REG-Cadogan Petroleum: Annual Financial Report <Origin Href="QuoteRef">CADP.L</Origin> - Part 1
28/04/2017 08:35
CADOGAN PETROLEUM PLC
ANNUAL FINANCIAL REPORT
2016
OVERVIEW
Summary of 2016
Key highlights of 2016:
* LTI&TRI(1): 1&1 (2015: 0&0)
* Greenhouse gases emissions(2): 27.44 of CO(2)e/boe produced (2015: 30.47
CO(2)e/boe)
* Production: 42,495 boe (2015: 39,680 boe)
* Realised price at year end: 46.5 $/boe (2015: 35.7$/boe)
* Gross revenues(3): $19.7 million (2015: $75.4 million)
* Gross profit: $1.1 million (2015: $5.9 million)
* Loss for the year(4): $5.9 million (2015: $23.3 million)
* Net cash(5) at year end: $39.7 million (2015: $36.5 million)
(1)LTI: Lost Time Incidents; TRI: Total Recordable Incidents
(2) E&P operations emissions. For total greenhouse gases emissions please see
page 26
(3) Gross revenues of $19.7 million (2015: $75.4 million) included $15.6
million (2015: $73.3 million) from trading of natural gas, $1.6 million (2015:
$1.8 million) from exploration and production and $2.5 million (2015: $0.4
million) from services
(4) In 2016 the Company decided to replace the British pound with the US
dollar as functional currency. Had the functional currency been changed from 1
January 2015, the loss for 2015 would have been $25.7 million
(5) Net cash includes cash and cash equivalents less short term borrowings
Group Overview
The Group has continued to maintain exploration and production assets in
Ukraine, to conduct trading operations, which include the importing of gas
from Slovakia and Poland and local purchasing and sales with physical delivery
of natural gas, and to operate a service business which includes work-over,
civil works services and other services provided to Exploration and Production
(“E&P”) companies.
Our business model
We aim to increase value through:
* Sourcing additional E&P assets to diversify Cadogan’s portfolio both
geographically and operationally; we will pursue exploration and/or near term
development assets with significant upside as well as producing assets to
cover G&A and provide free cash flow for exploration activities
* Pursuing farm-outs to contain investments in Ukrainian licences
* Maintaining sufficient capital base, complementing E&P cash flow with
revenues from gas trading and oil services businesses
The Group has continued to actively pursue its strategy of portfolio
re-loading and geographical diversification and at the beginning of 2017 has
implemented the first step of this strategy, the acquisition of a 90%
participating interest in Exploenergy s.r.l., an Italian company.
Both gas trading and service business started as an opportunistic use of
available resources, such as cash for trading and equipment and competences
for the service business, and continued to contribute to the Group’s goal of
being cash neutral, while actively searching for value accretive opportunities
in the E&P domain.
Ukraine
West Ukraine
The Group continued to produce oil from the Monastyretska licence, located in
the Carpathian fold belt (Skuba unit), and successfully re-entered two old,
suspended wells rented from Ukrnafta under a profit sharing agreement. Both
wells are currently producing under natural flow and are being monitored
before proceeding with the installation of sucker road pumps, which will
increase their rates of production.
The Group also continued to produce gas from Debeslavetske and Cheremkhivske
gas fields and has maintained both the Bitlyanska licence and its 15% interest
in Westgasinvest LLC (“WGI”), which holds the Reklynetska, Zhuzhelianska,
Cheremkhivsko-Strupkivska, Debeslavetska Production, Baulinska, Filimonivska,
Kurinna, Sandugeyivska and Yakovlivska licences for unconventional activities.
Eni is the operator of these shale gas licences and Cadogan is carried through
exploration.
East Ukraine
Cadogan has filed applications to convert Zagoryanska and Pirkivska licences
from exploration into production licences, while Pokrovska licence has been
relinquished at the end of its last exploration period. Both applications have
been negatively impacted by a dispute between central and local authorities on
the distribution of royalties on gas, which has brought the award process in
the regional Council to a complete halt.
Gas trading operations continued, with sales in Ukraine of both imported and
locally produced gas. Volumes, and revenues, though have substantially
decreased over the previous two years as more competitors entered the market.
Finally, the Group continued providing services through its wholly-owned
subsidiary Astroservice LLC. Services provided were primarily related to well
abandonment and site restoration and the turnover substantially increased over
the previous year as some of the activities which had been put on hold by the
clients were awarded.
Italy
In January 2017, Cadogan, through its fully owned Dutch subsidiary, finalised
the purchase of 90% of the Exploenergy s.r.l. (“Exploenergy”), an Italian
company which has filed applications for two exploration licences (Reno
Centese and Corzano) located in the Po Valley region, in close proximity to
fields discovered by the former operator; two leads have been identified in
these licences with combined, unrisked prospective resources estimated to be
in excess of 60 bcf of gas. Both applications are in an advanced stage of
their approval process.
