Empire Energy Group Limited
Annual Report 2016

Plain-text annual report

EMPIRE ENERGY GROUP LIMITED and its controlled entities ABN 29 002 148 361 DECEMBER 2016 ANNUAL REPORT EMPIRE ENERGY GROUP LIMITED and its controlled entities CONTENTS CORPORATE DIRECTORY EXECUTIVE CHAIRMAN’S REVIEW OF OPERATIONS DIRECTORS’ REPORT AUDITOR’S INDEPENDENCE DECLARATION CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME CONSOLIDATED STATEMENT OF FINANCIAL POSITION CONSOLIDATED STATEMENT OF CHANGES IN EQUITY CONSOLIDATED STATEMENT OF CASH FLOWS NOTES TO THE FINANCIAL STATEMENTS DIRECTORS’ DECLARATION INDEPENDENT AUDITOR’S REPORT SHAREHOLDER INFORMATION 3 4 16 25 26 27 28 30 31 69 70 74 2 EMPIRE ENERGY GROUP LIMITED and its controlled entities CORPORATE DIRECTORY Directors B W McLeod (Executive Chairman) D H Sutton K A Torpey Registered Offices Australian Office Level 7 151 Macquarie Street Sydney NSW 2000 US Office 380 Southpointe Boulevard Suite 130 Canonsburg PA 15317 Auditors Nexia Australia Level 16,1 Market Street Sydney NSW 2000 US Auditors Schneider Downs & Co. Inc One PPG Place, Suite 1700 Pittsburgh PA 15222 Share Registry Computershare Investor Services Pty Limited Level 3 60 Carrington Street Sydney NSW 2000 Telephone: 1300 85 05 05 Bankers Macquarie Bank Limited 50 Martin Place Sydney NSW 2000 Australia & New Zealand Banking Group Limited 242 Pitt Street Sydney NSW 2000 PNC Bank 249 Fifth Avenue One PNC Plaza Pittsburgh PA 15222 Company Secretary R V Ryan Australian Solicitors Clifford Chance Level 16 1 O’Connell Street Sydney NSW 2000 US Solicitors K&L Gates LLP K&L Gates Center 210 Sixth Avenue Pittsburgh PA 15222-2613 Barry Conge Harris LLP 1800 West Loop South, Suite 750 Houston, TX 77027 Stock Exchange Listings Australia Australian Securities Exchange (Home Exchange Sydney, New South Wales) ASX Code: EEG - Ordinary Shares United States of America New York OTCQB Market: Code: EEGNY OTC#: 452869103 Sponsor: Bank of New York 1 ADR for 20 Ordinary shares www.empireenergygroup.net 3 EMPIRE ENERGY GROUP LIMITED and its controlled entities Executive Chairman’s Review of Operations A. 2016 OVERVIEW & HIGHLIGHTS GROUP - Revenue $14.5 million (2015: $18.2 million). - - Profit after Income Tax Income $16.5 million (2015: -$27.0 million). EBITDAX $3.8 million (2015: $6.0 million). - Net tangible Assets US$36.1 million or US$0.10 cents per share. - Underwritten rights issue for A$6.1 million announced 14 December 2016, currently being completed. USA – APPALACHIA & MIDCON - - As with the global upstream oil and gas industry, the Company’s USA operations traded within a difficult environment throughout the first half of 2016 with oil and gas prices at 20 year lows. Price improvements in oil and then gas from around the half year, along with a conservative hedging program enabled the Company to generate a positive result for the year. An individual oil well efficiency monitoring system implemented in mid-2015 was able to monitor individual oil wells on a daily basis based on spot oil price volatility. This enable critical production savings to be made throughout the 2016 year. - With service costs at 15 year lows the Company is planning on drilling at least 6 to 8 gross wells over 2017. The first well to be drilled is expected to be spudded in Kansas is early April 2017. At least 6 gross drilled locations in Kansas have been prioritised with a further 4 to 6 in Kay County, Oklahoma. - Gross oil production 194,000 Bbls (Net 123,000 Bbls) (2015: Gross 216,000 Bbls). - Gross natural gas production 2.4 Bcf (Net 1.9 Bcf) (2015: Gross 2.2 Bcf). - Net production 1,203 Boe/d (2015: 1,192 Boe/d). - 2P Reserves 15.0 MMBoe, (2015:12.7 MMBoe) with 2P PV10 of $91.5 million (2015: $44.5 million). - Outstanding hedges as at December 31, 2016 valued at $3.3 million. - US$200 million credit facility extended to February 2019. AUSTRALIA – NORTHERN TERRITORY - - In December 2015, the Company entered into a US$75,000,000 Farm-out agreement (“Farmout”) for the development of its Northern Territory (NT) assets with AEGP Australia Pty Ltd (AEGP) a company controlled by Mr Aubrey K. McClendon. In March 2016 Mr McClendon was tragically killed in an accident. The Personal Representative of the McClendon Estate has confirmed that that Estate will not continue with the Farmout. Refer to page 16. A Prospective Resource P(50) (“PRP(50)”) of ~2.1 billion Boe or ~12.0Tcfe was announced in February 2016 for the Company’s NT Assets. The PRP(50) covers approximately 5.5 million acres of the total 14.6 million acres held by the Company and with an average shale thickness of 330 feet. In most of the area reviewed, the shale thickness can be considerably thicker than that used for the PRP(50) estimate. (Refer to page 11 for definition of Prospective Resource) - Over 2015/16 Imperial Oil & Gas Pty Ltd (“Imperial”) completed an extensive review of historical data which showed the Tawallah and McDermott Group of shales significantly extend the McArthur Basin tenements providing the possibility of adding very significant additional resources to the current PRP(50). Refer to page 14. B. OPERATIONS The Company maintains a small head office in Australia and manages the oil & gas production operations through its 100% owned USA subsidiary Empire Energy E&P, LLC (“Empire E&P”). The exploration program in the McArthur Basin, Northern Territory, is operated through its 100% owned subsidiary Imperial. 4 EMPIRE ENERGY GROUP LIMITED and its controlled entities Executive Chairman’s Review of Operation (Continued) C. OPERATIONS REVIEW – USA TABLE A Operating Statistics Notes Dec 31, 2016 Dec 31, 2015 % change Gross Production: Oil (MBbls) Natural gas (MMcf) Net Production: Oil (MBbls) Natural gas (MMcf) Net production (MBoe): 1.0 194 2,362 123 1,895 439 216 2,222 140 1,769 435 Net Daily Production (Boe/d): 1,203 1,192 Average sales price per unit (after hedging): Oil ($/Bbl) Natural gas ($/Mcf) Oil Equivalents ($/Boe) Average sales price per unit (before hedging): Oil ($/Bbl) Natural gas ($/Mcf) Oil Equivalents ($/Boe) Lifting Costs (incl taxes): Oil ($/Bbl) Natural gas ($/Mcf) Oil Equivalents ($/Boe) 2P Reserves (MMBoe): 1.1 $62.21 $ 3.04 $30.59 $38.52 $ 1.76 $18.40 $21.54 $ 1.61 $13.01 15.0 $72.31 $ 3.84 $38.93 $43.46 $ 1.84 $21.49 $24.53 $ 2.23 $16.97 12.7 Notes to Table A 1.0 BOE - based on SEC guidelines of an oil:gas ratio of 1:6. 1.1 Lifting Costs - includes lease operating expenses, production and ad valorem taxes. D. NET PRODUCTION BY REGION - USA -10% 6% -12% 7% 1% 1% -14% -21% -21% -11% -4% -14% -12% -28% -23% 18% TABLE B Operating Statistics Oil (MBbls) Appalachia Mid-Con Total (MBbls) Natural gas (MMcf) Appalachia Mid-Con Total (MMcf) Notes Dec 31, 2016 Dec 31, 2015 % change 3 120 123 1,880 15 1,895 4 136 140 1,761 8 1,769 -25% -11% -12% 7% 67% 7% 5 EMPIRE ENERGY GROUP LIMITED and its controlled entities Executive Chairman’s Review of Operation (Continued) E. REVIEW OF OPERATING RESULTS USA OPERATIONS In addition to the information presented in this financial report, to assist stakeholders in gaining a more comprehensive understanding of the operations the financial results have also been prepared with reference to an EBITDAX format. The presentation of “EBITDAX” accounting, which is a non-IFRS or statutory financial measure, may therefore not be comparable to similar measures presented by other companies. Management have attempted to ensure that EBITDAX accounting presented is consistent with reporting by other similar E&P companies so a useful production and financial comparison can be made. The EBITDAX accounts, based on the production date, are not meant to reconcile to the statutory accounts as the latter have been prepared on an accrual basis (effective date). However, if the EBITDAX accounts are prepared on an effective date basis they can then be reconciled to the statutory accounts. EBITDAX represents net income (loss) before interest expense, taxes, and depreciation, amortization, development and exploration expenses. Nonrecurring expenses have been included in EBITDAX. In summary, all revenues and operating expenses of the Company’s business are included in EBITDAX. All non-cash expenses, which may distort the presentation of operations as shown in the statutory accounts, have been either eliminated or reallocated and aggregated below the EBITDAX line. In summary, we believe that: • • • • • EBITDAX provides stakeholders with a much simpler and clear measure of our operating performance. EBITDAX is an important supplemental measure of operating performance because it eliminates items that have little bearing on our operating performance and so highlights trends in our core business that may not otherwise be apparent when relying solely on current statutory accounting and financial measures. EBITDAX is the material component of the covenants that are imposed on the Company under our credit agreements. Securities analysts and investors generally use EBITDAX (cash flow modelling) in the comparative evaluation of companies. Management and external users of our financial statements, rely on the use of EBITDAX to assess: the financial performance of our assets without regard to financing methods, capital structure or historical cost basis; the ability of our assets to generate cash sufficient to pay interest costs and support our indebtedness; our operating performance and return on capital as compared to those of other companies in our industry, without regard to financing or capital structure; and the feasibility and effectiveness of acquisitions and capital expenditure projects; and the overall rates of return on alternative investment opportunities. • • • • • Other companies may calculate EBITDAX differently than as presented. Based on the premises set out above, the following schedules present comparative operating statistics and financials on an EBITDAX basis: RECONCILIATION OF EBITDAX ACCOUNTS TO STATUTORY ACCOUNTS For the EBITDAX report actual numbers for production, income and expenses have been utilised. This method generates differences between what is shown in the EBITDAX accounts and what is represented in the statutory accounts. The table below provides a reconciliation EBITDAX to the financial statements. 6 EMPIRE ENERGY GROUP LIMITED and its controlled entities Executive Chairman’s Review of Operation (Continued) Net Earning - Effective Date (In $ thousands) EBITDAX- production date Net Earnings- effective date 31 December 2016 31 December 2015 $3,794 $(4,161) $6,020 $(6,588) Intergroup management fee $150 $150 Revenue and expenses (remaining Empire Group) Other Income Unrealised derivative movements* General and administration – head office General and administration – other* Write back/(Impairment) of asset * Net (loss)/profit before income tax expense * Indicates non-cash items $10 $(7,590) $(10) $(46) $28,144 $16,497 $168 $(306) $(6) $(456) $(22,203) $(29,241) EBITDAX in Table C relates to Empire Energy E&P and Net Earnings in Table D reports operational activities of Empire Energy Group. 7 EMPIRE ENERGY GROUP LIMITED and its controlled entities Executive Chairman’s Review of Operation (Continued) TABLE C Operations (In $ thousands) Net Revenue: Oil Sales Natural Gas Sales Working Interest Net Admin Income Other Income Total Revenue Production costs: Lease operating expenses – Oil Lease operating expenses - Gas Taxes - Oil Taxes - Natural Gas Total Field EBITDAX Less: Inventory adjustment Reserve Enhancements Nonrecurring expenses G & G Costs Field Overhead Total Operating EBITDAX Operating Margin Operating Margin Less: Field G & A Corporate G & A Delay rental payments Land Overhead & Non-leasing costs Dry hole expenses Total EBITDAX Net Margin Notes Dec 31, 2016 Dec 31, 2015 % change 1.0 1.0 1.1 1.2 1.2 1.3 1.4 1.5 1.6 1.7 1.8 7,666 5,757 8 369 119 10,153 6,790 12 356 166 13,919 17,477 2,529 2,903 126 153 5,711 8,208 (3) 22 756 26 1,250 2,051 6,157 44.2% 658 1,555 142 6 - 2,361 3,796 27.3% 3,292 3,247 190 197 6,926 10,551 160 63 821 51 788 1,883 8,668 49.6% 989 1,565 74 11 9 2,648 6,020 34.4% -24% -15% -33% 4% -28% -20% -23% -11% -34% -22% -18% -22% -102% -65% -8% -49% 59% -9% -29% -33% -1% 92% -45% -100% -11% -37% 8 EMPIRE ENERGY GROUP LIMITED and its controlled entities Executive Chairman’s Review of Operation (Continued) Notes to Table C: 1.0 Oil and Natural Gas Sales –includes realised net hedges of $5.4 million for natural gas and oil. 1.1 Net Admin Income – as operator for approximately most of the Company’s assets, the Company charges Working Interest Owners a fee to cover expenses such as administration, general insurance and supervision etc., or COPAS expenses. As part of this cost there is a net margin which accrues to the Company. 1.2 Taxes – includes production, severance and ad valorem taxes. 1.3 Inventory Adjustment – adjustment for oil in tanks as of December 31, 2016. 1.4 Reserve Enhancements – capital costs relating to the development of behind pipe reserves, plus polymer treatment program for wells. 1.5 Nonrecurring expenses – Costs relating to ongoing upgrade of well bores, wellhead equipment well and tank battery sites etc. 1.6 Field Overheads – field supervision and indirect operational expenses including motor vehicles, fuel, mechanics, roustabouts, supervisors, lease administration and land management, general property insurances, environmental and reserve reporting etc. Around 50% of this is covered by Net Admin Income (refer Note 1.1 above). Over 2016 the Company reallocated expenses between Field G&A and Field Overhead with the former now including all supervisory and direct field administration costs. Aggregate costs between both cost centres remained the same. 1.7 Field G&A - Empire Energy has field offices in each region it operates. Operations are expansive with over 2,200 operating wells, 3,700 leases, 1,600 right of ways, 20 marketing agreements, 40 employees and 15 contract pumpers operating in two regional areas, Appalachia and the Mid-Con. Field G&A expenses include expenses such as utilities, IT, postage, office rental, third party reservoir engineering reviews etc. Over 2016 the Company reallocated expenses between Field G&A and Field Overhead with the later now including all supervisory and direct field administration costs. Aggregate costs between both cost centres remained the same. 1.8 Corporate G&A – Empire Energy manages its USA operations from a corporate head office at Canonsburg, PA., were a staff of 4 full time and 2 part time hold responsibility for financial management, control and reporting, plus HR Services. Major expenses for the period were - salaries and wages $311,970; audit/tax and accounting $165,975; travel and accommodation $70,010; rent and associated, IT and office costs $159,748; Professional Services $140,532 and Management and Director Fees $403,000 (of which $150,000 was paid to Empire Energy Group Limited). 9 EMPIRE ENERGY GROUP LIMITED and its controlled entities Executive Chairman’s Review of Operation (Continued) F. NET EARNINGS TABLE D Net Earnings (In $ thousands) EBITDAX Geological Services Acquisition related expenses Capital Raising Expenses Australian HQ Northern Territory exploration expenses Total EBITDA Less: Expiration costs ARO Depn, Depletion, Amortisation Total EBIT Less: Interest Notes Dec 31, 2016 Dec 31, 2015 % change 1.9 1.10 3,796 6,020 17 55 21 1,140 289 1,522 2,274 299 478 1,621 2,398 (124) 29 262 17 1,203 946 2,457 3,563 426 422 6,227 7,075 (3,512) 2,416 2,060 369 42 150 (26) 510 614 357 - (3,075) (7,053) -37% -41% -79% 24% -5% -69% -38% -36% -30% 13% -74% -66% -96% 17% -28% -93% -58% 100% -56% Interest (non-cash) (Gain) loss on sale of assets (non-cash) 1.11 P&A vs. ARO (non-cash) Bad debts (non-cash) Net Earnings before Tax Notes to Table D: 1.9 Acquisition related expenses – Directly associated with acquisitions and include legal, engineering, tax and accounting advice, transition fees, recruitment and relocation costs. 1.10 Australian HQ – net cost of Australian operations (expenses are net of income received). Major expenses were consultants $342,903; salaries $246,850; audit & accounting $102,218; listing related expenses $60,262; rent, communications, IT hardware and support services $162,723. Australian expenses currency translation at AUD/USA 0.7236. 1.11 Interest (non-cash) – decreased due to warrant amortisation from previous years taken up in 2015. G. CAPITAL EXPENDITURE Capex (In $ thousands) Notes Dec 31, 2016 Dec 31, 2015 % change Capital Expenditures Acquisition Capital New Wells - IDC New Wells - Capital Undeveloped Leases Northern Territory, Australia Total 49 580 23 32 499 1,183 884 878 26 899 1,465 4,152 -94% -34% -12% -96% -66% -72% 10 EMPIRE ENERGY GROUP LIMITED and its controlled entities Executive Chairman’s Review of Operation (Continued) H. CREDIT FACILITY The draw down on the Macquarie Bank Limited Credit Facility as at December 31, 2016 was $40.1 million (cf $39.4 million at Dec 2015) at an average rate of LIBOR+6.5%. Principal repayments made in 2016 and 2015 were ~$465,000 and ~$3.7 million respectively. Interest expense is estimated to average $220,000/mth over 2017. The Credit Facility expires on 17 April 2019. I. HEDGING Due to the risk/growth model implemented by Empire, a comprehensive hedging strategy has been adopted to ensure a reduction in commodity risk over the period that a major portion of debt financing is repaid. The portion of production hedged will naturally reduce as drill bit production comes on line or on the other hand increase as non- economic wells are shut-in. Year Est. Net mmBtu Hedged mmBtu Average Est. Net Hedged Average % $/mmBtu Bbl Bbl % $/Bbl 2017 2018 2019 Total 1,700,000 1,068,000 62.8% 1,620,000 1,008,000 62.2% 1,550,000 498,000 32.1% 4,870,000 2,574,000 52.9% $4.05 $4.11 $3.45 $3.96 a Includes a collar implemented for additional 1,800Bbl/month over 2017 at $45.30/$54.30 119,500 114,000a 95.43% $66.95 119,500 114,000 95.43% $66.95 The fair value (marked to market) of combined oil and gas hedges in place as at December 31, 2016 was $3.3 million. Oil and gas hedge contracts were valued based on NYMEX Henry Hub and WTI forward curves at market close on December 31, 2016. J. RESERVES – USA The Company’s reserves are reviewed annually by independent third party reserve engineers. The scope of the reviews is to prepare an estimate of the proved, probable and possible reserves attributable to Empire’s ownership position in the subject properties. Reserves as at December 31, 2016 – USA (NYMEX Strip Dec 31, 2016) Reserves - As of Dec 31, 2016 Oil (Mbbls) Gas (MMcf) MBoe Gross Wells Capex US$M PV0 US$M PV10 US$M Reserves & Region Proved Developed Producing Proved Developed Non-producing Proved Behind Pipe Proved Undeveloped Total 1P Probable Total 2P Possible Possible - NY Shale Total 3P Prospective Resource P(50) Shale (NY) Prospective Resource P(50) - Aus (NT) Total Reserves & Resources Notes to Reserves 1,647 492 152 1,111 3,402 3,085 6,487 1,620 90,740 98,847 27,045 38 40 101 27,224 23,923 51,147 4,024 12,460 67,631 6,155 498 159 1,128 7,939 7,072 15,012 2,291 92,817 110,119 1,637 15 9 58 1,719 153 1,872 222 $80,033 $0 $12,606 $1,647 $5,878 $582 $10,479 $31,803 $12,708 $130,320 $42,376 $132,816 $55,084 $263,136 $54,576 $24,945 $36,626 $6,267 $1,416 $12,164 $56,473 $34,984 $91,457 $8,866 2,094 $80,029 $317,712 $100,323 203,500 1,221,000 407,000 222,000 11,076,000 2,068,000 524,347 12,364,631 2,585,119 - “Prospective Resources” is the estimated quantities of petroleum that may potentially be recovered by the application of a future development project(s) relate to undiscovered accumulations. These estimates have both an associated risk of discovery and a risk of development. Further exploration appraisal and evaluation is required to determine the existence of a significant quantity of potentially moveable hydrocarbons. - The scope of the Reserve Studies reviewed basic information to prepare estimates of the reserves and contingent resources. 11 EMPIRE ENERGY GROUP LIMITED and its controlled entities Executive Chairman’s Review of Operation (Continued) - The quantities presented are estimated reserves and resources of oil and natural gas that geologic and engineering data demonstrate are “In-Place”, and can be recovered from known reservoirs. - Oil prices are based on NYMEX West Texas Intermediate (WTI). - Gas prices are based on NYMEX Henry Hub (HH). - Prices were adjusted for any pricing differential from field prices due to adjustments for location, quality and gravity, against the NYMEX price. This pricing differential was held constant to the economic limit of the properties. - All costs are held constant throughout the lives of the properties. - The probabilistic method was used to calculate P50 reserves. - The deterministic method was used to calculate 1P, 2P & 3P reserves. - The reference point used for the purpose of measuring and assessing the estimated petroleum reserves is - - - - - - - the wellhead. “PV0” Net revenue is calculated net of royalties, production taxes, lease operating expenses and capital expenditures but before Federal Income Taxes. “PV10” is defined as the discounted Net Revenues of the company’s reserves using a 10% discount factor. “1P Reserves” or “Proved Reserves” are defined as Reserves which have a 90% probability that the actual quantities recovered will equal or exceed the estimate. “Probable Reserves” are defined as Reserves that should have at least a 50% probability that the actual quantities recovered will equal or exceed the estimate. “Possible Reserves” are defined as Reserves that should have at least a 10% probability that the actual quantities recovered will equal or exceed the estimate. “Bbl” is defined as a barrel of oil. “Boe” is defined as a barrel of oil equivalent, using the ratio of 6 Mcf of Natural Gas to 1 Bbl of Crude Oil. This is based on energy conversion and does not reflect the current economic difference between the value of 1 Mcf of Natural Gas and 1 Bbl of Crude Oil. “M” is defined as a thousand. “MMBoe” is defined as a million barrels of oil equivalent. “Mcf” is defined as a thousand cubic feet of gas. - - - - All volumes presented are net volumes and have had subtracted associated royalty burdens. - Utica shale gas potential resources have only been calculated for the region where drill data is available. - Very few wells have been drilled into the Utica in Western NY and NW Pennsylvania. Estimates for GIP have been made were the few existing wells have been drilled. Empire holds additional acreage outside the current potential resource region. It is expected that as with shale characteristics, the shale formations will continue within the remaining acreage. The potential GIP should increase if more data was available. - Reserve estimates have been prepared by the following independent reserve engineers: - New York & Pennsylvania (Appalachia) and Kansas (Mid-Con) - Ralph E. Davis Associates, Inc. - Oklahoma (Mid-Con) - Pinnacle Energy Services, LLC. - Northern Territory - Muir & Associates P/L and Fluid Energy Consultants. - The following NYMEX price strip, as at December 31, 2016, was used to calculate reserves and cash flow: Year 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029+ $/Bbl 56.26 56.54 56.08 56.05 56.23 56.57 57.48 57.88 58.10 58.10 58.10 58.10 58.10 $/Mcf 3.62 3.09 2.87 2.88 2.91 2.94 3.02 3.16 3.31 3.46 3.61 3.76 3.89 12 EMPIRE ENERGY GROUP LIMITED and its controlled entities Executive Chairman’s Review of Operation (Continued) Reconciliation of Reserves – USA (NYMEX Strip Dec 31, 2016) Reserves/Resources - MBoe As at December 31, 2015 Appalachia Mid-Con Northern Territory (3) TOTAL Production 2016 1P 2P 3P(2) 3,968 1,964 5,142 7,557 98,623 7,710 5,932 12,699 106,333 Prospective (P50)** 203,467 0 1,846,500 2,049,967 Appalachia Mid-Con -316 -123 Changes (1) Appalachia Mid-Con Northern Territory (3) As at December 31, 2016 Appalachia Mid-Con Northern Territory (3) TOTAL Change 1,047 1,399 862 1,451 2,399 1,387 4,699 3,240 7,939 34% 6,004 9,008 101,022 9,097 15,012 18% 110,119 4% 221,500 203,467 0 2,068,000 2,271,467 11% ** Unrisked (1) Includes acquisitions, divestments, discoveries, extensions and revisions. (2) 3P includes shale reserves but subject to current fracking ban in NY State. (3) The Company has completed its initial stage of delineating a prospective resource in its Northern Territory MacArthur Basin acreage. Over the past 3 years this program has included on ground exploration (where possible under Aboriginal Land requirements), review of existing well and log data, assaying of core and 3D geological modelling of the entire basin. Based on this data, the Company has had completed an independent Prospective Resource P(50) estimate of 2,068 MMBoe. Prospective resources are as yet, undiscovered and as such carry significant exploration risk. The degree of uncertainty is ‘most likely’. (4) 1P, 2P & 3P are calculated on a deterministic basis with applicable volumes are measured at the wellhead. (5) Unrisked - this estimate of prospective petroleum resources must be read in conjunction with the cautionary statement on page 11. Net 2P Reserves: An updated Reserve Estimate was carried out as of December 31, 2016 at the NYMEX strip as at December 31, 2016. An updated summary of 2P Reserves is shown below. Total 2P reserves are 15.0 MMBoe. Approximately 4.5 MMBoe of 2P reserves are uneconomic at current oil/gas prices. Uneconomic reserves are mostly held by production and will be written back at higher gas prices. 