Half Yearly Report

RNS Number : 3910N

Petroneft Resources PLC

28 September 2012

 



PetroNeft Resources plc

("PetroNeft" or the "Company")

2012 Interim Results

PetroNeft Resources plc (AIM: PTR) owner and operator of Licences 61 and 67, Tomsk Oblast, Russian Federation, is pleased to report its results for the 6 months ended 30 June 2012.

Highlights: 

·      H1 production of 394,652 barrels of oil for the period - average of 2,168 bopd

·      Arbuzovskoye oil field brought into production from the discovery well

·      Successful completion of the first of ten planned Arbuzovskoye production wells

·      Lineynoye pad 2 studies to inform future field development strategies

·      New debt facility for US$15 million agreed with Arawak Energy

·      Current group production 2,300 bopd

Dennis Francis, Chief Executive Officer of PetroNeft Resources plc, commented:

"The first part of 2012 was challenging but we now better understand the Lineynoye Pad 2 performance and believe the studies will enable us to avoid such outcomes in the future.  The recent results from the Arbuzovskoye oil field have however been very encouraging and demonstrate that PetroNeft is now on the right track to progressively grow its production and cash flows. We look forward to completing the additional Arbuzovskoye wells over the coming months and the resulting increase in our production profile and cash flows."

For further information, contact:

Dennis Francis, CEO, PetroNeft Resources plc	[phone]
Paul Dowling, CFO, PetroNeft Resources plc	[phone]
John Frain/Brian Garrahy, Davy (NOMAD and Joint Broker)	[phone]
Henry Fitzgerald-O'Connor, Canaccord Genuity Limited (Joint Broker)	[phone]
Martin Jackson/Jack Rich, Citigate Dewe Rogerson	[phone]
Joe Murray/Ed Micheau, Murray Consultants	[phone]

PetroNeft Resources Plc

Unaudited interim condensed

 consolidated financial statements

For the 6 months ended 30 June 2012

Directors                                                                                             David Golder (U.S. citizen)

                                                                                                                  (Non-Executive Chairman)

                                                                                                             Dennis Francis (U.S. citizen)

                                                                                                                  (Chief Executive Officer)

                                                                                                             Paul Dowling

                                                                                                                  (Chief Financial Officer)

                                                                                                             David Sanders (U.S. citizen)

                                                                                                                  (Executive Director and General Legal Counsel)

                                                                                                             Gerry Fagan

                                                                                                                 (Non-Executive Director)

                                                                                                             Thomas Hickey

                                                                                                                  (Non-Executive Director)

                                                                                                             Vakha Sobraliev (Russian citizen)

                                                                                                                  (Non-Executive Director)

Registered Office and Business Address                                      20 Holles Street     

                                                                                                             Dublin 2

                                                                                                             Ireland

Secretary                                                                                            David Sanders

Auditors                                                                                              Ernst & Young

                                                                                                             Chartered Accountants

                                                                                                             Harcourt Centre

                                                                                                             Harcourt Street

                                                                                                             Dublin 2

                                                                                                             Ireland

Nominated and ESM Adviser                                                          Davy

                                                                                                             49 Dawson Street

                                                                                                             Dublin 2

                                                                                                             Ireland

Joint Brokers                                                                                            Davy                                                   Canaccord Genuity

                                                                                                                    49 Dawson Street                            88 Wood street

                                                                                                                    Dublin 2                                            London

                                                                                                                    Ireland                                               EC2V 7QR

                                                                                                                                                                                United Kingdom

Principal Bankers                                                                                     Macquarie Bank Limited                AIB Bank

                                                                                                                    Ropemaker Place                             1 Lower Baggot Street

                                                                                                                    28 Ropemaker Street                       Dublin 2

                                                                                                                    London                                               Ireland

                                                                                                                    EC2Y 9HD

                                                                                                                    United Kingdom

                                                                                                                    KBC Bank Ireland

                                                                                                                    Sandwith Street

                                                                                                                    Dublin 2

                                                                                                                    Ireland

Solicitors                                                                                                    Eversheds

                                                                                                                    One Earlsfort Centre

                                                                                                                    Earlsfort Terrace

                                                                                                                    Dublin 2

                                                                                                                    Ireland

                                                                                                                    White & Case

                                                                                                                    5 Old Broad Street           4 Romanov Pereulok

                                                                                                                    London                               125009

                                                                                                                    EC2N 1DW                         Moscow

                                                                                                                    United Kingdom               Russia

Registered Number                                                                                408101

Registrar                                                                                                    Computershare

                                                                                                                    Heron House

                                                                                                                    Corrig Road

                                                                                                                    Sandyford Industrial Estate

                                                                                                                    Dublin 18

                                                                                                                    Ireland

Dear Shareholder,

The first half of 2012 was a challenging period for PetroNeft. Despite showing early positive results the production achieved from the Pad 2 wells at Lineynoye was far below expectations. More recently, however, the Arbuzovskoye oil field is showing itself to be a very promising oil field with initial rates of over 300 bopd from each of the first two wells drilled on that oil field. Achieving production and cash flow growth from the Arbuzovskoye oil field is the focus of the Company in the near term. On the financing front we agreed a new US$15 million debt facility with Arawak Energy.

Production

Production in the six months to 30 June 2012 was 394,652 barrels of oil or an average of 2,168 bopd. While the production from Pad 2 at Lineynoye was disappointing the production from Pad 1 is encouraging and we have seen the benefit of pressure support from the water injection programme we commenced in mid-2011.

We also brought the Arbuzovskoye No.1 discovery well into production in the first half of 2012 and achieved rates of 350 bopd from it. More recently we have announced the results of the first of up to ten planned production wells at Arbuzovskoye, at an initial rate of 310 bopd.  Group production is currently 2,300 bopd.