Strategic Report
The Strategic Report has been prepared in accordance with Section 414A of the
Companies Act 2006 (the “Act”) and presented hereunder. Its purpose is to
inform stakeholders and help them assess how the Directors have performed
their legal duty under Section 172 of the Act to promote the success of the
Company.
Principal activity and status of the Company
The Company is registered as a public limited company (registration number
05718406) in England and Wales. Its principal activity is oil and gas
exploration, development and production; the company also conducts gas trading
and provides services to other operators.
The Company’s shares have a standard listing on the Official List of the UK
Listing Authority and are traded on the main market of the London Stock
Exchange.
Key performance indicators
The Group monitors its performance through four key performance indicators
(“KPIs”):
* to increase oil, gas and condensate production measured on number of barrels
of oil equivalent produced per day (“boepd”);
* to decrease administrative expenses;
* to increase the Group’s basic earnings per share; and
* to maintain no lost time incidents.
The Group’s performance in 2016 against these KPI’s is set out in the
table below, together with the prior year performance data.
Unit 2016 2015
Average production (working interest basis) ((1)) boepd 116 109
Overhead (G&A) $ million 5.1 6.1
Basic loss per share ((2)) cents (2.6) (10.1)
Lost time incidents ((3)) incidents 1 0
((1)) Average production is calculated as the average daily
production during the year
((2)) Basic loss per Ordinary share is calculated by dividing
the net loss for the year attributable to equity holders of the parent company
by the weighted average number of Ordinary shares during the year
((3)) Lost time incidents relates to the number of injuries where
an employee/contractor is injured and has time off work (IOGP classification)
Chairman’s Statement
2016 has witnessed a slow, but continuous progress towards the integration of
Ukraine within Europe, its market and its regulations, notwithstanding the
still open confrontation with Russia and an unresolved economic crisis. In
this context, the reforms to improve and revitalise the country’s energy
sector were still timid and a real, strong commitment for their take-off was
not evident. Besides there have been setbacks, some of them particularly
damaging for Cadogan, which has remained subject to a punitive tax regime on
its gas production and has not yet been awarded the conversion of its eastern
licences from exploration to production.
The country’s cooperation with the leading financial institutions improved
during the year and this, combined with political reassurances on economic
measures to stabilise the country, led to the international credit lines being
extended. Some of this credit was used to replace Russian imported gas with
gas purchased in Europe and imported into Ukraine via the reverse flow, which
had been pioneered by Cadogan.
In this challenging context, Cadogan has continued its transformational
journey towards becoming a much leaner and efficient operator of marginal
fields, resilient to persistent low prices, while preserving its cash. G&A
have been further reduced while production has increased over the previous
year and is expected to increase further this year through the addition of a
couple of old suspended wells which will be re-entered and worked-over (thus
minimising the deployment of capital).
Though Cadogan is rooted in Ukraine, the Board and the Management remain
strongly committed to introduce an element of geographic diversification in
the Group’s portfolio in order to manage the exposure to a country which
still has an above the average level of risk. A healthy pipeline of potential
opportunities has been maintained through the year and I am pleased to say
that 2016 witnessed the very first step of this diversification process taking
place (though the acquisition was finalised in the early days of 2017).
The acquisition of Exploenergy s.r.l. (“Exploenergy”) is clearly not
enough and management will continue to actively pursue other opportunities in
the E&P domain, leveraging on the demonstrated skills and competences of the
company and its staff, on a strong balance sheet and on the experience and
network of contacts of the Directors. We are all committed to support Cadogan
in pursuing its diversification objectives in every way we can.
Finally 2016 was the last year of Cadogan being audited by Deloitte. Based on
existing regulations, a tender had to be launched to appoint the new auditor:
BDO won the tender and they will be proposed as the auditor at the next AGM.
While I welcome BDO, I wish to express my own and the entire Board’s
gratitude to Deloitte for the services rendered to Cadogan: their watchful eye
and rigour have helped me and the other Directors to discharge our duties by
giving the confidence that the company was properly managed.
Zev Furst
Non-Executive Chairman
27 April 2017
Chief Executive's Review
2016 has been an important year for Cadogan, which has succeeded in keeping
its E&P operations at break-even (2), notwithstanding the headwind of oil and
gas prices, which have only slightly recovered in the second part of the year,
and of a punitive taxation on its gas production.
2016 has also been the year that has seen the efforts to geographically
diversify the portfolio coming to fruition with the first acquisition outside
Ukraine being finalised in the early days of the new year; this is a small,
yet important step which has marked the beginning of a new business phase for
Cadogan.
While 2016 has witnessed some signs of recovery for the oil & gas industry, it
has been another difficult year for Ukraine, which has remained embroiled in
its confrontation with Russia and has not come out of its economic crisis. The
country has tried to slowly progress towards modernisation of its oil & gas
legislative framework, but the few steps ahead have been offset by some major
steps back, in particular a dispute between regional Councils and central
government, which has brought the award of licences to a nearly complete halt.
