Empire Energy Group Limited
Annual Report 2018

Plain-text annual report

EMPIRE ENERGY GROUP LIMITED and its controlled entities CONTENTS CORPORATE DIRECTORY CHAIRMAN’S LETTER TO SHAREHOLDERS CHIEF EXECUTIVE OFFICER’S LETTER TO SHAREHOLDERS OPERATIONS REVIEW 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 SHAREHOLDER INFORMATION 3 4 5 8 16 28 29 30 31 33 34 74 79 2 EMPIRE ENERGY GROUP LIMITED and its controlled entities CORPORATE DIRECTORY Directors Paul Espie AO (Chairman) Alexander Underwood (Chief Executive Officer and Managing Director) John Gerahty David Sutton Prof John Warburton (appointed 6 February 2019) Bruce McLeod (resigned 30 August 2018) Linda Tang (until 6 February 2019) Financial Controller Kylie Arizabaleta Company Secretary Julian Rockett Registered Offices Australian Office Level 7 151 Macquarie Street Sydney NSW 2000 US Office 380 Southpointe Boulevard Suite 130 Canonsburg PA 15317 Australian 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 Investors 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 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 700 Milam Street, Suite 1100 Houston, TX 77002 Stock Exchange Listings Australia Australian Securities Exchange (Home Exchange Sydney, New South Wales) ASX Code: EEG United States of America New York OTC 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 CHAIRMAN’S LETTER TO SHAREHOLDERS Dear Shareholders, Our Company is going through a significant period of change as we shift our focus from mature US production assets to the substantial potential of our world class assets in Australia’s Northern Territory. Since the new board took office during the year, we have formalised our strategy for value creation for shareholders. This is to: 1. Further reduce debt through the optimisation of our US assets to focus on our world-class Northern Territory McArthur and Beetaloo Basin position; 2. Build further our Northern Territory asset base focused on upstream oil and gas through strategic investment in the exploration, appraisal and development of our McArthur and Beetaloo Basin assets and potentially others consistent with the capital capacity and potential of Empire Energy and its partners; and 3. Build a Board of Directors and management team with the experience and capability to guide Empire through what we believe will be a significant and sustained period of growth. We recognise that, as a smaller company with limited cash resources, the preservation of funds to the greatest extent possible is an important element of the execution of our corporate strategy. We invest in our assets in a measured and careful way to maximise the value of the assets while minimising expenditure and preserving cash. The new team has made substantial progress executing this new strategy as our CEO has elaborated on below. Australia’s East Coast gas market continues to remain very tight and is expected to remain so for several years. Domestic gas prices on Australia’s East Coast are approximately double those in the United States of America presently. This is driven by a range of factors, particularly demand from new LNG liquefaction plants in Gladstone, coal seam gas field underdevelopment through environmental policies inter alia restricting the opening of new gas supplies in New South Wales and onshore Victoria. Meanwhile, demand for LNG from Asia has soared in recent years and we expect this to continue as Asia’s major economies continue to grow while seeking cleaner sources of reliable energy. The emerging onshore shale gas fields of the Northern Territory stand to benefit materially from these market forces. In January 2019, following the commissioning of the Northern Gas Pipeline which connects Tennant Creek in the Northern Territory to Mount Isa in Queensland, gas supplies from the Northern Territory were connected to the supply-constrained East Coast gas markets for the first time. Darwin is already a major LNG liquefaction base with both the LNG plant operated by ConocoPhillips and the Ichthys plant operated by Inpex exporting LNG to Asia. The Northern Territory Government understands the substantial economic benefits that are derived from responsible petroleum development and is implementing regulations which allow for the recommencement of onshore shale gas development and promotes the development of downstream industries such as LNG liquefaction and petrochemicals in Darwin and elsewhere. With neighbours adjoining our 14.5 million acres of tenements in the Beetaloo and McArthur Basins, Origin and Santos, expected to drill fracture stimulated horizontal appraisal wells later this year, Empire is uniquely positioned as a smaller ASX listed Company to benefit from the substantial petroleum industry growth expected in the Northern Territory, and market fundamentals in Australia’s East Coast and Asia. Yours sincerely, Paul Espie AO Chairman Empire Energy Group Limited 4 EMPIRE ENERGY GROUP LIMITED and its controlled entities CHIEF EXECUTIVE OFFICER’S LETTER TO SHAREHOLDERS Dear Shareholders, I am pleased to present you with Empire’s 2018 Annual Financial Report. 2018 was a year of great change for our Company. Much of this has been well documented in recent correspondence with Shareholders, however I would like to share some of our significant milestones and provide some further insight into our exciting future. In April 2018, shortly after my appointment, the Northern Territory Government announced that it would be lifting the moratorium on fracture stimulation of onshore shale gas reservoirs. This increased interest in our Company and its potential. Our Northern Territory assets remain a key focus of our strategy. During 2018 we were able to reduce outstanding debt by more than 30% from $38 million1 to $26 million. This was achieved following a competitive tendering process and was supported by an equity capital raising carried out in August 2018 which was critical to effect the refinancing of the maturing debt facility, and ultimately the longevity of the Company. After a period of several years during which no principal repayments could be made through cash flows, the Company is now making regular principal repayments from US production cash flows. Our cash balance at the end of 2018 stood at slightly more than $4 million2, compared to less than $1 million at the beginning of the year. In August 2018, our long running CEO and Executive Chairman, Bruce McLeod, resigned from his roles due to an illness which ultimately took his life. The Directors and I would like to recognise Bruce’s commitment and contribution to the Company. Building the right Board of Directors When I was appointed to this role, we commenced a process to rebuild the Board of Directors and review corporate structure and strategies. The Board’s composition was endorsed by a majority of shareholders who voted at the recent general meeting. We now have a strong and effective Board of Directors in place which is enabling us to execute our strategy. Debt Reduction through optimisation of US assets The operational performance of our US business over the course of 2018 has been positive. Prior to the successful refinancing of our debt facility and recapitalisation, the US management team was severely restricted in its access to capital yet was able to maintain production rates at relatively steady levels. Following the recapitalisation, a limited amount of capital from cash flow was allocated to the Kansas assets to increase production rates. The Kansas team carried out workovers and recompletions on 10 wells from late November 2018 to early January 2019. The results of that program have been strong although partially offset by recent oil price weakness and poor weather conditions which have hampered access to wells and tank batteries. The primary motivation for carrying out the Kansas program was to validate the value of the Kansas assets to potential acquirers of the Kansas assets. It is my view that the program achieved this goal. 1 Empire Group’s functional currency is in United States Dollars. All references to dollars are United States Dollars unless otherwise stated. 2 Shortly after the end of the year, the Company paid approximately $500,000 to the estate of the former CEO and Executive Chairman to discharge termination payment obligations and accrued but unpaid consulting fees. 5 EMPIRE ENERGY GROUP LIMITED and its controlled entities Over recent months we have commenced our strategy to reduce debt through the sale of US assets to focus on our Northern Territory assets in Australia. To that end, we have held discussions with several Australian and US based oil and gas companies that are interested in acquiring our US assets. We have received several indicative, non-binding proposals from interested parties. The Board is considering those proposals and will advise shareholders at the appropriate time if we enter into a sale agreement. The Board has implemented a new methodology for the valuation of the US assets which broadly reflects its view of typical valuations in the US oil and gas sector. This resulted in a non-cash write-down in the carrying value of the US assets of $14.9 million. A focus on the Northern Territory As we reach the end of an extended period of industry inactivity in the Northern Territory caused by the fracking moratorium, which was lifted in April 2018, and subsequent regulatory implementation, the immediate future for our Company is exciting. The shale development revolution that has occurred in the United States over the last decade has created hundreds of billions of dollars of value. The Marcellus Shale located in the Appalachia region of the USA now produces 25% of the USA’s natural gas and has strong geological similarities to the Velkerri Shale in the Beetaloo sub-Basin, a significant portion of which extends into our Northern Territory tenements. The Northern Territory Government is supportive of our industry and is working hard to implement the regulations required for a recommencement of industry investment. It has indicated that the necessary regulations will be in place in the coming weeks to allow regulatory approval requests to drill and complete fracture stimulated horizontal appraisal wells to be submitted. Recent public statements by Santos, Origin and the Northern Territory Government and associated press coverage indicate that the industry is on track to recommence substantial appraisal activities in the second half of 2019. Empire Energy is well placed to directly benefit from appraisal drilling programs by Origin and Santos in the Beetaloo sub-Basin. The Middle Velkerri Shale, one of the most prospective shales of the Beetaloo sub-Basin, contains more than 500 TCF of gas in place according to the Northern Territory Geological Survey. Our 100% owned EP187, EP184 and EP(A)188 tenements, which are directly adjacent to the tenement on which Santos will be drilling, contain an independently certified Velkerri Shale prospective resource of up to 3 TCF of recoverable gas equivalent, a substantial resource for a company of our size. Our tenements are highly prospective for not only gas but also petroleum liquids. The presence of liquids in the Velkerri Shale in our tenements is likely to enhance economics. In addition to the areas referred to above, our Northern Territory assets are also highly prospective for the Barney Creek Shale and Wollongorang Formation in the McArthur Basin Central Trough. These prospective areas, while early in their exploration, appraisal and development, have multibillion barrel of oil equivalent prospective resource potential. We are continuing to progress planning for the exploration of these areas. Major global oil and gas companies are watching the upcoming Beetaloo Basin work programs with great interest. It is my view that, with appraisal drilling success by our neighbours in the Northern Territory, we will attract substantial capital support from industry players, given the world class scale of our assets and likely continued ramp up in industry activity. The ingredients for success are coming together and as the only ASX listed company with a material Beetaloo sub-Basin and McArthur Basin footprint, Empire Energy and its shareholders are very well placed to benefit. I would like to publicly recognise the dedication, hard work and professionalism of our employees, contractors and consultants in Australia and the United States. Their efforts have set a platform for a bright future for our Company. 