20,000 18,000 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 - 2,021 1,971 2,126 2006 Gas MBoe 2P 2007 2008 Oil MBbl 2P RESERVES - 2P MBOE - 5,393 4,864 4,472 93 4,472 4,472 5,428 4,264 3,754 4,472 6,487 4,472 4,798 11,622 11,124 10,773 7,024 6,575 8,850 7,902 8,581 2010 2009 2012 Gas Uneconomic @ current price 2011 2014 2013 Oil Uneconomic @ current price 2015 2016 13 EMPIRE ENERGY GROUP LIMITED and its controlled entities Executive Chairman’s Review of Operation (Continued) Reconciliation of Economic Summary Projections – USA (NYMEX Strip Dec 31, 2016) Eco Projections PV10 ($M) As at December 31, 2015 1P 2P 3P (2) Appalachia Mid-Con TOTAL $12,727 $15,808 $28,535 $14,494 $30,004 $44,498 $15,746 $31,149 $46,895 Sales 2016 Changes (1) Appalachia Mid-Con -$3,626 -$4,865 Appalachia Mid-Con $8,520 $27,909 $6,793 $40,166 $13,223 $40,205 As at December 31, 2016 $21,287 $70,170 $91,457 106% Includes changes in strip prices, acquisitions, divestments, discoveries, extensions and revisions. Appalachia Mid-Con TOTAL Change $28,969 $71,354 $100,323 114% $17,621 $38,852 $56,473 98% (1) (2) Excludes any value attributable to NY shale reserves. (3) Reserves by: RE Davis Associates, Inc. & Pinnacle Energy Services, LLC Land Position The following table summarises the Company’s land holdings in Appalachia and the Mid-Continental regions in the United States and the Northern Territory, Australia, as at December 31, 2016. State 246,890 15,198 - 15,780 Total (Gross Acres) 262,260 15,198 4,937 16,340 ~14,600,000 14,898,735 NY PA OK KS NT TOTAL Marcellus/Utica = Shales, Appalachia Miss. = Mississippi Lime, MidCon CKU = Central Kansas Uplift: 277,868 HBP Marcellus Utica Miss. CKU 2017 2018 2019+ 262,260 8,293 - - 127,757 6,975 - - - - 4,937 6,098 - - 15,620 3,232 - 3,497 480 1,418 - 1,440 80 10,705 - - - 270,553 134,732 11,035 15,620 7,209 2,938 10,705 Arbuckle, Simpson, Viola, Lansing/Kansas City K. NORTHERN TERRITORY – A LARGE EMERGING PETROLEUM PLAY Empire Energy Group Limited, through its 100% owned subsidiary Imperial Oil & Gas Pty Ltd (“Imperial”), secured 100% interest in 59,000 square km (14.6 million acres) of prospective shale gas exploration acreage, approximately equal to 75% of the entire petroleum prospective central depositional trough of the Proterozoic McArthur Basin. The McArthur Basin is an underexplored petroleum frontier basin. - Over 2015/16 Imperial completed an extensive review of historical petroleum, mineral and water bore drilling and, where available, seismic and gravity data which showed the Tawallah Group of shales significantly extend within EP 184, EPA 183 and EP 187 in the McArthur Basin tenements. The study confirmed there is recognised source potential in the Tawallah Group units specifically within the McDermott and Wollogorang Formations as originally reported by Jackson et al (1987). A review has shown that historical core hole data identified shale source rock prospectivity in the Wollogorang and McDermott Formations of the Tawallah Group with live oil reported within the McDermott Formation in the GSD7 well drilled by BHP in 1995 (Brescianini and Brown 1995). The oil was described as coming from a 230 foot interval between 1800 and 2030 foot drill depth. This data was supported by mineral diamond drilling in 2014 that intersected 66ft of thick black organic rich shale intervals of the formation 14 EMPIRE ENERGY GROUP LIMITED and its controlled entities Executive Chairman’s Review of Operation (Continued) in a near surface positon on a domal anticline in the southern McArthur Basin. The presence of this deeper hydrocarbon generation from these formations demonstrates the increased potential for hydrocarbons below the Barney Creek Shale in EP187 and previously considered barren regions of EP184. - The work by Imperial has identified key correlations of interest across the Imperial tenements as the McDermott Formation with the Cottee Formation on the Arnhem Shelf and the Wollogorang Formation correlation with the McCaw Formation in the same area. This correlation may also include the Bonanza Creek Formation and the top of the Dhunganda Formation in the Walker Fault zone within EP(A) 180, 181 and 182. Importantly the McCaw Formation is generally considered to be 820 -1000 feet thick and locally up to 1300 feet thick. While the Cottee Formation is 1000 ft. thick and the Dhunganda Formation can be up to 1650 ft. thick. - A PRP(50) has not been calculated for the McDermott formation, but total areas mapped are approximately 2,000,000 acres, with an expected net average thickness of around 400 feet and with projected TOC’s between 6% to 7% in the EP187, EP184 and EP(A)183 and EP(A)188. The correlation work over 2016 showed that the same Tawallah Group of shales (and/or equivalents) extend northwards, underlying the Barney Creek shale equivalents in EPA’s 180, 181 and 182, adding a further estimated 10,000,000 acres to the potential resource base. This has the possibility of adding very significant additional resources to the current PRP(50). A study undertaken by Imperial in 2016 shows that the Wollogorang Shales extend through EP 184, 187 and EPA 188 into the northern McArthur EPA’s 180,181 and 182. Utilising a geological discount factor of only 0.1 (discounted by 90%) a PRP(50) = 221 MMBoe (3.7Tcfe) was calculated for the known Wollogorang Shales within the Company’s tenements. Refer to table below. - The Northern Territory Labor Party recently announced a review of fracking practices and procedures. While this review is being undertaken there will be no seismic or drilling done by Imperial. The Company had completed at its request an independent Prospective Resource as set out below: INDEPENDENTLY CERTIFIED ESTIMATED PROSPECTIVE RESOURCE (Unrisked) IDENTIFIED Barney Creek Formation Velkerri Formation Wollogorang Formation TOTAL Bcf MMBO Bcf MMBO Bcf MMBO MMBOE AREA M ac 2,982 P90 3,304 635 1,384 66 383 8 524 10 786 Conversion Factor oil:gas is 1:6. Refer to page 11 for definition of Prospective Resource P50 8,699 174 1,192 24 1,185 24 2,068 P10 20,172 403 3,086 62 2,371 47 4,783 L. COMPONENT PERSONS STATEMENT The information in this report which relates to the Company’s reserves is based on, and fairly represents, information and supporting documentation prepared by or under the supervision of the following qualified petroleum reserves and resources evaluators, all of whom are licensed professional petroleum engineer’s, geologists or other geoscientists with over five years’ experience and are qualified in accordance with the requirements of Listing Rule 5.42: Name Allen Barron John P Dick Wal Muir * SPE: Society of Petroleum Engineers *PESA: Petroleum Exploration Society of Australia None of the above evaluators or their employers have any interest in Empire Energy E&P, LLC or the properties reported herein. The evaluators mentioned above consent to the inclusion in the report of the matters based on their information in the form and context in which it appears. Organisation Ralph E Davis Associates, Inc Pinnacle Energy Services, LLC Muir and Associate P/L Professional Organisation SPE SPE PESA Qualifications BSc BPE BSc,MBA Note Regarding Forward- Looking Statements Certain statements made and information contained in this press release are forward-looking statements and forward looking information (collectively referred to as “forward-looking statements”) within the meaning of Australian securities laws. All statements other than statements of historic fact are forward-looking statements. 15 EMPIRE ENERGY GROUP LIMITED and its controlled entities DIRECTORS’ REPORT for the financial year ended 31 December 2016 In respect of the financial year ended 31 December 2016, the Directors of Empire Energy Group Limited (“Company”) present their report together with the Financial Report of the Company and of the consolidated entity (“Empire Group”), being the Company and its controlled entities, and the Auditor’s Report thereon. DIRECTORS The following persons held office as Directors of Empire Energy Group Limited at any time during or since the end of the financial year: B W McLeod D H Sutton K A Torpey Executive Chairman Non-Executive Director Non-Executive Director All the Directors have been in office since the start of the financial year unless otherwise stated. PRINCIPAL ACTIVITIES During the financial year the principal continuing activities of the consolidated entity consisted of: The acquisition, development, production, exploration and sale of oil and natural gas. The Empire Group sells its oil and gas products primarily to owners of domestic pipelines and refiners located in Pennsylvania, New York and Kansas. Reviewing new exploration, development and business opportunities in the oil and gas sector to enhance shareholder value. The Company holds two exploration licences and five licence applications over 14.6 million acres in the McArthur Basin, in the Northern Territory. Work undertaken to date has shown this region to be highly prospective for oil and gas shale. CONSOLIDATED RESULTS The consolidated net profit of the Empire Group for the financial year ended 31 December 2016 after providing for income tax was US$16,448,929 compared to a consolidated net loss for the previous corresponding reporting period of US$26,998,997. REVIEW OF OPERATIONS For information on a review of the Empire Group’s operations refer to the Executive Chairman’s Review of Operations Report contained on pages 4 to 15 of this annual report. DIVIDENDS The Directors have not recommended the payment of a final dividend. SIGNIFICANT CHANGES IN STATE OF AFFAIRS There were no significant changes in the state of affairs of the consolidated entity during the financial period under review. LIKELY DEVELOPMENTS Except for information disclosed on certain developments and the expected results of those developments included in this report under review of operations, further information on likely developments in the operations of the consolidated entity and the expected results of those operations have not been disclosed in this report because the Directors believe it would be likely to result in unreasonable prejudice to the consolidated entity. MATTERS SUBSEQUENT TO BALANCE DATE 1) In December 2015, the Company entered into a US$75,000,000 Farm-out agreement (“Farmout”) for the development of its Northern Territory (NT) assets with AEGP Australia Pty Ltd (AEGP) a company controlled by Mr Aubrey K. McClendon. The agreement included Imperial Oil & Gas’s 20% share of the Second Phase project funding. In March 2016 Mr McClendon was tragically killed in an accident. The Personal Representative of the McClendon Estate has confirmed that that Estate will not continue with the Farmout and in early 2017 AEGP and 16 EMPIRE ENERGY GROUP LIMITED and its controlled entities Directors’ Report for the year ended 31 December 2016 the Company agreed on the terms of a Termination Agreement for the Farmout. On 23rd January 2017 the Company signed the Termination Agreement and remains waiting for the return of the document from the McClendon Estate. 2) On 14 December 2016 Empire Energy Group Limited (the ‘Company’) announced a 11 for 5 pro-rata renounceable rights issue (‘Offer’) to raise approximately $6.1 million. The Offer was fully underwritten by 153 Fish Capital Pte Ltd (‘153 Fish Capital’). The Offer closed on the 27 January 2017. Existing shareholders took up 236,538,079 new shares under the Offer. The shortfall to the Offer was 527,553,373 shares amounting to approximately $4.2 million (“Shortfall Amount”). The Underwriter had forwarded to the Company Application Forms from Sub underwriters for a total of approximately $5.5 million (“Funds”) being approximately $1.3 million more than the Shortfall Amount. However, as of close of business on 17 February 2017 approximately $1.6 million of the Shortfall Amount had been received and shares have been issued. On 23 February 2017 the Company placed an additional 37,750,000 shares to investors as part of the shortfall. The Company is working with 153 Fish Capital to facilitate the placement of the remaining shortfall shares being $2.2 million. The Company does not have the available issuance capacity under ASX Listing Rule 7.1 to place the shares equivalent to the Shortfall without seeking shareholder approval. A General Meeting of the Company is being scheduled for the end of April 2017 with a date yet to be finalised as at the date of this report, to seek shareholder approval for the issue of 187,500,000 shares amounting to $1.5 million to place the remainder of the shortfall amount. The remainder of the shortfall will be issued under ASX Listing Rule 7.1 and 7.1A. 3) On 23 February 2017 the Company issued 17,693,153 shares to 153 Fish Capital Pte Ltd as a fee offset for the Offer. Following the share issues mentioned above the issued capital of the Company is 835,470,109 fully paid ordinary shares. There were no other matters or circumstances that have arisen since 31 December 2016 that has significantly affected or may significantly affect: • • • the operations, in financial years subsequent to 31 December 2016, of the Empire Group; or the results of those operations; or the state of affairs in financial years subsequent to 31 December 2016 of the Empire Group. INFORMATION ON DIRECTORS Bruce William McLeod, B.Sc (Maths), M.Com (Econ) Executive Chairman Age 64 Experience and Expertise Mr McLeod has had extensive experience in the Australian capital markets. Over the past 22 years he has been involved in raising debt and equity capital for a number of resource, property projects and companies, as well as the takeover and rationalisation of listed and unlisted companies. Prior to this he spent 6 years with a major international bank, where he was Executive Director, responsible for the financial and capital markets operations. Appointed a Director of the Company on 21 May 1996. Special Responsibilities Chairman of the Board – Chief Executive Officer and Member of Audit Committee Other Current Directorships Chairman of Anson Resources Limited. Former Directorships in Last 3 Years None. 17 EMPIRE ENERGY GROUP LIMITED and its controlled entities Directors’ Report for the year ended 31 December 2016 David Henty Sutton, B.Com ACIS Non-Executive Director Age 73 Experience and Expertise Mr Sutton has many years’ experience as a Director of companies involved with share broking and investment banking. He is the Executive Chairman and Director of Avalon Pacific Capital Pty Ltd (formerly Dayton Way Financial), a boutique financial services company focussing on the global resource sector. Prior to his current roles he was a partner and director of several securities exchange member firms. He became a member of the Stock Exchange of Melbourne and subsequently Australian Securities Exchange Limited. Appointed a Director of the Company on 17 January 1997. Special Responsibilities Member of Remuneration Committee and Member of Audit Committee Other Current Directorships Sinovus Mining Limited, and Avalon Pacific Capital Pty Ltd (formerly Dayton Way Financial) Former Directorships in Last 3 Years Silver Mines Limited, EHG Corporation Ltd, Chairman Precious Metals Limited Kevin Anthony Torpey, B.E., MIE Aus., CP Eng, FAusIMM, (CP) Non-Executive Director Age 77 Experience and Expertise Mr Torpey is a Chartered Professional Engineer and a graduate from Sydney University. Over the last 42 years he has been involved in the development of many diverse major projects involving oil, iron ore, aluminium, nickel, lead/zinc, uranium, magnesite, coal and gold, located locally and in Ireland and Indonesia. Generally these projects have been associated with major companies such as Consolidated Goldfields, EZ Industries, Alcan, International Nickel, Tara Minerals Limited (Ireland), Noranda, Denison Mines (Canada), Toyota, Mitsubishi and Iwatani. For the last 20 years his association has mainly been as a corporate officer initially as Managing Director of Denison Mines (Australia) and then Managing Director of Devex Limited. Over the last few years he has acted as a consultant to a number of companies involved in mining projects and new technologies. Appointed a Director of the Company on 26 November 1992. Special Responsibilities Member of Remuneration Committee and Member of Audit Committee Other Current Directorships Non-Executive Director of Latrobe Magnesium Limited Former Directorships in Last 3 Years None COMPANY SECRETARY Rachel Ryan Ms Ryan was employed in the Company’s Corporate Finances division in February 2006. She was appointed Joint Company Secretary on 21 July 2010 and assumed the role of Company Secretary on 31 July 2013. Ms Ryan also serves in the role of General Manager Operations. EXECUTIVES Kylie Arizabaleta B.Bus (Acct) (Fin) Financial Controller Ms Arizabaleta was appointed to the position of Financial Controller in March 2012. Before joining Empire Energy Group Limited she worked in the private practice as an external auditor and holds over 8 years’ experience. Dr John Warburton (FGS, MAICD) Director, Imperial Oil & Gas Pty Ltd Dr Warburton was appointed as an advisor to the Empire Energy Group in February 2010 and from March 2011 to March 2014 served as CEO of the Company’s wholly owned subsidiary Imperial Oil & Gas Pty Ltd. He continues as Non-Executive Director of Imperial Oil & Gas. A Geoscientist by profession, Dr Warburton has 34 years of technical 18 EMPIRE ENERGY GROUP LIMITED and its controlled entities Directors’ Report for the year ended 31 December 2016 and leadership experience in International Petroleum E&P including 11 years with BP and 4 years as General Manager Exploration & New Business for LASMO-Eni in Pakistan. Dr Warburton is currently Exploration & New Business Advisor to Oil Search Limited and is a Non-Executive Director of Senex Energy Limited. Dr Warburton’s operated & non-operated petroleum expertise covers the Middle East, Central and East Asia, Africa, Pakistan, Europe, Australia, New Zealand and PNG. John has been involved in the discovery of commercial oil & gas fields in Pakistan, UK, Kazakhstan, Azerbaijan and PNG and he has published 30 internationally recognised technical articles with particular focus on petroleum systems in complex fold and thrust belts. Dr Warburton has a First Class B.Sc. Honours Degree in Geological Sciences and a Ph.D. in Structural Geology. He is a Member of the Australian Institute of Company Directors, an Alumni of Cranfield Business School UK, a Fellow of the Geological Society of London and serves on the External Advisory Board at the Centre for Integrated Petroleum Engineering & Geoscience at the University of Leeds, UK. Geoff Hokin MSc(Hons) Geology; MSc Geology; Dip Coal Geology; Dip Training & Assessment, Cert IV Bus Mgmt.; Cert IV TAA; IQA ISO9000 & ISO14000 BMP Explorations & Operations, Imperial Oil & Gas Pty Ltd Mr Hokin holds the qualifications of Master Science (Honours) in Geology and a Master Science Geology (exploration, and basin setting and analysis). He has 14 years’ experience as an exploration geologist in the unconventional gas and coal sectors with various senior geology roles with a number of companies including Armour Energy Limited, Metgasco Limited, and Arrow Energy Limited. Mr Hokin has extensive geological and executive management experience to Executive Director level in other operations. He also holds post graduate qualifications in Anthropology and Cross Cultural Psychology with a particular focus on the Australian Aboriginals of Arnhem Land and the Southern Gulf region of the Northern Territory Australia. MEETINGS OF DIRECTORS The number of Directors’ meetings and committee meetings held and the attendance by each of the Directors of the Company at those meetings during the financial year were: Directors’ Meetings Remuneration Committee Meetings Audit Committee Meetings Director Attended Held Whilst in Office Attended Held Whilst in Office Attended Mr B W McLeod Mr D H Sutton Mr K A Torpey 17 17 17 17 17 17 - 1 1 - 1 1 7 7 7 Held Whilst in Office 7 7 7 The audit committee comprises the full Board of Directors. Mr D H Sutton and Mr K A Torpey were members of the remuneration committee during the financial year. Retirement, Election and Continuation in Office of Directors Mr D Sutton is the Director retiring by rotation at the next Annual General Meeting in accordance with Article 50.1 of the Company’s Constitution and being eligible offers himself for re-election. Remuneration Report – Audited This report outlines the remuneration arrangements in place for Directors and Executives of the Empire Group. REMUNERATION COMMITTEE The Remuneration Committee reviews and approves policy for determining executives remuneration and any amendments to that policy. The Committee makes recommendations to the Board on the remuneration of Executive Directors (including base salary, incentive payments, equity awards and service contracts) and remuneration issues for Non-Executive Directors. The members of the Remuneration Committee during the period were: D H Sutton – Independent Non-Executive Chairman K A Torpey – Independent Non-Executive The Committee meets as often as required but not less than once per year. The Committee met once during the period and Committee member’s attendance record is disclosed in the table of Directors Meetings shown above. 