existing cash resources and the new bank facility.

Certain fiscal changes have been brought into effect in Russia. These include provisions that reduce the tax burden on crude oil exports and a new basis of charges of Mineral Extraction Tax ("MET") on condensate. The oil export tax changes may lead to relative increases in crude oil prices in the domestic market, in which we sell our oil and condensate. In addition, the new rate of MET on condensate is significantly lower than the 17.5% charge on sales hitherto charged. Management believes these changes will be of material benefit to the Group in 2012.

We look forward to delivering a successful new stream of production and to pursuing the other growth opportunities that we see for the business.

Mikhail Ivanov

Chief Executive Officer

Operational Review

The Group achieved a significant increase in production in 2011 following the acquisition of the Dobrinskoye gas and condensate field and a third successive year of steady production from the Uzenskoye oil field. This increase in production enabled the Group and to reach a significantly higher level of EBITDA and cash flow than in previous years. Full details are discussed in the Financial Review below.

Operating activities in 2011 were principally focused on management of existing oil production, integration of Gazneftedobycha into the Group and preparation for first production from Vostochny Makarovskoye, although there was also one exploration well being drilled during the year: in the Urozhainoye-2 licence area.

Karpenskiy licence area ("KLA")

The Group has completed all of its exploration commitments on the KLA and consequently all future activity in this area is discretionary. There remains significant exploration potential within the licence both within the supra-salt and the sub-salt horizons. However, the Group's priority in 2011 was to advance the development of producing fields and to fulfill exploration commitments in its other licence areas.

Supra-salt oil production

Having reached its third year of full time production, the Yuzhny Uzenskoye oil field is the Group's longest established field and a core asset. During 2011, as in 2010, the focus was on managing and optimizing the output from the five established production wells on the field. Average production for the full year 2011 was 1,178 bopd (2010: 1,115 bopd).

During 2011, the Group identified the potential to increase production from the field by drilling sidetracks on two currently non-producing wells, #4 and #9. These wells were drilled at the edge of the field and were seen as potential future injection wells. However, with clear evidence of good natural water drive in the reservoir, it was decided that water injection would not be required in the medium term and that the wells could be partially re-drilled into more advantageous locations and put on production. These drilling operations commenced towards the end of 2011. As announced on 13 March 2012, when the first of these sidetracked wells, #9, was put on stream, it produced only water. This indicates that the oil:water contact had migrated to a higher elevation than had been anticipated on the basis of cumulative production of oil from the field. This higher than anticipated oil:water contact is likely to have implications for the remaining recoverable reserves on the Yuzhny Uzenskoye field, which will need to be reassessed with the new data derived from this well.

The Yuzhny Uzenskoye field, whilst of modest scale, is very profitable to the Group. With the field being located close to market and producing high quality oil, the sales prices achieved are comparatively advantageous. Furthermore, as the oil is sold directly at the field facilities, the field bears no oil transportation costs. It was developed at a cost of US$1.91 per barrel of C1 reserves and benefits from very low production costs, averaging US$ 2.00 per barrel in 2011 (2010: US$1.07 per barrel). The increase in per barrel costs is primarily due to expensing well repair work, as well as the first time inclusion of property taxes.

Vostochny Makarovskoye ("VM") licence area

The initial drilling programme was completed on the VM field early in 2009. As previously reported, there are currently two completed and tested wells on the field with intra field pipelines laid between the well locations to the boundary of the Dobrinskoye gas facility, approximately 5km from the VM licence area, in preparation for production. The acquisition in April 2011 of the Dobrinskoye gas field and plant finally provided the Group with ownership of the required infrastructure and access to the Gazprom trunk line which were required to commence commercial production.

Shortly after the acquisition of GND, the Group completed the tie-in of the VM field to the Dobrinskoye plant and relocated certain items of equipment to be used for extraction of sulphur from the VM field to the plant. As a result of this relocation, certain historic construction costs incurred on the VM field were expensed. This resulted in a one-off US$5.6 million non-cash charge in the Income Statement in 2011. In addition, there was a successful test conducted of the chemical process planned to be used to extract the sulphur and the decision was taken at the end of 2011 to complete the upgrade of the gas plant. The cost of the required upgrade has been budgeted at US$4.5 million and full time production expected in Q3 2012.