6 EMPIRE ENERGY GROUP LIMITED and its controlled entities I thank you for your support and assure you that the Empire team will continue to work tirelessly to unlock the value of our Company’s assets and generate strong returns for our Shareholders. Yours sincerely, Alex Underwood Chief Executive Officer Empire Energy Group Limited Map detailing major operators in Beetaloo and McArthur Basins 7 EMPIRE ENERGY GROUP LIMITED and its controlled entities OPERATIONS REVIEW A. 2018 OVERVIEW & HIGHLIGHTS Empire Group’s functional currency is in United States Dollars. All references to dollars are United States Dollars unless otherwise stated. GROUP FINANCIAL HIGHLIGHTS - Group Revenue $14.3 million (2017: $13.9 million) - Net production 1,185 boe per day (2017: 1,191 boe per day) - Outstanding debt $26.0 million (2017: $38.0 million) - Cash at bank $4.1 million (2017: $0.9 million) AUSTRALIA – NORTHERN TERRITORY - - - - A Prospective Resource P (50) (“PRP (50)”) of ~2.1 billion Boe or ~12.4Tcfe was announced in February 2016 for the Company’s Northern Territory Assets. The PRP (50) covers approximately 5.5 million acres of the total 14.5 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 12 for definition of Prospective Resource) In April 2018, the Northern Territory Government announced that it would lift the moratorium on fracture stimulation of onshore shale gas reservoirs and implement regulations in accordance with the recommendations of the Independent Inquiry into Fracture Stimulation of Onshore Unconventional Reservoirs in the Northern Territory. The Company is preparing for a recommencement of industry activity and intends to secure final regulatory approvals to acquire 231 line km 2D seismic in EP187 in the 2019 Dry Season (April – December). The Company also intends to recommence the process of securing landholder, Traditional Owner and Government approvals to progress its Exploration Permit Applications (EP(A) 180,181,182,183 and 188) to granted Exploration Permit status. Recommencement of these activities reflects increasing confidence given that the Northern Territory Government’s decision to support the onshore shale petroleum industry has provided greater investment certainty. USA – APPALACHIA & MIDCON - USA operations continued to trade in challenging market conditions throughout the 2018 characterised by gas prices remaining below $3/mcf for most of the year and oil prices experiencing significant volatility throughout the year. - - - The Company’s conservative hedging program provided another year of relatively steady earnings. Oil was unhedged throughout the year and approximately 60% of gas production was hedged at an average price of around $4.11/Mcf. The Company monitors individual oil wells daily, enabling wells to be produced profitably at prevailing oil prices. The management team was able to maintain production at a stable level year on year. This was an exceptional result in a region where production declines are normal. Following the successful refinancing of the maturing debt facility and recapitalisation, the Company carried out a Production Enhancement Program in late 2018 designed to increase production rates in Kansas. The total capital budget of the program of $440,000 was fully funded from free cash flow and has not been fully invested. The program was very successful as demonstrated by the increase in production rates and payback period of approximately two months. The program has been paused while the Company considers proposals to acquire part or all of the Company’s US assets to reduce debt. - Overall field volumes in Kansas have been negatively impacted by very poor weather conditions in late 2018 which are continuing. The primary impact has been from damage to roads which has impacted 8 EMPIRE ENERGY GROUP LIMITED and its controlled entities OPERATIONS REVIEW (Continued) access to well sites to export oil and workover some wells. This impact is expected to be reversed once weather conditions improve and has been mitigated by the successful Production Enhancement Program. - The Company did not carry out any development activities in the Appalachia region as new development drilling is uneconomic at current gas prices. Despite this, the Company maintained production rates on existing wells and acquired a small number of new wells for minimal cost. - Regional tightness in local gas markets has allowed the Company to enter into new gas marketing agreements with better differentials to NYMEX Henry Hub which are expected to have a positive impact on operating margins. - Gross oil production 190,000 Bbls (Net 128,000 Bbls) (2017: Gross 192,000 Bbls). - Gross natural gas production 2.30 Bcf (Net 1.83 Bcf) (2017: Gross 2.31 Bcf). - Gas reserves increased materially due to improved gas contracts which have extended the expected economic limits the Company’s long-life gas producing assets. - The Company’s credit facility was refinanced during the year with a new $26.06 million facility which closed in October 2018 and matures in February 2022. The balance reduced to slightly less than $26 million by the end of the year due to principal repayments made from free cash flow. INDEPENDENT REVIEW OF OIL & GAS RESERVES Although the Company assesses its US reserves based on a discount rate of 10%, for Australian reporting purposes the Company has utilised a discount rate of 12%. Reflecting the recent increase in the cost of capital and to align its Australian accounts (IFRS reporting) with its US accounts (GAAP reporting), a 12% discount rate for all reserve cashflow reporting is now utilised. It is the opinion of the Company’s new Board that the appropriate valuation benchmark for its US assets should be the discounted present value of its Proved Developed Producing reserves (whereas previously the Total Proved reserves were used as the valuation basis). This reflects typical trading metrics for mature producing upstream oil and gas assets in the current US M&A market. This change in valuation methodology has led to an impairment (non-cash) write down of these assets of $14.9 million. B. OPERATIONS The Company maintains a small head office in Australia and manages oil and gas production operations through its 100% owned USA subsidiary Empire Energy E&P, LLC (“Empire E&P”). The exploration programs in the Beetaloo and McArthur Basins in the Northern Territory, are operated through its 100% owned subsidiary Imperial Oil & Gas Pty Ltd. 9 EMPIRE ENERGY GROUP LIMITED and its controlled entities OPERATIONS REVIEW (Continued) C. OPERATIONS REVIEW – USA US Operations Key Operating Metrics Operating Statistics Notes Dec 31, 2018 Dec 31, 2017 % change Gross Production: Oil (MBbls) Natural gas (MMcf) Net Production: Oil (MBbls) Natural gas (MMcf) Net production (MBoe): 1.1 190 2,299 128 1,828 433 192 2,313 126 1,852 435 Net Daily Production (Boe/d): 1,185 1,191 Average sales price per unit (after hedging): Oil ($/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) 1.2 $59.71 $3.25 $31.40 $59.71 $2.69 $29.02 $23.19 $1.18 $11.85 $61.62 $2.99 $30.61 $45.83 $2.42 $23.61 $21.36 $1.17 $11.17 -1% -1% 2% -1% -1% -1% -3% 33% 3% 30% 11% 23% 5% 1% 9% 2P Reserves (MMBoe): 13.8 11.6 19% 1.1 1.2 BOE - based on SEC guidelines of an oil:gas ratio of 1:6. Lifting Costs - includes lease operating expenses, production and ad valorem taxes but excludes nonrecurring expenses, G&A and field overhead. D. OPERATIONS REVIEW – USA Net Production by Region Operating Statistics Oil (MBbls) Appalachia Mid-Con Total (MBbls) Natural gas (MMcf) Appalachia Mid-Con Total (MMcf) Dec 31, 2018 Dec 31, 2017 % change 3 124 127 1,819 9 1,828 3 123 126 1,843 10 1,853 - 1% 1% (1%) (10%) (1%) 10 EMPIRE ENERGY GROUP LIMITED and its controlled entities OPERATIONS REVIEW (Continued) E. US CAPITAL EXPENDITURE Capex (In $ thousands) Capital Expenditures Acquisition Capital New Wells – Drilling and Completion New Wells - Capital Undeveloped Leases Total Dec 31, 2018 Dec 31, 2017 48 343 71 - 462 82 242 162 2 488 F. CREDIT FACILITY The Company reached financial close on a new 3 year Credit Facility with Macquarie Bank Limited on 26 October 2018. The new facility has the following key terms: $26.06 million initial availability LIBOR + 650 bps (unchanged) 2% upfront fee on total initial availability 120 million unlisted options exercisable at A$0.032 per share on or before 31 December 2021 - - - - - Maturity Date 28 February 2022 - Repayment through sweep of 100% of US Net Operating Cash Flow (i.e. after payment of operating expenses with an allowance for general and administrative expenses and after interest expenses) subject to a minimum cumulative annual repayment of $2.5m, payable quarterly commencing in May 2019. Prior to financial close of the new Credit Facility, the Company’s loan balance stood at $37.95 million. The reduction in principal amount was effected by a cash repayment of $7.5 million funded from an equity capital raising, and a $4 million conversion of debt to equity by Macquarie Bank Limited. The draw down on the Macquarie Bank Limited Credit Facility as at December 31, 2018 was $26.0 million (cf $37.9 million at Dec 2017). Principal repayments made in 2018 and 2017 were ~$11.9 million1 and ~$2.2 million respectively. At 31 December 2018, the Company was in breach of the interest coverage covenant under the Credit Facility, which required a ratio of 1.8. This was due to several temporary factors including the fact that the Company’s oil production was unhedged in Q4 2018 and therefore impacted by low oil prices (whereas over 90% is hedged at $66.50 / bbl in 2019), poor weather conditions in Kansas which negatively impacted production rates and sales (offset by strong results of the Production Enhancement Program) and a higher loan balance early in the quarter which resulted in higher interest expense than is now incurred on the reduced loan balance. Macquarie Bank Limited formally waived this breach on 26 March 2019. G. 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. A summary of the hedging contracts can be found at Note 13 of the Financial Statements. The fair value (marked to market) of combined oil and gas hedges in place as at December 31, 2018 was $4.3 million2. Oil and gas hedge contracts were valued based on NYMEX Henry Hub and WTI forward curves at market close on December 31, 2018. 1 Which includes $4.0 million conversion of debt to equity. 2 Due to increasing commodity prices since 31 December 2018, as at the date of this report, the fair value (marked to market) of combined oil and gas hedges in place has reduced to approximately $1.7 million. 11 EMPIRE ENERGY GROUP LIMITED and its controlled entities OPERATIONS REVIEW (Continued) H. RESERVES – USA The Company’s reserves are reviewed annually by independent third-party reservoir 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. In previous years, the company attributed 3P Possible Reserves volumes and P(50) Prospective Resource volumes to its New York State shale properties. Given that there is a ban on fracture stimulation in New York State which prevents the Company from developing these areas, the Company has elected to reduce these volumes to zero. Reserves as at December 31, 2018 – USA (NYMEX Strip Dec 28, 2018 including hedges) Reserves - As of Dec 31, 2018 Reserves (Reserves) Proved Developed Producing Proved Developed Non-producing Proved Behind Pipe Proved Undeveloped Total 1P Probable Total 2P Possible Total 3P Prospective Resource P(50) - Aust (NT) Oil (Mbbls) 1,700 579 361 1,021 3,660 319 3,979 1,752 5,731 222,000 Gas (MMcf) MBoe Capex $M PV0 $M PV10 $M 48,183 - - 3,597 51,781 6,986 52,479 3,936 56,415 11,076,000 6,070 476 139 1,581 8,266 3,368 11,634 2,378 106,828 2,068,000 $29 $1,403 $583 $14,807 $16,821 $8,968 $25,798 $24,590 $50,388 $97,645 $14,145 $5,054 $31,603 $157,018 $23,930 $180,948 $63,185 $244,133 $34,337 $7,340 $5,054 $8,172 $54,904 $3,986 $58,890 $11,967 $70,856 USA Reserves by: Graves & Co Consulting Northern Territory Resources by: Muir & Associates P/L and Fluid Energy Consultants Notes to Reserves - “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. - 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 and 3P reserves. - The reference point used for 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. - - - 12 EMPIRE ENERGY GROUP LIMITED and its controlled entities OPERATIONS REVIEW (Continued) - - “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) – Graves & Co Consulting. - Oklahoma (Mid-Con) - Pinnacle Energy Services, LLC. - Northern Territory - Muir & Associates P/L and Fluid Energy Consultants. - The following NYMEX prices, as at December 31, 2018, were used to calculate reserves and cash flow: Year 2019 2020 2021 2022 2023 2024 2025 2026 2027 $/Bbl 46.62 48.25 49.30 50.31 51.25 51.84 52.08 52.11 52.03 $/Mcf 2.96 2.69 2.60 2.64 2.70 2.79 2.89 3.01 3.10 I. NORTHERN TERRITORY – A LARGE EMERGING PETROLEUM PLAY Empire Energy Group Limited, through its 100% owned subsidiary Imperial Oil & Gas Pty Ltd (“Imperial”), holds a 100% interest in 59,000 square km (14.5 million acres) of prospective shale oil and gas exploration acreage, in the central depositional trough of the Proterozoic McArthur Basin. The McArthur Basin is an underexplored petroleum frontier basin with abundant indications for the presence of gas and oil The Independent Prospective Resource estimates attributable to the Company’s Northern Territory tenements are set out below: INDEPENDENTLY CERTIFIED ESTIMATED PROSPECTIVE RESOURCE (Unrisked) IDENTIFIED AREA MM acres Barney Creek Formation Velkerri Formation Wollogorang Formation Bcf MMBO Bcf MMBO Bcf MMBO 2,982 635 1,384 TOTAL MMBOE P90 3,304 66 383 8 524 10 786 P50 8,699 174 1,192 24 1,185 24 2,068 Conversion Factor oil:gas is 1:6. Refer to page 12 for definition of Prospective Resource P10 20,172 403 3,086 62 2,371 47 4,783 13 EMPIRE ENERGY GROUP LIMITED and its controlled