Development drilling programme - Arbuzovskoye oil field

In the winter months of early 2012, we constructed a 10 km pipeline and utility line to link the Arbuzovskoye oil field to the central processing facility at Lineynoye. We also purchased the necessary materials including casing, diesel and other supplies necessary to drill ten production wells at Arbuzovskoye and transported these to the field using winter roads. In May 2012 we commenced production from the Arbuzovskoye No. 1 well through the pipeline at a rate of 350 bopd. It is currently producing 300 bopd. The necessary infrastructure is now complete, and materials for drilling purchased, so only the construction cost of about US$700,000 remains to be spent on each well.

In August 2012 we commenced drilling of new production wells at the Arbuzovskoye oil field and the first development well, No. 101, has delivered encouraging results. The core and log data indicate that the reservoir is substantially identical to the good quality reservoir in the Arbuzovskaya No. 1 discovery well. The reservoir is made up of coarse grained sandstone at the top and grades to fine grained sandstone to siltstone at the base - these types of sandstones are excellent reservoirs as demonstrated by the flow rates achieved at Arbuzovskaya No. 1. The second new well, No. 102, is drilling ahead at present and we expect to bring it into production by the end of October 2012.

Thereafter, wells are likely to be brought into production in batches of two or three rather than one by one as we need to revert to drilling at a five metre spacing at the surface between well heads due to space constraints at location. Once the last well of a batch is drilled we will bring all wells in the batch into production in quick succession. Our target initial rate for wells on this field is 150 bopd so we are encouraged to have exceeded this in our first two wells. Nevertheless, the 101 well is only the first of 10 planned wells and there may be some variation in flow rates as we look forward to the additional Arbuzovskoye wells coming into production and increasing cash flows.

Lineynoye oil field - Pad 2 studies

Since the results of Pad 2 became apparent in February 2012 we have been working hard to understand the reasons for this result and how to avoid such a result in future. Whilst all the studies are not yet complete we do now have a good understanding of the reasons for the poor results.

In first preparing the plan to develop the Lineynoye oil field we had used, amongst other information, the analysis of the core recovered from the Lineynoye No. 6 delineation well to assess the relative permeability of the reservoir and define parameters for how we expected oil and water to flow at different levels of oil saturation. This indicated that oil should dominate the liquid flow when oil saturations were in the 50% to 60% range.

The wells drilled at Pad 2 were generally lower structurally and closer to the oil-water-contact than the wells at Pad 1. Also at Pad 2 it appears that the reservoir properties were tighter and had lower oil saturations. The combination of relative permeability and fractional flow effects in the reservoir therefore led to much higher water cuts at Pad 2. Unfortunately these issues are not always obvious from the log analysis of individual wells.

Lineynoye oil field - Pad 2 studies; improvements made to future operations

In future we can seek to avoid the issues encountered at Pad 2 by drilling higher on the structures and avoiding potential oil and water transition zones. We will also take more cores in production wells and carry out more extensive transient pressure testing. At Arbuzovskoye we plan to core about three of the first ten wells drilled and will carry out transient pressure testing on each well at an early stage in its life. To date, wells on Arbuzovskoye have performed ahead of expectations.

Exploration

Licence 61

The successful exploration programme in 2011 led to discovery of two new oil fields at Licence 61 including the 50 mmbbl Sibkrayevskoye oil field. In the first half of 2012 we selected a location for a delineation well at Sibkrayevskoye, prepared the site and moved the drilling rig and the necessary supplies to the site. We now hope to drill this delineation well in 2013. We will also need to acquire additional seismic data at Sibkrayevskoye and this is currently planned for the winter of 2013/14.

Licence 67

In February 2012 we completed drilling of the Ledovaya No. 2a well and encountered oil at both the Lower Cretaceous and Upper Jurassic horizons. A modest flow test was achieved from the Upper Jurassic horizon but it was not possible to test the Lower Cretaceous interval for technical reasons. Further testing and analysis is required.

In February we also completed tests of the Cheremshanskoye No. 3 well where we identified three separate oil pools and achieved flow tests from all three. Cheremshanskoye is a large structure and will require further delineation and seismic to fully ascertain the size of the discovery.

We continue to study the results from Ledovoye and Cheremshanskoye and in the coming months we will agree the next steps for Licence 67 with our partner Arawak Energy.

Successful debt financing

In May 2012 PetroNeft agreed a new three year debt facility with Arawak Energy. The loan is secured on PetroNeft's 50% interest in Licence 67 and will be repayable in one lump sum at the end of the three-year loan period in May 2015. The interest payable under the loan will be LIBOR plus 6%, a competitive rate given present market conditions. Under the terms of the loan PetroNeft also granted Arawak 4,000,000 warrants over shares at a strike price of US$0.1345 per share.

Financial results for the period

The net loss after tax for the period was US$6,990,186 (6 months ended 30 June 2011 profit: US$3,067,178). The loss includes a foreign exchange loss of US$2,760,623 (6 months ended 30 June 2011 profit: US$5,969,474) on loans denominated in US Dollars and Russian Roubles from PetroNeft to its Russian subsidiaries Stimul-T and Granite Construction whose functional currency is the Russian Rouble. Net cash flows from operating activities in the period were US$4,685,880 (6 months ended 30 June 2011: US$ 3,432,954).