Cadogan’s application to convert Zagoryanska and Pirkovska exploration
licences into production licences have been amongst the casualties of this
protracted institutional standstill. Besides, Cadogan has remained subject
to a punitive tax regime, with royalties on gas set at 70%, a measure designed
to “punish” oligarchs and which has seen Cadogan as a sort of collateral
damage. All attempts to find a solution have failed, partly because of the
limits of the current legislation and partly because of the opposition of the
other foreign investor in WGI (3), the entity, which formally owns
Debeslavetska and Cheremkhivska licences.
2016 also witnessed a major change in the Ukrainian gas market. Direct imports
from Russia came to a halt and the demand was covered by production and
imports from Europe, which peaked at 11 billion mcm. The market became more
competitive and having paved the way to European import by pioneering the
reverse flow did not give Cadogan any competitive advantage. In this
challenging context Cadogan has protected its margin by pursuing opportunistic
deals, rather than volume.
In short, these were the highlights of 2016:
* A 7% increase in production, from 39,680 boe in 2015 to 42,495 boe this year
* A 15 % reduction of overhead (G&A), from $6.1 million in 2015 to $5.1
million this year
* A good year for the services business whose net result of $0.6 million
(2015: $0.1 million) partially offset the reduction in the trading result
* A difficult year for trading whose result was a loss of $2.2 million
compared to a positive result of $2.8 million last year, driven primarily by
lower volumes
* The beginning of the geographic diversification process with the acquisition
of an E&P company in Italy
* A balance sheet, which has remained very robust with a 9% increase of net
cash from $36.5 million in 2015 to $39.7 million this year.
Core operations
Cadogan has continued to safely and efficiently produce from its fields in the
west of the country. Production has increased over the value of the previous
year and operating expenses have been further reduced through a combination of
process and organisational streamlining. The agreement to rent two old
suspended wells from Ukrnafta under a profit sharing scheme has created the
premises for a significant increase of Monastyretska’s oil production
rate(1) which will materialise in 2017 once the wells are re-entered and
worked-over. The re-entry of existing wells is part of Cadogan’s strategy to
sustain production and promote reserves and resources to P1 (proved) category
with a minimum deployment of capital, given the still relatively high risk
profile of Ukraine.
Regrettably one LTI (Lost Time Incident) occurred to a contractor acting
against instructions, has diminished the value of these operational
achievements.
The conversion of exploration and production licences has witnessed other
setbacks. Notwithstanding the repeated filings, the approvals have not been
granted because of a disagreement between the local Council and the central
authorities on the distribution of royalties for gas. Management is
reviewing all available options to move forward.
The anticipated increase in competition, due to a surge in the imported volumes from Europe, which brought key players into Ukraine, has significantly eroded the opportunities for an independent trader, such as Cadogan. The impact of this challenging context has been compounded by the resignation of certain Cadogan’s traders. After an initial attempt to protect the market share, Cadogan has switched to pursuing opportunistic deals with good margins.
Non E&P operation
Revenue, and most importantly net profits, have remained subdued compared to
the past two years and are unlikely to go back to where they were in the
early days notwithstanding efforts to remain competitive because of structural
changes in the market which has become more mature and dominated by large
traders.
Services conversely have delivered excellent results driven by the execution
of the work, which had been contracted in 2015 and which execution had been
deferred on clients’ request. These positive results have partially
compensated for the lower than expected contribution from trading. Efforts to
expand the clients’ portfolio have continued and other contracts have been
won through tenders.
Outlook
Through the year Cadogan has continued its transformational journey towards
becoming a leaner and more efficient operator of marginal fields. G&A have
been further reduced and E&P operations have achieved break-even
notwithstanding a combination of negative factors. This drive towards
efficiency has made Cadogan more resilient to a context that will be unlikely
see the oil price go back to hundred dollars per barrel for a number of years.
Having secured its foundations and with a robust balance sheet, management
will focus on value delivery, acting on four levers:
* Re-load the licence portfolio while pursuing geographic diversification in
order to mitigate the exposure to a country, which maintains a relatively high
risk profile
* Closely monitor the performance of Monastyretska licence with a view of
preparing a staged development programme based on a short-term production
acceleration via work-overs of existing wells and a medium-term programme of
infill drilling to be executed upon securing the extension of the licence,
once it expires in 2019
* Safeguard the value of the Bitlyanska, Debeslavetska and Cheremkhivska
licences
* Continue with gas trading and services to supplement the E&P revenues and
remain cash neutral, while searching for assets with a high value upside.
Guido Michelotti
Chief Executive Officer
27 April 2017
(1) At the time this report was issued both wells had been successfully
re-entered and were producing an aggregate amount of 30 barrels oil per day
(2) On cash basis, net of $0.1 million of depreciation
(3 ) WGI, WestGasInvest LLC, which is owned by eni (50.01%), Nadra (34,99%)
and Cadogan (15%) is the licence holder
Operations review
Overview
At 31 December 2016 the Group held working interests in four conventional gas,
condensate and oil exploration and production licences in the west of Ukraine.
All these assets are operated by the Group and are located in either the
Carpathian basin in close proximity to the Ukrainian gas distribution
infrastructures.