19 EMPIRE ENERGY GROUP LIMITED and its controlled entities Directors’ Report for the year ended 31 December 2016 Executive Directors’ and Executive Remuneration Executive remuneration and other terms of employment are reviewed annually and are based predominantly on the past year’s growth of the Empire Group’s net tangible assets and shareholder value, having regard to performance against goals set at the start of the year, relevant comparative information and independent expert advice. As well as basic salary, remuneration packages include superannuation and other bonuses and incentives linked to predetermined performance criteria. Executive Directors and executives are able to participate in an Employee Share Option Scheme. Remuneration packages are set at levels that are intended to attract and retain executives capable of managing the Consolidated Entity’s operations. Consideration is also given to reasonableness, acceptability to shareholders and appropriateness for the current level of operations. Performance Based Remuneration As part of the Executive Directors’ remuneration package there is a performance-based component, consisting of key performance indicators (KPIs). The intention of this program is to facilitate goal congruence between executives and that of the Empire Group and shareholders. Performance in relation to the KPIs will be assessed annually, with bonuses being awarded depending on performance of the Empire Group over the past year. Following the assessment, the KPIs will be reviewed by the Remuneration Committee in light of the desired and actual outcomes, and their efficiency assessed in relation to the Empire Group’s goals and shareholder wealth. Non-Executive Directors’ Remuneration Remuneration of Non-executive Directors is determined by the Board based on recommendations from the Remuneration Committee and the maximum amount approved by shareholders from time to time. Non-executive Directors are also able to participate in an Employee Share Option Scheme. The Board undertakes an annual review of its performance and the performance of the Board Committees against performance goals set. Details of the nature and amount of each element of the remuneration of each Director and each specified executive of the Empire Group receiving the highest remuneration are set out in the following tables. Short term benefits December 2016 Cash salary and fees US$ Bonus payments US$ Non- monetary US$ Post- employment benefits Super contributions US$ Long-term benefits Long service leave Share/optio n based payments* Total US$ - - - 26,795 - 2,010 14,886 26,414 - - 342,925(1) 14,886 - Directors B W McLeod K A Torpey D H Sutton J Warburton Executives A Boyer 319,452 (1) Includes accrued $216,732 but not paid. * Share/Option based payments reflect a proportion of the independently valued cost of options granted under the Employee Share Option Plan (“ESOP”). The cost shown is a non-cash cost and includes, on a pro-rata basis, the independently valued cost of options issued. Once the options reach vesting date, the cost shown amortises to $0. The non-cash cost of the above options issued under the ESOP over the year was $18,185 the non-cash loss on options relating to the above directors that expired over the year was $30,976. The net non-cash cost of options issued to the above directors and executives for the year was $(12,790). (2) Includes $78,000 of previous payments from 2013 to 2016 not paid. 15,288 - - - 384,627 16,896 14,886 253,000(2) 62,559 26,795 3,893 - - - - - - - - - - 20 EMPIRE ENERGY GROUP LIMITED and its controlled entities Directors’ Report for the year ended 31 December 2016 Short term benefits December 2015 Cash salary and fees US$ Bonus payments US$ Non- monetary US$ Post- employment benefits Super contributions US$ Long-term benefits Long service leave Share/optio n based payments* Total US$ - - - 83,191 25,211 - - 330,149 15,048 - Directors B W McLeod K A Torpey D H Sutton J Warburton Executives A Boyer 251,825 * Share/Option based payments reflect a proportion of the independently valued cost of options granted under the ESOP. The cost shown is a non-cash cost and includes, on a pro-rata basis, the independently valued cost of options issued. Once the options reach vesting date, the cost shown amortises to $0. The non-cash cost of the above options issued under the ESOP over the year was $55,268 the non-cash loss on options relating to the above directors that expired over the year was $25,649. The net non-cash cost of options issued to the above directors and executives for the year was $29,618. 46,769 - - - 402,129 16,402 15,048 - 1,354 15,048 178,000 65,326 83,191 8,499 - - - - - - - - - - Service Agreements Terms of employment with Mr B W McLeod (Executive Chairman) have been formalised in a service agreement. The terms of this agreement are as detailed below: Terms of the agreement: • • • • Agreed management consultant fees of A$460,735 in 2016 to be reviewed annually by the remuneration committee Payment of termination benefits apply other than for gross misconduct Performance based incentive bonus based on annual performance set against key performance indicators Long term incentives occurring up on the monetisation of an asset, this long term incentive continues beyond term of the agreement • Other benefits include provision of fully maintained motor vehicle and participation in the Company’s Director/Employee Share Option Plan The terms of the agreement have been approved by the remuneration committee. There are no other service agreements in place formalising the terms of remuneration of directors or specified executives of the Company and the consolidated entity. Loans to Directors and Executives There were no loans made to Directors or Specified Executives of the Company and the consolidated entity during the period commencing at the beginning of the financial period and up to the date of this report. There are no loans outstanding at the date of this report. Share Options Granted to Directors and Specified Executives During the financial year there were no executive options to acquire ordinary shares granted to Directors and specified executives of the Company. At the date of this report there were no unissued shares held under option to Directors and specified executives. Directors’ Interests and Benefits The relevant interest of each director and specified executive in the share capital of the Company as at the date of this report is: Particulars of Interests in the Issued Capital of the Company Direct Interest Director B W McLeod D H Sutton K A Torpey End of Audited Remuneration Report - 1,683,079 377,776 Shares Options - - - Indirect Interest Shares Options 24,229,999 384,333 5,378,116 - - - 21 EMPIRE ENERGY GROUP LIMITED and its controlled entities Directors’ Report for the year ended 31 December 2016 SHARE OPTIONS Movements Grant of Options The following options were granted during the financial year: Number 1,000,000 Unlisted options Exercise Price Pre Rights Issue A$ $0.03 Exercise Price post Rights Issue A$* $0.028 Expiry Date 25 August 2019 * Following a Pro-Rata Rights Issue announced in December 2016 the exercise price of outstanding options were adjusted pursuant to the terms and conditions of the options and ASX Listing Rule 6.22. No options were granted during the period since the end of the financial year and up to the date of this report. Exercise of Options No options were exercised during the financial year or in the period since the end of the financial year and up to the date of this report. Expiry of Options The following options expired during the financial period: Number 4,250,000 Unlisted options 3,500,000 Unlisted options 1,500,000 Unlisted options 1,500,000 Unlisted options 10,750,000 Exercise Price post Rights Issue A$ $0.119 $0.149 $0.169 $0.179 Expiry Date 26 February 2016 31 December 2016 31 December 2016 31 December 2016 No options have expired since the end of the financial year and up to the date of this report. At the date of this report the total number of unissued shares held under option was 1,000,000. These options are exercisable on the following terms. Number 1,000,000 Unlisted options * Adjustment of Option exercise prices Exercise Price pre Rights Issue A$ $0.03 Exercise Price post Rights Issue A$* $0.028 Expiry Date 25 August 2019 Following the completion of a Pro-Rata Rights Issue announced in December the exercise prices of 1,000,000 outstanding options were adjusted pursuant to the terms and conditions of the options and ASX Listing Rule 6.22 as outlined above. 22 EMPIRE ENERGY GROUP LIMITED and its controlled entities Directors’ Report for the year ended 31 December 2016 PERFORMANCE RIGHTS During the 2013 financial year the Company issued 2,500,000 Performance Rights over fully paid ordinary shares in the Company as part consideration for the buy back of the minority interest equity holder in Empire Energy USA LLC. The minority interest holder also received 4,000,000 fully paid ordinary shares in the issued capital of Empire Energy Group Limited. The Performance Rights are exercisable at no cost under the following events: - - Lifting of the current moratorium on oil and/or natural gas fracking in New York State; If the Company sells, transfers or assigns all or substantially all of its property interest Chautauqua and Cattaraugus Counties in the State of New York to an unaffiliated third party then the performance rights will vest in accordance with the following schedule: Fair Market Value of Consideration Received by the Company Less than $25.0 million Performance rights exercisable 0.0% At least $25.0 million but less than $45.0 million Percentage calculated by dividing Fair Market Value of Consideration received by the Company by $45.0 million. $45.0 million or more 100.0% - If the holder of the Performance Rights in any way disposes of more than 75% of the 4 million ordinary shares assigned as part of the minority interest buy back transaction prior to either the moratorium being terminated or a third party sale being consummated then the performance rights will be cancelled. DIRECTORS’ AND OFFICERS’ INDEMNITIES AND INSURANCE During the financial year Empire Energy Group Limited paid an insurance premium, insuring the Company’s Directors (as named in this report), Company Secretary, executive officers and employees against liabilities not prohibited from insurance by the Corporations Act 2001. A confidentiality clause in the insurance contract prohibits disclosure of the amount of the premium and the nature of insured liabilities. Proceedings on Behalf of the Company No person has applied for leave of court to bring proceedings on behalf of the Company or intervene in any proceedings to which the Company is a party for the purpose of taking responsibility on behalf of the Company for all or any part of those proceedings. The Company was not a party to any such proceedings during the year. Environmental Regulations There are significant environmental regulations surrounding mining activities which have been conducted by the Empire Group. However, there has been no breach of these regulations during the financial period or since the end of the financial period and up to the date of this report. Declaration by the Group Executive Officer and Chief Financial Controller The Directors have received and considered declarations from the Chief Executive Officer and Chief Financial Controller in accordance with Section 295A of the Corporations Act. The declaration states that in their opinion the Company’s and Consolidated Entity’s financial reports for the financial year ended 31 December 2016 present a true and fair view in all material aspects of the financial position and performance and are in accordance with relevant accounting standards. Non-Audit Services The Directors are satisfied that the provision of non-audit services during the period by the auditor (or by another person or firm on the auditors behalf) is compatible with the general standard of independence for auditors imposed by the Corporations Act 2001. Details of amounts paid or payable to the auditor for non-audit services are outlined in Note 32 to the financial statements. The audit firm is engaged to provide tax compliance services. The Directors believe that given the size of the Empire Group’s operations and the knowledge of those operations by the audit firm that it is appropriate for the auditor to provide these services. The Directors are of the opinion that these services will not compromise the auditor’s independence requirements of the Corporations Act 2001. 23 EMPIRE ENERGY GROUP LIMITED and its controlled entities Directors’ Report for the year ended 31 December 2016 Auditors’ Independence Declaration Under Section 307 of the Corporations Act 2001 A copy of the Auditors’ Independence declaration as required under Section 307C of the Corporations Act 2001 is set out on page 25 and forms part of the Director’s Report for the financial year ended 31 December 2016. Auditor Nexia Australia continues in office in accordance with Section 327 of the Corporations Act 2001. No officers of the Empire Group were previously partners of the audit firm. This report is made in accordance with a resolution of the Directors. B W McLEOD Director Sydney 17 March 2017 24 The Board of Directors Empire Energy Group Limited Level 7, 151 Macquarie Street SYDNEY NSW 2000 17 March 2017 To the Board of Directors of Empire Energy Group Limited Auditor’s Independence Declaration under section 307C of the Corporations Act 2001 As lead audit partner for the audit of the financial statements of Empire Energy Group Limited for the financial year ended 31 December 2016, I declare that to the best of my knowledge and belief, there have been no contraventions of: (a) the auditor independence requirements of the Corporations Act 2001 in relation to the audit; and (b) any applicable code of professional conduct in relation to the audit. Yours sincerely Nexia Sydney Partnership Lester Wills Partner 25 EMPIRE ENERGY GROUP LIMITED and its controlled entities CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME for the year ended 31 December 2016 Note Year ended December 2016 US$ Year ended December 2015 US$ 5a 6 5b 8a 7 9a Sales Revenue Cost of Sales Gross Profit Other income General and administration expenses Exploration expenses Other non-cash expenses Operating Profit/(Loss) before interest costs Net interest (expense)/income Profit/ (Loss) before income tax expense Income tax (expense)/benefit Profit/ (Loss) after income tax benefit from continuing operations Other comprehensive income (Loss) on the revaluation of available-for-sale assets Exchange differences on translation of foreign operations Other comprehensive income for the year, net of tax 14,538,956 (8,604,524) 5,934,432 229,770 (3,301,879) (318,869) 16,373,999 18,917,453 18,236,209 (9,701,346) 8,534,863 493,278 (4,746,575) (955,295) (30,507,331) (27,181,060) (2,420,361) (2,059,868) 16,497,092 (29,240,928) (48,163) 2,241,931 16,448,929 (26,998,997) - 26,890 (5,145) (175,883) 26,890 (181,028) Total comprehensive income for the year 16,475,819 (27,180,025) Basic earnings per share Diluted earnings per share 28 28 Cents per share 4.76 4.76 Cents per share (7.84) (7.84) The above statements of comprehensive income should be read in conjunction with the accompanying notes. 26 EMPIRE ENERGY GROUP LIMITED and its controlled entities CONSOLIDATED STATEMENT OF FINANCIAL POSITION as at 31 December 2016 Note As at December 2016 US$ As at December 2015 US$ CURRENT ASSETS Cash and cash equivalents Trade and other receivables Prepayments Inventories Financial assets, including derivatives TOTAL CURRENT ASSETS NON-CURRENT ASSETS Financial assets, including derivatives Oil and gas properties Property, plant and equipment Intangible assets TOTAL NON-CURRENT ASSETS TOTAL ASSETS CURRENT LIABILITIES Trade and other payables Interest-bearing liabilities Provisions TOTAL CURRENT LIABILITIES NON-CURRENT LIABILITIES Interest-bearing liabilities Provisions Deferred income tax liability TOTAL NON-CURRENT LIABILITIES TOTAL LIABILITIES NET ASSETS EQUITY Contributed equity Reserves Accumulated losses TOTAL SHAREHOLDERS’ EQUITY 10 11 12 13 13 14 14 15 16 17 18 17 18 9(e) 19 641,493 2,175,522 437,535 544,772 2,022,174 1,126,543 1,874,474 672,044 553,184 5,579,991 5,821,496 9,806,236 1,334,091 83,943,173 487,872 68,217 5,766,521 58,275,023 532,286 68,217 85,833,353 64,642,047 91,654,849 74,448,283 3,871,331 38,656,987 6,986 3,760,766 40,460,495 12,377 42,535,304 44,233,638 - 12,902,647 - 31,560 11,496,833 - 12,902,647 11,528,393 55,437,951 55,762,031 36,216,898 18,686,252 74,239,177 5,175,471 (43,197,750) 74,240,545 4,436,865 (59,991,158) 36,216,898 18,686,252 The above consolidated statements of financial position should be read in conjunction with the accompanying notes. 27 EMPIRE ENERGY GROUP LIMITED and its controlled entities CONSOLIDATED STATEMENT OF CHANGES IN EQUITY for the year ended 31 December 2016 Consolidated Issued Capital Fair Value Reserve Foreign Currency Translation Reserve Options Reserve Accumulated Losses Attributable to owners of equity parent Total Equity Balance at 31 December 2015 74,240,545 127,396 (96,233) 4,405,702 (59,991,158) 18,686,252 18,686,252 Total Comprehensive income for year Profit after income tax from continuing operations Exchange differences on translation of foreign operations Total comprehensive income for the year Transactions with owners, recorded directly in equity Issue of ordinary shares Less: share issue transaction costs Options lapsed in period, transferred to retained earnings Options issued during the year – share-based payments Warrants issued during the year Total transactions with owners - - - 30,304 (31,672) - - - (1,368) - - - - - - - - - - 26,890 26,890 - - - - - - - - - - - (344,479) 36,613 1,019,582 711,716 16,448,929 16,448,929 16,448,929 - 26,890 26,890 16,448,929 16,475,819 16,475,819 - - 344,479 - - 344,479 30,304 (31,672) - 36,613 1,019,582 1,054,827 30,304 (31,672) - 36,613 1,019,582 1,054,827 Balance at 31 December 2016 74,239,177 127,396 (69,343) 5,117,418 (43,197,750) 36,216,898 36,216,898 The above consolidated statements of changes in equity should be read in conjunction with the accompanying notes. 28 EMPIRE ENERGY GROUP LIMITED and its controlled entities CONSOLIDATED STATEMENT OF CHANGES IN EQUITY for the year ended 31 December 2016 Consolidated Issued Capital Fair Value Reserve Foreign Currency Translation Reserve Options Reserve Accumulated Losses Attributable to owners of equity parent Total Equity Balance at 31 December 2014 73,683,238 132,541 79,650 4,228,939 (32,992,161) 45,132,207 45,132,207 Total Comprehensive income for year Profit after income tax from continuing operations Exchange differences on translation of foreign operations Gain on the revaluation available-for-sale investments, net of tax Total comprehensive income for the year Transactions with owners, recorded directly in equity Issue of ordinary shares Less: share issue transaction costs Options lapsed in period, transferred to retained earnings Options issued during the year – share-based payments Warrants issued during the year Total transactions with owners - - - - 571,563 (14,256) - - - 557,307 - - - (175,883) (5,145) - (5,145) (175,883) - - - - - - - - - - - - - - - - - - - 176,763 - 176,763 (26,998,997) (26,998,997) (26,998,997) (175,883) (175,883) - (5,145) (5,145) (26,998,997) (27,180,025) (27,180,025) - - - - - - 571,563 (14,256) - 571,563 (14,256) - 176,763 176,763 - - 734,070 734,070 Balance at 31 December 2015 74,240,545 127,396 (96,233) 4,405,702 (59,991,158) 18,686,252 18,686,252 The above consolidated statements of changes in equity should be read in conjunction with the accompanying notes. 29 EMPIRE ENERGY GROUP LIMITED and its controlled entities CONSOLIDATED STATEMENT OF CASH FLOWS for the year ended 31 December 2016 CASH FLOWS FROM OPERATING ACTIVITIES Receipts from customers Payments to suppliers and employees Interest received Interest paid Income taxes paid Net cash flows from operating activities CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from sale of oil and gas assets Proceeds from sale of investments in equity Payments for oil and gas assets Payments for property, plant and equipment Net cash flows from investing activities CASH FLOWS FROM FINANCING ACTIVITIES Net proceeds from issuing of shares Repayment of interest bearing liabilities Finance lease payments Net cash flows from financing activities Note Year ended 31 December 2016 US$ Year ended 31 December 2015 US$ 14,417,766 (11,993,762) 298 (2,267,051) (48,163) 109,088 21,191,292 (17,640,200) 4,416 (2,074,475) 179,851 1,660,884 27(b) 49,419 - (119,038) (69,281) 201,815 207,030 (1,468,461) (21,371) (138,900) (1,080,987) (1,368) (464,881) (13,298) 557,307 (3,180,449) (10,874) (479,547) (2,634,016) Net (decrease)/increase in cash and cash equivalents (509,359) (2,054,119) Cash and cash equivalents at beginning of financial year Effect of exchange rate changes on cash and cash equivalents 1,126,543 24,309 3,092,991 87,671 CASH AND CASH EQUIVALENTS AT THE END OF FINANCIAL YEAR 27(a) 641,493 1,126,543 The above consolidated statements of cash flow should be read in conjunction with the accompanying notes. 30 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2016 1. SIGNIFICANT ACCOUNTING POLICIES Corporate information The financial report covers Empire Energy Group Limited and its controlled entities (“Empire Group”). Empire Group is a company limited by shares whose shares are publicly traded on the Australian Securities Exchange. The parent entity of the Empire Group is incorporated and domiciled in Australia with its core operations in the United States of America (“USA”). The principal activities of the Empire Group during the financial year are described in the Directors’ Report. The financial report of the Empire Group for the year ended 31 December 2016 was authorised for issue in accordance with a resolution of Directors on 17 March 2017. Basis of preparation The general purpose financial statements have been prepared in accordance with Australian Accounting Standards, other authoritative pronouncements of the Australian Accounting Standards Board, Urgent Issues Group Interpretations, and the requirements of the Corporations Act 2001, as appropriate for for-profit orientated entities. The consolidated financial statements have been prepared on a cost basis, modified, where applicable, by the measurement at fair value of available-for-sale financial assets and derivative financial instruments. Statement of compliance The financial report complies with Australian Accounting Standards (‘AASB’s’). Compliance with AASBs ensures that the financial report, comprising the financial statements and accompanying notes, complies with International Financial Reporting Standards (‘IFRS’). Presentation currency Due to sustained international growth, the Empire Group’s cash flows and economic returns are now principally denominated in US dollars (“US$”). From 1 July 2011, Company changed the currency in which it presents its consolidated and parent Company financial statements from Australian dollars to US dollars. New, revised or amending Accounting Standards and Interpretations adopted None of the new standards and amendments to standards that are mandatory for the first time for the financial year beginning 1 January 2016 affected any of the amounts recognised in the current period or any prior period and are not likely to affect future periods. Early adoption of standards The Empire Group has not elected to apply any pronouncements before their operative date in the annual reporting period beginning 1 January 2016. Principles of Consolidation The consolidated financial statements comprise the financial statements of Empire Energy Group Limited and its controlled entities. Controlled entities are all those entities over which the Empire Group has the power to govern the financial and operating policies. Controlled entities are consolidated from the date on which control is transferred to the Empire Group and cease to be consolidated from the date on which control is transferred out of the Empire Group. Jointly controlled entities are accounted for using the equity method (equity accounted investees) and are initially recognised at cost. All intercompany transactions, balance, including unrealised profits arising from intercompany transactions, have been eliminated in full. Unrealised losses are eliminated unless costs cannot be recovered. The acquisition of subsidiaries is accounted for using the acquisition method of accounting. A change in ownership, without the loss of control, is accounted for as an equity transaction, where the difference between the consideration transferred and the book value of the share of the non-controlling interest acquired is recognised directly in the equity attributable to the parent. 