	Key Financial Metrics
				Unaudited				Audited
				6 months ended 30 June 2012		6 months ended 30 June 2011		Year ended 31 December 2011
				US$		US$		US$
	Revenue			17,646,024		15,974,980		29,031,693
	Cost of sales			(15,115,280)		(12,827,718)		(25,598,616)
	Gross profit			2,530,744		3,147,262		3,433,077
	Gross margin			14%		20%		12%
	Administrative expenses
	Overheads			(3,548,720)		(3,622,312)		(5,848,021)
	Share-based payment expense			(500,044)		(558,291)		(1,108,446)
	Other foreign exchange gain/(loss)			83,607		(22,951)		159,244
				(3,965,157)		(4,203,554)		(6,797,223)
	Foreign exchange on intra-Group loans			(2,760,623)		5,969,474		(5,114,345)
	Impairment of oil and gas properties			-		-		(5,000,000)
	Finance revenue			10,518		31,493		59,854
	Finance costs			(1,750,892)		(1,156,829)		(2,501,070)
	Income tax expense			(876,512)		(720,668)		(1,491,320)
	Loss for the period attributable to equity holders of the Parent			(6,990,186)		(3,067,178)		(17,913,356)
	Capital expenditure in the period			8,972,891		30,820,764		52,136,170
	Bank and cash balance at period end (including restricted cash)			5,715,486		3,736,309		6,030,005

Conclusion

The first half of 2012 was a busy period for the Company. While the Lineynoye production rate build up has been slower than desired we have learned key lessons from the work carried out to date and the outlook for growing our production this year and in future years is good.

The first delineation well at Arbuzovskoye (Well No. 101) displays excellent reservoir characteristics and has proved to be almost identical to the Arbuzovskoye No. 1 discovery well. These wells are now producing at around 300 bopd each, which is an excellent initial rate. We look forward to building on production and cash flow as we drill additional development wells at Arbuzovskoye.

David Golder

Non-Executive Chairman

28 September 2012

	Interim Consolidated Income Statement
	For the 6 months ended 30 June 2012
				Unaudited				Audited
				6 months ended 30 June 2012		6 months ended 30 June 2011		Year ended 31 December 2011
		Note		US$		US$		US$
	Continuing operations
	Revenue			17,646,024		15,974,980		29,031,693
	Cost of sales			(15,115,280)		(12,827,718)		(25,598,616)
	Gross profit			2,530,744		3,147,262		3,433,077
	Administrative expenses			(3,965,157)		(4,203,554)		(6,797,223)
	Impairment of oil and gas properties			-		-		(5,000,000)
	Exchange (loss)/profit on intra-group loans			(2,760,623)		5,969,474		(5,114,345)
	Operating (loss)/profit			(4,195,036)		4,913,182		(13,478,491)
	Profit on disposal of subsidiary undertaking			-		-		223,222
	Loss on disposal of oil and gas properties			-		-		(391,188)
	Share of joint venture's net loss			(178,264)		-		(334,363)
	Finance revenue			10,518		31,493		59,854
	Finance costs	5		(1,750,892)		(1,156,829)		(2,501,070)
	(Loss)/profit for the period for continuing operations before taxation			(6,113,674)		3,787,846		(16,422,036)
	Income tax expense	6		(876,512)		(720,668)		(1,491,320)
	(Loss)/profit for the period attributable to equity holders of the Parent			(6,990,186)		3,067,178		(17,913,356)
	(Loss)/profit per share attributable to ordinary equity holders of the Parent			(1.68)		0.74		(4.30)
	Basic and diluted - US dollar cent
	Interim Consolidated Statement of Comprehensive Income
	For the 6 months ended 30 June 2012
				Unaudited				Audited
				6 months ended 30 June 2012		6 months ended 30 June 2011		Year ended 31 December 2011
				US$		US$		US$
	(Loss)/profit for the period attributable to equity holders of the Parent			(6,990,186)		3,067,178		(17,913,356)
	Currency translation adjustments			(1,056,282)		3,130,795		(1,802,179)
	Total comprehensive (loss)/profit for the period attributable to equity holders of the Parent			(8,046,468)		6,197,973		(19,715,535)

	Interim Consolidated Statement of Financial Position
	as at 30 June 2012
				Unaudited				Audited
				30 June 2012		30 June 2011		31 December 2011
		Note		US$		US$		US$
	Assets
	Non-current Assets
	Oil and gas properties	7		93,862,706		91,334,153		92,697,976
	Property, plant and equipment	8		1,710,360		2,369,291		1,925,938
	Exploration and evaluation assets	9		25,962,359		28,494,908		24,552,717
	Equity-accounted investment in joint venture	10		3,573,728		-		3,851,880
				125,109,153		122,198,352		123,028,511
	Current Assets
	Inventories	11		1,612,014		1,679,254		1,856,813
	Trade and other receivables	12		1,512,656		5,072,771		2,810,459
	Cash and cash equivalents	13		1,715,486		1,236,309		1,030,005
	Restricted cash	13		4,000,000		2,500,000		5,000,000
				8,840,156		10,488,334		10,697,277
	Assets held for sale			-		3,433,968		-
				8,840,156		13,922,302		10,697,277
	Total Assets			133,949,309		136,120,654		133,725,788
	Equity and Liabilities
	Capital and Reserves
	Called up share capital			5,636,142		5,636,142		5,636,142
	Share premium account			122,431,629		122,431,629		122,431,629
	Share-based payment reserve			5,591,829		4,344,830		4,894,985
	Retained loss			(50,781,339)		(22,810,619)		(43,791,153)
	Currency translation reserve			(8,686,793)		(2,697,537)		(7,630,511)
	Other reserves			336,000		336,000		336,000
	Equity attributable to equity holders of the Parent			74,527,468		107,240,445		81,877,092
	Non-current Liabilities
	Provisions			1,655,442		965,278		1,147,988
	Interest-bearing loans and borrowings	15		14,474,828		14,630,284		-
	Deferred tax liability	6		3,961,350		2,352,250		3,157,557
				20,091,620		17,947,812		4,305,545
	Current Liabilities
	Trade and other payables	14		9,635,150		8,932,397		12,938,593
	Non-interest-bearing loans and borrowings			-		2,000,000		-
	Interest-bearing loans and borrowings	15		29,695,071		-		34,604,558
				39,330,221		10,932,397		47,543,151
	Total Liabilities			59,421,841		28,880,209		51,848,696
	Total Equity and Liabilities			133,949,309		136,120,654		133,725,788