During 2011, the Group continued with its extended pilot production programme on the VM#1 and VM#2 wells. The wells were individually flowed through a test separator installed at the field site. Condensate was gathered in storage tanks on location for sale while gas produced from the wells was flared. Although this activity was primarily a technical test programme, it provided a small profit contribution. Revenues from the sales of condensate from this operation were not included in Group revenues but provided an offset to the related costs, including installation of test equipment, and generated a modest surplus that contributed to profits.

The data gathered from the test programme has enabled the Group to develop a production plan for the field. Initial production from the field will be managed to enable higher recovery of condensate from the reservoir in the early years while in the later years an increasing proportion of gas is planned to be produced from the wells.

In addition to the existing production wells, a previously suspended exploration well, VM #30, is to be re-opened and completed as an additional producing well from the shallower Bobrikovskiy sandstone reservoir. Although the reserves in this secondary reservoir are a relatively minor part of the VM field's resources, this well can make a potentially significant short and medium term contribution to production.

Dobrinskoye field and gas processing plant

Since the acquisition in April 2011, the Dobrinskoye gas/condensate field has provided a material contribution to Group production and operating cash flow. During July and August 2011, the field was shut in while repairs were undertaken on the two wells in the Dobrinskoye field. It was decided during this operation that a sidetrack to well #22 would be necessary to enable optimum production from that well. At the same time, it was also considered prudent to place a smaller choke on the other well, #26, which re-commenced production at the end of August 2011.

Drilling operations on the sidetrack to well # 22 are to commence in April 2012 and the well is expected to be back on stream before July 2012.

Other than completion of tie-in and planning of modifications and upgrades in preparation for production from the VM field outlined above, operations on the gas plant proceeded normally.

Urozhainoye-2 licence area exploration

The Yuzhny Romanovskoye #1 exploration well in the Urozhainoye-2 Licence area was spudded in April 2011 and by November 2011 had reached its initial target zone at a depth of 2,885 metres without discovering commercial hydrocarbons. The decision was taken to continue drilling the well to the deeper target zones which lie at a depth of approximately 4,000 metres. The well is currently at a depth of 3,900 metres.

Oil, gas and condensate reserves as of 1 January 2012

Inclusion of the reserves in the Dobrinskoye field have increased the Group's Russian category C1 recoverable oil, gas and condensate reserves, as approved by the State Committee for Reserves, to 57.1 million barrels of oil equivalent (2010: 45.0 mmboe) taking into account production of 0.8 mmboe during 2011, upward revisions of 5.4 mmboe and the acquisition of 7.5 mmboe of C1 reserves. The reserves are presented in detail in the table below. The changes from the previous year reflect volumes of oil produced and a reclassification of certain C2 category reserves into C1 category. There was a downward revision in category C2 reserves on the VM field following a remapping of the reservoir. Any revision to the reserves in Yuzhny Uzenskoye will be recognised during 2012.

Mikhail Ivanov

Chief Executive Officer

Oil, gas and condensate reserves

Financial Review

Results for the year

In 2011, the Group generated US$28.6 million in turnover (2010: US$13.1 million) from the sale of 546,818 barrels of crude oil and condensate (2010: 407,050 barrels) and 1,348 million cubic feet of natural gas (2010: nil). Oil and condensate sales were made into the domestic market during the period. Gas sales were made to Trans Nafta and the sales proceeds were offset against payments of debt outstanding between Gazneftedobycha ("GND") and Trans Nafta. The average price realised for liquids was the equivalent of US$46.25 per barrel (2010: US$32.06 per barrel). The contract price for gas sales during 2011 averaged US$2.46 per thousand cubic feet. With sales made exclusively into the regional market in the Volga Region at the wellhead, our oil and condensate sales prices closely reflect international prices, adjusted for export taxes and transportation costs. Production activities generated a gross profit of US$13.0 million in 2011 (2010: profit of US$6.2 million).