31 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2016 1. SIGNIFICANT ACCOUNTING POLICIES (Continued) Non-controlling interest in the results and equity of subsidiaries are shown separately in the consolidated statement of comprehensive income and consolidated statement of financial position. Losses incurred by the Empire Group are attributed to non-controlling interest in full, even if that results in a deficit balance. Foreign Currency Translations The financial report is presented in United States Dollars (US$) which is the functional currency for the majority of the entities within the Empire Group. The functional currency of Empire Energy Group Limited is in Australian Dollars. Foreign currency transactions Transactions in foreign currencies are translated at the foreign exchange rate ruling at the date of the transaction. Monetary assets and liabilities denominated in foreign currencies at the end of the reporting period are translated to US dollars at the foreign exchange rate ruling at that date. Foreign operations The assets and liabilities of entities that have a functional currency in A$ are translated to US$ at exchange rates at the reporting date. The revenue and expense of entities that have a functional currency in A$ are translated to US dollars at exchange rates at the dates of the transaction. Foreign currency differences on translation are recognised directly in equity. Revenue recognition Natural gas revenue Revenue from the sale of natural gas is recognised when natural gas has been delivered to a custody transfer point, persuasive evidence of a sales arrangement exists, the rights and responsibility of ownership pass to the purchaser upon delivery, collection of revenue from the sale is reasonably assured, and the sales price is fixed or determinable. Natural gas is sold by the Empire Group under contracts with terms ranging from one month up to the life of the well. Virtually all of the Empire Group contracts' pricing provisions are tied to a market index with certain adjustments based on, among other factors, whether a well delivers to a gathering or transmission line, quality of natural gas and prevailing supply and demand conditions, so that the price of the natural gas fluctuates to remain competitive with other available natural gas suppliers. Because there are timing differences between the delivery of natural gas and the Empire Group's receipt of a delivery statement, the Empire Group has unbilled revenues. These revenues are accrued based upon volumetric data from the Empire Group's records and the Empire Group's estimates of the related transportation and compression fees, which are, in turn, based upon applicable product prices. Oil revenue Revenue from the sale of oil is recognised when the significant risks and rewards of ownership have been transferred to the buyer and can be measured reliably, which is usually at the time of lifting, transferred into a vessel, pipe or other delivery mechanism. Well operations Well operations and pipeline income are recognised when persuasive evidence of an arrangement exists, services have been rendered, collection of revenues is reasonably assured and the sales price is fixed or determinable. The Empire Group is paid a monthly operating fee for each well it operates for outside owners. The fee covers monthly operating and accounting costs, insurance and other recurring costs. The Empire Group might also receive additional compensation for special nonrecurring activities, such as reworks and recompletions. Finance income Finance income comprises interest income on funds invested as well as fair value gains on oil and gas derivatives the group is party to. Interest income is recognised as it accrues, using the effective interest method. 32 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2016 1. SIGNIFICANT ACCOUNTING POLICIES (Continued) Cash and cash equivalents Cash and cash equivalents includes cash on hand, deposits held at call with financial institutions, other short-term, highly liquid investments with original maturities of three months or less that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value. For the statement of cash flows presentation purposes, cash and cash equivalents also includes bank overdrafts, which are shown within borrowings in current liabilities on the statement of financial position. Trade and other receivables Trade receivables, which generally have 30-90 day terms, are recognised and carried at original invoice amount less an allowance for any uncollectible amounts. An estimate for doubtful debts is made when collection of the full amount is no longer probable. Bad debts are written-off when identified. Inventories Inventories consists of crude oil, stated at the lower of cost to produce or market and other production supplies intended to be used in natural gas and crude oil operations. Financial Assets, including derivatives The Empire Group utilises oil and gas forward contracts to manage the exposure to price volatility. The Empire Group recognises its derivatives on the consolidated statement of financial performance at fair value at the end of each period. Changes in the fair value of the oil and gas forward contracts are recognised in the statement of profit and loss. Derivatives are classified as current or non-current depending on the expected period of realisation. Oil and gas properties Oil and gas properties are stated at cost, less accumulated depreciation and accumulated impairment losses. Oil and natural gas exploration and development expenditure is accounted for using the successful efforts method of accounting for gas producing activities. Costs to acquire mineral interests in gas properties, drill and equip exploratory wells that find proved reserves, and drill and equip development wells and related asset retirement costs are capitalised. Depletion is based on cost less estimated salvage value using the unit-of-production method. The process of estimating and evaluating gas reserves is complex, requiring significant decisions in the evaluation of geological, geophysical, engineering and economic data. Costs to drill exploratory wells that do not find proved reserves, geological and geophysical costs, and costs of carrying and retaining unproved properties are expensed. Major maintenance and repairs Expenditure on major maintenance refits or repairs comprises the cost of replacement assets or parts of assets, inspection costs and overhaul costs. Where an asset or part of an asset that was separately depreciated and is now written off is replaced and it is probable that future economic benefits associated with the item will flow to the Empire Group, the expenditure is capitalised. Where part of the asset was not separately considered as a component, the replacement value is used to estimate the carrying amount of the replaced assets which is immediately written off. Property, plant and equipment Property, plant and equipment is stated at cost less accumulated depreciation and any impairment in value. The capitalised value of a finance lease is also included within property, plant and equipment. Plant and equipment are depreciated over their estimated useful lives using the straight line method as follows: Plant and equipment 10-20% Assets are depreciated from the date of acquisition. Profits and losses on sales of property, plant and equipment are taken into account in determining the results for the year. For an asset that does not generate largely independent cash inflows, the recoverable amount is determined for the cash-generating unit to which the asset belongs. 33 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2016 1. SIGNIFICANT ACCOUNTING POLICIES (Continued) Recoverable amount of assets At each reporting date, the Empire Group assesses whether there is any indication that an asset may be impaired. Where an indicator of impairment exists, the Empire Group makes a formal estimate of recoverable amount. Where the carrying amount of an asset exceeds its recoverable amount the asset is considered impaired and is written down to its recoverable amount. Recoverable amount is the greater of value less costs to sell and value in use. It is determined for an individual asset, unless the asset’s value in use cannot be estimated to be close to its fair value less costs to sell and it does not generate cash inflows that are largely independent of those from other assets or Empire Groups of assets, in which case, the recoverable amount is determined for the cash-generating unit to which the asset belongs. In assessing value in use, the estimated future cash flows are discounted to their present value using a pre tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset or cash generating unit. Investments All investments are initially recognised at cost, being the fair value of the consideration given and including acquisition charges associated with the investment. Certain investments in equity securities are classified as available-for-sale financial assets. Subsequent to initial recognition, they are measured at fair value and changes therein are recognised directly in equity. For unlisted investments, where information regarding the fair value is unreliable, the investment is held at cost under AASB139. When an investment is derecognised, the cumulative gain or loss in equity is transferred to profit or loss. For investments that are actively traded in organised financial markets, fair value is determined by reference to Stock Exchange quoted market bid prices at the close of business on the reporting date. Intangible Assets Intangible assets consist of goodwill. Goodwill is tested for impairment annually under AASB 136. Interest-bearing liabilities Interest-bearing borrowings are recognised initially at fair value less attributable transaction costs. Subsequent to initial recognition, interest-bearing borrowings are stated at amortised cost with any difference between cost and redemption value being recognised in the income statement over the period of the borrowings on an effective interest basis. Provisions – Employee Benefits Obligations for contributions to accumulation plans are recognised as an expense in the consolidated statements of comprehensive income as incurred. Liabilities for employee benefits for wages, salaries, annual leave and represent present obligations resulting from employees’ services provided to reporting date, calculated at undiscounted amounts based on remuneration wage and salary rates that the Empire Group expects to pay as at the reporting date including related on-costs, such as, workers compensation insurance, superannuation and payroll tax. Asset Retirement Obligations Asset retirement obligations are recognised when the Empire Group has a present legal or constructive obligation as a result of past events, and it is probable that an outflow of resources will be required to settle the obligation, and a reliable estimate of the amount of obligation can be made. The present value of the estimated asset retirement costs is capitalised as part of the carrying amount oil and gas properties. For the Empire Group, asset retirement obligations primarily relate to the plugging and abandonment of oil and gas-producing facilities. The estimated liability is based on historical experience in plugging and abandoning wells, estimated remaining lives of those based on reserve estimates, external estimates as to the cost to plug and abandon the wells in the future, and regulatory requirements. The liability is discounted using a discount rate that reflects market conditions as at reporting date. Revisions to the liability could occur due to changes in estimates of plugging and abandonment costs, 34 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2016 1. SIGNIFICANT ACCOUNTING POLICIES (Continued) remaining lives of the wells, if regulations enact new plugging and abandonment requirements, or there is a change in the market- based discount rate. Changes in the estimated timing of decommissioning or decommissions cost estimates are dealt with prospectively by recording an adjustment to the provision, and a corresponding adjustment to oil and gas properties. The unwinding of the discount of the asset retirement obligation is recognised as a finance cost. Income tax Current tax is the expected tax payable on the taxable income for the year, using tax rates enacted or substantially enacted at the balance sheet date, and any adjustment to tax payable in respect of previous years. Deferred tax is provided using the balance sheet liability method, providing for temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for taxation purposes. The amount of deferred tax provided is based on the expected manner of realisation of settlement of the carrying amount of assets and liabilities, using tax rates enacted or substantively enacted at the balance sheet date. A deferred tax asset is recognised only to the extent that it is probable that future taxable profits will be available against which the asset can be utilised. Deferred tax assets are reduced to the extent that it is no longer probable that the related tax benefit will be realised. Tax consolidation Empire Energy Group and its wholly-owned Australian resident entities form a tax-consolidated Empire Group. As a consequence, all members of the tax-consolidated Empire Group have been taxed as a single entity since 1 July 2003. The head entity within the tax-consolidated Empire Group is Empire Energy Group Limited. Current tax expense/income, deferred tax liabilities and deferred tax assets arising from temporary differences of the members of the tax-consolidated Empire Group are recognised in the separate financial statements of the members of the tax-consolidated Empire Group using the ‘separate taxpayer within Empire Group’ approach by reference to the carrying amounts of assets and liabilities in the separate financial statements of each entity and the tax values applying under tax consolidation. Any current tax liabilities (or assets) and deferred tax assets arising from unused tax losses of the subsidiaries are assumed by the head entity in the tax-consolidated Empire Group and are recognised by the Empire Group as amounts payable/(receivable) to/from other entities in the tax-consolidated Empire Group in conjunction with any tax funding arrangement amounts (refer below). Any difference between these amounts is recognised by the Empire Group as an equity contribution or distribution. The Empire Group recognises deferred tax assets arising from unused tax losses of the tax consolidated Empire Group to the extent that it is probable that future taxable profits of the tax consolidated Empire Group will be available against which the asset can be utilised. Any subsequent period adjustments to deferred tax assets arising from unused tax losses as a result of revised assessments of the probability of recoverability is recognised by the head entity only. Nature of tax funding arrangements and tax sharing arrangements The head entity, in conjunction with other members of the tax-consolidated Empire Group, has entered into a tax funding arrangement which sets out the funding obligations of members of the tax-consolidated Empire Group in respect of tax amounts. The tax funding arrangements require payments to/from the head entity equal to the current tax liability/(asset) assumed by the head entity and any tax-loss deferred tax asset assumed by the head entity, resulting in the head entity recognising an inter-entity receivable/(payable) equal in amount to the tax liability/(asset) assumed. The inter-entity receivables/(payables) are at call. Contributions to fund the current tax liabilities are payable as per the tax funding arrangement and reflect the timing of the head entity’s obligation to make payments for tax liabilities to the relevant tax authorities. The head entity in conjunction with other members of the tax-consolidated Empire Group, has also entered into a tax sharing agreement. The tax sharing agreement provides for the determination of the allocation of income tax liabilities between the entities should the head entity default on its tax payment obligations. No amounts have been recognised in the financial statements in respect of this agreement as payment of any amounts under the tax sharing agreement is considered remote. 35 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2016 1. SIGNIFICANT ACCOUNTING POLICIES (Continued) Goods and Services Tax Revenues, expenses and assets are recognised net of the amount of goods and services tax (GST), except where the amount of GST incurred is not recoverable from the Australian Taxation Office (ATO). In these circumstances the GST is recognised as part of the cost of acquisition of the asset or as part of an item of the expense. Receivables and payables are stated with the amount of GST included. The net amount of GST recoverable from, or payable to, the ATO is included as a current asset or liability in the Consolidated Statement of Financial Position. Cash flows are included in the statement of cash lows on a gross basis. The GST components of cash flows arising from investing and financing activities which are recoverable from, or payable to, the ATO are classified as operating cash flows. Earnings per share Earnings per share is calculated by dividing the profit attributable to the owners of Empire Energy Group Limited, excluding any costs of servicing equity other than ordinary shares, by the weighted average number of ordinary shares outstanding during the financial year. There are no preference shares issued in Empire Energy Group Limited, thereby resulting in no dilutive effect being noted in any calculation of diluted earnings per share. Share based payment transactions The Empire Group provides benefits to directors and senior executives of the Empire Group through the executive share option plan whereby eligible participants render services in exchange for options over shares. New Accounting Standards and Interpretations not yet adopted Australian Accounting Standards and Interpretations that have recently been issued or amended but are not yet mandatory, have not been early adopted by the consolidated entity for the annual reporting period ended 31 December 2016. The consolidated entity’s assessment of the impact of these new or amended Accounting Standards and Interpretations, most relevant to the consolidated entity, are set out below. New and Revised Standards that are effective for Annual Periods beginning on or after 1 January 2017 AASB 2016-1 Recognition of Deferred Tax Assets for Unrealised Losses [AASB 112] This Standard amends AASB 112 Income Taxes to clarify the circumstances in which the recognition of deferred tax assets may arise in respect of unrealised losses on debt instruments measured at fair value. AASB 2016-2 Disclosure Initiative: Amendments to AASB 107 This Standard amends ASB 107 Statement of Cash Flows to include additional disclosures and reconciliation relating to changes in liabilities arising from financing activities, including both changes arising from cashflows and non-cash changes. AASB 2016-3 Clarifications to AASB 15 This Standard amends AASB 15 Revenue from Contracts with Customers to clarify the requirements on identifying performance obligations, principal versus agent considerations and the timing of recognising revenue from granting a licence, it provides further practical expedients on transition to AASB 15. AASB 2016-5 Classifications and Measurement of Share-based Payment Transactions This Standard amends AASB 2 Share-based Payment to address: (a) the accounting for the effects of vesting and non-vesting conditions on the measurement of cash-settled share-based payments; 36 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2016 1. SIGNIFICANT ACCOUNTING POLICIES (Continued) (b) the classification of share-based payment transactions with a net settlement feature for withholding tax (c) obligations; and the accounting for a modification to the terms and conditions of a share-based payment that changes the classification of the transaction from cash-settled to equity-settled. AASB 2014-10 Sale of Contribution of Assets between an Investor and its Associate or Joint Venture (Amendments to AASB 10 and AASB 128) Amends AASB 10 and AASB128 to remove the inconsistency in dealing with the sale or contribution of assets between an investor and its associate or joint venture. A full gain or loss is recognised when a transaction involves a business (whether it is housed in a subsidiary or not). A partial gain or loss is recognised when a transaction involves assets that do not constitute a business, even if these assets are housed in a subsidiary. The mandatory application date of AASB 2014-10 has been amended and deferred to annual reporting periods beginning on or after 1 January 2018 by AASB 2015-140. AASB 9 Financial Instruments AASB 9 includes requirements for the classification and measurement of financial assets and incorporates amendments to the accounting for financial liabilities and hedge accounting rules to remove the quantitative hedge effectiveness tests and have been replaced with a business model test. AASB 9 improves and simplifies the approach for classification and measurement of financial assets compared with the requirements of AASB 139 as follows: (a) Financial assets that are debt instruments will be classified based on (1) the objective of the entity’s business model for managing the financial assets; (2) the characteristics of the contractual cash flows. (b) Allows an irrevocable election on initial recognition to present gains and losses on investments in equity instrument that are not held for trading in other comprehensive income. (c) Financial assets can be designated and measured at fair value through profit or loss at initial recognition if doing so eliminates or significantly reduces a measurement or recognition inconsistency that would arise from measuring assets or liabilities, or recognising the gains and losses on them, on different bases. i. Where the fair value option is used for financial liabilities the change in fair value, the change attributable to changes in credit risk are present in other comprehensive income (OCI) and the remaining change is presented in profit or loss. AASB 2012-6 also modifies the relief from restating prior periods by amending AASB 7 to require additional disclosures on transition to AASB 9 in some circumstances. Consequential amendments were made to other standards as a result of AASB 9 by AASB 2014-7 and AASB 2014-8. The mandatory application date of AASB 9 has been deferred to annual reporting periods beginning on or after 1 January 2018 by AASB 2014-1. AASB 15 Revenue from Contracts with Customers AASB 15 replaces AASB 118 Revenue, AASB 111 Construction Contracts and four interpretations issued by the AASB and amends the principles for recognising revenue from contracts with customers. The Standard requires an entity to recognise revenue on a basis that depicts the transfer of promised goods or services to customers at an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve that principle, an entity shall apply all of the following steps: (a) identify the contract with a customer; (b) identify the separate performance obligations in the contract; (c) determine the transaction price; (d) allocate the transaction price to the separate performance obligations in the contract; and (e) recognise revenue when (or as) the entity satisfies a performance obligation. Consequential amendments to other Standards are made by AASB 2014-5 Amendments to Australian Accounting Standards arising from AASB 15. 