entities OPERATIONS REVIEW (Continued) J. BUSINESS RISK Exploration Risk - Empire and its subsidiaries have interests in assets at various stages of exploration, appraisal and development. Many leases have had very low levels of exploration undertaken to date and may not yield commercial quantities of hydrocarbons. Oil and gas exploration is inherently subject to numerous risks, including the risk that drilling will not result in commercially viable oil and gas production. Application Risk – A number of Empire’s Northern Territory assets are in application stage requiring native title and / or regulatory approvals to be granted as Leases capable of being explored on. Such approvals may or may not be granted which could adversely impact the value of the Company. Regulatory Risk – Empire has operations spanning several States in the USA and the Northern Territory, Australia. Regulatory approvals are required to explore, appraise, develop and produce from the assets. Where such regulatory approvals are already in place, there is a risk that they could be revoked. Where such regulatory approvals are not in place, there is a risk that they may not be granted. Debt Facility Risk – Empire, through its US subsidiaries, has debt facilities in place with Macquarie Bank Limited. Whilst Empire has financial flexibility and expects to generate sufficient cash flow to repay the debts in full, there is a risk in the future that financial and other covenants under the debt facilities, could be breached, which could result in Macquarie exercising its security rights under the facilities. Commodity Price Risk – Empire, through its US subsidiaries, sells oil and gas at market prices to customers who price the products off US benchmark oil and gas markets. Empire is exposed to the risk of material declines in the prices of those commodities. Empire, through its Australian subsidiary, explores for oil and gas in Australia and maybe subject to domestic Australian gas price risk, LNG price risk and oil price risk. Reliance on Key Personnel – Empire’s success depends in large measure on certain key personnel. The loss of the services of such key personnel may have a material adverse effect on the business, financial condition, results of operation and prospects. Economic Risk – General economic conditions, movements in interest rates, inflation rates and foreign exchange rates, investor sentiment, demand for, and supply of capital and other general economic conditions may have a negative impact on Empire and its subsidiaries ability to carry out its exploration, appraisal, development and production plans. Environmental Risk – The upstream oil and gas industry is exposed to environmental risks, including the risk of oil and chemical spills, the risk of uncontrolled gas venting, and other material environmental risks. If an environmental incident was to occur, it may result in Empire’s subsidiaries’ licenses being revoked, its rights to carry on its activities suspended or cancelled, or significant legal consequences. Title Risk – Interests in tenements in Australia are governed by the respective Territory legislation and are evidenced by the granting of licences or leases. Each licence or lease is for a specific term and carries with it annual expenditure and reporting commitments, as well as other conditions requiring compliance. Consequently, the Company could lose title to or its interest in the Tenements if licence conditions are not met or if insufficient funds are available to meet expenditure commitments. Native Title and Aboriginal Land - The Tenements extend over areas in which legitimate common law native title rights of indigenous Australians exist. The ability of the Company to gain access to its Tenements and to conduct exploration, development and production operations remains subject to native title rights and aboriginal land rights and the terms of registration of such title agreements. Reserves Risk – Reserves assessment is a subjective process that provides an estimate of the volume of recoverable reserves. Oil and gas estimates are not precise and are based on knowledge, experience, interpretation and industry practices. There is a risk that the Company’s reserves do not generate the actual revenues and cashflows that are currently being budgeted which could adversely impact the Company. Services Risk – Empire engages the services of third party service providers to carry out exploration, appraisal, development and operating activities. The cost of such services is subject to very high price volatility, particularly in remote areas. There is a risk that such services may not be able to be provided at a reasonable price, thereby preventing exploration, appraisal, development and operations activities from occurring. Production Risk – Empire has producing oil and gas assets in the USA. If these assets do not produce the level of production currently budgeted by Empire, then the cashflow they deliver will not materialise. The carrying values of these assets could also be adversely impacted. Production risk has the potential to adversely impact the Company. 14 EMPIRE ENERGY GROUP LIMITED and its controlled entities OPERATIONS REVIEW (Continued) Insurance Risk – The Company intends to insure its operations in accordance with industry practice. However, in certain circumstances, the Company’s insurance may not be of a nature or level to provide adequate insurance cover. The occurrence of an event that is not covered or fully covered by insurance could have a material adverse effect on the business, financial condition and results of the Company. Insurance against all risks associated with mining exploration and production is not always available and where available the costs can be prohibitive. Acquisitions – The Company may decide to pursue potential acquisitions in the future. This may give rise to various operational and financial risks, including, but not limited to, poor integration resulting in higher than expected integration costs, and financial underperformance of the acquired assets. There is also additional risk associated with the Company’s inability to identify suitable acquisitions in the future that meet the Company’s criteria. This may potentially have an adverse impact on the financial performance of the Company. Funding Risk – The Company may need future capital in the future to progress the development of its acreage. There can be no guarantee that future capital, whether it be debt or equity, will be available or will be available on attractive terms. The inability to secure future capital, or in the ability to secure future capital on attractive terms, could adversely impact the value of the Company. K. 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 Mel Hainey Organisation Graves & Co. Consulting LLC Qualifications BSc Professional Organisation SPE Wal Muir Muir and Associate P/L BSc,MBA PESA * 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. 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 2018 In respect of the financial year ended 31 December 2018, 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: Paul Espie AO Appointed Non-Executive Chairman 5 February 2019 Appointed Non-Executive Director 8 November 2018 Alexander Underwood Appointed Managing Director and Chief Executive Officer 30 August 2018 Alternate Director from 23 July 2018 to 30 August 2018 John Gerahty Appointed Non-Executive Director 8 November 2018 David Sutton Bruce McLeod Linda Tang Non-Executive Director Interim Chairman from 30 August 2018 to 5 February 2019 Chief Executive Officer and Executive Chairman Resigned 30 August 2018 Non-Executive Director Until 6 February 2019 Prof John Warburton Appointed Non-Executive Director 6 February 2019 All 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 Beetaloo Basin and McArthur Basin, in the Northern Territory, Australia. Work undertaken to date has shown this region to be highly prospective for conventional and unconventional oil and gas. In November 2018, the Company announced a new strategy focused on the reduction of debt through US asset sales in order to focus on the value creation potential of its Northern Territory assets. CONSOLIDATED RESULTS The consolidated net loss of the Empire Group for the financial year ended 31 December 2018 after providing for income tax was $15,867,054 compared to a consolidated net loss for the previous corresponding reporting period of $20,107,246. The 31 December 2018 net loss after tax reflects a non-cash write-down in the carrying value of the US assets of $14,944,148 in accordance with accounting standards. REVIEW OF OPERATIONS For information on a review of the Empire Group’s operations refer to the Operations Report contained on pages 8 to 15 of this annual report. 16 EMPIRE ENERGY GROUP LIMITED and its controlled entities Directors’ Report for the year ended 31 December 2018 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) On 12 December 2018, the Company announced that on 10 December 2018 it received notice under section 249D of the Corporations Act 2001 (Cth), from Global Energy & Resources Development Limited (“GERD”), a shareholder owning greater than 5% of the Company’s issued capital, requesting the directors of the Company to call and arrange to hold a general meeting of the members of the Company. The purpose was to consider the following resolutions: 1) that each and every one of the present directors be removed from his or her office of director of the Company; 2) that each of Edward Jacobson, Joseph Graham, James Hulme and Bruce Garlick be appointed as a director of the Company. On 6 February 2019 an Extraordinary General Meeting was conducted to consider the GERD resolutions. Shareholders voted against all resolutions other than the removal of Linda Tang, which shareholders voted in favour of. 2) On 6 February 2019, the Company appointed Professor John Warburton as Non-Executive Director of the Board. 3) On 5 February 2019, the Company appointed Mr Paul Espie AO as Non-Executive Chairman and Mr David Sutton resigned as Interim Chairman and returned to the role of Non-Executive Director. 4) On 6 March 2019, the Company announced that pursuant to its strategy to reduce debt through the sale of US assets, that it had received a number of proposals which the Directors were considering. That process is ongoing and shareholders will be provided further updates at the appropriate time. 5) At 31 December 2018, the Company was in breach of the interest cover covenant under the Credit Facility, which required a ratio of 1.8. This was due to several temporary factors including the fact that the Company’s oil production was unhedged in Q4 2018 and therefore impacted by low oil prices (over 90% is hedged at $66.50 / bbl in 2019), poor weather conditions in Kansas which negatively impacted production rates and sales (offset by strong results of workover and recompletion program) and a higher loan balance early in the quarter which resulted in higher interest expense than is now incurred on the reduced loan balance. Macquarie Bank Limited formally waived this breach on 26 March 2019. INFORMATION ON DIRECTORS Paul Espie AO, BSc, MBA Non-Executive Chairman Appointed Non-Executive Director 8 November 2018 Appointed Non-Executive Chairman 5 February 2019 Age 74 Mr Paul Espie AO was the founding principal of Pacific Road Capital, a manager of private equity funds investing in the resources sector internationally, in 2006. He was Chairman of Oxiana Limited during the development of the Sepon copper/gold project in Laos (2000 to 2003) and prior to that Chairman of Cobar Mines Pty Ltd after a management buy- out in 1993. Mr Espie was previously responsible for Bank of America operations in Australia, New Zealand and Papua New Guinea and Chairman of the Australian Infrastructure Fund. He is a Director of Aurelia Metals Limited, a Fellow of 17 EMPIRE ENERGY GROUP LIMITED and its controlled entities Directors’ Report for the year ended 31 December 2018 the Australian Institute of Company Directors, Trustee of the Australian Institute of Mining & Metallurgy, Educational Endowment Fund, and a Director of the Menzies Research Centre. Special Responsibilities: Member of Remuneration Committee Other Current Listed Public Company Directorships: Aurelia Metals Limited Former Listed Public Company Directorships in Last 3 Years: Nil Alexander Underwood, LLB, BCom (Hons) Managing Director and Chief Executive Officer Appointed Managing Director and Chief Executive Officer on 30 August 2018 Appointed Alternate Director on 23 July 2018 (resigned as Alternate Director on 30 August 2018) Age 36 Mr Underwood was appointed as an Executive of Empire and a Director and Chief Executive Officer of the Company’s wholly owned subsidiary, Imperial Oil & Gas Pty Ltd on 6 March 2018. Mr Underwood has nearly fifteen years of specialist upstream oil and gas investing and financing experience. Previously he spent two years with the Commonwealth Bank of Australia, Singapore as Director of Natural Resources and spent nine years with Macquarie Bank in Sydney and Singapore as Associated Director of Energy Markets Division. He commenced his