Summary of the Group’s licences (as at 31 December 2016)
Working interest (%) Licence Expiry Licence type (()(1))
99.8 Bitlyanska December 2019 E&D
99.2 Debeslavetska ((2)) November 2026 Production
54.2 Cheremkhivska ((2)) May 2018 Production
99.2 Monastyretska November 2019 E&D
(1) E&D = Exploration and Development
(2) In addition, the Group has 99.2% and 54.2% of economic benefit in
conventional activities in Debeslavetska and Cheremkhivska licences
respectively through Joint Activity Agreements (“JAA”).
Debeslavetska Exploration, Sloboda and Pokrovska licences have reached the end
of the last extension of their exploration periods and have been relinquished,
while Zagoryanska and Pirkovska licences are in the process of being converted
from Exploration to Production licence.
In addition to the above licences, the Group has a 15% carried interest in
Westgasinvest LLC (“WGI”), which holds the Reklynetska (expired in March
2017), Zhuzhelianska (expired in March 2017), Cheremkhivsko-Strupkivska,
Debeslavetska Production, Baulinska, Filimonivska, Kurinna, Sandugeyivska and
Yakovlivska licences for unconventional activities.
East Ukraine
Applications for Zagoryanska and Pirkovska 20-year production licences have
been repeatedly resubmitted for approval. Although the Group has fulfilled its
legal obligations and requirements and filed the applications before their
expiration date, delays have occurred due to legislative changes introduced
into the award process and to an ongoing dispute between central and local
authorities. This conflict revolves around distribution of revenues from
subsoil use tax (royalties) and has brought to a complete halt the award
process.
Conversely, the Group has decided to relinquish Pokrovska licence after its
last extension expired in August 2016 as the lack of commercial discoveries
did not justify its conversion into a production licence.
West Ukraine
The Bitlyanska licence covers an area of 390 square kilometres. Bitlyanska,
Borynya and Vovchenska are three hydrocarbon discoveries in this licence area.
The Borynya field holds 3P reserves, contingent recoverable resources and
prospective resources. Bitlyanska and Vovchenska fields hold contingent
recoverable resources.
Borynya 3 well, has been kept on hold, monitored and routinely bled-off for an
eventual re-entry and stimulation.
The Monastyrestska licence continued to regularly produce oil at a rate of 46
boepd (2015: 48 boepd) through one well. Two more producing wells were added
in December and they were being re-entered at the end of the reporting period
(1); the wells have been rented from Ukrnafta under a profit sharing
agreement.
Debeslavetska and Cheremkhivska continued producing with a stable gas
production rate of 70 boepd (2015: 76 boepd).
The Slobodo-Rungurska and Debeslavetska exploration licences were both
relinquished at the expiry of their last extension period, in April 2016 and
September 2016, respectively.
Gas trading
The Group continued to import gas from Europe via Slovakian and Polish borders
and to sell it in Ukraine along with some locally purchased quantities.
Volumes were lower than in previous years as some of the largest clients
migrated to other suppliers which had entered the market and a new portfolio
of smaller buyers had to be built; margins were also lower owing to increased
competition and storage requirements set by the regulator (2).
Margins generated by trading were offset by Cadogan’s administrative
expenses, that are no longer commensurate to the current level of trading
activity.
Management has taken a decisive action by (i) tightening the terms and
conditions of gas sales (no transfer of title without payment); and (ii)
proposing to the Board a streamlining of the Executive management, which was
approved and will be implemented in 2017.
Service
The Group continued providing services through its wholly-owned subsidiary
Astroservice LLC. Services provided were primarily related to well abandonment
and site restoration and the turnover substantially increased over the
previous year as some of the activities which had been put on hold by the
clients were awarded.
(1) Both re-entries were successful and the wells were producing some 30
barrels oil per day prior to the installation of sucker rod pumps
(2) Storage requirements have been set at 50% of the volume sold to final
consumers starting 1 January 2016. In November 2016 the requirement has been
decreased to 10%. Starting from January 2017 the requirements have been
cancelled.
Financial Review
Overview
In 2016 the Group continued with its efforts to approach cash neutrality
through a number of cost reduction initiatives, while supplementing E&P
revenues with service activities and gas trading.
The functional currency of the UK subsidiaries of the Group has been changed
from GBP to USD starting 1 January 2016 (Note 3(d)).
The Group has acquired the remaining ownership of 30% of Pokrovskoe Petroleum
B.V. and 60% of Zagoryanskoe Petroleum B.V. from eni for an immaterial
consideration, which resulted in a profit on acquisition of $0.1 million in
2016. As part of the assets, the Group acquired $5.9 million of VAT credit and
$103 million of unused tax losses of both companies, for which the impairment
has been recognised in prior years (Note 17).