	Interim Consolidated Statement of Changes in Equity
	For the 6 months ended 30 June 2012
		Share capital		Share premium		Share-based payment and other reserves		Currency translation reserve		Retained loss		Total
		US$		US$		US$		US$		US$		US$
	At 1 January 2011	5,624,840		122,082,388		3,977,064		(5,828,332)		(25,877,797)		99,978,163
	Loss for the year	-		-		-		-		(17,913,356)		(17,913,356)
	Currency translation adjustments	-		-		-		(1,802,179)		-		(1,802,179)
	Total comprehensive loss for the year	-		-		-		(1,802,179)		(17,913,356)		(19,715,535)
	Share options exercised in year	11,302		349,241		-		-		-		360,543
	Share-based payment expense	-		-		1,108,446		-		-		1,108,446
	Share-based payment expense - Macquarie warrants	-		-		145,475		-		-		145,475
	At 31 December 2011	5,636,142		122,431,629		5,230,985		(7,630,511)		(43,791,153)		81,877,092
	At 1 January 2012	5,636,142		122,431,629		5,230,985		(7,630,511)		(43,791,153)		81,877,092
	Loss for the period	-		-		-		-		(6,990,186)		(6,990,186)
	Currency translation adjustments	-		-		-		(1,056,282)		-		(1,056,282)
	Total comprehensive loss for the period	-		-		-		(1,056,282)		(6,990,186)		(8,046,468)
	Share-based payment expense	-		-		500,044		-		-		500,044
	Share-based payment expense - Arawak warrants	-		-		196,800		-		-		196,800
	At 30 June 2012	5,636,142		122,431,629		5,927,829		(8,686,793)		(50,781,339)		74,527,468

	Interim Consolidated Cash Flow Statement
	For the 6 months ended 30 June 2012
				Unaudited				Audited
				6 months ended 30 June 2012		6 months ended 30 June 2011		Year ended 31 December 2011
				US$		US$		US$
	Operating activities
	(Loss)/profit before taxation			(6,113,674)		3,787,846		(16,422,036)
	Adjustment to reconcile loss/(profit) before tax to net cash flows
	Non-cash
	Depreciation			1,933,985		1,597,085		4,293,949
	Impairment of oil and gas properties			-		-		5,000,000
	Loss on disposal of oil and gas properties			-		-		391,188
	Profit on disposal of subsidiary undertaking			-		-		(223,222)
	Share loss in joint venture			178,264		-		334,363
	Share-based payment expense			500,044		558,291		1,108,446
	Finance revenue			(10,518)		(31,493)		(59,854)
	Finance costs	5		1,750,892		1,156,829		2,501,070
	Working capital adjustments
	Decrease in trade and other receivables			1,204,750		966,019		3,372,948
	Decrease/(increase) in inventories			447,077		(606,526)		(646,118)
	Increase/(decrease) in trade and other payables			4,805,860		(3,995,097)		6,285,719
	Income tax paid			(10,800)		-		(68,029)
	Net cash flows from operating activities			4,685,880		3,432,954		5,868,424
	Investing activities
	Purchase of oil and gas properties			(11,748,966)		(18,390,893)		(32,967,288)
	Advance payments to contractors			(92,963)		(1,623,828)		(199,568)
	Purchase of property, plant and equipment			(6,219)		(755,057)		(570,396)
	Exploration and evaluation payments			(1,260,416)		(5,261,525)		(6,629,469)
	Investment in assets held for sale			-		(1,413,290)		-
	Investment in joint venture undertaking			-		-		(3,850,000)
	Decrease/(increase) in restricted cash			1,000,000		-		(2,500,000)
	Interest received			10,518		31,493		55,861
	Net cash used in investing activities			(12,098,046)		(27,413,100)		(46,660,860)
	Financing activities
	Proceeds from exercise of options			-		360,543		360,543
	Proceeds from loan facilities			15,000,000		17,000,000		37,000,000
	Transaction costs on loans and borrowings			(337,754)		(271,743)		(472,696)
	Repayment of loan facilities			(5,000,000)		(14,212,000)		(16,212,000)
	Interest paid			(1,575,270)		(593,605)		(1,729,447)
	Net cash received from financing activities			8,086,976		2,283,195		18,946,400
	Net increase/(decrease) in cash and cash equivalents			674,810		(21,696,951)		(21,846,036)
	Translation adjustment			10,671		151,379		94,160
	Cash and cash equivalents at the beginning of the period			1,030,005		22,781,881		22,781,881
	Cash and cash equivalents at the end of the period	13		1,715,486		1,236,309		1,030,005

1.         Corporate information

The interim condensed consolidated financial statements of the Group for the six months ended 30 June 2012 were authorised for issue in accordance with a resolution of the Directors on 27 September 2012.

PetroNeft Resources plc ('the Company', or together with its subsidiaries, 'the Group') is a Company incorporated in Ireland. The Company is listed on the Alternative Investment Market ('AIM') of the London Stock Exchange and the Enterprise Securities Market ('ESM') of the Irish Stock Exchange. The address of the registered office and the business address in Ireland is 20 Holles Street, Dublin 2. The Company is domiciled in the Republic of Ireland.