In 2011, the total cost of production increased to US$2.4 million (2010: US$0.4 million), including the operating costs of the Dobrinskoye gas plant and field from April 2011. Production based taxes increased to US$9.5 million (2010: US$5.3 million) reflecting the increase in the Urals oil price, which determines the rate of Mineral Extraction Tax ("MET") for crude oil, and higher volumes. With relatively lower rates of MET charged on gas and condensate, MET in 2011 represented 33% of revenues (2010: 40% of revenues). The gross profit margin in 2011 was 47% (2010: 48%).

Operating and administrative expenses in 2011 were US$6.7 million (2010: US$4.7 million) as a result of including GND overheads from April 2011.

During 2011, the Group continued extended production testing on the Vostochny Makarovskoye gas-condensate field. The full costs incurred, including installation of test equipment and operating costs, were expensed during the year. These costs, offset by condensate sales from test production, were included in exploration and evaluation expenses.

The Group experienced a significant increase in EBITDA (defined as operating profit before non-cash charges, exploration expense, depletion and depreciation) to US$8.9 million (2010: US$2.6 million).

After recording a non-cash expense in 2011 of US$ 5.6 million (2010: nil) together with a small exploration and evaluation expense of US$0.2 million (2010: US$23.9 million), the Group recorded an operating profit for the year of US$0.5 million (2010: operating loss of US$22.5 million). The non-cash expense arose from certain past construction costs and other items of Property, Plant and Equipment becoming redundant when a partially constructed gas processing unit was transferred from the VM field site to the Dobrinskoye gas plant as part of the latter's upgrade project. In 2010 the exploration and evaluation expense was primarily an impairment charge relating to the unsuccessful Grafovskaya #1 well in the KLA.

Including foreign exchange and other losses, the Group recognised a loss before tax of US$1.1 million (2010: loss before tax of US$22.2 million) and reported net loss after tax of US$1.1 million (2010: net loss of US$16.9 million).

No dividends have been paid or proposed for the year (2010: nil).

Cash flow

Group cash flow from operating activities before working capital movements was US$7.6 million (2010: US$5.5 million). The net cash flow of the Group was reduced by US$3.1 million of gas sales being applied to debt reduction (2010: nil). Net working capital movements attributed to prepayments on capital expenditure contributed to a cash outflow of US$1.8 million in 2011 (2010: US$2.5 million inflow from working capital movements). With lower capital expenditures in 2011, the net outflow from investing activities was US$5.7 million (2010: US$13.9 million). During 2011, the majority of the net cash outflow arose from the repayment of debts owed by GND to its former owner Trans Nafta, amounting to US$15.7 million, with a further US$3.1 million of repayments by offset of gas sales (2010: nil).

Capital Expenditure

During 2011 a total of US$5.7 million was invested in capital expenditure on the Group's licence areas (2010: US$13.9million) as detailed below:

The most significant individual components of the capital expenditure were US$4.4 million on oil and gas exploration assets, predominantly the Yuzhny Romanovskaya #1 exploration well. Expenditure on development and producing assets primarily relates to the VM field.

GND acquisition

On 28 April 2011, the Group acquired GND for a consideration of RUR 30 million (US$1.1 million). At that date, GND had loans advances outstanding of RUR 667 million (US$24.4 million) owing to Trans Nafta and, had received an advance payment from the Group of RUR 600 million (US$ 21.6 million). The total capital employed in this business combination; amounting to RUR 1,307 million (US$47.2 million) has been subject to a provisional fair value allocation, with the significant majority of non-current assets being apportioned between the Dobrinskoye gas field and the Gas Plant.

Balance sheet and financing

As at 31 December 2011, the Group held cash and bank deposits of US$10.1 million (2010: US$26.6 million) and had short term non-interest bearing debt outstanding of US$4.2 million (31 December 2010: nil). The borrowings are loans due to Trans Nafta by GND.

As at 31 December 2011, the Group's intangible assets increased to US$39.5 million (2010: US$29.0 million) and the Group's property, plant and equipment increased to US$60.8 million (2010: US$ 37.5 million) following the provisional fair value allocation of assets acquired with GND. The prepayment of RUR 600 million, made to Trans Nafta in November 2008, shown on the Balance sheet as at 31 December 2010 as a US$19.7 million Security deposit, constituted part of the fair value allocation for GND assets.