37 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2016 1. SIGNIFICANT ACCOUNTING POLICIES (Continued) AASB 16 Leases AASB 16 replaces AASB 117 Leases and sets out the principles for the recognition, measurement, presentation and disclosure of leases. AASB 16 introduces a single lessee accounting model and requires a lessee to recognise assets and liabilities for all leases with a term of more than 12 months, unless the underlying asset is of low value. A lessee is required to recognise a right-of-use asset representing its right to use the underlying leased asset and a lease liability representing its obligations to make lease payments. A lessee measure right-of-use assets similarly to other non-financial assets (such as property, plant and equipment) and lease liabilities similarly to other financial liabilities. As a consequence, a lessee recognises depreciation of the right-of-use asset and interest on the lease liability, and also classifies cash repayments of the lease liability into a principal portion and an interest portion and presents them in the statement of cash flows applying AASB 107 Statement of Cash Flows. AASB 16 substantially carries forward the lessor accounting requirements in AASB 117 Leases. Accordingly, a lessor continues to classify its leases as operating leases or finance leases. Early application is permitted provided the entity also applies AASB 15 Revenue from Contracts with Customers at or before the same date. Estimates and assumptions In particular, information about significant areas of estimation uncertainty considered by management in preparing the consolidated financial statements are described in the following notes: 2. CRITICAL ACCOUNTING JUDGMENTS, ESTIMATES AND ASSUMPTIONS • Note 8 • Note 9 • Note 14 • Note 18 • Note 24 – Impairment expense – Income tax – Oil and gas properties – Provisions for liabilities and charges – Share based payments Judgments In the process of applying the Empire Group’s accounting policies, the Directors have made the following judgments at apart from those involving estimates, which may have the most significant effect on the amounts recognised in the consolidated financial statements: Reserves base Estimates of recoverable quantities of proven, probable and possible reserves reported include judgmental assumptions regarding commodity prices, exchange rates, discount rates and production and transportation costs for future cash flows. It also requires interpretation of complex and difficult geological and geophysical models in order to make assessment of the size, shape, depth and quality of reservoirs, and their anticipated recoveries. The economic, geological and technical factors used to estimate may change from period to period. Changes in reported reserves can impact asset carrying values and the recognition of deferred tax assets due to changes in expected future cash flows. Reserves are integral to the amount of amortisation charged to the income statement. Future development costs are estimated using assumptions as to the number of wells required to produce the commercial reserves, the cost of such wells and associated production and other capital costs. The current NYMEX forward oil and gas price curves are used for price assumptions. The Empire Group uses suitably qualified persons to prepare annual evaluation of proven hydrocarbon reserves, compliant with US professional standards for petroleum engineers. Carrying value of oil and gas assets Oil and gas properties are depreciated using the units-of-production (UOP) method over proved developed and undeveloped reserves. 38 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2016 2. CRITICAL ACCOUNTING JUDGMENTS, ESTIMATES AND ASSUMPTIONS (Continued) The calculation of the UOP rate of depreciation, depletion and amortisation could be impacted to the extent that actual production in the future is different from current forecast production based on proved reserves. This would generally result from significant changes in any of the factors or assumptions used in estimating reserves. Estimates of gas reserve quantities provide the basis for calculation of depletion, depreciation and amortisation and impairment, each of which represents a significant component of the consolidated financial statements. These factors could include changes in proved reserves, the effect on proved reserves of differences between actual commodity prices and commodity price assumptions, and unforeseen operational issues Impairment indicators The fair value of oil and gas properties is determined with reference to estimates of recoverable quantities of reserves (as outlined above) to determine the estimated future cash flows. An impairment loss is recognised for the amount by which the asset or Empire Group of assets carrying value exceeds the present value of its future cash flows. For the purposes of assessing impairment, assets are grouped at the lowest levels for which there are separately identifiable cash inflows which are largely independent of the cash inflows from other assets or groups of assets (cash generating units). Recoverable amount The recoverable amount of an asset is the greater of its fair value less costs of disposal and its value-in-use, using an asset’s estimated future cash flows (as described below) discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and risks specific to the asset. Significant judgement – Impairment of oil and gas assets For oil and gas assets, the expected future cash flow estimation is based on a number of factors, variables and assumptions, the most important of which are estimates of reserves, future production profiles, commodity prices, costs and foreign exchange rates. In most cases, the present value of future cash flows is most sensitive to estimates of future oil price and discount rates. The estimated future cash flows for the value-in-use calculation are based on estimates, the most significant of which are hydrocarbon reserves, future production profiles, commodity prices, operating costs and any future development costs necessary to produce the reserves. Estimates of future commodity prices are based on the Group’s best estimate of future market prices with reference to external market analysts’ forecasts, current spot prices and forward curves. Future commodity prices are reviewed at least annually. The discount rates applied to the future forecast cash flows are based on the Group’s weighted average cost of capital, adjusted for risks where appropriate, including functional currency of the asset, and risk profile of the country in which the asset operates. In the event that future circumstances vary from these assumptions, the recoverable amount of the Group’s oil and gas assets could change materially and result in impairment losses or the reversal of previous impairment losses. Due to the interrelated nature of the assumptions, movements in any one variable can have an indirect impact on others and individual variables rarely change in isolation. Additionally, management can be expected to respond to some movements, to mitigate downsides and take advantage of upsides, as circumstances allow. Consequently, it is impracticable to estimate the indirect impact that a change in one assumption has on other variables and hence, on the likelihood, or extent, of impairments or reversals of impairments under the different sets of assumptions in subsequent reporting periods. Asset retirement obligations Asset retirement costs will be incurred by the Empire Group at the end of the operating life of some of Empire Group’s facilities and properties. The ultimate asset retirement costs are uncertain and cost estimates can vary in response to many factors including changes to relevant legal requirements, the emergence of new restoration techniques or experience at other production sites. The expected timing and amount of expenditure can also change, for example, in response to changes in reserves or changes in laws and regulations or their interpretation. As a result, there could be significant adjustments to the provisions established which would affect future financial results. 39 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2016 2. CRITICAL ACCOUNTING JUDGMENTS, ESTIMATES AND ASSUMPTIONS (Continued) Share-based payments The consolidated entity measures the cost of equity-settled transactions with employees by reference to the fair value of the equity instruments at the date which they are granted. The fair value is determined by using either the Binomial or Black-Scholes model taking into account the terms and conditions upon which the instruments were granted. The accounting estimates and assumptions relating to equity-settled share-based payments would have no impact on the carrying amounts of assets and liabilities within the next annual reporting period but may impact profit or loss and equity. 3. GOING CONCERN The consolidated financial statements have been prepared on a going concern basis, which contemplates the realisation of assets and settlement of liabilities in the normal course of business. The Empire Group’s Statement of Financial Position reflects an excess of current liabilities over current assets of $36.71m. This is primarily due to the Board determining the debt facilities be classified as current liabilities although the current credit facility does not expire until 17 February 2019. Net assets are $36.22m. On 14 December 2016 the Company announced an 11 for 5 pro-rata renounceable rights issue at an issue price of $0.008 per new share to raise approximately $6.1m before costs. The offer was fully underwritten and closed on the 27th of January 2017 with the Company receiving applications for $1.9m. The shortfall to the offer was $4.2m and the Company has issued a further $2.0m to the date of this report (leaving a shortfall of $2.2m). The Company announced on the 2 March 2017, and it is working with the Underwriter to complete raising the funds equivalent to the shortfall amount and in the short term expects to enter into an Escrow Agreement with the Underwriter to secure the shortfall in funds. The directors have reviewed the Group’s financial position and are of the opinion that the use of the going concern basis of accounting is appropriate as they believe the Group will secure the additional funds to meet both working capital and capital expenditure requirements, as and when required. However, if the Group is not successful in securing sufficient additional funds through the Underwriter or through other arrangements when required, then to meet its expenditure targets there may be uncertainty about whether the Group is able to realise assets and/or extinguish liabilities in the normal course of business at the amounts stated in the financial report. The financial report does not contain any adjustments relating to the recoverability and classification of recorded assets or to the amounts or classification of recorded assets or liabilities that might be necessary should the Group not be able to continue as a going concern. 4. FINANCIAL RISK MANAGEMENT OBJECTIVES AND POLICIES The Empire Group’s principal financial instruments, other than derivatives comprise bank loans, available for sale financial assets, and cash and cash equivalents. The main purpose of these financial instruments is to raise finance for the Empire Group’s operations. The Empire Group has various other financial assets and liabilities such as trade receivables and payables, which arise from its operations. The Empire Group also enters derivative transactions, principally commodity hedges. The board has overall responsibility for the determination of the Empire Group’s risk management objectives and policies and has the responsibility for designing and operating processes that ensure the effective implementation of the objectives and policies to the Empire Group’s finance function. The board receives monthly reports through which it reviews the effectiveness of the processes put in place and appropriateness of the objectives and policies it sets. The overall objective of the board is to set policies that seek to reduce risk as far as possible without unduly affecting the Empire Group’s competitiveness and flexibility. The Empire Group is exposed to risks that arise from its use of financial instruments. The main risks arising from the Empire Group’s financial instruments are interest rate risk, commodity price risk, liquidity risk, equity risk and credit risk. This note describes the Empire Group’s objectives, policies and processes for managing those risks and methods used to measure them. Further quantitative information in respect of these risks is presented throughout these financial statements. There have been no substantive changes in the Empire Group’s exposure to financial instrument risks, its objectives, policies and processes for managing those risks or the methods used to measure them from previous periods unless otherwise stated in this note. 40 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2016 4. FINANCIAL RISK MANAGEMENT OBJECTIVES AND POLICIES (Continued) Further details regarding these policies are set out below: (A) MARKET RISK (i) Foreign Exchange Risk The Empire Group’s core operations are located in the United States where both revenues and expenditures are recorded. The Statement of Financial Position can be affected by movement in the US$/A$ exchange rates upon translation of the A$ operations into the US$ presentation currency. Foreign exchange risk arises from commercial transactions and recognised assets and liabilities denominated in a currency that is not the entity’s functional currency. The Empire Group seeks to mitigate the effect of its foreign currency exposure by borrowing in US$ for US operations and maintaining a minimum cash balance in Australia. Excluding presentation translation adjustments, the Empire Group’s exposure to foreign exchange risk at the reporting date is limited to loans and investments between the Parent entity and the US subsidiaries. (ii) Commodity Price Risk The Empire Group’s revenues and cash flows are exposed to commodity price fluctuations, in particular oil and gas prices. The Empire Group enters forward commodity hedges to manage its exposure to falling spot oil and gas prices. To mitigate a portion of the exposure to adverse market changes, the Empire Group’s commodity hedging programs utilise financial instruments based on regional benchmarks including NYMEX WTI for oil and NYMEX Natural Gas Henry Hub for gas. The Empire Group enters into derivative instruments for the Empire Group’s production to protect against price declines in future periods while retaining some of the benefits of price increases. While these derivatives are structured to reduce exposure to changes in price associated with the derivative commodity, they also limit benefits the Empire Group might otherwise have received from price changes in the physical market. The Empire Group believes the derivative instruments in place continue to be effective in achieving the risk management objectives for which they were intended. The Empire Group’s policy is to maintain a balance between spot and hedged sales. For the year ended 31 December 2016 the Empire Group hedged approximately 98% of its oil (2015: 78%) and 63% of its total gas production (2015: 59%). For 2017 the Empire Group has approximately 95% of estimated oil production hedged at $67/Bbl and 63% of current estimated gas production hedged at $4.05/Mcf. (iii) Interest rate risk The Empire Group is constantly monitoring its exposure to trends and fluctuations in interest rates in order to manage interest rate risk. The Empire Group’s exposure to interest rate risk at 31 December 2016 is set out in the following tables. The Empire Group’s exposure to the risk of changes in market interest rates relates primarily to the Empire Group’s long-term debt obligations with a floating interest rate in the US. The Empire Group manages its interest cost using a mix of fixed and variable rate debt. The Empire Group’s policy is to continually review the portion of its US$ borrowings that are either at floating or fixed rates of interest. To manage this mix in a cost-efficient manner, the Empire Group previously entered into interest rate swaps, in which Empire agrees to exchange, at specified intervals, the difference between fixed and variable interest rate amounts calculated by reference to an agreed upon notional principal amount. These swaps were designated to hedge underlying debt obligations. There are no interest rate swaps at 31 December 2016. The Empire Group monitors forecasts and actual cash flows and the maturity profiles of financial assets and liabilities to manage its liquidity risk. 41 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2016 4. FINANCIAL RISK MANAGEMENT OBJECTIVES AND POLICIES (Continued) % Floating Interest Rate Fixed Interest Maturing in Over 1 to 5 1 Year or Years Less Non-Interest Bearing Total 1.65 641,493 - - 641,493 - - - - - - - - - 641,493 2,175,522 3,356,265 5,531,787 2,175,522 3,356,265 6,173,280 - - 7.27 - 38,656,987 - 38,656,987 - - - - - - 3,871,331 3,871,331 - - - 38,656,987 3,871,331 42,528,318 % Floating Interest Rate Fixed Interest Maturing in Over 1 to 5 1 Year or Years Less Non-Interest Bearing Total 1.13 1,126,543 - - 1,126,543 - - - - - - - - - - - - 1,126,543 1,874,474 11,346,512 13,220,986 1,874,474 11,346,512 14,347,529 - - 3,760,766 3,760,766 - 40,460,495 - 40,460,495 - 31,560 31,560 - - - 40,492,055 3,760,766 44,252,821 31 December 2016 Financial Assets Cash and cash equivalents Trade and other receivables Financial assets Financial Liabilities Trade & other payables Financial liabilities, including derivatives Interest-bearing liabilities 31 December 2015 Financial Assets Cash and cash equivalents Trade and other receivables Financial assets Financial Liabilities Trade & other payables Financial liabilities, including derivatives Interest-bearing liabilities 4.00 (iv) Empire Group Sensitivity Based on the financial instruments held at 31 December 2016, had the WTI NYMEX and Henry Hub prices increase/decreased by 10% and 10% respectively, with all other variables held constant, the Empire Group’s post- tax profit for the year would not change due to the extent of effective hedging of oil and gas production. Equity would not have changed under either scenario. The directors do not expect any reduction in interest rates during 2017. Should interest rates increase by 1% the impact on post-tax profit would be a decrease of approximately US$390,000. (B) CREDIT RISK Credit risk is the risk that the other party to the financial instrument will fail to discharge their financial obligation in respect of that instrument resulting in the Empire Group incurring a financial loss. The Empire Group’s exposure to credit risk arises from potential default of the counter party with the maximum exposure equal to the carrying amount of these instruments. There are no significant concentrations of credit risk within the Empire Group. The Empire Group trades only with recognised, credit worthy third parties. In the US, trade receivables, (balances with oil and gas purchases) have not exposed the Empire Group to any bad debt to date. All derivatives are with the same counterparty. 