The principal activities of the Group are oil and gas exploration, development and production. 

2.          Going concern

As noted in the 2011 Annual Report the Lineynoye Pad 2 results meant that certain production and cash flow covenants that were part of the Macquarie facility were not met during, at and post the year-end. While Macquarie waived these covenants at the year-end, it meant that it was not possible to increase the amount available under the borrowing base loan facility. Macquarie supported and agreed to the Arawak additional loan facility and did not seek repayment of their base loan facility as Macquarie prefer to see Arbuzovskoye coming into production as it offers the best option for increasing Group production and cash flows.

Although Macquarie remains a supportive lender and key shareholder, they have indicated, absent any alternative funding option, their preference that the debt be reduced by about US$7.5 million by mid 2013. However they did not seek a repayment out of the proceeds of the Arawak loan facility and remain supportive of the Group's plans to bring the Arbuzovskoye oil field into production this year particularly in light of the recent rates achieved from the Arbuzovskoye No. 1 well. The Board has a plan to bring the Arbuzovskoye oil field into production in the coming months thereby increasing the Group's long-term cash flows. The recent success of the Arbuzovskoye 101 well was a first step in this regard.

The Board remain positive about the resilience of the Group despite the pressures outlined above. The Group has analysed its cash flow requirements through to 31 December 2013 in detail. The cash flow includes estimates for a number of key variables including timing of cash flows of development expenditure, oil price, production rates, and with the ongoing support of its lenders and management of working capital the Directors believe that the Group's cash flow forecasts represent the Group's best estimate of the actual results over the forecast period at the date of approval of the financial statements. The cash flow is stress tested to assess the adverse effect arising from reasonable changes in circumstance. It is recognised that the cash flow impact of these changes could result in additional funding being required. The Group is also in discussions with a range of strategic investors about possible farm-outs, long term off-take agreements and potential equity or asset investments which would strengthen the Group's financial position. 

These circumstances represent a material uncertainty that may cast significant doubt upon the Group and the Company's ability to continue as a going concern. Nevertheless, after making enquiries, and considering the uncertainties described above, the Directors are confident that the Group and the Company will have adequate resources to continue in operational existence for the foreseeable future. For these reasons, the Directors continue to adopt the going concern basis in preparing these interim condensed consolidated financial statements.

Accordingly, these interim condensed financial statements do not include any adjustments to the carrying amount or classification of assets and liabilities that would result if the Group or Company was unable to continue as a going concern.

3.          Accounting policies

3.1       Basis of Preparation

The interim condensed consolidated financial statements for the six months ended 30 June 2012 have been prepared in accordance with IAS 34 Interim Financial Reporting.

The interim condensed consolidated financial statements do not include all the information and disclosures required in the annual financial statements, and should be read in conjunction with the Group's annual financial statements as at 31 December 2011 which are available on the Group's website - www.petroneft.com.

The interim condensed consolidated financial statements are presented in US dollars ("US$").

3.2       Significant Accounting Policies

The accounting policies adopted in the preparation of the interim condensed consolidated financial statements are consistent with those followed in the preparation of the Group's annual financial statements for the year ended 31 December 2011.

4.          Segment information

At present the Group has one reportable operating segment, which is oil exploration and production. As a result, there are no further disclosures required in respect of the Group's reporting segment.

The risk and returns of the Group's operations are primarily determined by the nature of the activities that the Group engages in, rather than the geographical location of these operations.  This is reflected by the Group's organisational structure and the Group's internal financial reporting systems.

Management monitors and evaluates the operating results for the purpose of making decisions consistently with operating profit or loss in the consolidated financial statements.

Geographical segments

All of the Group's sales are in Russia. Substantially all of the Group's capital expenditures are in Russia.

	Non-current assets
	Assets are allocated based on where the assets are located:
				Unaudited				Audited
				30 June 2012		30 June 2011		31 December 2011
				US$		US$		US$
	Russia			125,101,637		122,186,983		123,019,068
	Ireland			7,516		11,369		9,443
				125,109,153		122,198,352		123,028,511

5.	Finance costs
				Unaudited				Audited
				6 months ended 30 June 2012		6 months ended 30 June 2011		Year ended 31 December 2011
				US$		US$		US$
	Interest on loans			1,673,265		1,122,505		2,438,971
	Unwinding of discount on decommissioning provision			77,627		64,846		62,099
	Discount on deposit paid for pipeline usage (see below)			-		(30,522)		-
				1,750,892		1,156,829		2,501,070

During 2010 the Group paid a deposit of US$400,000 to Nord Imperial for the usage of their pipeline. This deposit will be returned at the end of the contract which is in 2033. In the interim consolidated financial statements this deposit has been discounted and the unwinding of a discount of US$5,975 has been taken to finance revenue in the current period (6 months 2011: reversal of discount of US$30,552 was taken to finance costs).

