Operational Review

RNS Number : 0848U

Cadogan Petroleum PLC

18 June 2009

Cadogan Petroleum plc

('Cadogan' or the 'Company')

Outcome of strategic and operational review

Directorate change

Potential accounting restatement

As previously announced, following Ian Baron's appointment as Interim Chief Executive on 19 March 2009, the Board of Cadogan Petroleum plc (the Company) requested that he undertake a review of the Company's strategy and operations (the 'Review'). Although the Review remains ongoing the Board is able to report its preliminary findings.

Summary of the outcome of the Review

The Review confirmed that the Company has been unsuccessful to date in capitalising on the potential of its asset base in the Pokrovska (Pok), Pirkovskaya (Pirk) and Zagoranska (Zag) licence areas in eastern Ukraine and the Bitlayanska (Bit) licence area in western Ukraine. Despite significant resource commitment, well tests in eastern Ukraine have not been encouraging to date, with test flow rates lower than anticipated in all three fields and high decline in test flow rates on Pirk and Zag. It is not clear whether these results are due to fundamental reservoir characteristics or to the inability of the local rigs to drill wells to the standard required or to other operational difficulties causing the tests to be misleading. Nevertheless the results to date leave a significant question as to the potential of the fields in eastern Ukraine.

Over the last three months a number of actions have been taken to reduce expenditures while the Review has been underway. These initiatives include reducing the number of active drilling units from 5 to 1 and reducing headcount by 27 per cent. Drilling has continued only on the Borynya 3 well, which has encountered positive gas indications through limited duration drill stem tests.

The Review reached the following key conclusions:

The Company needs to identify the primary reasons for the poor test results on the wells in eastern Ukraine. This requires further data analysis to better understand the reservoir characteristics of the major fields as well as changes to technical and operational practices and organisational structures;
In view of the Company's current resources, the previous strategy of concurrently drilling a large number of wells and the resultant significant expenditures on its licences is not sustainable;
The minor fields and assets remain of limited strategic and economic benefit to the long-term future of the business; and
Further actions should be implemented immediately to reduce ongoing expenditures and strengthen the cash position of the Company. As of 17 June 2009, the Company has net cash balances of £47.5 million, primarily held in the UK.

Company's proposed actions

Having considered the Review, the Board has concluded that the Company should continue its programme to rationalise its asset portfolio, further reduce expenditures and commitments and strengthen its cash position.

As part of this, the Company intends to:

(i) dispose of or relinquish the minor fields and assets;

(ii) pursue all avenues to realise cash from non-essential assets such as surplus inventory and the gas treatment plants; and

(iii) make further significant headcount reductions to match the reduced operational activity levels.

Drilling activities on Pirk, Pok and Zag will remain suspended and work on the minor fields will be limited to production operations and technical updates, as appropriate, to enable the marketing of these assets for disposal.

The Board also considers that there are a number of operational measures which have the potential to enhance the value of the Company's assets and which it intends to discuss with shareholders. A detailed analysis of the cost and timing implications of each of these is currently being undertaken.

Further data evaluation on the major licence areas of Pirk, Pok, Zag and Bit. This would include additional seismic, re-processing and interpretation work as appropriate and the re-evaluation of the well test results in a more consistent manner in order to aid the understanding of the issues leading to the poor test results and inhibiting the production of gas from Pirk, Pok and Zag. Further seismic acquisition is under consideration to enable better definition of the prospectivity of the Bit licence;
Commissioning a new third party reserves report to incorporate all the well data and related information gathered recently;
Ongoing drilling on Borynya 3 which is currently at a depth of 4,514 meters where it will be logged before running casing. Having encountered good gas shows over this section of hole, the well may then be tested if the logs have good hydrocarbon indications. The proposed target depth of the well is 5,200 metres;
Subject to the results of the data evaluation and completion of the above work plan, pursuit of farm out or similar arrangements for each of its retained assets to reduce the Company's upfront commitments whilst retaining significant upside for existing shareholders; and
Continued engagement with the relevant Ukrainian authorities to ensure its work obligations on the various licence interests are aligned to the above proposed actions.

The Board reiterates that it remains open to all potential courses of action for maximising value for shareholders. The Board notes that in order to pursue certain options, including a managed exit and return of capital to shareholders, significant corporate/legal/tax restructuring would be necessary and confirms that it intends to commence the preparatory work for such restructuring.

The Board intends to consult with shareholders concerning the various courses of action open to the Company and, depending on the outcome of the shareholder consultation process, to hold an Extraordinary General Meeting to enable shareholders to vote on the strategy to be adopted.

Update on legal proceedings

As previously reported, during 2008 the Group was faced with indirect legal challenges to its Zag and Pirk licences. Following various court hearings, the Company lodged an appeal to the Supreme Court of Ukraine on the Pirk licence and an initial hearing took place on 2 June 2009. The case was adjourned at that point and there was a further hearing on 16 June 2009. The Company is awaiting written confirmation as to the result of this hearing and will make a further announcement when that is available. The Company has obtained new and independent advice from a leading Ukrainian law firm that has not previously been involved in the case. Based on that advice, it remains confident that the challenges are entirely without merit.

Potential accounting restatement

During the Board's investigation into matters surrounding irregular payments, it has been identified that certain payments are likely to have been inaccurately characterised in the Company's consolidated financial statements for the years ending 31 December 2006, 2007 and 2008. These payments, totalling $9.7 million, were classified as capital expenditure rather than operating expenditure. Further investigation into this matter is underway. If the financial statements are to be restated the Board expects to propose the adjournment of the Annual General Meeting convened for 30 June 2009 until restated financial statements can be put forward.

Directorate change

Alex Sawka has notified the Board of his resignation from the Board with immediate effect. He will however remain engaged by the Company to assist with the ongoing investigations and to arrange a hand-over of his duties. In view of this, Resolution number 5 in the notice of Annual General Meeting dated 29 May 2009 is hereby withdrawn.