42 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2016 4. FINANCIAL RISK MANAGEMENT OBJECTIVES AND POLICIES (Continued) In the US, all of the purchasers that the Empire Group’s operators choose to deal with are major oil or gas companies. Trade and other receivable balances are monitored on an ongoing basis with the Empire Group’s exposure to bad debts minimal. The maximum exposure to credit risk at balance date is as follows: Trade, other receivables, and derivatives 2016 US$ 2015 US$ 5,438,127 12,618,358 The maximum exposure to credit risk at balance by country is as follows: 2015 US$ 2016 US$ Australia United States of America - 5,438,127 - 12,618,358 (C) LIQUIDITY RISK Liquidity risk is the inability to access funds, both anticipated and unforeseen, which may lead to the Empire Group being unable to meet its obligations in an orderly manner as they arise. The Empire Group’s liquidity position is managed to ensure sufficient funds are available to meet financial commitments in a timely and cost-effective manner. The Empire Group is primarily funded through on-going cash flow, debt funding and equity capital raisings, as and when required. Funding is in place with reputable financial institutions in the US and Australia. The borrowing base is re-determined and reviewed once a year. Bank compliance reporting is undertaken quarterly and adherence to covenants checked regularly. Management also regularly monitors actual and forecast cash flows to manage liquidity risk. Maturity Analysis 31 December 2016 Non Derivatives Current Trade and other payables Interest bearing liabilities Non-current Interest bearing liabilities Derivatives Financial asset Financial liability Maturity Analysis 31 December 2015 Non Derivatives Current Trade and other payables Interest bearing liabilities Non-current Interest bearing liabilities Derivatives Financial asset Financial liability Fair Value US$ Carrying Amount US$ Contractual Cash flows US$ 1 year US$ 1-5 years US$ 3,871,331 40,156,562 3,871,331 37,636,987 3,871,331 40,156,562 3,871,331 40,156,562 - - - - - - - (3,283,904) - Fair Value US$ (3,283,904) - Carrying Amount US$ (3,283,904) - Contractual Cash flows US$ (2,022,174) - (1,261,730) - 1 year US$ 1-5 years US$ 3,760,766 40,557,729 3,760,766 40,460,495 3,760,766 40,557,729 3,760,766 40,557,729 - - 31,560 31,560 31,560 - 31,560 (10,873,451) - (10,873,451) - (10,873,451) - (5,579,991) - (5,293,460) - 43 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2016 4. FINANCIAL RISK MANAGEMENT OBJECTIVES AND POLICIES (Continued) (D) EQUITY RISK The Empire Group is exposed to equity securities price risk arising from investments held by the Empire Group which are classified as available for sale assets. Investments in equity securities are managed by the Board. The Empire Group relies on equity markets to raise capital for its exploration and development activities, and is thus exposed to equity market volatility. Equity price risk arises from investments in equity securities and Empire Energy Group Limited’s issued capital. The Company’s equity risk is considered minimal and as such no sensitivity analysis has been completed. Fair Value of Financial Assets and Liabilities The fair value of all monetary financial assets and liabilities of Empire Energy Group Limited approximate their carrying value there were no off-balance financial assets and liabilities at year end. Fair value of financial instruments The Empire Group is required to classify financial instruments, measured at fair value, using a three level hierarchy, being: • • • Level 1: Quoted prices (unadjusted) in active markets for identical assets or liabilities; Level 2: Inputs other than quoted prices included within level 1 that are observable for the asset or liability, either directly (as prices) or indirectly (derived from prices); and Level 3: Inputs for the asset or liability that are not based on observable market data (unobservable inputs). An instrument is required to be classified in its entirety on the basis of the lowest level of valuation inputs that is significant to fair value. Considerable judgement is required to determine what is significant to fair value and therefore which category the financial instrument is placed in can be subjective. The fair value of financial instruments classified as level 3 is determined by the use of valuation models. These include discounted cash flow analysis or the use of observable inputs that require significant adjustments based on unobservable inputs. 44 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2016 4. FINANCIAL RISK MANAGEMENT OBJECTIVES AND POLICIES (Continued) Consolidated 31 December 2016 Assets Unlisted available-for-sale equities Fair value of derivatives Total assets Liabilities Fair value of derivatives Total liabilities Consolidated 31 December 2015 Assets Unlisted available-for-sale equities Fair value of derivatives Total assets Liabilities Fair value of derivatives Total liabilities Level 1 Level 2 Level 3 Total Level 1 - - - - - - - - - - - 72,360 3,283,904 3,283,904 - 72,360 72,360 3,283,904 3,356,264 Level 2 - - - - - - - Level 3 Total 473,060 473,060 10,873,451 - 10,873,451 10,873,451 473,060 11,346,511 - - - - - - There were no transfers between levels during the financial year. Capital Risk Management The Company considers its capital to comprise its ordinary share capital and reserves. In managing its capital, the Company’s primary objective is to maintain a sufficient funding base to enable the Company to meet its working capital and strategic operation needs. In making decisions to adjust its capital structure to achieve these aims, either through altering its dividend policy, new share issues, or consideration of debt the Company considers not only its short-term position but also its long- term operational and strategic objectives. 5. REVENUE a. Sales revenue Revenue from oil and gas sales Revenue from well operations b. Other income Gain on sale of investment Interest income Rental income Other income 2016 US$ 2015 US$ 13,626,195 912,761 14,538,956 17,581,328 654,881 18,236,209 - 298 9,500 219,972 229,770 161,782 4,416 6,334 320,746 493,278 45 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2016 6. COST OF SALES Oil and gas production 7. INTEREST EXPENSE Interest paid/payable on financial liabilities 8. EXPENSES a. Other non-cash expenses Leasing expiration expenses (note 8c) Impairment of assets (note 8c) Depreciation, depletion and amortisation Finance costs (note 8b) Unrealised derivative movement Other expenses Total other expenses b. Finance expenses (non-cash) Accretion of asset retirement obligation (note 18) Unwind of discount of debt Total finance costs (non-cash) c. Profit/(loss) before income tax includes the following specific expenses: Depreciation, depletion and amortisation Oil & Gas properties and plant & equipment (note 14) Employee benefits expense Defined contribution superannuation expense Other employee expenses Total employee benefits expense Impairment expense(a) 2016 US$ 2015 US$ (8,604,524) (8,604,524) (9,701,346) (9,701,346) (2,420,361) (2,420,361) (2,059,868) (2,059,868) 298,600 (27,762,128) 2,213,627 1,131,819 7,589,547 154,536 (16,373,999) 426,200 22,202,568 5,770,977 1,098,565 305,548 703,473 30,507,331 477,568 654,251 422,431 676,134 1,131,819 1,098,565 2,213,627 2,213,627 17,665 3,940,621 3,958,285 5,770,977 5,770,977 16,345 3,504,424 3,520,769 Impairment of additional asset retirement obligation Impairment of available for sale financial assets and receivables Impairment of property plant & equipment Reversal of impairment of property plant & equipment Total (write back)/impairment expense 400,000 482,336 296,274 (28,940,738) (27,762,128) 2,455,568 - 19,747,000 - 22,202,568 Loss on disposal of property, plant & equipment - 703,473 Leasing expiration expense (b) 298,600 426,200 (a) Impairment expense For the period 31 December 2016, the Company wrote back the oil and gas properties by $28,940,738 due to the increase in oil prices resulting in an increase of the recoverable amount of those assets(1). Furthermore, an increase in the asset retirement obligation of $400,000, resulting from the accounting differences between US GAAP and IFRS, was recognised as an impairment charge. (1) An impairment of oil and gas properties was also recognised during the year of $296,274. 46 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2016 8. EXPENSES (Continued) (b) Leasing expiration expense A charge of $298,600 has been taken against the book value of undeveloped leases which have expired, or are to expire. The Company has an ongoing program to renew expiring leases, to take up options on expiring leases or acquire new leases if and when possible. The charge is a non-cash entry which has no effect on cash-flows. 9. INCOME TAX a. Income tax expense Current tax Deferred tax Income tax benefit attributable to continuing operations Deferred income tax expense included in income tax expense comprises: Increase/(decrease) in deferred tax liabilities (note 9(e)) b. Numerical reconciliation of income tax expense to prima facie tax payable Profit/(loss) before income tax Tax at the Australian tax rate of 30% (2015: 30%) Tax effect of amounts which are not deductible/(taxable) in calculating taxable income: - Non-deductible expenses Withholding tax paid Deferred tax asset in relation to tax losses and temporary differences (utilised)/not recognised Effect of difference in overseas tax rates Income tax benefit c. Deferred tax assets not recognised relate to the following: Tax losses Capital losses Temporary differences relating to Oil & Gas assets Other 2016 US$ 2015 US$ 48,163 (179,851) - (2,062,080) 48,163 (2,241,931) - - (2,062,080) (2,062,080) 16,497,092 (29,240,928) 4,949,128 (8,772,278) 13,477 34,788 9,795 18,892 (5,257,551) 10,510,504 308,321 (4,008,844) 48,163 (2,241,931) 4,202,418 4,071,782 141,410 141,410 - 9,486,489 291,842 - 4,635,670 13,699,681 47 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2016 9. INCOME TAX (Continued) The potential benefit of the deferred tax asset attributable to tax losses will only be obtained if: (i) the consolidated entity derives future assessable income of a nature and of an amount sufficient to enable the benefit from the deduction for the loss to be realised; or (ii) the consolidated entity continues to comply with the conditions for deductibility imposed by the law; and (iii) no changes in tax legislation adversely affect the consolidated entity in realising the asset. d. Dividend Franking Account There are no franking account credits available as at 31 December 2016. e. Deferred tax liabilities The balance comprises temporary differences attributable to: Forward commodity contracts Oil & Gas and Property, Plant & Equipment Other Set-off of deferred tax liabilities pursuant to set-off provisions (note f) Net deferred tax liabilities f. Deferred tax assets The balance comprises temporary differences attributable to: Accrued asset retirement obligation Oil & Gas and Property, Plant & Equipment Other Set-off of deferred tax assets pursuant to set-off provisions (note e) Net deferred tax assets 10. TRADE AND OTHER RECEIVABLES Current Trade receivables Other 11. PREPAYMENTS Prepayments 12. INVENTORIES Crude oil and production supplies 2016 US$ 2015 US$ 1,238,534 574,412 95,261 1,908,207 - 8,378,469 81,904 8,460,373 (1,908,207) (8,460,373) - - 1,429,237 - 478,970 1,908,207 1,245,839 7,214,534 - 8,460,373 (1,908,207) (8,460,373) - - 2,119,597 55,925 2,175,522 1,821,890 52,584 1,874,474 437,535 672,044 544,772 553,184 48 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2016 13. FINANCIAL ASSETS, INCLUDING DERIVATIVES Current 2016 US$ 2015 US$ Oil and gas price forward contracts 2,022,174 5,579,991 Non-current Oil and gas price forward contracts Shares – other corporations: • Unlisted available-for-sale equities (at cost) Less: accumulated impairment on unlisted equities Total Non-current Commodity hedge contracts outstanding are outlined below. 1,261,731 5,293,460 628,401 (556,041) 1,334,091 629,102 (156,041) 5,766,521 2016 NATURAL GAS - HENRY HUB - NYMEX - Swaps 2015 NATURAL GAS - HENRY HUB - NYMEX - Swaps Premium Product Period Swap Price Premium Product Period Swap Price Jan 17 - Dec 17 4.57 Jan 17 - Dec 17 4.57 Jan 17 - Dec 17 3.45 Jan 17 - Dec 17 3.45 Jan 18 - Dec 18 4.75 Jan 18 - Dec 18 4.75 Jan 18 - Dec 18 Jan 18 - Dec 18 3.45 3.45 Jan 19 - Dec 19 3.45 Jan 19 - Dec 19 3.45 $Nil $Nil $Nil $Nil $Nil $Nil $Nil $Nil $Nil $Nil 66,000 mmbtu Jan 16 - Dec 16 504,000 mmbtu Jan 16 - Dec 16 420,000 mmbtu Jan 16 - Dec 16 78,000 mmbtu Jan 16 - Dec 16 54,000 mmbtu Jun 16 - Dec 16 456,000 mmbtu Jan 17 - Dec 17 420,000 mmbtu 78,000 mmbtu 420,000 mmbtu 78,000 mmbtu Jan 17 - Dec 17 Jan 17 - Dec 17 Jan 17 - Dec 17 Jan 18 - Dec 18 Jan 18 - Dec 18 Jan 18 - Dec 18 Jan 18 - Dec 18 Jan 19 - Dec 19 Jan 19 - Dec 19 4.37 4.49 4.49 4.37 3.45 4.57 4.57 3.45 3.45 4.75 4.75 3.45 3.45 3.45 3.45 2016 OIL - WTI - NYMEX 2015 OIL - WTI - NYMEX Jan 17 - Dec 17 85.23 Jan 17 - Dec 17 63.10 Jan 17 - Dec 17 45.30 – 54.30 $Nil $Nil $Nil 39,600 BO Jan 16 - Dec 16 85.67 52,800 BO Jan 16 - Dec 16 63.10 21,600 BO Jan 17 - Dec 17 85.23 Jan 17 - Dec 17 63.10 $Nil $Nil $Nil $Nil $Nil $Nil $Nil $Nil $Nil $Nil $Nil $Nil $Nil $Nil $Nil $Nil $Nil $Nil $Nil 72,000 mmbtu 72,000 mmbtu 528,000 mmbtu 528,000 mmbtu 105,000 mmbtu 66,000 mmbtu 504,000 mmbtu 420,000 mmbtu 78,000 mmbtu 54,000 mmbtu 456,000 mmbtu 420,000 mmbtu 78,000 mmbtu 420,000 mmbtu 78,000 mmbtu 42,000 BO 52,800 BO BO 39,600 52,800 BO 49 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2016 14. OIL AND GAS PROPERTIES AND PROPERTY PLANT & EQUIPMENT Cost in US$ At 1 January 2016 Additions New asset retirement obligation Write-off of asset retirement obligation Reclassifications Sale of wells Disposals Expiration costs Write-off of exploration expense At 31 December 2016 Accumulated Depreciation in US$ At 1 January 2016 Depreciation and depletion Write-off sale of wells Write-off plugged wells Impairment Write-back of impaired assets At 31 December 2016 Oil & Gas – Proved Oil & Gas – Unproved Land Buildings Equipment Motor Vehicles Total 116,883,304 115,719 1,022,525 (45,249) - (96,670) (791,938) - (34,060) 7,243,258 74,849 - - - - (435,062) (298,600) - 30,591 - - - - - - - - 328,948 - - - - - - - - 716,286 39,614 - - - - - - - 639,941 29,667 - - - - - - - 125,842,328 259,849 1,022,525 (45,249) - (96,670) (1,227,000) (298,600) (34,060) 117,053,631 6,584,445 30,591 328,948 755,900 669,608 125,423,123 (65,603,144) (2,100,077) 8,825 19,249 (696,274) 28,940,738 (39,430,683) - - - - - - - - - - - - - - (62,803) (12,554) - - - - (593,570) (49,926) - - - - (501,221) (51,070) - - - - (66,760,738) (2,213,627) 8,825 19,249 (696,274) 28,940,738 (75,357) (643,496) (552,291) (40,701,827) Opening written down value 51,280,160 6,994,863 30,591 266,145 118,401 117,149 58,807,309 Impact of foreign currency adjustments - (264,220) - - (4,318) (21,713) (290,251) Closing written down value 77,622,948 6,320,225 30,591 253,591 108,086 95,604 84,431,045 50 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2016 14. OIL AND GAS PROPERTIES AND PROPERTY PLANT & EQUIPMENT (continued) Cost in US$ At 1 January 2015 Additions New asset retirement obligation Write-off of asset retirement obligation Disposals Expiration costs At 31 December 2015 Accumulated Depreciation in US$ At 1 January 2015 Depreciation and depletion Write-off sale of wells Disposals Impairment Change in ARO At 31 December 2015 Oil & Gas – Proved Oil & Gas – Unproved 113,043,192 2,779,610 3,205,890 (88,341) (2,057,047) - 6,723,646 1,213,873 - - (268,061) (426,200) Land Buildings Equipment Motor Vehicles Total 30,591 - - - - - 328,948 - - - - - 717,543 4,107 - - (5,364) - 633,942 20,078 - - (14,079) - 121,477,864 4,017,668 3,205,890 (88,341) (2,344,551) (426,200) 116,883,304 7,243,258 30,591 328,948 716,286 639,941 125,842,328 (37,890,234) (5,616,528) 88,694 - (22,202,568) 17,492 (65,603,144) - - - - - - - - - - - - - - (50,250) (12,553) - - - - (508,320) (85,177) - (73) - - (461,204) (56,719) - 16,702 - - (38,910,008) (5,770,977) 88,694 16,629 (22,202,568) 17,492 (62,803) (593,570) (501,221) (66,760,738) Opening written down value 75,152,958 6,723,646 30,591 278,698 206,231 157,258 82,549,382 Impact of foreign currency adjustments - (248,395) - - (4,315) (21,571) (274,281) Closing written down value 51,280,160 6,994,863 30,591 266,145 118,401 117,149 58,807,309 51 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2016 14. OIL AND GAS PROPERTIES AND PROPERTY PLANT & EQUIPMENT (continued) At 31 December 2016, the group reassessed the carrying amounts of its non-current assets for indicators of impairment in accordance with the Group’s accounting policy. Estimates of recoverable amounts are based on an asset’s value in use or fair value less costs to sell, using a discounted cash flow method, and are most sensitive to the key assumptions described in note 2. Recoverable amounts for the year ended 31 December 2016 are: Oil and gas assets Kansas Appalachia Total Subsurface assets US$ 43,196,646 33,972,400 77,169,046 Recoverable amount US$ 47,979,160 33,972,400 81,951,560 The post tax discount rate that has been applied to the above oil and gas assets is 8%. The write-back charges noted above primarily result from a higher oil and gas price environment. 15. INTANGIBLE ASSETS Goodwill 16. TRADE AND OTHER PAYABLES Current Trade creditors Other creditors 17. INTEREST-BEARING LIABILITIES Current Finance lease liability Bank loan -secured Non-current Finance lease liability Classification of Borrowings 2016 US$ 2015 US$ 68,217 68,217 68,217 68,217 3,843,827 27,504 3,871,331 3,746,225 14,541 3,760,766 31,257 38,625,730 12,996 40,447,499 38,656,987 40,460,495 - 31,560 These accounts are presented on the basis that all borrowings have been classified as current liabilities. This treatment is as a result of a strict application of the relevant provisions of AASB 101 Presentation of Financial Statements ("AASB 101"). This accounting standard requires the Group to classify liabilities as current if the Group does not have an unconditional right to defer payment for twelve months at period end. However, the expected repayment of the borrowings is not for complete repayment within the twelve month period. In February 2016 the Company extended the Facility for a further 3 years through to 26 February 2019. Credit Facility Summary Empire Energy USA, LLC maintains a long-term credit facility with Macquarie Bank Limited (Macquarie), which matures on 17 February 2019, consisting of the following: Revolver facility (revolving line-of-credit): Term Loan facility: $50,000,000 $150,000,000 52 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2016 17. INTEREST-BEARING LIABILITIES (Continued) Uses of credit facility: Revolver: To refinance existing debt and to undertake acquisitions. The Revolver is subject to a borrowing base consistent with normal and customary oil and gas lending practices of the bank. Term Loan: As an acquisition and development term credit facility to undertake acquisitions and support capital expenditure under an agreed development plan for oil and gas properties and services companies in the United States. Drawdown on the Term Facility is based on predefined benchmarks and segregated in tranches. Credit facility structure Revolver: Borrowing base limit Interest rate Availability (1) Maturity Repayment $3,000,000 LIBOR+6.5% Nil Feb 2019 Feb 2019 (1) the borrowing base limit changes with operations and opportunities with approval of the lender. Term Loan: Borrowing base limit Current portion payable Interest rate Availability (1) Maturity Repayment (2) $35,083,291 $1,500,000 LIBOR+6.5% Nil Feb 2019 Amortization (1) (2) draw down is based on predefined benchmarks, with approval of the lender. repayment is monthly from net cash flow and capital transaction proceeds of USA operations, with remaining payable at maturity. Other features of the credit facility: • Outstanding borrowings under the facilities are secured by a majority of the assets of the Company. The Revolver and Term Facility are guaranteed by the Company. • Reserve Assessment of 1P reserves are based on third party reserve engineering consultants. • Under terms of the facilities, the Company is required to maintain financial ratios customary for the oil and gas industry. These include certain operational and financial covenants for which the Company is required to maintain, the most restrictive of which is the adjusted proved developed producing (PDP) present value (PV). Key financial covenants: Fees: Amendments to Credit Facility: 1.5x 1P PV10 coverage to net loan (after adjustment for cash & hedges). 1.0x PDP PV10 coverage to net loan (after adjustment for cash & hedges). 1.0x Current Ratio. 1.8x EBITDA/Interest Ratio. 1.0% on draw down amount. In February 2016, the credit facility was extended for 3 years. Under this extension the Company agreed to allocate US$5 million of the initial US$7.5 million payment to be received on April 20, 2016 from AEGP Australia Pty Ltd (AEGP) a company controlled by Mr Aubrey K. McClendon (as part of an 80% Farmout of the Company’s interest in its McArthur Basin, Northern Territory project). Following the tragic death of Mr McClendon in March 2016 the McClendon Estate confirmed that that Estate be unlikely to continue with the Farmout. Without receipt of the US$5 million, the Company entered into two amendments to the credit facility to ensure continued compliance with key covenant ratios. The key amendments were as follows: 53 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2016 17. INTEREST-BEARING LIABILITIES (Continued) • • • • The payment of US$5 million from the Farmout Agreement was confirmed as being cancelled. In its place, a payment of US$1.5 million was due on September 16, 2016 from a proposed equity raising. An extension was further granted and the amount was to be repaid (or offset for an asset purchase) to February 2017. This amount has been repaid/offset. The average margin payable on the credit facility increased from LIBOR+4.35% to LIBOR+6.5%. This increase in margin led to a breach in the interest cover ratio which was waiver in September 2016 leading to a change in the interest rate coverage ratio. The Interest Rate Coverage Ratio was reduced from 2.5x to 1.8x. The original Macquarie credit agreement assigned warrants to Macquarie to purchase 10% of the equity in the Company’s subsidiary Empire Energy USA, LLC (EEUSA). Under the new Credit Facility signed in February 2016, previous warrants expired and were replaced with a new agreement. Keys points in relation to the warrants are as follows: • Macquarie can exercise warrants at $0.01 to purchase 10% of the equity in EEUSA. • Costs of the warrants are treated as a transaction cost and amortised over the life of the loan. • Amortisation of the warrants over the current period is $295,828. Under the terms of the Loan Facility (“Facility”), Empire Energy allocates 90% of monthly free cash flow to repay principle outstanding. The Company repays the facilities monthly to the extent of an applicable percentage of net operating cash flow and capital transactions. Principal payments made in 2016 and 2015 were approximately $464,880 and $3,665,000, respectively. The expected loan repayments over the next 12 months comprise payment of 90% of any monthly free cash flow. A summary of period end debt is as follows: Term Tranche Tranche A Tranche B Tranche C Tranche D Revolver Sub-Total Less discount on debt Less deferred financing costs, net Acquisition Commitment (1) Finance Lease Liability Total Current Debt Current portion due 31 December 2016 Residual current balance Current debt per balance sheet (1) 2016 US$ 2015 US$ 6,181,553 10,583,403 10,360,349 10,000,000 3,000,000 40,125,305 - (1,499,575) 38,625,730 - 31,257 38,656,987 6,181,553 10,583,403 9,585,871 10,000,000 3,000,000 39,350,827 (97,234) - 39,253,593 1,193,896 13,006 40,460,495 1,500,000 37,156,987 38,656,987 - 40,460,495 40,460,495 In February 2016 the Company elected not to complete a purchase of assets and as such the debt liability was not drawn. Refer to Note 33 (3). 54 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2016 18. PROVISIONS Current Employee entitlements Non-current Asset retirement obligations Movement in Asset Retirement Obligation Balance at beginning of the period Additions for the period Write-off accrued plugging costs Accretion expense for the period, included in finance costs Change in estimate(a) Balance end of the period 2016 US$ 2015 US$ 6,986 12,377 12,902,647 11,496,833 11,496,833 622,802 (94,556) 477,568 400,000 7,953,969 353,413 (113,922) 422,431 2,880,942 12,902,647 11,496,833 (a) Due to the write down of oil and gas properties to their recoverable amount, $400,000 has been written off as impaired from the carrying value of the oil and gas properties, refer to Note 8c. Asset Retirement Obligation The Empire Group makes full provision for the future costs of decommissioning oil and gas production facilities and pipelines on a discounted basis on the installation or acquisition of those facilities. The provision represents the present value of decommissioning costs which are expected to be incurred up to 2050. The estimated liability is based on historical experience in plugging and abandoning wells, estimated remaining lives of those based on reserve estimates, external estimates as to the cost to plug and abandon the wells in the future, and regulatory requirements. Assumptions, based on the current economic environment, have been made which management believe are a reasonable basis upon which to estimate the future liability. These estimates are reviewed regularly to take into account any material changes to the assumptions. However, actual decommissioning costs will ultimately depend upon future market prices for the necessary decommissioning works. Furthermore, the timing of decommissioning is likely to depend on when the assets cease to produce at economically viable rates. This in turn will depend upon the future oil and gas prices, which are inherently uncertain. 