Net cash, which included cash and cash equivalents mostly denominated in USD
net of short-term borrowings denominated in UAH, increased to $39.7 million at
31 December 2016 compared to $36.5 million at 31 December 2015.
Income statement
Revenue has decreased from $75.4 million in 2015 to $19.7 million in 2016 due
to loss of customers and increased competition in gas trading operations,
which represent $15.6 million (2015: $73.3 million) of total revenues;
notwithstanding a higher production volume, revenues from production have
slightly declined to $1.6 million (2015: $1.8 million) owing to lower realised
price.
Revenue from the service business, which includes drilling and civil works
services, increased to $2.5 million (2015: $0.4 million), as some of the work
awarded, but suspended by the clients in 2015, was executed this year. Cost of
sales represents $15.5 million (2015: $67.4 million) of purchases of gas for
the trading operating segment, $3.1 million (2015: $2.2 million) of production
royalties and taxes, depreciation and depletion of producing wells and direct
staff costs for exploration and development and the service segment. Gross
profit has decreased to $1.1 million (2015: $5.9 million).
Administrative expenses of $5.6 million (2015: $6.1 million) comprise,
professional fees, brokerage fees, depreciation charges on non-producing
property, plant and equipment, staff costs and Directors’ remuneration.
Share of loss in joint ventures of $0.2 million (2015: $12.8 million losses)
comprise of: i) $2.3 million revenues received by one of the Group
subsidiaries for decommissioning services provided to the joint ventures (Note
17); ii) $1.7 million of operating loss and iii) $0.8 million loss recognised
as impairment of Westgasinvest LLC.
Finance costs of $1.1 million (2015: $2.6 million) represent interest expense
to BNPP on credit line used for trading net of the interest income on cash
deposit used for trading.
As a result, loss before tax was $5.8 million (2015: $22.2 million (2)).
2 Loss before tax would have been $25.7 million had the group started using
last year the USD as functional currency
Balance sheet
The cash position of $43.3 million at 31 December 2016, including restricted
cash of $10.9 million used as a pledge for the credit line, has decreased from
$49.4 million at 31 December 2015.
Intangible Exploration and Evaluation (“E&E”) assets of $2.4 million
(2015: $2.7 million) represent the carrying value of the Bitlyanska licence.
The PP&E balance was $1.3 million at 31 December 2016 (2015: $1.7 million).
Investments in joint ventures of $2.3 million (2015: $2.2 million) mainly
represent the carrying value of the Group’s investments in Westgasinvest
LLC, for which impairment of $0.8 million have been recognised (note 17).
Trade and other receivables of $4.1 million (2015: $14.4 million) include $2.2
million (2015: $8.5 million) trading receivables, $0.8 million prepayments for
natural gas (2015: $3.2 million), $0.8 million VAT recoverable (2015: nil)
which is expected to be recovered through trading and services activities.
The $3.6 million outstanding short-term borrowings as of 31 December 2016
(2015: $12.9 million) represents a credit line to purchase natural gas, drawn
in UAH at Ukrainian bank, which is a 100% subsidiary of a UK bank. The credit
line is secured by $10 million of cash balance placed at the UK bank; this has
been decreased to $5 million in March 2017 owing to lower volumes traded and
lower gas prices. Borrowings are taken in UAH in order to preserve the USD
amount of own cash and mitigate a risk related to currency fluctuations in
Ukraine. A short-term credit line provides an easy access to quick financings
to support the Group’s trading operations.
The $1.6 million of trade and other payables as of 31 December 2016 (2015:
$3.7 million) represent $0.9 million (2015: $0.2 million) of accrued expenses,
$0.5 million (2015: $1.7 million) of other creditors and $0.3 million (2015:
$0.9 million) of VAT payable for supplies of natural gas.
Provisions include $0.7 million of long-term provision for decommissioning
costs (2015: $0.7 million of long-term provision) and $1.3 million (2015: $1.5
million) provision for corporate tax for the dispute on the treatment of
taxable income and expenses.
Net cash, which included cash and cash equivalents mostly denominated in USD
net of short-term borrowings denominated in UAH, increased to $39.7 million at
31 December 2016 compared to $36.5 million at 31 December 2015. Net cash
mostly improved of improved collection of receivables, decrease of inventories
in stock and improvement of working capital cycle.
Cash flow statement
The Consolidated Cash Flow Statement on page 60 shows operating cash outflow
before movements in working capital of $4.4 million (2015: $1.1 million). In
2016 the Group contributed $2.3 million (2015: $0.7 million) into joint
ventures to repay its current liabilities. Management maintained its focus on
optimising the working capital and this focus, combined with a reduction of
the mandatory gas storage requirements, substantially improved the cash
inflows from operating activities from $1.2 million in 2015 to $2.5 million in
2016.
In 2016 the Group financed its trading operations with short-term borrowings
(Note 22) with proceeds of $1.9 million and repayments of $10.2 million (2015:
proceeds of $13.2 million and repayments of $12.2 million).
Related party transactions
Related party transactions are set out in note 28 to the Consolidated
Financial Statements.