career at BHP Billiton Petroleum. Special Responsibilities: Chief Executive Officer of Imperial Oil & Gas Pty Limited Managing Member of the Company’s 100% wholly owned US subsidiaries Other Current Listed Public Company Directorships: Nil Former Listed Public Company Directorships in Last 3 Years: Nil John Gerahty, BCom, MBA Non-Executive Director Appointed on 8 November 2018 Age 76 Mr John Gerahty is a former investment banker and company director with wide experience in business and commerce. He was a Founding Director of Macquarie Bank and has served as a director of a considerable number of publicly listed companies, including roles as Chairman of AFP Group PLC and MPI Mines Ltd. He is currently Chairman of Hardie Grant Pty Ltd publishing group, its major shareholder Associated Media Investments Pty Ltd, and an associated company AMI Advertising Media Pty Ltd. He is also a Director of Kaplan Partners Pty Ltd and Kaplan Funds Management Pty Ltd, as well as his family owned Liangrove group companies. He was formerly a Director (and Chairman) of the Sydney Swans, a Director of Cricket NSW, and a Trustee of the SCG Trust. Special Responsibilities: Member of the Audit Committee Other Current Listed Public Company Directorships: Nil Former Listed Public Company Directorships in Last 3 Years: Nil 18 EMPIRE ENERGY GROUP LIMITED and its controlled entities Directors’ Report for the year ended 31 December 2018 David Sutton, B.Com ACIS Non-Executive Director Appointed Non-Executive Director 17 January 1997 Age 75 Mr Sutton has many years’ experience as a director of companies involved in share broking and investment banking in Australia and Hong Kong. He is executive chairman of APC Securities Pty Ltd, a boutique financial services company focusing on the global resource sector. Prior to his current role he was a partner and director of several ASX participant firms and a member of the Stock Exchange of Melbourne and subsequently Australian Securities Exchange Limited. Apart from Empire Energy he has been a director of several ASX listed resource companies including Silver Mines Limited. He has also been a director of a number of private mineral exploration companies. Special Responsibilities: Member of Audit Committee Other Current Listed Public Company Directorships: Nil Former Listed Public Company Directorships in Last 3 Years Silver Mines Limited Precious Metals Investments Limited Professor John Warburton, PhD, FGS, FPESA, MAICD Non-Executive Director Appointed Non-Executive Director 6 February 2018 Age 61 John Warburton has 35 years of professional oil and gas experience in operated and non-operated conventional and unconventional petroleum discovery, development and in new business delivery. John has worked in Western Europe, West Africa, Central Asia, Middle East, Pakistan, Papua New Guinea and throughout the Asia Pacific Region including Australia and New Zealand. He has resided as an expatriate in a number of these regions and has a keen focus on people, safety, cultural heritage and environment. Prof Warburton’s career includes 14 years of senior technical and leadership roles at BP. He was Executive General Manager for Exploration & New Business at Eni in Pakistan, and until March 2018 John was Chief of Geoscience & Exploration Excellence at Oil Search Ltd. Prof Warburton has been a Director of Empire’s wholly owned Northern Territory subsidiary, Imperial Oil & Gas Pty Limited (“Imperial”), since 2011 and was its Chief Executive Officer from 2011 to 2014. He continues to serve as a Non-Executive Director of Imperial. In addition, John is Visiting Professor in the School of Earth & Environment at Leeds University UK where he has served eight years on the External Advisory Board of ‘Petroleum Leeds’, the centre for excellence in Petroleum Engineering & Geoscience. Special Responsibilities Non-Executive Director of Imperial Oil & Gas Pty Limited Member of the Remuneration Committee Other Current Listed Public Company Directorships: Senex Energy Limited Former Listed Public Company Directorships in Last 3 Years: Nil Bruce McLeod, B.Sc (Maths), M.Com (Econ) Former Executive Chairman Appointed Executive Chairman 21 May 1996 Resigned 30 August 2018 Age 65 Mr McLeod had extensive experience in the Australian capital markets. Over the past 25 years he was involved in raising debt and equity capital for a number of resource, property projects and companies, as well as the takeover and 19 EMPIRE ENERGY GROUP LIMITED and its controlled entities Directors’ Report for the year ended 31 December 2018 rationalisation of listed and unlisted companies. Prior to that he spent six years with a major international bank, where he was Executive Director, responsible for the financial and capital markets operations. Special Responsibilities Executive Chairman and Chief Executive Officer until 30 August 2018 Member of Audit Committee until 30 August 2018 Other Current Listed Public Company Directorships: Nil Former Listed Public Company Directorships in Last 3 Years: Anson Resources Limited Linda Tang, MBA (Acct), B.Tech (Acct) Non-Executive Director Appointed Non-Executive Director 2 June 2017 Removed 6 February 2019 Age 37 Ms Tang has over 12 years of experience within the finance and energy sectors. Previously she spent 7 years in the Energy Finance SBU at China Minsheng Banking Corporation, Beijing, China. Prior to that she was the Financial Manager for Global Oil Corporation Limited which has among other operating assets, three Production Sharing Contracts with PetroChina in Jilin province, China. Ms Tang has an MBA in Accounting (Monmouth University, NJ, USA) and a Bachelor of Technology. Special Responsibilities Member of Remuneration Committee until 6 February 2019 Member of Audit Committee until 6 February 2019 Other Current Listed Public Company Directorships: Nil Former Listed Public Company Directorships in Last 3 Years: Nil COMPANY SECRETARY Julian Rockett Mr Rockett was appointed Joint Company Secretary on 28 March 2019. Mr Rockett is employed by Boardroom Pty Limited in their Corporate Secretarial Services Division. Mr Rockett is a qualified corporate lawyer and an experienced Company Secretary for ASX Listed companies. 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 Chartered Accounting firms specialising in Audit and Assurance Services and holds over 8 years’ experience. Geoff Hokin MSc(Hons) Geology; MSc Geology; Dip Coal Geology; Dip Arts Anthropology & Cross-Cultural Psychology, Dip Training & Assessment, Cert IV Bus Mgmt. Explorations & Operations, Imperial Oil & Gas Pty Ltd Mr Hokin has 15 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, Arrow Energy Limited, and Xstrata Coal Australia. Mr Hokin has extensive geological and executive management experience to Executive Director level in other operations. He has authored and co-authored a number of publications including ‘An emerging shale gas play in the Northern Territory’ (2012) and ‘Peasant resistance and Disadvantage’ (2017). Mr Hokin also has significant qualifications and experience in safety and risk management, team leadership, conflict resolution, and project management. 20 EMPIRE ENERGY GROUP LIMITED and its controlled entities Directors’ Report for the year ended 31 December 2018 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 Held Whilst in Office Mr A Underwood Mr B W McLeod Mr D H Sutton Ms L Tang Mr P Espie Mr J Gerahty 5 14 14 14 1 1 5 14 14 14 1 1 - - 2 2 - - - - 2 2 - - - 3 6 6 - - - 3 6 6 - - During the Financial Year, the audit committee comprised Mr McLeod, Mr Sutton and Ms Tang. Mr Sutton and Ms Tang were members of the remuneration committee during the financial year. Retirement, Election and Continuation in Office of Directors Mr McLeod resigned as Chief Executive Officer and Executive Chairman on 30 August 2018. Mr Underwood was appointed Alternate Director on 23 July 2018 until 30 August 2018, then appointed Chief Executive Officer and Managing Director on 30 August 2018. As a new addition to the Board, Mr Underwood will stand for re- election at the Company’s next Annual General Meeting. Mr Sutton was appointed Interim Chairman 30 August 2018 until 6 February 2018, then returned to the role of Non- Executive Director. Mr Espie AO was appointed Non-Executive Director on 8 November 2018. As a new addition to the Board, Mr Espie will stand for re-election at the Company’s next Annual General Meeting. Mr Gerahty was appointed a Non-Executive Director on 8 November 2018. As a new addition to the Board, Mr Gerahty will stand for re-election at the Company’s next Annual General Meeting. Prof Warburton was appointed a Non-Executive Director on 6 February 2019. As a new addition to the Board, Prof Warburton will stand for re-election at the Company’s next Annual General Meeting. Ms Tang was removed from the Board by a resolution of shareholders at the Extraordinary General Meeting conducted on 6 February 2019. Remuneration Report – Audited This report outlines the remuneration arrangements in place for Directors and Executives of the Empire Group. REMUNERATION COMMITTEE During the Financial Year, the Remuneration Committee reviewed and approved 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 L Tang Independent Non-Executive Chairman Independent Non-Executive Director The Committee meets as often as required but not less than once per year. The Committee met twice during the period and Committee member’s attendance record is disclosed in the table of Directors Meetings shown above. 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 21 EMPIRE ENERGY GROUP LIMITED and its controlled entities Directors’ Report for the year ended 31 December 2018 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. The Chief Executive Officer and Managing Director, Mr Underwood, was appointed to the role on 30 August 2018. The Remuneration Committee comprising Mr Sutton and Ms Tang considered a remuneration package for Mr Underwood in September 2018 but it was unable to resolve to recommend a remuneration package to the Board. Consequently, the Chief Executive Officer and Managing Director continued to be remunerated under the terms of a consulting services agreement between his services company and the Company and its subsidiary, Imperial Oil & Gas Pty Limited, from the date of his appointment to the roles of Chief Executive Officer and Managing Director of the Company. The Board has sought the advice of a leading Australian remuneration consultant regarding the composition of the Chief Executive Officer’s remuneration package. Once a remuneration agreement has been executed, shareholders will be notified. It is likely that the remuneration package will comprise a combination of a cash base salary and performance-based remuneration which may comprise a combination of cash and equity-linked awards. Performance Based Remuneration As part of the executives’ remuneration packages 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 are assessed annually, with bonuses 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. The Company is considering implementing a new Share Rights scheme to provide for performance based remuneration to executives of the Company. Any such scheme would be implemented subject to shareholder approval. 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. The annual limit on remuneration that can be paid to each non-executive director has not increased for many years and is currently under review by reference to market compensation for the non-executive directors of comparable ASX listed companies. If the company resolves to increase this limit, shareholder approval will be sought. 22 EMPIRE ENERGY GROUP LIMITED and its controlled entities Directors’ Report for the year ended 31 December 2018 Short term benefits Post-employment Long-term benefits benefits December 2018 Cash salary and fees Bonus payments Non- monetary Super contributions Termination Payment Long service leave Share/ option based payments** Total $ Directors B W McLeod A Underwood D H Sutton L Tang P Espie J Gerahty J Warburton Executives A Boyer 253,269 210,010 - 14,958 2,172 2,172 23,391 219,520 - - - - - - - - 15,599 - - - - - - 72,362 - - 14,958 - - - - - 362,100* - - - - - - - - - - - - - - 49,328 680,296 57,218 267,228 10,428 10,428 - - - 25,386 25,386 2,172 2,172 23,391 11,957 303,839 * Mr McLeod’s services company had a services agreement in place with the Company which provided for termination payments to be made in the event of the termination of Mr McLeod’s consulting services agreement. The termination payment made to Mr McLeod’s services company was made in accordance with the consulting services agreement, subject to statutory limitations on the quantum of termination payments allowable under the Corporations Act 2001 (Cth). ** 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 using the Black Scholes methodology. 