55 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2016 19. CONTRIBUTED EQUITY a) Shares Issued Capital Balance at beginning of period Movement in ordinary share capital 2016 US$ 2015 US$ 74,240,545 73,683,238 - Issue of 35,450,195 fully paid ordinary shares in September 2015 @ A$0.023 pursuant to a Pro-Rata Rights Issue - 571,563 - Issue of 2,000,000 fully paid ordinary shares in July 2016 @ A$0.01 in lieu of cash payment for fees for services rendered - Issue of 1,000,000 fully paid ordinary shares in August 2016 @ A$0.02 in lieu of cash payment for fees for services rendered Less costs associated with the share issues detailed above Less costs associated with capital raise Balance as at 31 December 2016 b) Shares Movements in ordinary issued shares Balance at beginning of period Movement in ordinary share capital 15,042 15,262 - - (1,441) (14,256) (30,231) - 74,239,177 74,240,545 No. of shares No. of shares 344,313,877 308,863,682 - Issue of 35,450,195 fully paid ordinary shares in September 2015 @ A$0.023 pursuant to a Pro-Rata Rights Issue - 35,450,195 - Issue of 2,000,000 fully paid ordinary shares in July 2016 @ A$0.01 in lieu of cash payment for fees for services rendered - Issue of 1,000,000 fully paid ordinary shares in August 2016 @ A$0.02 in lieu of cash payment for fees for services rendered 2,000,000 1,000,000 - - - Balance as at 31 December 2016 347,313,877 344,313,877 Share Options Movements Granted 1,000,000 options were granted during the financial period. The options were granted in lieu of payment for services rendered to the Company. The exercise price of the granted options is $0.028* expiring 25 August 2019. No options were granted since the end of the financial year and up to the date of this report. Exercise of Options No options were exercised during the financial year or in the end of the financial year and up to the date of this report. Expiry/Lapse of Options The following unlisted options were not exercised by their expiry date and as a consequence have lapsed: - - - - 4,250,000 unlisted options at A$0.119 expiring 26 February 2016 3,500,000 unlisted options at A$0.149 expiring 31 December 2016 1,500,000 unlisted options at A$0.169 expiring 31 December 2016 1,500,000 unlisted options at A$0.179 expiring 31 December 2016 No options have expired since the end of the financial year. 56 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2016 19. CONTRIBUTED EQUITY (Continued) At balance date the Empire Group had on issue, the following securities: Shares - 347,313,877 listed fully paid ordinary shares – ASX Code: EEG The Company does not have authorised capital or par value in respect of its issued shares. All issued shares are fully paid. The holders of ordinary shares are entitled to receive dividends as declared from time to time and are entitled to one vote per share at meetings of the Company. No dividends were paid or declared during the year, or since the year-end. Options At balance date the Company had 1,000,000 unissued shares under option. These options are exercisable on the following terms: Number 1,000,000 Unlisted options Exercise Price A$ $0.03* Expiry Date 25 August 2019 * Adjustment of Option exercise prices In February 2017 following the completion of a Pro-Rata Rights Issue announced in December 2016 the exercise price of 1,000,000 outstanding options expiring 25 August 2019 was adjusted pursuant to the terms and conditions of the options and ASX Listing Rule 6.22. with the adjusted exercise price being $0.028. Performance Rights During the 2013 financial year the Company issued 2,500,000 Performance Rights over fully paid ordinary shares in the Company as part consideration for the buyback of the minority interest equity holder in Empire Energy USA LLC. The minority interest holder also received 4,000,000 fully paid ordinary shares in the issued capital of Empire Energy Group Limited. The Performance Rights are exercisable at no cost under the following events: - - Lifting of the current moratorium on oil and/or natural gas fracking in New York State; If the Company sells, transfers or assigns all or substantially all of its property interest Chautauqua and Cattaraugus Counties in the State of New York to an unaffiliated third party then the performance rights will vest in accordance with the following schedule: Fair Market Value of Consideration Received by the Company Less than $25.0 million Performance rights exercisable 0.0% At least $25.0 million but less than $45.0 million Percentage calculated by dividing Fair Market Value of Consideration received by the Company by $45.0 million. $45.0 million or more 100.0% - If the holder of the Performance Rights in any way disposes of more than 75% of the 4 million ordinary shares assigned as part of the minority interest buy back transaction prior to either the moratorium being terminated or a third party sale being consummated then the performance rights will be cancelled. 57 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2016 20. RESERVES Fair value reserve The fair value reserve comprises the cumulative net change in the fair value of available-for-sale assets until the investment is derecognised. Foreign currency translation reserve The foreign currency translation reserve comprises all foreign currency differences arising from the translation of the financial statements of foreign operations. Option Reserve The option reserve comprises the value of options issued but not exercised at balance date. 21. CONTINGENT LIABILITIES Empire Energy Group Limited has executed a Deed of Guarantee and indemnity in favour of Macquarie Bank Limited guaranteeing the obligations of each of Empire Energy USA LLC and its subsidiary Empire Energy E&P LLC pursuant to the Macquarie Bank Limited credit facility. The Empire Group is involved in various legal proceedings arising out of the normal conduct of its business. In the opinion of management, the ultimate resolution of such matters will not have a material effect on the consolidated financial position or results of operations of the Empire Group. The Empire Group is subject to various federal, state and local laws and regulations relating to the protection of the environment. The Empire Group has established procedures for the ongoing evaluation of its operations, to identify potential environmental exposures and to comply with regulatory policies and procedures. Environmental expenditures that relate to current operations are expensed or capitalised as appropriate. Expenditures that relate to an existing condition caused by past operations, and do not contribute to current or future revenue generation, are expensed. Liabilities are recorded when environmental assessment and or clean-up is probable, and the costs can be reasonably estimated. The Empire Group maintains insurance that may cover in whole or in part certain environmental expenditures. At 31 December 2016, the Empire Group had no environmental contingencies requiring specific disclosure or accrual. There have been no changes in contingent liabilities since the last annual reporting date. 22. CONTINGENT ASSETS The Company has a claim outstanding against the JV Partner for a 75% interest in the Carrolltown Prospect Gas Wells. The Company expects to receive ~US$40,000 in compensation. 58 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2016 23. COMMITMENTS FOR EXPENDITURE Exploration and Mining Tenement Leases In order to maintain current rights of tenure to exploration and mining tenements, the Company and the companies in the consolidated entity are required to outlay lease rentals and to meet the minimum expenditure requirements of the various Government Authorities. These obligations are subject to re-negotiation upon expiry of the relevant leases or when application for a mining licence is made. No expenditure commitment exists at 31 December 2015. i) Equipment and Operating Leases Commitments in relation to equipment/motor vehicle leases contracted for at and subsequent to the reporting date but not recognised as liabilities: 2016 US$ 2015 US$ Not later than one year Later than one year not later than two years Later than two years not later than five years More than five years 291,469 225,469 328,937 - 311,842 158,794 82,000 - 845,875 552,636 The Company leased its US corporate headquarters under a non-cancellable operating lease of monthly payments of approximately $7,700 through February 2017. Net rental expense approximated $97,000 and $87,000, net of reimbursements, for the year ended 31 December 2016 and 31 December 2015. The Company extended the lease terms through February 2022 with reduced monthly payments ranging from $3,665 to $3,966 over the course of the agreement. The Kansas headquarters four-year lease agreement is of monthly payments of approximately $2,800 through April 2017. The agreement was extended through April 2021 with monthly payments ranging from $2,853 to $2,945. The net rental expense approximated $34,000 for the years ended December 31, 2016 and 2015. The Company leases trucks under an operating agreement. The term of the agreement begins upon the delivery of each truck and lasts for a period of up to 48 months. Lease payments in 2016 and 2015 were approximately $320,000 and $249,000 respectively. The Empire Group has the option to acquire the leased assets at the agreed value on the expiry of the leases. ii) Property Licence The Company has entered into a cancellable licence agreement over the occupation of office premises. The leased assets were pledged as security over the lease commitment. The term of the occupancy licence was for a term of 59 months and concluded on 30 June 2011. Since expiry of the occupancy licence the Company has occupied the premises on a month to month basis. Terms on a new licence agreement are being negotiated. 24. SHARE BASED PAYMENTS Year Ending – 31 December 2016 During the current financial the following share based payments occurred: The Company granted 2,000,000 ordinary fully paid shares to a company in July 2016 in lieu of cash payment of A$20,000 for services rendered, at a deemed issued price of $0.01 per share. The Company granted 1,000,000 ordinary fully paid shares to a company in August 2016 in lieu of cash payment of A$20,000 for services rendered, at a deemed issued price of $0.02 per share along with 1,000,000 unlisted options exercisable at $0.03 prior to 25 August 2019. Options were issued for nil cash consideration. During the 2016 financial year no options were granted pursuant to the Employee Share Option Plan 2014. Year Ending – 31 December 2015 During the 2015 financial year no share based payments occurred. During the 2015 financial year no options were granted. 59 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2016 24. SHARE BASED PAYMENTS (Continued) a) Options The options outstanding at 31 December 2016 are detailed below. Grant Date Expiry Date Exercise Price Balance at start of year Granted during year Expired during year Exercised during year Balance at end of year 26 February 2014 26 February 2016 11.9 cents 4,250,000 15 July 2014(1) 31 December 2016 14.9 cents 3,500,000 15 July 2014(1) 31 December 2016 16.9 cents 1,500,000 15 July 2014(1) 31 December 2016 17.9 cents 1,500,000 - - - - 4,250,000 3,500,000 1,500,000 1,500,000 25 August 2016(2) 25 August 2019 0.03 cents - 10,750,000 1,000,000 1,000,000 - (10,750,000) - - - - - - - - - - 1,000,000 1,000,000 (1) Options granted pursuant to Employee Share Plan approved 30 May 2014. The plan provides for vesting restrictions on minimum period of employment (2) Options granted in lieu of cash payment for fees for services rendered to the Company b) Expenses arising from share based payment transactions Year ending - 31 December 2016 The share based payments transactions costs during the financial year relate to previously granted options based on a pro-rata portion of the vesting period was A$49,195. Year ending - 31 December 2015 The share based payments transactions costs during the financial year relate to previously granted options based on a pro-rata portion of the vesting period was A$234,933. 60 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2016 25. SEGMENT INFORMATION The Empire Group has two reportable segments as described below. Information reported to the Empire Group’s chief executive office for the purpose of resource allocation and assessment of performance is more significantly focused on the category of operations. Reportable segment profit/(loss) before tax 21,185,415 (22,512,492) Oil & Gas Investments Other Eliminations Total 2016 2015 2016 2015 2016 2015 2016 2015 2016 2015 14,538,955 18,236,209 219,972 320,745 - - - - - - 161,782 (140,312) (345,898) (2,293,786) (1,137,179) (1,285,838) - - - - - - 14,538,955 18,236,209 79,660 136,629 20,048,236 (26,092,116) 298 4,416 358,972 347,882 738 5,205 (358,972) (347,882) 1,036 9,621 (3,901,079) (3,500,513) - - (10,073) (5,802) 358,972 347,882 (3,552,180) (3,158,433) 16,497,092 (29,240,928) 92,267,669 74,734,756 72,361 173,061 203,888 243,617 (889,069) (703,151) 91,654,849 74,448,283 55,437,951 55,762,031 889,069 703,151 - (889,069) (703,151) 55,437,951 55,762,031 Non-cash items included in Finance costs: - Asset retirement obligation accretion (477,845) (422,431) - Discount on debt & overriding royalty interest (654,251) (676,135) - Fair value gain/(loss) on forward commodity contracts - - Capital expenditure (1,213,093) (4,743,805) (2,200,961) (5,758,201) (1,178,610) (22,202,568) 28,940,738 - - - (298,600) (426,200) - - - - - - - - - - - 161,782 - - - - - (12,666) (12,802) - - - - - - - - - - - - - - (69,281) (24,185) - - - - - - - - - - - - - - - - - - (2,213,627) (5,771,003) (1,178,610) (22,202,568) 28,940,738 - - 161,782 (298,600) (426,200) (477,845) (422,431) (654,251) (676,135) - (1,282,374) (4,767,900) 61 in USD Revenue (external) Other income (excluding Finance income) Finance income Finance costs Profit/(loss) for the period before tax Reportable segment assets Reportable segment liabilities Other material non-cash items: Gain on disposal of acreage - Depreciation and amortisation - Impairment expense - Reversal of impairment - Gain on disposal - Lease expiration costs EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2016 25. SEGMENT INFORMATION (Continued) The revenue reported above represents revenue generated from external customers. There were no intersegment sales during the period. Included in Other income above are gains disclosed separately of the face of the statement of Comprehensive Income. The Empire Group’s reportable segments under AASB 8 are as follows: • Oil and gas operations - includes all oil and gas operations located in the USA. Revenue is derived from the • sale of oil and gas and operation of wells. Investments - includes all investments in listed and unlisted entities, including the investment in Empire Energy Group USA (eliminated on consolidation). Revenue is derived from the sale of the investments. • Other - includes all centralised administration costs and other minor other income. Segment profit/(loss) represents the profit/(loss) earned by each segment without allocation of central administration costs and directors’ salaries, finance income and finance expense, gains or losses on disposal of associates and discontinued operations. This is the measure reported to the chief operating decision maker for the purposes of resource allocation and assessment of segment performance. Geographical information All Revenue from external customers is derived from operations in the USA. The majority of the Empire Group's assets are located in the USA. Major customers Revenues from two major customers of the Empire Group’s Oil & Gas segment represents approximately $13,230,448 (2015: two major customer $12,400,622) of the Empire Group’s total revenues. 26. RELATED PARTY DISCLOSURES a. Disclosures Relating to Directors i. The names of persons who were directors of the Company at any time during the financial year were: • B W McLeod • D H Sutton • K A Torpey ii. Directors’ Shareholdings Number of shares held by the Company Directors Director Balance at 1 January 2016 Acquired during period through Pro Rata Rights Issue Other changes during period Balance at 31 December 2016 B W McLeod D H Sutton K A Torpey 8,924,997 734,295 2,191,449 - - - - - - 8,924,997 734,295 2,191,449 Option holdings Number of options over ordinary shares in the Company held during the financial period by each Director of the Company, including their related entities are set out below: Director Balance at 1 January 2016 Granted during year as Remuneration Exercised during year Expiring during year Balance at 31 December 2016 Vested exercisable at 31 December 2016 B W McLeod D H Sutton K A Torpey 3,000,000 - - - - - - - 3,000,000 - - - - - - - - 62 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2016 26. RELATED PARTY DISCLOSURES (Continued) The options held by Directors’ were issued under an Employee Share Option Plan and were exercisable on the following basis and subject to a minimum term of employment conditions: Director B W McLeod No. of options Exercise Price A$ 1,500,000 1,500,000 $0.179 $0.169 Expiry Date 31 December 2016 31 December 2016 iii. Transactions with Key Management Personnel 1) B W McLeod is a director and shareholder of Eastern & Pacific Capital Pty Limited. The Empire Group incurred the following transactions: - Management consultant fees - Bonus payment * of this amount $126,193 was paid during the financial period 2016 US$ 2015 US$ 342,925* - 330,149 - 2) Aggregate amounts payable to Directors and their related Companies at balance date: - Eastern & Pacific Capital - Management consultant fees accrued during the year - Bonus payments accrued from previous years - Reimbursements 216,732 29,750 33,761 66,809 30,260 - 3) J Warburton is a director and CEO of wholly-owned subsidiary Imperial Oil & Gas Pty Limited. The Empire Group paid the following transactions: Advisory fees - - Director fees 2,137 26,795 56,104 27,086 b. Disclosures Relating to Controlled Entities Empire Energy Group Limited is the ultimate controlling Company of the Consolidated Entity comprising the Company and its wholly-owned controlled companies. During the year, the Company advanced and received loans, and provided accounting and administrative services to other companies in the Consolidated Entity. These balances, along with associated charges, are eliminated on consolidation. c. Investments in Controlled Companies Country of Incorporation Class of Share Controlling Empire Group Empire Energy Group Limited Australia Interest Held December 2016 % December 2015 % Controlled Companies Imperial Oil & Gas Pty Limited Imperial Energy Pty Ltd Cobalt Energy Pty Ltd Empire Energy Holdings, LLC Empire Energy USA, LLC Empire Energy (MidCon), LLC Empire Energy E&P, LLC Australia Australia Australia USA USA USA USA Ordinary Ordinary Ordinary Units Units Units Units 100 100 100 100 100 100 100 100 100 100 100 100 100 100 All entities are audited by Nexia Australia with the exception of Empire Energy Holdings, LLC, Empire Energy USA LLC, Empire Energy (MidCon), LLC and Empire Energy E&P, LLC which are companies incorporated in the USA and are audited by Schneider Downs. 63 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2016 27. NOTES TO THE STATEMENT OF CASH FLOWS (a) Reconciliation of Cash Cash at the end of the financial year is shown in Statement of Financial Position as follows: Cash at bank and in hand 641,493 1,126,543 December 2016 US$ December 2015 US$ (b) Reconciliation of profit after income tax expense to net cash flows from operating activities Profit/(Loss) for the period after income tax expense 16,448,929 (26,998,997) Adjustments for non-cash items: Depreciation & amortisation expense Impairment of property, plant & equipment Impairment of available for sale assets and related receivables 2,213,627 696,274 482,366 5,770,977 22,202,568 - Loss/(gain) on disposal of property, plant & equipment - 703,473 (Write-back) of property, plant & equipment (28,940,738) Expiration of leases Profit/Loss on disposal of available for sale financial assets Discount on debt Asset retirement obligation accretion Share-based payment expense Unrealised loss/(gain) on forward commodity contracts Operating profit before changes in working capital and provisions Change in Trade and other receivables Change in Prepayments and other current assets Change in Inventories Change in Current tax asset Change in Trade and other payables Change in Provisions Change in Deferred Tax Liability Net cash flows from operating activities 332,660 - 654,251 428,538 36,613 7,589,547 (57,933) (383,384) 234,508 8,412 - 312,876 (5,394) - 426,200 (161,782) 676,135 407,823 176,761 305,548 3,508,706 2,597,380 (429,860) 57,818 - (2,011,212) 132 - (2,062,080) 167,021 109,088 (1,847,822) 1,660,884 (c) Non-Cash Financing and Investing Activities During the current financial the following non cash financing and investing activities occurred: The Company granted 2,000,000 ordinary fully paid shares to a company in July 2016 in lieu of cash payment of $20,000 for services rendered, at a deemed issued price of $0.01 per share. The Company granted 1,000,000 ordinary fully paid shares to a company in August 2016 in lieu of cash payment of $20,000 for services rendered, at a deemed issued price of $0.02 per share along with 1,000,000 unlisted options exercisable at $0.03 prior to 25 August 2019. Options were issued for nil cash consideration. 64 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2016 27. NOTES TO THE STATEMENT OF CASH FLOWS (Continued) A proportional value of options already issued based on a pro-rata portion of the vesting period was expensed during the financial year as follows: - - - - 3,500,000 options exercisable @ A$0.149 expiring 31/12/2016 1,500,000 options exercisable @ A$0.169 expiring 31/12/2016 1,500,000 options exercisable @ A$0.179 expiring 31/12/2016 1,000,000 option exercisable @ A$0.028 expiring 25/08/2019 A$27,252 A$10,471 A$10,068 A$1,404 A$49,195 During the previous financial year there were no non cash financing and investing activities. 28. EARNINGS PER SHARE Basic earnings per share (cents per share) Diluted earnings per share (cents per share) 2016 4.76 4.76 2015 (7.84) (7.84) Profit/loss used in the calculation of basic and diluted earnings per share 16,448,929 (26,998,997) Weighted average number of ordinary shares on issue used in the calculation of basic earnings per share 345,634,425 344,313,877 Weighted average number of potential ordinary shares used in the calculation of diluted earnings per share 345,634,425 344,313,877 29. SUPERANNUATION COMMITMENTS The Empire Group contributed to externally managed accumulation superannuation plans on behalf of employees. Empire Group contributions are made in accordance with the Empire Group’s legal requirements. 