The Group intends to fund its continuing development and exploration expenditures using a combination of cash flow from operations, cash-on-hand and debt. On 26 March 2012, it signed a loan agreement for a US$10 million bank facility to provide an additional source of funds.

The Group's financial statements are presented on a going concern basis.

Tony Alves

Chief Financial Officer

Financial and operational summary

Group Income Statement

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Group Statement of Comprehensive Income

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Group Balance Sheet

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Group Cash Flow Statement

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Group Statement of Changes in Shareholders' Equity

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1. Summary of significant accounting policies

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

1.1 Basis of preparation

The consolidated financial statements of Volga have been prepared in accordance with International Financial Reporting Standards, as adopted by the European Union (IFRSs as adopted by the EU), IFRIC interpretations, and the Companies Act 2006 applicable to companies reporting under IFRS. The consolidated financial statements have been prepared under the historical cost convention, as modified by the revaluation of financial assets and financial liabilities (including derivative instruments) at fair value through profit or loss.

The consolidated financial statements have been prepared on the going concern basis as the directors have concluded that the Group will continue to have access to sufficient funds in order to meet its obligations as they fall due for at least the foreseeable future.

1.2 Oil and gas exploration assets

The Company and its subsidiaries apply the successful efforts method of accounting for Exploration and Evaluation ("E&E") costs, in accordance with IFRS 6 "Exploration for and Evaluation of Mineral Resources". Costs are accumulated on a field-by-field basis. Costs directly associated with an exploration well, including certain geological and geophysical costs, and exploration and property leasehold acquisition costs, are capitalised until the determination of reserves is evaluated. If it is determined that a commercial discovery has not been achieved, these costs are charged to expense after the conclusion of appraisal activities. Exploration costs such as geological and geophysical that are not directly related to an exploration well are expensed as incurred.

Capital expenditure is recognised as property, plant and equipment or intangible assets in the financial statements according to the nature of the expenditure and the stage of development of the associated field, i.e. exploration, development, production.

Once commercial reserves are found, exploration and evaluation assets are tested for impairment and transferred to development tangible and intangible assets. No depreciation or amortisation is charged during the exploration and evaluation phase.

(a) Development tangible and intangible assets

Expenditure on the construction, installation or completion of infrastructure facilities such as platforms, pipelines and the drilling of development wells into commercially proven reserves, is capitalised within property, plant and equipment and intangible assets depending on the nature of the expenditure. When development is completed on a specific field, it is transferred to producing assets as part of property, plant and equipment or intangible assets. No depreciation or amortisation is charged during the development phase.

(b) Oil and gas production assets

Development and production assets are accumulated generally on a field by field basis and represent the cost of developing the commercial reserves discovered and bringing them into production together with E&E expenditures incurred in finding commercial reserves and transferred from the intangible E&E assets as described above.

The cost of development and production assets also includes the cost of acquisitions and purchases of such assets, directly attributable overheads, finance costs capitalised and the cost of recognising provisions for future restoration and decommissioning.

Where major and identifiable parts of the production assets have different useful lives, they are accounted for as separate items of property, plant and equipment. Costs of minor repairs and maintenance are expensed as incurred.

(c) Depreciation/amortisation

Oil and gas properties intangible assets are depreciated or amortised using the unit-of-production method. Unit-of-production rates are based on proved and probable reserves, which are oil, gas and other mineral reserves estimated to be recovered from existing facilities using current operating methods. Oil and gas volumes are considered produced once they have been measured through meters at custody transfer or sales transaction points at the outlet valve on the field storage tank.

(d) Impairment - exploration and evaluation assets

Exploration and evaluation assets are tested for impairment prior to reclassification to development tangible or intangible assets, or whenever facts and circumstances indicate that an impairment condition may exist. An impairment loss is recognised for the amount by which the exploration and evaluation assets' carrying amount exceeds their recoverable amount. The recoverable amount is the higher of the exploration and evaluation assets' fair value less costs to sell and their value in use. For the purposes of assessing impairment, the exploration and evaluation assets subject to testing are grouped with existing cash-generating units of production fields that are located in the same geographical region.