6.		Income tax
								Unaudited									Audited
								6 months ended 30 June 2012				6 months ended 30 June 2011					Year ended 31 December 2011
								US$				US$					US$
			Current income tax
			Current income tax charge					61,920				4,889					7,756
			Income tax on dividends (paid in Russia)					10,797				-					-
			Adjustment in respect of prior periods					-				-					(37,518)
			Total current income tax					72,717				4,889					(29,762)
			Deferred tax
			Relating to origination and reversal of temporary differences					803,795				715,779					1,521,082
			Total deferred tax					803,795				715,779					1,521,082
			Income tax expense reported in the Consolidated Income Statement					876,512				720,668					1,491,320

7.	Oil and gas properties
	Group
		Wells		Equipment and facilities		Pipeline		Total
		US$		US$		US$		US$
	Cost
	At 1 January 2011	35,213,042		13,553,500		14,174,036		62,940,578
	Transfer from exploration and evaluation assets	2,803,399		111,368		-		2,914,767
	Additions	30,033,170		13,846,905		51,406		43,931,481
	Disposals	(19,843)		(127,661)		(249,045)		(396,549)
	Translation adjustment	(4,418,308)		(1,826,123)		(660,975)		(6,905,406)
	At 1 January 2012	63,611,460		25,557,989		13,315,422		102,484,871
	Additions	4,547,196		1,579,783		492,235		6,619,214
	Disposals	(19,525)		-		-		(19,525)
	Translation adjustment	(2,302,677)		(911,057)		(450,886)		(3,664,620)
	At 30 June 2012	65,836,454		26,226,715		13,356,771		105,419,940
	Depreciation
	At 1 January 2011	550,067		216,050		30,660		796,777
	Charge for the year	3,476,558		816,099		96,576		4,389,233
	Impairment	5,000,000		-		-		5,000,000
	Depreciation on disposals	(500)		(4,126)		(735)		(5,361)
	Translation adjustment	(314,243)		(69,603)		(9,908)		(393,754)
	At 1 January 2012	8,711,882		958,420		116,593		9,786,895
	Charge for the period	1,601,331		424,925		47,985		2,074,241
	Translation adjustment	(234,153)		(62,201)		(7,548)		(303,902)
	At 30 June 2012	10,079,060		1,321,144		157,030		11,557,234
	Net book values
	At 30 June 2012	55,757,394		24,905,571		13,199,741		93,862,706
	At 31 December 2011	54,899,578		24,599,569		13,198,829		92,697,976

The net book value at 30 June 2012 includes US$27,190,270 (30 June 2011: US$37,512,574) in respect of assets which are not yet being depreciated.

Additions are construction works mainly in relation to oilfield infrastructure and acquisition of construction materials for drilling of wells in Arbuzovskoye oilfield.

8.	Property, Plant and Equipment
	Group	Land and		Plant and		Motor
		buildings		machinery		vehicles		Total
		US$		US$		US$		US$
	Cost
	At 1 January 2011	1,099,715		1,119,864		123,597		2,343,176
	Additions	-		745,073		-		745,073
	Translation adjustment	(52,992)		(116,255)		(5,927)		(175,174)
	At 1 January 2012	1,046,723		1,748,682		117,670		2,913,075
	Additions	-		6,218		-		6,218
	Translation adjustment	(33,686)		(54,535)		(3,686)		(91,907)
	At 30 June 2012	1,013,037		1,700,365		113,984		2,827,386
	Depreciation
	At 1 January 2011	89,472		547,893		31,595		668,960
	Charge for the year	66,787		288,205		27,149		382,141
	Translation adjustment	(10,008)		(50,117)		(3,839)		(63,964)
	At 1 January 2012	146,251		785,981		54,905		987,137
	Charge for the period	32,092		129,469		13,046		174,607
	Translation adjustment	(7,816)		(34,160)		(2,742)		(44,718)
	At 30 June 2012	170,527		881,290		65,209		1,117,026
	Net book values
	At 30 June 2012	842,510		819,075		48,775		1,710,360
	At 31 December 2011	900,472		962,701		62,765		1,925,938

9.	Exploration and evaluation assets
						Exploration & Evaluation Expenditure
						US$
	Cost
	At 1 January 2011					21,391,491
	Additions					7,459,616
	Reclassification to oil and gas properties					(2,914,767)
	Translation adjustment					(1,383,623)
	At 1 January 2012					24,552,717
	Additions					2,347,459
	Translation adjustment					(937,817)
	At 30 June 2012					25,962,359
	Net book values
	At 30 June 2012					25,962,359
	At 31 December 2011					24,552,717

Exploration and evaluation expenditure represents active exploration projects. These amounts will be written off to the Consolidated Income Statement as exploration costs unless commercial reserves are established, or the determination process is not completed and there are no indications of impairment. The outcome of on-going exploration, and therefore whether the carrying value of these assets will ultimately be recovered, is inherently uncertain.

In accordance with IFRS 6, once commercial viability is demonstrated, the capitalised exploration and evaluation costs are transferred to oil and gas properties or intangibles, as appropriate after being assessed for impairment.

Additions in the six months ended 30 June 2012 relate mainly to exploration wells in Sibkraevskaya and North Varyakhskaya prospects, Kondrashevskoye oilfield.

10.

Equity-accounted investment in joint venture

PetroNeft Resources plc has a 50% interest in Russian BD Holdings B.V., a jointly controlled entity which holds 100% of LLC Lineynoye, an entity involved in oil and gas exploration and the registered holder of Licence 67. The interest in this joint venture is accounted for using the equity accounting method. Russian BD Holdings B.V. is incorporated in the Netherlands and carries out its activities in Russia.

	Equity-accounted investment in joint venture
				Share of net assets
				US$
	At 1 January 2011			-
	Subsidiary undertaking becoming joint venture			445,748
	Investment			3,850,000
	Retained loss			(334,363)
	Translation adjustment			(109,505)
	At 1 January 2012			3,851,880
	Loss for the period			(178,264)
	Translation adjustment			(99,888)
	At 30 June 2012			3,573,728

10.