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 $108,884 and the non-cash loss on options relating to the above directors that expired over the year was $53,276. The net non-cash cost of options issued to the above directors and executives for the year was $55,608. Short term benefits Long-term benefits December 2017 Cash salary and fees Bonus payments Non- monetary Super contributions Long service leave Share/option based payments* Total $ Directors B W McLeod K A Torpey D H Sutton L Tang J Warburton Executives A Boyer 365,489(1) 7,555 31,063(2) - 25,791 - - 7,555 16,999 219,018 - - - - - - - 63,513 - 718 15,110 - - - - - - - - - 1,206 - - - - 423,549 8,273 15,110 7,555 16,999 241 282,772 (1) Includes accrued $145,135 but not paid. (2) In relation to a bonus issued in December 2014. * 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 using the Black Scholes methodology. 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 $19,058 the non-cash loss on options relating to the above directors that expired over the year was $32,462. The net non-cash cost of options issued to the above directors and executives for the year was $(13,404). 23 EMPIRE ENERGY GROUP LIMITED and its controlled entities Directors’ Report for the year ended 31 December 2018 Service Agreements Remuneration and other terms of employment for key management personnel are formalised in service agreements. Details of these agreements are as follows: Bruce McLeod Former Executive Chairman Terms of the agreement: • • • • Agreed management consultant fees of A$507,960 per annum of which A$338,640 was paid up to the date of his resignation (30 August 2018). Payment of termination benefits applied and were paid in accordance with the terms of the consulting services agreement. The termination payment made was subject to a cap under the Corporations Act 2001 (Cth) which the Company applied. Performance based incentive bonus based on annual performance set against key performance indicators. None were paid in the 2018 Financial Year or are payable in the future. Long term incentives occurring up on the monetisation of an asset, this long-term incentive continues beyond term of the agreement. None were paid in the 2018 Financial Year or are payable in the future. Under the terms of the termination payment, Mr McLeod’s services company waived its rights to any long-term incentives beyond the date of termination of the consulting services agreement. • Other benefits include provision of fully maintained motor vehicle and participation in the Company’s Director/Employee Share Option Plan. These benefits ceased to be provided to Mr McLeod following his resignation. The terms of the agreement were approved by the remuneration committee. Alexander Underwood Managing Director Terms of the agreement: Agreed management consulting fees of A$27,000 per month. • • Consulting services are provided in respect of Mr Underwood’s roles as Chief Executive Officer of Imperial • • • Oil & Gas Pty Limited and as an executive of the Company. As at the date of this report, the terms of Mr Underwood’s employment agreement for his role as Chief Executive Officer and Managing Director of the Company have not been formalised. Award of 4,500,000 sign on shares (of which 1,500,000 are subject to a minimum 12 month service condition and 1,500,000 are subject to a 24 month service condition) issued under Listing Rule 7.1. Award of 6,000,000 options under the Employee Share Option Plan (of which 3,000,000 are exercisable at A$0.03 per share on or before 30 December 2021 subject to a 12 month service condition and 3,000,000 are exercisable at A$0.03 per share on or before 30 December 2021 subject to a 24 month minimum service condition). Payment of termination benefits apply other than for gross misconduct. Potential to earn performance based incentive payments. • • • Other benefits include participation in the Company’s Director/Employee Share Option Plan. Since his appointment as Chief Executive Officer and Managing Director, Mr Underwood and the Board of Directors of the Company have been finalising the terms of an employment contract which will replace the existing consulting services agreements in place between the Company, Imperial Oil & Gas Pty Limited and Mr Underwood’s consulting services company. Shareholders will be informed of the key terms of Mr Underwood’s CEO employment agreement and shareholder approval will be sought for the award of equity-linked incentives to Mr Underwood if required. John Warburton Non-Executive Director There is a consulting services agreement in place between Imperial Oil & Gas Pty Limited and Prof John Warburton’s consulting services company for the purpose of Prof Warburton providing technical consulting services to Imperial Oil & Gas Pty Limited and the Company. The consulting services agreement provides for a day rate only. During the 2018 Financial Year it provided for a minimum retainer fee to compensate Prof Warburton for his role as a Non-Executive Director of Imperial Oil & Gas Pty Limited. That retainer has been reduced to zero as Prof Warburton will be remunerated instead in his capacity as a Non-Executive Director of the Company. 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. 24 EMPIRE ENERGY GROUP LIMITED and its controlled entities Directors’ Report for the year ended 31 December 2018 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 the following options were issued: 17,000,000 options were granted pursuant to the Company’s Employee Share Option plan to several employees of the Company. The exercise price of the options is A$0.03 and they are exercisable on or before 30 December 2022. 6,000,000 options were granted pursuant to the service agreement between Alexander Underwood and the Company. As part of his service agreement Mr Underwood was issued: - - 3,000,000 options exercisable at A$0.03 expiring 30 December 2021 and vesting 12 months from grant date 3,000,000 options exercisable at A$0.03 expiring 30 December 2021 and vesting 24 months from grant date At the date of this report there were 37,000,000 unissued shares held under option to Directors and specified executives. Directors’ Interests and Benefits The relevant interest of each director in the share capital of the Company as at the date of this report is: Particulars of Interests in the Issued Capital of the Company Director A Underwood D Sutton L Tang P Espie AO J Gerahty Prof J Warburton Direct Interest Indirect Interest Shares 8,000,000 1,683,079 - - - - Options - 2,000,000 2,000,000 - - - Shares 9,500,000 - - 8,500,000 122,450,000 - Options 8,500,000 - - 3,750,000 55,625,000 - End of Audited Remuneration Report SHARE OPTIONS Movements Grant of Options The following options were granted during the financial year: Number 5,000,000 3,000,000 3,000,000 17,000,000 375,000,000 10,000,000 120,000,000 6,000,000 539,000,000 Unlisted options Unlisted options Unlisted options Unlisted options Unlisted options Unlisted options Unlisted options Unlisted options Exercise Price A$ $0.03 $0.03 $0.03 $0.03 $0.03 $0.032 $0.032 $0.03 Expiry Date 31 January 2020 30 December 2021 30 December 2021 30 December 2022 26 September 2020 31 July 2020 31 December 2021 26 October 2020 No options were granted during the period since the end of the financial year and upto the date of this report. Exercise of Options No options were exercised during the financial year or in the period since the end of the financial year and up to the date of this report. 25 EMPIRE ENERGY GROUP LIMITED and its controlled entities Directors’ Report for the year ended 31 December 2018 Expiry of Options No options have expired since the end of the financial year and up to the date of this report. At the date of this report the total number of unissued shares held under option was 553,000,000. These options are exercisable on the following terms. Number 1,000,000 13,000,000 5,000,000 3,000,000 3,000,000 17,000,000 375,000,000 10,000,000 120,000,000 6,000,000 553,000,000 Unlisted option Unlisted options Unlisted options Unlisted options Unlisted options Unlisted options Unlisted options Unlisted options Unlisted options Unlisted options Exercise Price A$ $0.028* $0.03 $0.03 $0.03 $0.03 $0.03 $0.03 $0.032 $0.032 $0.03 Expiry Date 25 August 2019 30 December 2021 31 January 2020 30 December 2021 30 December 2021 30 December 2022 26 September 2020 31 July 2020 31 December 2021 26 October 2020 * Following a Pro-Rata Rights Issue announced in December 2016 the original exercise price of these options ($0.03) was adjusted pursuant to the terms and conditions of the options and ASX Listing Rule 6.22. 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. The holder of the Performance Rights is an associated entity of a senior executive of the Company’s US subsidiaries, Mr Allen Boyer. 26 EMPIRE ENERGY GROUP LIMITED and its controlled entities Directors’ Report for the year ended 31 December 2018 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 material 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 2018 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. 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 28 and forms part of the Director’s Report for the financial year ended 31 December 2018. 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. Alexander Underwood Chief Executive Officer and Managing Director Sydney 29 March 2019 27 The Board of Directors Empire Energy Group Limited Level 7, 151 Macquarie Street SYDNEY NSW 2000 29 March 2019 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 2018, 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 28 EMPIRE ENERGY GROUP LIMITED and its controlled entities CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME for the year ended 31 December 2018 Sales Revenue Cost of Sales Gross Profit Other income General and administration expenses Exploration expenses Other non-cash expenses Operating Loss before interest costs Net interest expense Loss before income tax expense Income tax expense Loss after income tax expense Other comprehensive loss Exchange differences on translation of foreign operations Note Year ended December 2018 US$ Year ended December 2017 US$ 5a 6 5b 8a 7 9a 14,252,216 (9,253,241) 4,998,975 2,303,829 (3,495,862) (441,297) (16,141,511) (12,775,866) 13,942,325 (8,357,296) 5,585,029 126,409 (2,978,837) (148,873) (19,597,489) (17,013,761) (2,975,717) (2,966,623) (15,751,583) (19,980,384) (115,471) (126,862) (15,867,054) (20,107,246) (101,039) (28,993) Other comprehensive loss for the year, net of tax (101,039) (28,993) Total comprehensive loss for the year (15,968,093) (20,136,239) Basic earnings per share Diluted earnings per share 28 28 Cents per share (1.05) (1.05) Cents per share (2.13) (2.13) The above statements of profit or loss and other comprehensive income should be read in conjunction with the accompanying notes. 29 EMPIRE ENERGY GROUP LIMITED and its controlled entities CONSOLIDATED STATEMENT OF FINANCIAL POSITION as at 31 December 2018 Note As at December 2018 US$ As at December 2017 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 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 19 4,157,175 2,613,129 402,915 626,779 2,311,597 908,318 2,397,842 237,237 540,706 1,265,784 10,111,595 5,349,887 1,662,885 51,738,073 490,344 68,217 316,935 69,614,396 493,663 68,217 53,959,519 70,493,211 64,071,114 75,843,098 3,897,813 24,378,654 17,805 3,405,031 36,976,225 12,289 28,294,272 40,393,545 60,847 14,346,023 - 15,186,576 14,406,871 15,186,576 42,406,871 55,580,121 21,369,972 20,262,977 94,071,529 6,470,493 (79,172,050) 78,415,335 5,152,638 (63,304,996) 21,369,972 20,262,977 The above consolidated statements of financial position should be read in conjunction with the accompanying notes. 30 EMPIRE ENERGY GROUP LIMITED and its controlled entities CONSOLIDATED STATEMENT OF CHANGES IN EQUITY for the year ended 31 December 2018 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 2017 78,415,335 127,396 (98,333) 5,123,575 (63,304,996) 20,262,977 20,262,977 Total Comprehensive income for year Profit after income tax Exchange differences on translation of foreign operations Total comprehensive income for the year Transactions with owners, recorded directly in equity Issue of ordinary shares Plus: share issue transaction costs Options issued during the year – share-based payments Total transactions with owners - - - 16,628,221 (972,027) - 15,656,194 - - - - - - - - (101,040) (101,040) - - - - - - - - - 1,418,895 1,418,895 (15,867,054) (15,867,054) (15,867,054) - (101,040) (101,040) (15,867,054) (15,968,094) (15,968,094) - - - - 16,628,221 16,628,221 (972,027) 1,418,895 (972,027) 1,418,895 17,075,089 17,075,089 Balance at 31 December 2018 94,071,529 127,396 (199,373) 6,542,470 (79,172,050) 21,369,972 21,369,972 The above consolidated statements of changes in equity should be read in conjunction with the accompanying notes. 31 EMPIRE ENERGY GROUP LIMITED and its controlled entities CONSOLIDATED STATEMENT OF CHANGES IN EQUITY for the year ended 31 December 2017 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 2016 74,239,177 127,396 (69,343) 5,117,418 (43,197,750) 36,216,898 36,216,898 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 issued during the year – share-based payments Total transactions with owners - - - 4,635,835 (459,677) - 4,176,158 - - - - - - - - (28,990) (28,990) - - - - - - - - - 6,157 6,157 (20,107,246) (20,107,246) (20,107,246) - (28,990) (28,990) (20,107,246) (20,136,236) (20,136,236) - - - - 4,635,835 (459,677) 6,157 4,635,835 (459,677) 6,157 4,182,315 4,182,315 Balance at 31 December 2017 78,415,335 127,396 (98,333) 5,123,575 (63,304,996) 20,262,977 20,262,977 The above consolidated statements of changes in equity should be read in conjunction with the accompanying notes. 