(e) Impairment - proved oil and gas production properties and intangible assets

Proven oil and gas properties and intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. An impairment loss is recognised for the amount by which the asset's carrying amount exceeds its recoverable amount. The recoverable amount is the higher of an asset's fair value less costs to sell and value in use. The cash generating unit applied for impairment test purposes is generally the field, except that a number of field interests may be grouped together where the cash flows of each field are interdependent, for instance where surface infrastructure is used by one or more field in order to process production for sale.

(e) Decommissioning

Provision is made for the cost of decommissioning assets at the time when the obligation to decommission arises. Such provision represents the estimated discounted liability (the discount rate used currently being at 10% per annum) for costs which are expected to be incurred in removing production facilities and site restoration at the end of the producing life of each field. A corresponding item of property, plant and equipment is also created at an amount equal to the provision. This is subsequently depreciated as part of the capital costs of the production facilities. Any change in the present value of the estimated expenditure attributable to changes in the estimates of the cash flow or the current estimate of the discount rate used are reflected as an adjustment to the provision and the property, plant and equipment. The unwinding of the discount is recognised as a finance cost.

1.3 Inventories

Crude oil inventories are stated at the lower of cost of production and net realisable value. Materials and supplies inventories are recorded at average cost and are carried at amounts which do not exceed the expected recoverable amount from use in the normal course of business. Cost comprises direct materials and, where applicable, direct labour plus attributable overheads based on a normal level of activity and other costs associated in bringing inventories to their present location and condition.

1.4 Trade and other receivables

Trade and other receivables are recorded initially at fair value and subsequently measured at amortised cost using the effective interest method, less provision for impairment. A provision for impairment of trade receivables is established when there is objective evidence that the Group will not be able to collect all amounts due according to the original terms of the receivables. The amount of the provision is the difference between the asset's carrying amount and the present value of estimated future cash flows, discounted at the original effective interest rate.

1.5 Trade payables

Trade payables are recognised initially at fair value and subsequently measured at amortised cost using the effective interest method.

1.6 Revenue recognition

Revenue comprises the fair value of the consideration received or receivable for the sale of oil and gas in the ordinary course of the Group's activities. Revenue is shown net of value added tax, returns, rebates and discounts and after eliminating sales within the Group.

Revenue from the sale of oil or gas is recognised when the oil/gas is delivered to customers and title has transferred. Revenue is stated net of value-added tax. For oil sales, this is at the physical point of delivery, i.e. the loading of a customer's truck. For gas sales, this is typically the point of entry to the gas distribution system. In 2009 and 2010 all of the Group's revenue related to oil sales collected directly by customers.

1.7 Provisions

Provisions for environmental restoration, restructuring costs and legal claims are recognised when: the group has a present legal or constructive obligation as a result of past events; it is probable that an outflow of resources will be required to settle the obligation; and the amount has been reliably estimated. Restructuring provisions comprise lease termination penalties and employee termination payments. Provisions are not recognised for future operating losses.

Where there are a number of similar obligations, the likelihood that an outflow will be required in settlement is determined by considering the class of obligations as a whole. A provision is recognised even if the likelihood of an outflow with respect to any one item included in the same class of obligations may be small.

Provisions are measured at the present value of the expenditures expected to be required to settle the obligation using a pre-tax rate that reflects current market assessments of the time value of money and the risks specific to the obligation. The increase in the provision due to passage of time is recognised as interest expense.

1.8 Business combinations

Business combinations are accounted for using the acquisition method. The cost of an acquisition is measured as the fair value of the assets acquired, equity instruments issued and liabilities incurred or assumed at the date of completion of the acquisition. Acquisition costs incurred are expensed and included in administrative expenses. Identifiable assets acquired and liabilities and contingent liabilities assumed in a business combination are measured initially at their fair values at the acquisition date. If there is excess of the cost of acquisition over the fair value of the acquired entity's share of the identifiable net assets acquired, then the excess is recorded as goodwill. If the cost of the acquisition is less than acquired entity's share of the net assets required, the difference is recognised directly in the statement of income.