30. PARENT ENTITY INFORMATION Information relating to Empire Energy Group Limited: Current Assets Total Assets Current Liabilities Total Liabilities Shareholder's Equity: Issued Capital Reserves - Fair value reserve - Foreign currency translation reserve - Options reserve - Share based payment reserve - General Reserve Accumulated Losses Total Shareholder’s Equity Profit/(loss) for the period Total Comprehensive income 2016 US$ 2015 US$ 146,433 35,921,121 (1,531,433) (1,531,433) 143,675 34,361,251 (209,243) (240,802) (74,239,177) (74,240,544) (575,677) 8,000,137 (575,677) 7,995,916 (1,510,540) (1,646,201) (167,567) (241,272) (168,442) (241,144) 34,344,408 34,821,211 (34,389,688) (34,054,881) 461,128 664,713 456,907 (1,403,332) 65 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2016 31. DIRECTORS AND EXECUTIVE OFFICERS REMUNERATION Determination of Remuneration of Directors Remuneration of non-executive directors comprise fees determined having regard to industry practice and the need to obtain appropriate qualified independent persons. Remuneration of the executive director is determined by the Remuneration Committee (refer statement of Corporate Governance Practices and the Remuneration Report for further details). In this respect, consideration is given to normal commercial rates of remuneration for similar levels of responsibility, consistent with the Empire Group’s level of operations. Determination of Remuneration of Other Key Management Personnel Remuneration of senior executives is determined by the Remuneration Committee (refer statement of Main Corporate Governance Practices for further details). In this respect, consideration is given to normal commercial rates of remuneration for similar levels of responsibility, consistent with the Empire Group’s level of operations. Directors’ and Executive Officers’ Remuneration Details of the nature and amount of each major element of the remuneration of each director of the Empire Group and each named officer of the Empire Group and the Consolidated Entity receiving the highest remuneration are: Short term benefits Cash salary and fees US$ Bonus payments US$ Non- monetary US$ Post- employment benefits Super contributions US$ Long- term benefits Long service leave Share/option based payments * 342,925(1) 14,886 - 26,795 - - - - 26,414 - - - - 2,010 14,886 - - - - - 15,288 - - - Total US$ 384,627 16,896 14,886 26,795 December 2016 Directors B W McLeod K A Torpey D H Sutton J Warburton 253,000(2) Executives A Boyer (1) Includes accrued $216,732 but not paid. * Share/Option based payments reflect a proportion of the independently valued cost of options granted under the Employee Share Option Plan (“ESOP”). The net cost shown is a non-cash cost and includes, on a pro-rata basis, the independently valued cost of previous options issued. Once the options reach vesting date, the cost shown amortises to $0. The Cost of the above options issued under the ESOP over the year was $18,185. The loss on options relating to the above directors that expired over the year was $30,975. The net cost of options issued to the above directors and executives for the year was $(12,791). (2) Includes $78,000 of previously accrued payments over the 2013 to 2016 period. 319,452 62,559 3,893 - - - Short term benefits Cash salary and fees US$ Bonus payments US$ Non- monetary US$ Post- employment benefits Super contributions US$ Long- term benefits Long service leave Share/option based payments * Total US$ 330,149 15,048 - 83,191 - - - - 25,211 - - - - 1,354 15,08 - - - - - 46,769 - - - 402,129 16,402 15,048 83,191 December 2015 Directors B W McLeod K A Torpey D H Sutton J Warburton 178,000 Executives A Boyer * Share/Option based payments reflect a proportion of the independently valued cost of options granted under the ESOP. The net cost shown is a non-cash cost and includes, on a pro-rata basis, the independently valued cost of previous options issued. Once the options reach vesting date, the cost shown amortises to $0. The Cost of the above options issued under the ESOP over the year was $55,268. The loss on options relating to the above directors that expired over the year was $25,649. The net cost of options issued to the above directors and executives for the year was $29,618. 251,825 65,326 8,499 - - - 66 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2016 32. AUDITORS’ REMUNERATION Audit Services Auditors of the Company – Nexia Australia: Audit and review of financial reports Other auditors: Audit and review of financial reports Other services Auditors of the Company – Nexia Australia: Taxation services Other auditors: Taxation services 2016 US$ 2015 US$ 89,536 99,400 89,588 188,016 179,124 287,416 12,682 9,211 1,303 13,985 1,029 10,240 33. MATTERS SUBSEQUENT TO BALANCE DATE 1) In December 2015, the Company entered into a US$75,000,000 Farm-out agreement (“Farmout”) for the development of its Northern Territory (NT) assets with AEGP Australia Pty Ltd (AEGP) a company controlled by Mr Aubrey K. McClendon. The agreement included Imperial’s 20% share of the Second Phase project funding. In March 2016 Mr McClendon was tragically killed in an accident. The Personal Representative of the McClendon Estate has confirmed that that Estate will not continue with the Farmout and in early 2017 AEGP and the Company agreed on the terms of a Termination Agreement for the Farmout. On 23rd January 2017 the Company signed the Termination Agreement and remains waiting for the return of the document from the McClendon Estate. 2) On 14 December 2016 Empire Energy Group Limited (the ‘Company’) announced a 11 for 5 pro-rata renounceable rights issue (‘Offer’) to raise approximately $6.1 million. The Offer was fully underwritten by 153 Fish Capital Pte Ltd (‘153 Fish Capital’). The Offer closed on the 27 January 2017. Existing shareholders took up 236,538,079 new shares under the Offer. The shortfall to the Offer was 527,553,373 shares amounting to approximately $4.2 million (“Shortfall Amount”). The Underwriter had forwarded to the Company Application Forms from Sub underwriters for a total of approximately $5.5 million (“Funds”) being approximately $1.3 million more than the Shortfall Amount. However, as of close of business on 17 February 2017 approximately $1.6 million of the Shortfall Amount had been received and shares have been issued. On 23 February 2017 the Company placed an additional 37,750,000 shares to investors as part of the shortfall. The Company is working with 153 Fish Capital to facilitate the placement of the remaining shortfall shares being $2.2 million. The Company does not have the available issuance capacity under ASX Listing Rule 7.1 to place the shares equivalent to the Shortfall without seeking shareholder approval. A General Meeting of the Company is being scheduled for the end of April 2017 with a date yet to be finalised as at the date of this report, to seek shareholder approval for the issue of 187,500,000 shares amounting to $1.5 million to place the remainder of the shortfall amount. The remainder of the shortfall will be issued under ASX Listing Rule 7.1 and 7.1A. 3) On 23 February 2017 the Company issued 17,693,153 shares to 153 Fish Capital Pte Ltd as a fee offset for the Offer. 67 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2016 33. MATTERS SUBSEQUENT TO BALANCE DATE (Continued) Following the share issues mentioned above the issued capital of the Company is 835,470,109 fully paid ordinary shares. There were no other matters or circumstances that have arisen since 31 December 2016 that has significantly affected or may significantly affect: • • • the operations, in financial years subsequent to 31 December 2016, of the Empire Group; or the results of those operations; or the state of affairs in financial years subsequent to 31 December 2016 of the Empire Group. 68 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2016 DIRECTORS’ DECLARATION In the opinion of the directors of Empire Energy Group Limited (the “Company”): a b c The financial statements and notes of the Company and the remuneration disclosures that are contained in the Remuneration report in the Directors’ report set out on pages 19 to 21, are in accordance with the Corporations Act 2001, including: i ii Giving a true and fair view of the Company’s and Group’s financial position as at 31 December 2016 and of their performance, for the year ended on that date; and Complying with Australian Accounting Standards (including the Australian Accounting Interpretations) and the Corporations Regulations 2001; the financial report also complies with the International Financial Reporting Standards as disclosed in note 1; and there are reasonable grounds to believe that the Company will be able to pay its debts as and when they become due and payable. The directors have been given the declarations required by section 295A of the Corporations Act 2001 from the Chief Executive Office and the Chief Financial Controller for the year ended 31 December 2016. Signed in accordance with a resolution of the directors. B W McLEOD Director Dated: 17 March 2017 69 Independent Auditor’s Report to the Members of Empire Energy Group Limited Report on the Audit of the Financial Report Opinion We have audited the financial report of Empire Energy Group Limited (the Company and its subsidiaries (the Group)), which comprises the consolidated statement of financial position as at 31 December 2016, the consolidated statement of profit or loss and other comprehensive income, consolidated statement of changes in equity and consolidated statement of cash flows for the year then ended, and notes to the financial statements, including a summary of significant accounting policies, and the directors’ declaration. In our opinion, the accompanying financial report of the Group is in accordance with the Corporations Act 2001, including: i) giving a true and fair view of the Group’s financial position as at 31 December 2016 and of its financial performance for the year then ended; and ii) complying with Australian Accounting Standards and the Corporations Regulations 2001. Basis for opinion We conducted our audit in accordance with Australian Auditing Standards. Our responsibilities under those standards are further described in the ‘Auditor’s responsibilities for the audit of the financial report’ section of our report. We are independent of the Group in accordance with the auditor independence requirements of the Corporations Act 2001 and the ethical requirements of the Accounting Professional and Ethical Standards Board’s APES 110 Code of Ethics for Professional Accountants (the Code) that are relevant to our audit of the financial report in Australia. We have also fulfilled our other ethical responsibilities in accordance with the Code. We confirm that the independence declaration required by the Corporations Act 2001, which has been given to the directors of the Company, would be in the same terms if given to the directors as at the time of this auditor’s report. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion. Material uncertainty related to going concern We draw your attention to Note 3 ‘Going concern’ of the financial report, which indicates the Group has an excess of current liabilities over current assets of $36.71m as at 31 December 2016. The Company is currently finalising the shortfall in the rights issue of $2.2m with the Underwriter. In Note 3, the directors state why they consider the going concern basis used in the preparation of the financial report is appropriate. As discussed in that note, if the Group is not successful in securing sufficient additional funds through the Underwriter or through other arrangements when required, there exists a material uncertainty that may cast significant doubt as to whether the Group will be able to continue as a going concern. Our opinion is not modified in respect of this matter. Key audit matters Key audit matters are those matters that, in our professional judgement, were of most significance in our audit of the financial report of the current period. These matters were addressed in the context of our audit of the financial report as a whole, and in forming our opinion thereon, and we do not provide a separate opinion on these matters. 70 Key audit matter How our audit addressed the key audit matter Impairment of oil and gas properties Our procedures included, amongst others: Refer to note 14 (Oil and Gas properties and property, plant and equipment)  Assessing whether the external expert engaged by management to provide independent valuations were appropriately experienced and qualified; At 31 December 2016, the Group has capitalised proved oil and gas assets of $77.62m. AASB 136 Impairment of Assets requires that the recoverable amount of an asset, or cash generating unit to which it belongs, be determined whenever an indicator of impairment exists. The Group’s assessment of the recoverable amount of its producing oil and gas properties was a key audit matter because the carrying value of the assets are material to the financial statements and management’s assessment of recoverable amounts incorporate significant internal and external judgements and assumptions including commodity prices, available reserves, residual values and discount rates. Asset retirement obligations Refer to note 18 (Provisions) The measurement of the provision for Asset Retirement Obligations incorporates significant judgement and uncertainty, with cost estimates varying in response to many factors including changes in technology, legal requirements, discount rates, past experience at other production sites, and estimates of future restoration costs. The expected timing and amount of expenditure can also change, for example, in response to changes in laws and regulations  We evaluated management’s key assumptions and estimates used to determine the recoverable amount of its assets, including those related to forecast commodity prices and revenue, costs, discount rates and estimated residual values;  We checked the mathematical accuracy of the cash flow models, testing inputs from valuation reports produced, as well as external inputs, including spot and forward prices for crude oil (WTI) and gas at the reporting date;  We assessed the accuracy of management’s forecasting by assessing the reliability of historical forecasts and reviewing whether current market conditions would impact those forecasts; and  Assessing whether appropriate disclosure regarding significant areas of uncertainty has been made in the financial report. Our procedures included, amongst others:  Evaluating management’s process of estimating and measuring the provision for asset retirement obligations;  Evaluating whether the discount rate applied by management to the forecast cash outflows is appropriate and consistent with the requirements of AASB 137 Provisions, Contingent Liabilities and Contingent Assets;  We considered the Group’s estimates of plugging costs per well, including assessment of whether there have been changes in technology or costs that would materially impact those estimates. We compared the estimates for plugging costs against actual costs incurred in 2016;  We considered whether the key assumptions and judgements used in management’s estimates were consistently applied in measuring the asset retirement provision and in assessing the recoverable amount of the related assets; and  We performed sensitivity analysis on management’s estimates used in calculating the obligation. 71 How our audit addressed the key audit matter Our procedures included, amongst others: We evaluated management’s process for estimating delivered but un- invoiced oil and gas sales by:     assessing the historical accuracy of management’s estimates by comparing previous estimates to the actual delivery for that period; comparing estimates of line loss to historical data, as part of the calculation for November (gas) and December (oil and gas) revenues; testing a sample of leases by comparing revenue by well to revenue as per leases, as well as agreeing production to relevant purchaser statements; and to the extent possible, compared the amounts accrued for oil and gas deliveries to subsequent receipts and/or delivery statements. Key audit matter or their interpretation. This was a key area of audit focus due to the size and nature of these estimates and their consequential effects on assessing the recoverable amount of producing assets. Revenue estimates Refer to note 5 (Revenue) and note 10 (Trade and Other Receivables) Due to timing differences between the delivery of oil and gas and the receipt of the delivery statement from the customers, the Group has recognised accrued revenues of $1.4m at balance date. These revenues are accrued based on volumetric data from the Group's records and estimated sales prices for the relevant months. These considerations combined create an area of significant estimation which we have determined to be a key audit matter. Other information The directors are responsible for the other information. The other information comprises the information in the Group’s annual report for the year ended 31 December 2016, but does not include the financial report and the auditor’s report thereon. Our opinion on the financial report does not cover the other information and we do not express any form of assurance conclusion thereon. In connection with our audit of the financial report, our responsibility is to read the other information and, in doing so, consider whether the other information is materially inconsistent with the financial report or our knowledge obtained in the audit or otherwise appears to be materially misstated. If, based on the work we have performed, we conclude that there is a material misstatement of the other information we are required to report that fact. We have nothing to report in this regard. 72 Directors’ responsibility for the financial report The directors of the Company are responsible for the preparation of the financial report that gives a true and fair view in accordance with Australian Accounting Standards and the Corporations Act 2001 and for such internal control as the directors determine is necessary to enable the preparation of the financial report that gives a true and fair view and is free from material misstatement, whether due to fraud or error. In preparing the financial report, the directors are responsible for assessing the Group’s ability to continue as a going concern, disclosing, as applicable, matters related to going concern and using the going concern basis of accounting unless the directors either intend to liquidate the Group or to cease operations, or have no realistic alternative but to do so. Auditor’s responsibility for the audit of the financial report Our objectives are to obtain reasonable assurance about whether the financial report as a whole is free from material misstatement, whether due to fraud or error, and to issue an auditor’s report that includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with the Australian Auditing Standards will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of this financial report. A further description of our responsibilities for the audit of the financial report is located at The Australian Auditing and Assurance Standards Board website at: http://www.auasb.gov.au/Home.aspx. This description forms part of our auditor’s report. Report on the Remuneration Report Opinion on the Remuneration Report We have audited the Remuneration Report included in pages 19 to 21 of the directors’ Report for the year ended 31 December 2016. In our opinion, the Remuneration Report of Empire Energy Group Limited for the year ended 31 December 2016, complies with section 300A of the Corporations Act 2001. Responsibilities The directors of the Company are responsible for the preparation and presentation of the Remuneration Report in accordance with section 300A of the Corporations Act 2001. Our responsibility is to express an opinion on the Remuneration Report, based on our audit conducted in accordance with Australian Auditing Standards. Nexia Sydney Partnership Lester Wills Partner Dated: 17 March 2017 Sydney 73 EMPIRE ENERGY GROUP LIMITED and its controlled entities SHAREHOLDER INFORMATION ORDINARY SHARES a Substantial Shareholders as at 28 February 2017 Name Macquarie Bank Limited (Metals & Energy CAP DIV A/C) b Distribution of Fully Paid Ordinary Shares 1 1,001 5,001 10,001 100,001 and over – – – – 1,000 5,000 10,000 100,000 Total number of holders Number of Shares 53,666,666 % Holding 6.42 Holders 302 725 415 860 514 Number of Shares 118,528 2,042,686 3,113,143 33,308,788 796,886,964 % Holding 0.01 0.24 0.37 3.99 95.38 2,816 835,470,109 100.00 i ii Number of holders of less than a marketable parcel Percentage held by 20 largest holders 2,119 39.62 c Twenty Largest Shareholders grouped as at 9 March 2016 Name Macquarie Bank Limited Fanchel Pty Ltd Mr Sean Anthony Dennehy HSBC Custody Nominees (Australia) Limited Rhodes Capital Pty Ltd John Wardman & Associates Pty Ltd Chifley Portfolios Pty Ltd 153 Fish Capital Pte Ltd Colowell Pty Ltd 1 2 3 4 5 6 7 8 9 10 Transition Metals Pty Ltd 11 Mr Ee Chye Chuan 12 13 Ms Geraldine Tan Choon Shan 14 Soh Chei-Yong + Susie See 15 Serlett Pty ltd 16 Asenna Wealth Solutions Pty Ltd 17 Classic Roofing Pty Limited 18 Colowell Pty Ltd 19 Mr Liang Kwang Lim + Mrs Jennifer Lynne Lim 20 WYT Nominees Pty Ltd Low Peng Koon Number of Shares 53,666,666 30,000,000 23,011,521 22,831,265 20,149,998 19,200,000 17,750,000 17,693,153 13,717,396 12,877,015 12,500,000 12,500,000 12,500,000 12,500,000 11,439,038 10,875,000 9,600,000 7,680,000 7,600,000 7,367,118 % Holding 6.42 3.59 2.75 2.73 2.41 2.30 2.12 2.12 1.64 1.54 1.50 1.50 1.50 1.50 1.37 1.30 1.15 0.92 0.91 0.88 335,458,170 40.14 d Voting Rights On a show of hands every member present in person or by proxy shall have one vote and upon a poll every member, present in person or by proxy, shall have one vote for every share except if the issue price has not been paid in full, then the holder is only entitled to a fraction of a vote on that share, being, the quotient of the amount paid up divided by the issue price of that share. 74 EMPIRE ENERGY GROUP LIMITED and its controlled entities SHAREHOLDER INFORMATON (Continued) UNQUOTED SECURITIES AS AT 7 MARCH 2017 Class of unquoted securities No. of securities No. of holders - Unlisted options exercisable at $0.28 expiring 25 August 2019 1,000,000 Unlisted Performance Rights subject to certain preconditions being met 2,500,000 1 1 Voting Rights There are no voting rights attached to any of the unquoted securities listed above. LIST OF MINERAL LEASES – USA AND AUSTRALIA A full list of the mineral (oil & gas) leases and rights of way held by the Company was announced on the Australian Securities Exchange on 17 March 2017. Given the extensive list (61 pages) it was not practical to include this listing in the Annual Report of the Company. CORPORATE GOVERNANCE STATEMENT The Company’s corporate governance statement can be found on the Company’s website at the following location: http://empireenergygroup.net/company-overview/corporate-governance 75 

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