32 EMPIRE ENERGY GROUP LIMITED and its controlled entities CONSOLIDATED STATEMENT OF CASH FLOWS for the year ended 31 December 2018 CASH FLOWS FROM OPERATING ACTIVITIES Receipts from customers Payments to suppliers and employees Interest received Interest paid Income taxes paid Note Year ended 31 December 2018 US$ Year ended 31 December 2017 US$ 16,414,087 (13,585,895) 1,785 (2,975,717) (115,468) 13,839,036 (11,777,677) 1,976 (2,966,623) (126,862) Net cash flows used in operating activities 27(b) (261,208) (1,030,150) CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from sale of oil and gas assets Payments for oil and gas assets Payments for property, plant and equipment Net cash flows used in investing activities CASH FLOWS FROM FINANCING ACTIVITIES Net proceeds from issuing of shares Repayment of interest bearing liabilities Finance lease payments 97,560 (168,071) (49,011) 120,226 (588,714) (143,988) (119,522) (612,476) 11,677,098 (7,878,290) (14,113) 4,176,158 (2,178,743) (27,539) Net cash flows from financing activities 3,784,695 1,969,876 Net increase/(decrease) in cash and cash equivalents Cash and cash equivalents at beginning of financial year Effect of exchange rate changes on cash and cash equivalents 3,403,965 908,318 (155,108) 327,250 641,493 (60,425) CASH AND CASH EQUIVALENTS AT THE END OF FINANCIAL YEAR 27(a) 4,157,175 908,318 The above consolidated statements of cash flows should be read in conjunction with the accompanying notes. 33 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 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 2018 was authorised for issue in accordance with a resolution of Directors on 29 March 2019. 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, 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 Presented Empire Group’s cash flows and economic returns are in US dollars (“US$”). 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 2018 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 2018. Principles of Consolidation The consolidated financial statements comprise the financial statements of Empire 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. 34 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 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 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, contracts exist with customers, control of the assets passes 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 and Gas revenue Revenue from the sale of oil and gas is recognised when control of the asset has 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. There are no elements at variable consideration in contracts with customers and prices are determined based on prevailing market sales price data. 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. 35 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 1. SIGNIFICANT ACCOUNTING POLICIES (Continued) Please refer to the page 40 for further commentary on the adoption of AASB 15 Revenue from Contracts with Customers. 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 expected credit loss. An estimate of expected credit is loss is made based on historic data on collectability and consideration of the credit worthiness of customers. 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. 36 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 1. SIGNIFICANT ACCOUNTING POLICIES (Continued) 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. 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 37 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 1. SIGNIFICANT ACCOUNTING POLICIES (Continued) 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, 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. 38 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 1. SIGNIFICANT ACCOUNTING POLICIES (Continued) 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. 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 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 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 and Revised Standards that are effective for Annual Periods beginning on or after 1 January 2018 The consolidated entity has adopted all of the new, revised or amending Accounting Standards and Interpretations issued by the Australian Accounting Standards Board (‘AASB’) that are mandatory for the current reporting period. Any new revised or amending Accounting Standards or Interpretations that are not yet mandatory have not been early adopted. AASB 9 Financial Instruments AASB 9 Financial Instruments replaces AASB 139 Financial Instruments: Recognition and Measurement. It makes major changes to the previous guidance on the classification and measurement of financial assets and introduces an ‘expected credit loss’ model for impairment of financial assets. The Group adopted this standard on 1 January 2018. The Group have evaluated the impacts of the standard and have determined the following: - - The recognition and measurement of derivatives has not changed under AASB 9, being that they are still measured at fair value through profit or loss. AASB 9 contemplates an expected credit loss model to reflect the probability and amount of impairment that may be recognised on trade receivables based on anticipated future events. This replaces the ‘incurred loss’ model under AASB 139, whereby historical events were used to determine the extent of impairment of trade receivables. The transition to an expected credit loss model does not result in a material impact on the Group’s provision for trade receivables reflected in the statement of financial position as at 31 December 2018. Consequently, the adoption of AASB 9 Financial Instruments has not resulted in a material impact on the Group’s financial report for the year ended 31 December 2018. 39 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 1. SIGNIFICANT ACCOUNTING POLICIES (Continued) AASB 15 Revenue from Contracts with Customers AASB 15 replaces AASB 118 Revenue, AASB 111 Construction Contracts and several revenue-related Interpretations. AASB 15 uses a five-step model to be applied to all contracts with customers. Under AASB 15, revenue is recognised at an amount that reflects the consideration an entity expects to be entitled to in exchange for providing services or transferring goods to a customer. The Group adopted this standard on 1 January 2018. Revenue is recognised when the Group transfers the control of goods (being oil and gas) to a customer, at the amount to which the Group expects to be entitled. Revenue from the sale of oil and gas is recognised at a point in time when control of the asset is transferred to the customer, being on delivery of the goods to the customer. This policy does not result in a material impact arising from the adoption of AASB 15. Accordingly, this does not result in any transitional adjustments to comparative figures. AASB 15 also requires disclosure to disaggregate revenue to depict the nature, amount, timing and uncertainty of revenue and cash flows and how they are affected by economic factors. As the Group’s revenue is recognised at a point in time, earned through the Oil & Gas operating segment, and there are no components of variable consideration, disaggregation disclosure is consistent with that made in the Operating Segments note (Note 25). 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 2018. 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 2018 AASB 16 Leases (effective for accounting periods beginning on or after 1 January 2019) 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. The Group is currently assessing the impact of this Standard. 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: 40 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 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. 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. 41 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 2. CRITICAL ACCOUNTING JUDGMENTS, ESTIMATES AND ASSUMPTIONS (Continued) 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. 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 $17.8m. This is primarily due to the Board determining the debt facilities be classified as current liabilities although the current credit facility expires on 28 February 2022. Net assets are $21.7m. At December 31, 2018 the Group had breached the interest cover financial covenant on its borrowings with Macquarie Bank. The interest coverage ratio was below the required 1.8. Refer to Note 17. This was due to a number of temporary factors including the fact that oil production was unhedged in Q4 2018 during a period of low oil prices (90% of forecast oil production hedged at $66.50 / bbl in 2019), poor weather in Kansas which negatively impacted oil production and sales (partly offset by strong results of production enhancement program) and higher previous loan balance than currently prevails incurring higher interest expense. Macquarie Bank Limited formally waived this breach on 26 March 2019. On the 6 August 2018 the Company announced that it had successfully refinanced its existing credit facility with Macquarie and executed a two tranche placement to sophisticated and institutional investors, with strong support from existing major shareholders. As part of the credit facility refinancing, Macquarie Bank agreed to convert $4 million of the existing credit facility to equity at the Equity Raising price (“the Debt to Equity Conversion”). 42 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 3. GOING CONCERN (Continued) In conjunction with the new credit facility and Debt to Equity Conversion, the Company successfully carried out a two tranche A$15 million placement of shares to sophisticated and institutional investors. The Equity Raise received strong support from existing major shareholders, new sophisticated investors and new institutional investors. Based on the above 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 or through other arrangements when required, then, in that circumstance, the Group is able to reduce its discretionary expenditures so as to meet payment obligations arising over the next 12 months from cash reserves. 4. FINANCIAL RISK MANAGEMENT OBJECTIVES AND POLICIES The Empire Group’s principal financial instruments, other than derivatives comprise bank loans, 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. 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. 43 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 4. FINANCIAL RISK MANAGEMENT OBJECTIVES AND POLICIES (Continued) (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 2018 the Empire Group did not hedge any of its oil (2017: 98%) production and 63% of its total gas production (2017: 63%). During the 2018 Financial Year, the Group hedged approximately 63% of gas production at a fixed price of $4.11/Mcf (referenced to NYMEX Henry Hub). In accordance with the terms of the debt facility it entered into with Macquarie Bank Limited in August 2018, the company entered into new oil and gas hedges which hedge approximately 90% of forecast oil and gas production in 2019, approximately 80% of forecast oil and gas production in 2020 and approximately 25% of forecast oil and gas production in 2021. Details can be found in Note 13 to the Financial Statements. (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 2018 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 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 2018. The Empire Group monitors forecasts and actual cash flows and the maturity profiles of financial assets and liabilities to manage its liquidity risk. 44 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 4. FINANCIAL RISK MANAGEMENT OBJECTIVES AND POLICIES (Continued) 31 December 2018 Financial Assets Cash and cash equivalents Trade and other receivables Financial assets % Floating Interest Rate Fixed Interest Maturing in Over 1 to 5 1 Year or Years Less Non-Interest Bearing Total 1.25 4,157,175 - - 4,157,175 - - - - - - - - - 4,157,175 2,613,129 3,974,482 6,587,611 2,613,129 3,974,482 10,744,786 Financial Liabilities Trade & other payables Interest-bearing liabilities 9.02 - - - - 24,378,654 24,378,654 - 60,847 60,847 3,897,813 - 3,897,813 24,439,501 3,897,813 28,337,314 % Floating Interest Rate Fixed Interest Maturing in Over 1 to 5 1 Year or Years Less Non-Interest Bearing Total 31 December 2017 Financial Assets Cash and cash equivalents Trade and other receivables Financial assets 0.83 908,318 - - 908,318 - - - - Financial Liabilities Trade & other payables Interest-bearing liabilities 8.06 (iv) Empire Group Sensitivity - - - - 36,976,225 36,976,225 - - - - - - - - 908,318 2,397,842 1,582,719 3,980,561 2,397,842 1,582,719 4,888,879 3,405,031 - 3,405,031 3,405,031 36,976,225 40,381,256 Based on the financial instruments held at 31 December 2018, had the NYMEX WTI and Henry Hub prices increased/decreased by 10% and 10% respectively, with all other variables held constant, the Empire Group’s post- tax profit for the year would not materially change due to the extent of effective hedging of oil and gas production. Equity would not have materially changed under either scenario. The directors do not expect any reduction in interest rates during 2019. Should interest rates increase by 1% the impact on post-tax profit would be a decrease of approximately $250,000. (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. 