Equity-accounted investment in joint venture (continued)

Summarised financial statement information prepared in accordance with IFRS of the equity-accounted joint venture entity is disclosed below:

Summarised Interim Financial statements of equity-accounted joint venture (50% share)
				Unaudited				Audited
				6 months ended 30 June 2012		6 months ended 30 June 2011		Year ended 31 December 2011
				US$		US$		US$
	Sales and other operating revenues			-		-		-
	Operating expenses			(105,815)		-		(176,278)
	Exchange loss			(63,427)		-		(149,640)
	Finance revenue			1,380		-		1,408
	Finance costs			(8,338)		-		(9,496)
	Loss before taxation			(176,200)		-		(334,006)
	Taxation			(2,064)		-		(357)
	Loss for the period			(178,264)		-		(334,363)
				Unaudited				Audited
				30 June 2012		30 June 2011		31 December 2011
				US$		US$		US$
	Current assets			189,733		-		3,906,526
	Non-current assets			4,243,349		-		532,830
	Total assets			4,433,082		-		4,439,356
	Current liabilities			(33,450)		-		(581,340)
	Non-current liabilities			(825,904)		-		(6,136)
	Total liabilities			(859,354)		-		(587,476)

11.	Inventories
				Unaudited				Audited
				30 June 2012		30 June 2011		31 December 2011
				US$		US$		US$
	Oil stock			1,417,696		1,350,367		1,619,333
	Materials			194,318		328,887		237,480
				1,612,014		1,679,254		1,856,813

12.	Trade and other receivables
				Unaudited				Audited
				30 June 2012		30 June 2011		31 December 2011
				US$		US$		US$
	Russian VAT			335,395		2,485,260		1,802,450
	Other receivables			359,750		511,887		77,860
	Receivable from jointly controlled entity (Note 16)			647,868		-		520,921
	Advances to and receivables from related parties (Note 16)			50,702		1,415,173		47,397
	Advances to contractors			42,261		411,404		152,171
	Prepayments			76,680		249,047		209,660
				1,512,656		5,072,771		2,810,459

13.	Cash and Cash Equivalents and Restricted Cash
				Unaudited				Audited
				30 June 2012		30 June 2011		31 December 2011
				US$		US$		US$
	Cash at bank and in hand			1,715,486		1,236,309		1,030,005
	Restricted cash			4,000,000		2,500,000		5,000,000
				5,715,486		3,736,309		6,030,005

At 30 June 2012 restricted cash amounting to US$4 million (30 June 2011: US$2.5 million) was held in a Macquarie Debt Service Reserve Account ("DSRA"). This account is part of the security package held by Macquarie and may be offset against the loan in the event of a default on the loan or by agreement between the parties.

14.		Trade and other payables
									Unaudited								Audited
									30 June 2012				30 June 2011				31 December 2011
									US$				US$				US$
			Trade payables						3,063,278				3,826,711				7,383,976
			Trade payables to jointly controlled entity (Note 16)						16,768				-				-
			Trade payables to related parties (Note 16)						3,113,786				3,962,422				4,548,673
			Corporation tax						69,746				99,682				7,827
			Other taxes and social welfare costs						2,318,789				60,378				117,177
			Other payables						187,785				177,404				160,237
			Accruals						864,998				805,800				720,703
									9,635,150				8,932,397				12,938,593

15.	Loans and borrowings
						Unaudited				Audited
				Effective interest rate	Maturity	30 June 2012		30 June 2011		31 December 2011
				%		US$		US$		US$
	Interest bearing < 1 year
	Macquarie Bank - US$30,000,000 loan facility			9.53%	31-May-14	29,695,071		14,630,284		29,628,011
	Arawak - US$5,000,000 loan			6.68%	30-Jun-12	-		-		4,976,547
	Interest bearing > 1 year
	Arawak - US$15,000,000 loan			6.75%	31-May-15	14,474,828
	Non- interest bearing < 1 year
	Arawak - US$2,000,000 loan			0.00%	31-Dec-11	-		2,000,000		-
						44,366,699		16,630,284		34,604,558
	Contractual undiscounted liability					45,000,000		17,000,000		35,000,000

15.	Loans and borrowings (continued)

Macquarie loan facility

On 28 May 2010 the Group agreed a loan facility agreement for up to US$30 million with Macquarie to re-finance an existing facility of US$5 million. In April 2011, PetroNeft signed a revised borrowing base loan facility agreement with Macquarie for up to US$75 million. The initial borrowing base was set at US$30 million and remains at this level.

Under the various loan agreements Macquarie was granted 6.7 million warrants at various strike prices and with various expiry dates. There was also a 1% cash arrangement fee associated with the new loan facility in 2011.

Total transaction costs, including share-based payment expense connected with the warrants granted, incurred in 6 months 2012 amounted to US$Nil (2011: US$0.6 million) and are applied against the proceeds. The effective interest rate will be applied to the liability to accrete the transaction costs over the period of the loan.

No borrowing costs were capitalised in the 6 months ended 30 June 2012 and 2011.

Certain oil and gas properties (wells, central processing facility, pipeline) together with shares in WorldAce Investments Ltd, shares in Stimul-T, certain bank accounts and inventories are pledged as a security for the Macquarie loan facility agreement.

During the period the Group was in breach of certain financial and non-financial covenants and conditions subject to the loan agreement, relating primarily to receipt of certain amount of cash by sale of oil, certain financial ratios and registration of pledge over certain assets of the Group in favour of Macquarie and submitting the documents.  These conditions were waived by Macquarie in a letter prior to the period-end, such that the Group was not in breach as at the year-end.  However as the waiver did not extend to more than 12 months after the year-end, all of the Macquarie debt is classified as repayable within one year.

Arawak Energy Russia B.V. loan facility

The US$5 million loan from Arawak Energy Russia B.V. was a general purpose short-term bridge loan in advance of a larger three year-term loan completed in May 2012. It was repaid in June 2012 out of the proceeds of the new three-year loan. The initial short term bridge loan was unsecured but the new three year term loan signed in May 2012 is secured on PetroNeft's 50% interest in Russian BD Holdings B.V.