2. Cost of sales, operating and administrative expenses

Cost of sales and administrative expenses are as follows:

Total operating and administrative expenses are analysed as follows:

(a) Exploration and evaluation

The principal component of the 2010 exploration and evaluation expense is the impairment charge on the carrying value of intangible assets relating to the Grafovskaya #1 well. This includes the cost of seismic studies as well as costs of drilling and testing operations on the well.

(b) Write-off of development assets

During 2011, certain items of processing equipment were relocated from the Vostochny-Makarovskoye field site to the Dobrinskoye gas plant site as part of the upgrade project for the gas plant. As a consequence of this activity, construction costs and other items of Property, plant & equipment of US$5.612 million were written off in 2011 (2010: nil).

3. Other gains and losses

4. Current and deferred income tax

5. Intangible assets

Intangible assets represent exploration and evaluation assets such as licenses, studies and exploratory drilling, which are stated at historical cost.

The impairment in 2010 relates to the write off of the Grafovskaya exploration well on the Karpenskiy licence and associated costs. It did not encounter commercial quantities of hydrocarbons and, as a result, the well and associated costs have been written off.

6. Property, plant and equipment

Movements in property, plant and equipment, for the years ended 31 December 2011 and 2010 are as follows:

7. Other non-current assets

Management believes that it may not be able to recover all VAT specific to license and e&e contractors' payments within the 12 months of the balance sheet date. Therefore this VAT is classified as a non-current asset.

8. Security deposit on acquisition of fixed assets (2010: US$19.7 million)

The security deposit on acquisition of fixed assets of US$19.7 million as at 31 December 2010 relates to an advance of RR 600 million that was paid by the Group to Trans Nafta in 2008. The payment was for the Group's share of costs associated with the construction of a Gas Processing Unit ("GPU") to be jointly owned by the Group and Trans Nafta and was recognised as a prepayment received by Gazneftedobycha ("GND"). Following the acquisition by the Group of GND in April 2011, the prepayment was converted into an intercompany debt between GNS and GND, which is eliminated on consolidation into the Group balance sheet. The prepayment has been recognised in the provisional fair value exercise as part of the consideration paid for the acquisition of GND. (See note 12 below.)

9. Inventories

 10. Other receivables

Prepayments to contractors relate to initial advances made in respect of drilling, construction and other projects.

11. Trade and other payables

The maturity period of the Group's financial liabilities, comprising only trade and other payables at 31 December 2011 and 2010 is as follows:

12. Business combination

Effective 1 April 2011, the Group obtained control of OOO Gazneftedobycha ("GND") by acquiring 100% of its equity share capital from Trans Nafta. GND owns the producing Dobrinskoye gas and condensate field and the related gas processing and transportation infrastructure.

The acquisition has been classified as a business combination and the Group's consolidated financial statements are now inclusive of GND. The accounting for the GND business combination was incomplete on the basis that the Group has not obtained fair values for all of the assets and liabilities acquired.

The recognised amounts provisionally determined for assets acquired and liabilities assumed are as follows:

There was no goodwill arising from the business combination based on the provisional accounting. As a part of the provisional accounting for the business combination the excess amount of the consideration paid over the provisional net fair value of the other assets and liabilities acquired has been attributed to the fair value of the Dobrinskoye production license, which is owned by GND.

The fair value of the consideration paid plus liabilities assumed in the acquisition of GND was:

There is no contingent consideration due upon the acquisition of GND.

The fair value of trade and other receivables is US$520,000 and includes trade receivables with a fair value of less than US$100.

The revenue included in the consolidated income statement from 1 April 2011 to 31 December 2011 contributed by GND was $9,262,000. GND also contributed profit of US$1,083,000 over the same period.

Had GND been consolidated from 1 January 2011, the consolidated income statement for the six months ended 30 June 2011 would show revenue of US$13,197,000 and profit of US$2,631,000.

Subsequent to the acquisition and between 28 April 2011 and 31 December 2011, GND made repayments to Trans Nafta totalling US$18,883,000, including US$3,146,000 of repayments by way of offset of gas sales made to Trans Nafta.

13 Post-Balance Sheet Events

On 26 March 2012, the group entered into a loan agreement with ZAO Raiffeisen Bank to provide up to US$10 million of debt by way of a 2 year amortising credit facility.