Treasury
The Group continually monitors its exposure to currency risk. It maintains a
portfolio of cash and cash equivalent balances mainly in US dollars
(“USD”) held primarily in the UK. Production revenues from the sale of
hydrocarbons are received in the local currency in Ukraine; however the
hydrocarbon prices are linked to the USD denominated gas and oil prices. To
date, funds from such revenues have been used in Ukraine in operations rather
than being remitted to the UK.
Risks and uncertainties
There are a number of potential risks and uncertainties that could have a
material impact on the Group’s long-term performance and could cause the
results to differ materially from expected and historical results. Executive
management review the potential risks and then classify them as having a high
impact, above $5 million, medium impact, above $1 million but below $5
million, and low impact, below $1 million. They also assess the likelihood of
these risks occurring. Risk mitigation factors are reviewed and documented
based on the level and likelihood of occurrence. The Audit Committee reviews
the risk register and monitors the implementation of improved risk mitigation
procedures via Executive management, who are carrying out a robust assessment
of the principal risks facing the Group, including those potentially
threatening its business model, future performance, solvency and liquidity.
The Group has analysed the following categories as key risks:
Risk Mitigation
Operational risks
Health, Safety and Environment (“HSE”)
The oil and gas industry by its nature conducts activities, which can cause health, safety and environmental incidents. Serious incidents can have not only a financial impact but can also damage the Group’s reputation and the opportunity to undertake further projects. The Group maintains a HSE management system in place and demands that management, staff and contractors adhere to it. The system ensures that the Group meets Ukraine legislative standards in full and achieves international standards to the maximum extent
possible.
Drilling and Work-Over operations
The technical difficulty of drilling or re-entering wells in the Group’s locations and equipment limitations can result in the unsuccessful completion of the well. The incorporation of detailed sub-surface analysis into a robustly engineered well design and work programme, with appropriate procurement procedures and competent on site management, aims to minimise risk.
Production and maintenance
There is a risk that production or transportation facilities can fail due to non-adequate maintenance, control or poor performance of the Group’s suppliers. All plants are operated and maintained at standards above the Ukraine minimum legal requirements. Operative staff are experienced and receive supplemental training to ensure that facilities are properly operated and maintained. When not in use the
facilities are properly kept under conservation and routinely monitored. Service providers are rigorously reviewed at the tender stage and are monitored during the contract period.
Sub-surface risks
The success of the business relies on accurate and detailed analysis of the sub-surface. This can be impacted by poor quality data, either historic or recently gathered, and limited coverage. Certain information provided by external sources may not be accurate. All externally provided and historic data is rigorously examined and discarded when appropriate. New data acquisition is considered and appropriate programmes implemented, but historic data can be reviewed and reprocessed to improve the overall knowledge
base. Agreements with qualified local and international G&G contractors have been entered into to supplement and broaden the pool of expertise available to the Company.
Data can be misinterpreted leading to the construction of inaccurate models and subsequent plans. All analytical outcomes are challenged internally and peer reviewed. Analysis is performed using modern geological software.
Area available for drilling operations is limited by logistics, infrastructures and moratorium. This increases the risk for setting optimum well coordinates. If not covered by 3D seismic or fitting over 2D seismic lines, the eventual well’s dislocation will not be accepted.
The Group may not be successful in achieving commercial production from an asset and consequently the carrying values of the Group’s oil and gas assets may not be recovered through future revenues, because of reservoir performances below the expectations. The Group performs a review of its oil and gas assets for impairment on an annual basis, and considers whether to commission a review from a third or a Competent Person’s Report (“CPR”) from an independent qualified contractor depending on the
circumstances.
Financial risks
The Group is at risk from changes in the economic environment both in Ukraine and globally, which can cause foreign exchange movements, changes in the rate of inflation and interest rates and lead to credit risk in relation to the Group’s key counterparties. Revenues in Ukraine are received in UAH and expenditure is made in UAH, however the prices for hydrocarbons are implicitly linked to USD prices. The Group continues to hold most of its cash reserves in the UK mostly in USD. Cash reserves are placed with
leading financial institutions, which are approved by the Audit Committee. The Group is predominantly a USD denominated business. Foreign exchange risk is considered a normal and acceptable business exposure and the Group does not hedge against this risk
for its E&P operations. For trading operations, the Group matches the revenues and the source of financing. Refer to note 26 to the Consolidated Financial Statements for detail on financial risks.
The Group is at risk that the counterparty will default on its contractual obligations resulting in a financial loss to the Group. We monitor the credit quality of our counterparties and seek to reduce the risk of customer non-performance by limiting the title transfer to product until the payment is received, prepaying only to known credible suppliers.
The Group is at risk that fluctuations in gas prices will have a negative result for the trading operations resulting in a financial loss to the Group. The Group mostly enters into back-to-back transactions where the price is known at the time of committing to purchase and sell the product. Sometimes the Group takes exposure to open inventory positions when justified by the market conditions in Ukraine.
Country risks
Legislative changes may bring unexpected risk and be time consuming for securing the licences obligations. Accurate monitoring and dialogue with competent authorities are kept in place to minimise the risk.