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. 45 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 4. FINANCIAL RISK MANAGEMENT OBJECTIVES AND POLICIES (Continued) The maximum exposure to credit risk at balance date is as follows: Trade, other receivables, and derivatives 2018 $ 2017 $ 6,587,611 3,977,561 The maximum exposure to credit risk at balance by country is as follows: Australia United States of America 2018 $ - 6,587,611 2017 $ - 3,977,561 (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. 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 2018 Non Derivatives Current Trade and other payables Interest bearing liabilities Non-current Interest bearing liabilities Derivatives Financial asset Financial liability Maturity Analysis 31 December 2017 Non Derivatives Current Trade and other payables Interest bearing liabilities Derivatives Financial asset Financial liability Fair Value $ Carrying Amount $ Contractual Cash flows $ 1 year $ 1-5 years $ 3,893,813 24,378,654 3,893,813 24,378,654 3,893,813 25,977,421 3,893,813 2,500,000 - 23,477,421 60,847 60,847 60,847 - 60,847 (3,974,482) 25,977,421 (3,974,482) 24,041,894 (3,974,482) - (2,311,597) 2,500,000 (1,662,885) 23,477,421 Fair Value $ Carrying Amount $ Contractual Cash flows $ 1 year $ 1-5 years $ 3,405,031 37,946,361 3,405,031 37,976,225 3,405,031 37,946,561 3,405,031 37,946,561 - - (1,582,719) 37,946,561 (1,582,719) 36,976,225 (1,582,719) - (1,265,784) - (316,935) - 46 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 4. FINANCIAL RISK MANAGEMENT OBJECTIVES AND POLICIES (Continued) (D) EQUITY RISK 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 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 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. 47 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 4. FINANCIAL RISK MANAGEMENT OBJECTIVES AND POLICIES (Continued) Consolidated 31 December 2018 Assets Fair value of derivatives Total assets Liabilities Fair value of derivatives Total liabilities Consolidated 31 December 2017 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 - - - - - - - - - 3,974,482 3,974,482 - - - Level 2 1,582,719 1,582,719 - - - - - - 3,974,482 3,974,482 - - Level 3 Total 78,000 - 78,000 - - 78,000 1,582,719 1,660,719 - - 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 Interest income Rental income Insurance proceeds Other income 2018 $ 2017 $ 13,547,590 704,626 14,252,216 13,205,070 737,255 13,942,325 1,785 6,110 2,004,700 291,234 2,303,829 1,976 11,554 - 112,879 126,409 48 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 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. (Loss)/Profit 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) 2018 $ 2017 $ 9,253,241 9,253,241 8,357,296 8,357,296 2,975,717 2,975,717 2,966,623 2,966,623 142,500 14,944,148 1,717,522 1,490,520 (2,391,765) 238,586 16,141,511 142,500 13,654,019 2,943,375 1,032,139 1,701,185 124,271 19,597,489 526,706 963,814 502,900 529,239 1,490,520 1,032,139 1,717,522 1,717,522 15,024 4,226,017 4,241,041 2,943,375 2,943,375 17,911 4,072,760 4,090,671 (Write-back)/Impairment of additional asset retirement obligation Impairment of available for sale financial assets and receivables Impairment of property plant & equipment Total impairment expense (1,642,361) - 16,586,509 14,944,148 1,832,503 75,553 11,745,963 13,654,019 (Gain)/Loss on disposal of property, plant & equipment (33,234) 76,675 Leasing expiration expense (b) 142,500 142,500 (a) Impairment expense For the period 31 December 2018, the Company wrote down the oil and gas properties by $16,586,509 due to evidence of impairment. Furthermore, a decrease in the asset retirement obligation of $1,642,361 resulted from a change in the discount rate reflecting the current commercial bond rate and was recognised as an impairment write back. (b) Leasing expiration expense A charge of $142,500 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. 49 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 9. INCOME TAX a. Income tax expense Current tax Deferred tax Income tax benefit attributable to continuing operations b. Numerical reconciliation of income tax expense to prima facie tax payable Profit/(loss) before income tax Tax at the Australian tax rate of 27.5% (2017: 27.5%) 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 Other 2018 $ 2017 $ 115,471 126,862 - - 115,471 126,862 (15,414,823) (19,980,385) (4,239,076) (5,494,606) 101,427 51,737 3,929,067 5,104,314 324,051 115,471 465,417 126,862 918,262 141,410 5,010,435 5,055,843 141,410 455,174 6,070,107 5,652,427 50 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 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 2018. 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 2018 $ 2017 $ 997,731 4,567,585 630,369 6,195,685 397,317 5,531,403 65,069 5,993,789 (6,195,685) (5,993,789) - - 666,886 4,004,892 1,523,907 6,195,685 1,195,977 3,689,006 1,108,806 5,993,789 (6,195,685) (5,993,789) - - 2,530,179 82,950 2,613,129 2,367,081 30,761 2,397,842 402,915 237,237 626,779 540,706 51 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 13. FINANCIAL ASSETS, INCLUDING DERIVATIVES Current 2018 $ 2017 $ Oil and gas price forward contracts 2,311,597 1,265,784 Non-current Oil and gas price forward contracts 1,662,885 316,935 Commodity hedge contracts outstanding are outlined below. 2018 NATURAL GAS - HENRY HUB - NYMEX - Swaps 2017 NATURAL GAS - HENRY HUB - NYMEX - Swaps Period Swap Price Jan 19 – Dec 19 3.45 Jan 19 – Dec 19 3.45 - - - - - - - - Premium Product Period Swap Price Premium Product - - - - - - 420,000 mmbtu Jan 18 - Dec 18 78,000 mmbtu Jan 18 - Dec 18 - - - - - - - - Jan 18 - Dec 18 Jan 18 - Dec 18 Jan 19 - Dec 19 Jan 19 - Dec 19 4.75 4.75 3.45 3.45 3.45 3.45 - - - - - - 54,000 mmbtu 456,000 mmbtu 420,000 mmbtu 78,000 mmbtu 420,000 mmbtu 78,000 mmbtu 2018 OIL - WTI – NYMEX - Swaps 2017 OIL - WTI – NYMEX – Swaps Jan 20 – Dec 20 $66.50 Jan 21 – Dec 21 $64.00 Jan 22 – Dec 22 $60.00 - - 108,000 96,000 24,000 bbl bbl bbl - - - - - - - - - - 2018 NATURAL GAS - HENRY HUB - NYMEX - Floors Period Floor Price Premium Product Jan 20 – Dec 20 $2.50 $0.23 1,020,000 mmbtu Jan 21 – Dec 21 $2.50 $0.23 1,440,000 mmbtu Jan 22 – Dec 22 $2.50 $0.23 300,000 mmbtu 52 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 14. OIL AND GAS PROPERTIES AND PROPERTY PLANT & EQUIPMENT Cost in $ At 1 January 2018 Additions New asset retirement obligation Write-back of asset retirement obligation Sale of wells Expiration costs At 31 December 2018 Accumulated Depreciation in $ At 1 January 2018 Depreciation and depletion Write-off sale of wells Write-off plugged wells Impairment At 31 December 2018 Oil & Gas – Proved Oil & Gas – Unproved 119,028,365 181,308 321,539 (1,688,798) (65,899) - 6,443,729 37,503 - (142,500) Land Buildings Equipment Motor Vehicles Total 30,591 - 328,948 2,850 896,420 22,800 608,376 84,208 - - - - - - - - 127,336,429 328,659 321,539 (1,642,361) (25,134) (142,500) 117,776,505 6,338,732 30,591 331,798 919,220 692,584 126,089,430 (55,616,054) (1,608,357) 41,748 6,655 (14,944,148) (72,120,156) - - - - - - - - - - - - (86,044) (8,246) - - - (717,849) (70,033) - - - (542,696) (30,886) - - - (56,962,643) (1,717,522) 41,748 6,655 (14,944,148) (94,290) (787,882) (573,582) (73,575,910) Opening written down value 63,412,311 6,202,085 30,591 242,904 174,704 45,464 70,108,059 Impact of foreign currency adjustments - (257,007) - - (4,046) (24,049) (285,101) Closing written down value 45,656,348 6,081,725 30,591 237,508 127,292 94,953 52,228,417 53 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 14. OIL AND GAS PROPERTIES AND PROPERTY PLANT & EQUIPMENT (continued) Cost in $ At 1 January 2017 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 2017 Accumulated Depreciation in $ At 1 January 2017 Depreciation and depletion Write-off sale of wells Write-off plugged wells Write-back Write-back of impaired assets At 31 December 2017 Oil & Gas – Proved Oil & Gas – Unproved Land Buildings Equipment Motor Vehicles Total 117,053,631 679,398 1,832,503 (58,941) - - (478,226) - - 6,584,445 2,432 - - - - (648) (142,500) - 30,591 - - - - - - - - 328,948 - - - - - - - - 755,900 140,520 - - - - - - - 669,608 3,468 - - - - (64,700) - - 125,423,123 825,818 1,832,503 (58,941) - - (543,574) (142,500) - 119,028,365 6,443,729 30,591 328,948 896,420 608,376 127,336,429 (39,430,683) (2,828,980) 222,075 - - (13,578,466) (55,616,054) - - - - - - - - - - - - - - (75,357) (10,687) - - - - (643,496) (74,353) - - - - (552,291) (29,355) - - 38,950 - (40,701,827) (2,943,375) 222,075 - 38,950 (13,578,466) (86,044) (717,849) (542,696) (56,962,643) Opening written down value 77,622,948 6,320,225 30,591 253,591 108,086 95,604 84,431,045 Impact of foreign currency adjustments - (241,644) - - (3,867) (20,216) (265,727) Closing written down value 63,412,311 6,202,085 30,591 242,904 174,704 45,464 70,108,059 54 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 14. OIL AND GAS PROPERTIES AND PROPERTY PLANT & EQUIPMENT (continued) At 31 December 2018, 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 2018 are: Oil and gas assets Kansas Appalachia Total Subsurface assets $ 33,765,102 26,393,956 60,159,058 Recoverable amount $ 18,182,620 12,686,266 30,868,886 The pre-tax discount rate that has been applied to the above oil and gas assets is 12% (2017: 10%). 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 Bank loan – secured Classification of Borrowings 2018 $ 2017 $ 68,217 68,217 68,217 68,217 3,869,141 28,672 3,897,813 3,366,359 38,672 3,405,031 10,002 24,368,652 - 36,976,225 24,378,654 36,976,225 60,847 - 60,847 - - - 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. On 6 August 2018 the Company announced that it had successfully refinanced its existing credit facility with Macquarie Bank Limited. As part of the credit facility refinancing, Macquarie agreed to convert $4 million of the existing credit facility to equity at the Equity Raising price (“the Debt to Equity Conversion”) and provide a new 3 year credit facility through to 28 February 2022. The new credit facility reached financial close on 26 October 2018. 55 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 17. INTEREST-BEARING LIABILITIES (Continued) Credit Facility Summary Empire Energy USA, LLC maintains a long-term credit facility with Macquarie Bank Limited (Macquarie), which matures on 28 February 2022, consisting of a single tranche term loan facility with an opening availability of $26,060,000. Uses of credit facility: Term Loan: To refinance the existing secured loan facilities with Macquarie Bank Limited. Credit facility structure Term Loan: Borrowing base limit $26,060,000 Current portion payable Interest rate Availability (1) Maturity Repayment $2,500,000 amortisation payable instalments minimum annual in quarterly LIBOR+6.5% $26,060,000 28 February 2022 100% of Net Operating Cash Flow of US operations after operating costs, G&A and interest subject to minimum $$2.5 million per annum Other features of the credit facility: • Outstanding borrowings under the facility are secured by the US assets of the Company and a pledge of the Company’s shareholding in Imperial Oil & Gas Pty Limited. The facility is guaranteed by the Company. • Reserve Assessment of 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: 1.5x 1P PV10 coverage to net loan (after adjustment for cash & hedges). 1.3x PDP PV10 coverage to net loan (after adjustment for cash & hedges). 1.0x Current Ratio. 1.8x EBITDA/Interest Ratio. Upfront Fees: 2.0% on draw down amount. 120m options exercisable at A$0.032 (refer to Note 19) on or before 31 December 2021 The Group breached the EBITDA/Interest ratio at 31 December 2018. Macquarie Bank Limited has waived the breach. Please refer to Note 3 for further details. 56 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 17. INTEREST-BEARING LIABILITIES (Continued) Amendments to Credit Facility: On 26 October 2018, the Company entered into a Third Amendment to the Credit Facility. This required a principal payment of $7,500,000 which was made in accordance with the Third Amendment. Under the terms of the Loan Facility (“Facility”), Empire Energy USA, LLC allocates 100% of monthly free cash flow (after operating costs, overheads and interest) to repay principal outstanding. Principal repayments are subject to cumulative minimum quarterly amortisation of U$625,000 (to achieve minimum repayments of $2.5 million per annum). A summary of period end debt is as follows: Facility Revolver Sub-Total Less deferred financing costs, net Finance Lease Liability Total Debt 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 2018 $ 22,997,421 3,000,000 25,997,421 (1,628,769) 24,368,352 70,850 24,439,501 2017 $ 34,946,561 3,000,000 37,946,561 (970,336) 36,976,225 - 36,976,225 2018 $ 2017 $ 17,805 12,289 14,346,023 15,186,576 15,186,576 321,539 (46,437) 526,706 (1,642,361) 12,902,647 7,467 (58,941) 502,900 1,832,503 14,346,023 15,186,576 (a) ($1,642,361) is due to an increase in the discount rate (2017: $1,832,503 was is due to a decrease in the discount rate and change in effective life estimate. 