On 30 May 2012, PetroNeft signed a three-year loan agreement with Arawak for $15 million. The loan is secured on PetroNeft's 50% interest in Licence 67 and will be repayable in one lump sum at the end of the three-year loan period in May 2015. The interest payable under the loan will be LIBOR plus 6%, a competitive rate given present market conditions. Under the terms of the loan PetroNeft also granted Arawak 4,000,000 warrants over shares at a strike price of US$0.1345 per share.

Total transaction costs relating to the US$15 million loan and incurred in the 6 months ended 30 June 2012 amounted to US$337,754 (6 months 2011: US$Nil) and are applied against the proceeds. The effective interest rate will be applied to the liability to accrete the transaction costs over the period of the loan.

The existing US$30m facility with Macquarie Bank Limited remains in place and Macquarie has granted permission under the terms of their facility for this additional debt facility with Arawak.

16.     Related party disclosures

Transactions between PetroNeft Resources plc and its subsidiaries, Stimul-T, Granite, Pervomayka, Dolomite, World Ace Investments have been eliminated on consolidation. Details of transactions between the Group and other related parties are disclosed below.

In 2010 Stimul-T entered into several contracts with TBNG for the drilling of wells at the Lineynoye oilfield, Arbuzovskaya prospect and Kondrashevskoye oilfield. Under these contracts TBNG assumes substantially all liabilities in relation to the health and safety, environmental and other risks associated with drilling operation. The total value of these contracts is US$31.2 million. Payments of US$3,859,858 were made during 6 months 2012 (FY 2011: US$17,691,713) in relation to these contracts. As at 30 June 2012 the outstanding amount payable to TBNG is US$1,582,783 (FY 2011: US$4,363,261).

In 2011 Stimul-T entered into a contract with TBNG for the drilling of well #1 at the North Varyakhskoye prospect. This is a "turnkey" contract. Under this contract TBNG assumes substantially all liabilities in relation to the health and safety, environmental and other risks associated with drilling operation. The total value of the contract is US$2.5 million. Payments of US$Nil were made during 6 months 2012 (FY 2011: US$2,038,585) in relation to this contract. As at 30 June 2012 the outstanding amount payable to TBNG is US$543,443 (YE 2011: US$Nil).

In 2011 Stimul-T entered into a contract with TBNG for the drilling of production wells at pad #1 at the Arbuzovskoye oilfield. Under this contract TBNG assumes substantially all liabilities in relation to the health and safety, environmental and other risks associated with drilling operation. The total value of the contract is US$15.7 million. Payments of US$Nil were made during 6 months 2012 (FY 2011: US$Nil) in relation to this contract. As at 30 June 2012 the outstanding amount payable to TBNG is US$473,364 (YE 2011: US$Nil).

In 2012 Stimul-T entered into a contract with TBNG for the installation of drilling equipment on well #9 at the Lineynoye oilfield. Under this contract TBNG assumes substantially all liabilities in relation to the health and safety, environmental and other risks associated with drilling operation. The total value of the contract is US$0.5 million. Payments of US$Nil were made during 6 months 2012 (FY 2011: US$Nil) in relation to this contract. As at 30 June 2012 the outstanding amount payable to TBNG is US$412,914 (YE 2011: US$Nil).

An amount of US$Nil (FY 2011: US$73,883) was received from TBNG during 6 months 2012 in relation to shared use of helicopter services, where the service provider billed the entire amount to Stimul-T, and for the sale of materials and other minor transactions with TBNG. A balance of US$49,376 (YE 2011: US$44,805) is outstanding from TBNG at 30 June 2012.

16.     Related party disclosures (continued)

A total of US$75,626 (YE 2011: US$185,412) is outstanding to other parties, related to Vakha Sobraliev, a Director of PetroNeft, for repair works on wells, maintenance works in the oilfield and transportation services. An amount of US$1,326 (YE 2011: US$2,592) is shown as advance payments. Payments of US$282,137 (FY 2011: US$1,292,074) were made to these entities during 6 months 2012.

The Group provided various goods and services to the jointly controlled entity, Russian BD Holdings B.V. its wholly-owned subsidiary LLC Lineynoye, venture during 6 months 2012 amounting to US$250,067 (FY 2011: US$2,165,377), received goods and services during 6 months 2012 amounting to US$16,768 (FY 2011: US$Nil) and provided a loan to RBD in the amount of US$600,000 (FY 2011: US$Nil). The amount of US$647,868 (YE 2011: US$520,921) is outstanding from these entities and the amount of US$16,768 (YE 2011: US$Nil) is payable to these entities at 30 June 2012.

The Group has an indirect 50% interest in Lineynoye which in turn is 100% owned by the jointly controlled entity Russian BD Holdings B.V.

In 2011 Lineynoye entered into a contract with TBNG for the drilling of well No. 3 of the Cheremshanskaya prospect and well No. 2a of the Ledovoye oilfield. This is a "turnkey" contract. Under this contract TBNG assumes substantially all liabilities in relation to the health and safety, environmental and other risks associated with drilling operation. The total value of the contract is US$5.4 million. Payments of US$1,396,631 were made during 6 months 2012 (FY 2011: US$3,461,009) in relation to this contract. As at 30 June 2012 the outstanding amount payable to TBNG is US$Nil (2010: US$549,178).

A total of US$9,104 (YE 2011: US$Nil) is outstanding to TBNG and other parties, related to Vakha Sobraliev, a Director of PetroNeft, for transportation services and other minor works. Payments of US$Nil (FY 2011: US$Nil) were made to these entities during 6 months 2012.

 

END

 

 

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