Ukraine is an emerging market and as such the Group is exposed to greater regulatory, economic and political risks, more than other jurisdictions. Emerging economies are generally subject to a volatile political environment which could adversely impact The Group minimises this risk by maintaining the funds in international banks outside Ukraine and by continuously maintaining a working dialogue with the regulatory authorities.
Cadogan’s ability to operate in the market.
Others risks
The Group's success depends upon skilled management as well as technical and administrative staff. The loss of service of critical members from the Group's team could have an adverse effect on the business. The Group periodically reviews the compensation and contract terms of its staff.
The Group is at risk of underestimating the risk and complexity associated with the entry into new countries. The Group applies a set of very rigorous and strict screening criteria in order to evaluate potential investment opportunities. It also seek for opinion of independent and qualified experts when deemed necessary. Besides the level of required rate of return is adjusted to the
perceived level of risk.
Statement of Reserves and Resources
In December 2015, the Group commissioned a third party for the Reserves and
Resources Evaluation of the Group’s oil and gas assets in Ukraine. The
evaluation was assigned to a qualified Ukrainian G&G consulting contractor,
which delivered its final report in March 2016. The evaluation was conducted
in accordance with SPE Petroleum Resources Management System (‘PRMS’). The
summary of the Reserves and Resources as per the report is presented below.
Summary of Reserves(1)
at 31 December 2016
Mmboe
Proved, Probable and Possible Reserves at 1 January 2016 8 . 71
Production (0.04)
Revisions (0.8)
Proved, Probable and Possible Reserves at 31 December 2016 7.87
(1 The study has been conducted by third-party Brend Vik and since then
Cadogan has entered into a Technical Service Agreement with Brend Vik.)
Reserves are assigned to the Bitlyanska, Monastyretska and Debeslavetska
fields.
In addition to the tabled reserves Cadogan has 15.40 million boe of contingent
resources associated with Bitlyanska and Monastyretska licences. Reserves for
Zagoryanska and Pirkovska licences have been downgraded to resources given the
uncertainty on the time to complete the award process.
Corporate Responsibility
The Board recognises the requirement under Section 414C of the Companies Act
2006 (the “Act”) to detail information about employees, human rights and
community issues, including information about any policies it has in relation
to these matters and the effectiveness of these policies.
The Group considers the sustainability of its business as a key and
competitive element of its strategy. Meeting the expectations of our
stakeholders is the way in which we secure our licence to operate and to be
recognised in the values we declare is the best added value we can bring in
order to profitably prolong our business. The Board recognises that the
protection of the health and safety of its employees and communities as well
as of the environment which it impacts is not just an obligation, but it is
part of the personal ethics and beliefs of management and staff; these are the
key drivers for the sustainable development of the Company’s activity. Our
Code of Ethics and the adoption of internationally recognised best practices
and standards are our, and our employees’, references for conducting our
operations.
Our activities are carried out in accordance with a policy manual, endorsed by
the Board, which has been disseminated to all staff. The manual includes
policies on business conduct and ethics, anti-bribery, the acceptance of gifts
and hospitality and whistleblowing.
The Chief Operating Officer is the Chairman of the HSE Committee and is
supported in his role by Cadogan Ukraine’s HSE Manager. Her role is to
ensure that the Group has developed suitable procedures, and that operational
management have incorporated them into daily operations and that she has the
necessary level of autonomy and authority to discharge her duties effectively
and efficiently.
The Board believes that health and safety procedures and training across the
Group should be to the standard expected in any company operating in the oil
and gas sector. Accordingly, it has set up a Committee to review and agree
health and safety initiatives and report back on progress. Management is
regularly reporting to the Board on health, safety and environment and key
safety and environmental issues, which are discussed by the Executive
Management. The Health, Safety and Environment Committee Report is on page 37
to 38.
Health, safety and environment
The Group has developed an integrated Health, Safety and Environmental
(“HSE”) management system. The system aims, by a continuous improvement
programme, to ensure that a safety and environmental protection culture is
embedded in the organisation and continuously improved. The HSE management
system ensures that both Ukrainian and international standards are met, with
the Ukrainian HSE legislation requirements taken as an absolute minimum
although the international requirements are in the main met or exceeded. All
the Group’s local operating companies in east and west Ukraine have all the
necessary documentation and systems in place to ensure compliance with
Ukrainian legislation and Company’s standards.
A proactive approach to the prevention of incidents has been in place
throughout 2016, which relies on a reliable near-miss reporting. Staff
training on HSE matters is recognised as the key factor to generate continuous
improvement. In-house training is provided to help staff meet international
standards and follow best practice. At present, special attention is being
given to training on risk assessments, emergency response, incident
prevention, reporting and investigation, as well as emergency drills regularly
run on operations’ sites and offices, to ensure that international best
practices and standards are maintained to comply with or exceed those required
by Ukrainian legislation.
The Board monitors lost time incidents as a key performance indicator of the
business, to reasonably verify that the procedures in place are robust. The
Board has benchmarked safety performance against the HSE performance index
measured and published annually by the International Association of Oil & Gas
Producers. In 2016, the Group recorded close to 315,000 man-hours worked. In
February, there was one incident after over 2.2 million man-hours and 4.5
years, unfortunately caused by a contractor acting in violation of the
company’s procedures and daily inductions.
During 2016 the Group continued to monitor the activity’s performances in
terms of greenhouse gas emissions as well as to collect statistical data
related to consumption of electricity and industrial water and fuel
consumption by cars, plants and other work sites.
Employees
Wellness and professional development is part of the Company’s sustainable
development policy and wherever possible local staff are recruited; the Group
operations in Ukraine are now managed by an entirely local staff. Procedures
are in place to ensure that all recruitments are undertaken on a transparent
and fair basis with no discrimination against applicants. Each operating
company has its own Human Resources staff to ensure that the Group’s
employment policies are properly implemented and followed. As required by
Ukrainian legislation, Collective Agreements are in place with the Group’s
Ukrainian subsidiary companies, which provide an agreed level of staff
benefits and other safeguards for employees. The Group’s Human Resources
policy covers key areas such as equal opportunities, wages, overtime and
non-discrimination. All staff are aware of the Group’s grievance procedures.
The uncertainty on the timing of the award of Zagoryanska and Pirkovska
licences and the need to reduce costs to remain profitable in the West,
notwithstanding a punitive tax regime, forced the Group to reduce the level of
staffing; the concerned personnel were duly informed and all the necessary
procedures were taken. Local qualified contractors are considered to
supplement the required expertise when and to the extent it is necessary.
Sufficient level of health insurance is provided by the Group to employees to
ensure they have access to good medical facilities. Each employee’s training
needs are assessed on an individual basis to ensure that their skills are
adequate to support the Group’s operations, and to help them to develop.
Gender diversity
The Board of Directors of the Company comprised seven male Directors
throughout the year to 31 December 2016. The appointment of any new Director
is made on the basis of merit. See pages 20 to 21 for more information on the
composition of the Board.
As at 31 December 2016, the Company comprised a total of 69 persons, as
follows:
Male Female
Non-executive directors 4 -
Executive directors 3 -
Management, other than Executive directors 7 3
Other employees 31 21
Total 45 24
Human rights
Cadogan’s commitment to the fundamental principles of human rights is
embedded in our HSE polices and throughout our business processes. We promote
the core principles of human rights pronounced in the UN Universal Declaration
of Human Rights. Our support for these principles is embedded throughout our
Code of Conduct, our employment practices and our relationships with suppliers
and partners wherever we do business.
Community
The Group’s activities are carried out in rural areas of Ukraine and the
Board is aware of its responsibilities to the local communities in which the
Group operates and from which some of the employees are recruited. At current
operational sites, management works with the local councils to ensure that the
impact of operations is as low as practicable by putting in place measures to
mitigate their effect. Projects undertaken include improvement of the road
infrastructure in the area, which provides easier access to the operational
sites while at the same time minimising inconvenience for the local population
and allowing improved road communications in the local communities, especially
during winter season or harsh meteorological conditions. Specific community
activities are undertaken for the direct benefit of local communities. All
activities are followed and supervised by managers who are given specific
responsibility for such tasks.
The Group’s local companies see themselves as part of the community and are
involved not only with financial assistance, but also with practical help and
support. The recruitment of local staff generates additional income for areas
that otherwise are predominantly dependent on the agricultural sector.
Approval
The Strategic Report was approved by the Board of Directors on 27 April 2017
and signed on its behalf by:
Ben Harber
Company Secretary
27 April 2017
Board of Directors
Zev Furst, 69, American
Non-executive Chairman
Appointed to the Board on 2 August 2011, Mr Furst is a leading global business
and communications strategist who has advised political leaders, foreign
principals and corporate executives of Fortune 100 companies. He is the
Chairman and CEO of First International Resources, an international corporate
and political consulting firm he founded in 1992. Mr Furst specialises in
providing strategic counsel on crisis management, market entry, corporate
positioning and personal reputational issues. In recent years, he has also
advised and consulted with candidates running for national office in Israel,
Japan, Mexico and Ukraine.
In 1986, Mr Furst was a founding partner of Meridian Resources and Development
Ltd, an international commodities trading company specialising in chemicals
and petroleum products.
Mr Furst currently serves as Chairman of the International Board of the Peres
Center for Peace and is a member of the Advisory Board of the Kennan Institute
in Washington, DC. He has written and lectured extensively on international
affairs, business and political strategy and the role of media in politics and
diplomacy.
Mr Furst is Chairman of the Company’s Nomination Committee and a member of
the Remuneration Committee.
Guido Michelotti, 62, Swiss
Chief Executive Officer
Mr Michelotti was appointed to the Board of Directors as Chief Executive
Officer on 25 June 2015. An Oil & Gas executive with over 30 years of
international experience across the entire E&P cycle, he spent more than 10
years in senior executive roles with eni, leading E&P companies as well as
managing major capital projects. Prior to joining Cadogan he
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