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. 57 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 19. CONTRIBUTED EQUITY a) Shares Issued Capital Balance at beginning of period Movement in ordinary share capital - Issue of 236,538,079 fully paid ordinary shares in January 2017 @$0.008 pursuant to a Pro-Rata Rights Issue - - Issue of 196,175,000 fully paid ordinary shares in February 2017 being shortfall shares to the Pro-Rata Rights Issue - - - Issue of 17,693,153 fully paid ordinary shares in February 2017 in lieu of cash payment for fees and services rendered - - - Issue of 37,750,000 fully paid ordinary shares in February 2017 as a private placement to raise funds - - - Issue of 74,222,500 fully paid ordinary shares in May 2017 as a private placement to raise funds - - - Issue of 187,500,000 fully paid ordinary shares in June 2017 as a private placement to raise funds - - - Issue of 13,544,567 fully paid ordinary shares in June 2017 in lieu of cash payment for fees and services rendered - Issue of 73,000,000 fully paid ordinary shares in February 2018 as a private placement to raise funds - Issue of 2,000,000 fully paid ordinary shares in February 2018 as a private placement to raise funds - Issue of 75,000,000 fully paid ordinary shares in April 2018 as a private placement to raise funds - Issue of 4,500,000 fully paid ordinary shares in April 2018 in lieu of services rendered - Issue of 189,785,575 fully paid ordinary shares in August 2018 as a private placement to raise funds - Issue of 560,214,425 fully paid ordinary shares in September 2018 as a private placement to raise funds - Issue of 297,847,000 fully paid ordinary shares in October 2018 as partial replacement of debt Less costs associated with the share issues detailed above Balance as at 31 December 2018 2018 $ 2017 $ 78,415,335 74,239,177 - - - - - - - 1,445,342 1,209,850 108,806 232,148 448,838 1,108,500 82,351 726,806 19,515 726,656 43,701 2,782,636 8,328,907 4,000,000 - - - - - - - (972,027) (459,677) _____________ 94,071,529 _____________ 78,415,335 58 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 19. CONTRIBUTED EQUITY (continued) b) Shares Issued shares 2018 No. of shares 2017 No. of shares Balance at beginning of period 1,110,737,176 347,313,877 Movement in ordinary share capital - Issue of 236,538,079 fully paid ordinary shares in January 2017 @$0.008 pursuant to a Pro-Rata Rights Issue - - Issue of 196,175,000 fully paid ordinary shares in February 2017 being shortfall shares to the Pro-Rata Rights Issue - - - Issue of 17,693,153 fully paid ordinary shares in February 2017 in lieu of cash payment for fees and services rendered - - - Issue of 37,750,000 fully paid ordinary shares in February 2017 as a private placement to raise funds - - - Issue of 74,222,500 fully paid ordinary shares in May 2017 as a private placement to raise funds - - - Issue of 187,500,000 fully paid ordinary shares in June 2017 as a private placement to raise funds - - - Issue of 13,544,567 fully paid ordinary shares in June 2017 in lieu of cash payment for fees and services rendered - - - - - - - 236,538,079 196,175,000 17,693,153 37,750,000 74,222,500 187,500,000 13,544,567 - Issue of 73,000,000 fully paid ordinary shares in February 2018 as a private placement to raise funds - Issue of 2,000,000 fully paid ordinary shares in February 2018 as a private placement to raise funds - Issue of 75,000,000 fully paid ordinary shares in April 2018 as a private placement to raise funds - Issue of 4,500,000 fully paid ordinary shares in April 2018 in lieu of services rendered 73,000,000 2,000,000 75,000,000 4,500,000 - Issue of 189,785,575 fully paid ordinary shares in August 2018 as a private placement to raise funds 189,785,575 - Issue of 560,214,425 fully paid ordinary shares in September 2018 as a private placement to raise funds 560,214,425 - Issue of 297,847,000 fully paid ordinary shares in October 2018 as partial replacement of debt 297,847,000 - - - - - - - Balance as at 31 December 2018 _____________ 2,313,084,176 _____________ 1,110,737,176 59 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 19. CONTRIBUTED EQUITY (continued) Share Options Movements Granted 5,000,000 options were granted to each of the Joint Lead Managers of the February 2018 capital raising in partial consideration of the provision of services to the Company. The exercise price of the options is A$0.03 and they are exercisable on or before 31 January 2020. 17,000,000 options were granted pursuant to the Company’s Employee Share Option plan to several employees of the Company. The exercise price of the options is A$0.03 and they are exercisable on or before 30 December 2022. 6,000,000 options were granted pursuant to the service agreement between Alexander Underwood and the Company. As part of his service agreement Mr Underwood was issued: - - 3,000,000 options exercisable at A$0.03 expiring 30 December 2021 and vesting 12 months from grant date 3,000,000 options exercisable at A$0.03 expiring 30 December 2021 and vesting 24 months from grant date 375,000,000 options granted to certain sophisticated and professional investors pursuant to a capital raising in September 2018. The exercise price of the options is A$0.03 and they are exercisable on or before 26 September 2020. 10,000,000 options granted to the Joint Lead Managers of the August 2018 capital raising in partial consideration of the provision of services to the Company. The exercise price of the options is A$0.032 and they are exercisable on or before 31 July 2020. 120,000,000 options granted to Macquarie Bank Limited in accordance with the terms of the new credit facility. The exercise price of the options is A$0.032 and they are exercisable on or before 31 December 2021. 6,000,000 options were granted to certain sophisticated and professional investors pursuant to a capital raising in October 2018. The exercise price of the granted options was A$0.03 expiring 26 October 2020. Exercise of Options No options were exercised during the financial year up to the date of this report. Expiry/Lapse of Options No options have expired/lapsed since the end of the financial year. At balance date the Empire Group had on issue, the following securities: Shares - 2,313,084,176 (2017: 1,110,737,176) listed fully paid ordinary shares – ASX Code: EEG The Company does not have authorised capital or par value in respect of its issued shares. All issued shares are fully paid. The holders of ordinary shares are entitled to receive dividends as declared from time to time and are entitled to one vote per share at meetings of the Company. No dividends were paid or declared during the year, or since the year- end. 60 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 19. CONTRIBUTED EQUITY (continued) Options At balance date the Company had 552,000,000 (2017: 14,000,000) unissued shares under option. These options are exercisable on the following terms: Number 1,000,000 13,000,000 5,000,000 3,000,000 3,000,000 17,000,000 375,000,000 10,000,000 120,000,000 6,000,000 553,000,000 Unlisted option Unlisted options Unlisted options Unlisted options Unlisted options Unlisted options Unlisted options Unlisted options Unlisted options Unlisted options Exercise Price A$ $0.028 $0.03 $0.03 $0.03 $0.03 $0.03 $0.03 $0.032 $0.032 $0.03 Expiry Date 25 August 2019 30 December 2021 31 January 2020 30 December 2021 30 December 2021 30 December 2022 26 September 2020 31 July 2020 31 December 2021 26 October 2020 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 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. The holder of the Performance Rights is an entity associated with a senior US executive of the Company, Mr Allen Boyer. 20. RESERVES Fair value reserve The fair value reserve comprises the cumulative net change in the fair value of equity investments 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. 61 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 21. CONTINGENT LIABILITIES Empire 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 legal proceedings arising out of the normal conduct of its US 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 2018, the Empire Group had no environmental contingencies requiring specific disclosure or accrual. There have been no other changes in contingent liabilities since the last annual reporting date. 22. CONTINGENT ASSETS There are no contingent assets as at the date of this annual report. 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 2018. 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: 2018 $ 2017 $ 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 268,490 193,490 163,000 - 257,536 232,536 261,536 - 624,980 751,608 The Company leases its corporate headquarters under a non-cancellable operating lease of monthly payments ranging from $3,665 to $3,966 through February 2022. Net rental expense approximated $51,000 and $55,000, for the years ended 31 December 31, 2018 and 2017 respectively. The Kansas headquarters four-year lease agreement is of monthly payments ranging from $2,853 to $2,945 through April 2021. The net rental expense approximated $34,000 for the years ended December 31, 2018 and 2017. The Company leases trucks under an operating agreement. The term of the agreement begins upon the delivery of each truck and last for a period of up to 48 months, Lease payments in 2018 and 2017 were approximately $194,000 and $239,000 respectively. The Empire Energy Group has the option to acquire the leased assets at the agreed value on the expiry of the leases. 62 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 23. COMMITMENTS FOR EXPENDITURE (continued) 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. 24. SHARE BASED PAYMENTS Year Ending – 31 December 2018 During the 2018 financial period the following share based payments occurred: The Company granted 4,500,000 ordinary fully paid shares to Mr A Underwood under the terms of his service agreement with the Company at a deemed issue price of A$0.018 per share. The following was issued: - - - 1,500,000 fully paid ordinary shares issued on signing 1,500,000 fully paid ordinary shares issued 12 months after the commencement date 1,500,000 fully paid ordinary shares issued 24 months after the commencement date During the financial year the following options were granted pursuant to the Employee Share Option Plan. No. of Options 5,000,000 3,000,000 3,000,000 17,000,000 120,000,000 Grant Date 16 February 2018 16 April 2018 16 April 2018 18 June 2018 26 September 2018 Vesting Date 16 February 2018 16 April 2018 16 April 2019 18 June 2020 26 October 2018 Exercise Price A$ $0.03 $0.03 $0.03 $0.03 $0.032 Expiry Date 31 January 2020 30 December 2021 30 December 2021 30 December 2022 31 December 2021 For the options granted during the current financial year, the valuation model inputs used to determine the fair value at the grant date, are as follows: Granted during year Grant date Expiry date Share price at grant date A$ Exercise price A$ Expected volatility Dividend yield Risk-free interest rate 5,000,000 16 February 2018 3,000,000 16 April 2018 3,000,000 16 April 2018 17,000,000 18 June 2018 31 January 2020 30 December 2021 30 December 2021 30 December 2022 375,000,000 26 September 2018 26 September 2020 10,000,000 26 September 2018 31 July 2020 120,000,000 26 September 2018 31 December 2021 6,000,000 26 September 2018 26 October 2020 $0.023 $0.023 $0.018 $0.036 $0.022 $0.022 $0.019 $0.019 $0.03 $0.03 $0.03 $0.03 $0.03 $0.032 $0.032 $0.03 123.95% 118.99% 118.99% 114.90% 132.50% 133.25% 124.04% 131.28% - - - - - - - - 1.99% 2.20% 2.20% 2.34% 2.07% 2.07% 2.03% 1.99% The weighted average share price during the financial year was A$0.028 (2017: A$0.010). The weighted average remaining contractual life of options outstanding at the end of the financial year was 2.1 years (2017: 3.8 years) Year Ending – 31 December 2017 During the 2017 financial period the following share based payments occurred: The Company granted 17,693,153 ordinary fully paid shares to 153 Fish Capital Pte Ltd in connection with the capital raising conducted by Sanston Securities in February 2017 in lieu of cash payment of A$141,545 for services rendered, at a deemed issued price of A$0.008 per share. The Company granted 13,544,567 ordinary fully paid shares to 153 Fish Capital Pte Ltd in connection with the capital raising conducted by Sanston Securities in June 2017 in lieu of cash payment of A$108,357 for services rendered, at a deemed issued price of A$0.008 per share. 63 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 24. SHARE BASED PAYMENTS (Continued) During the previous financial year the following options were granted pursuant to the Employee Share Option Plan. No. of Options 13,000,000 Grant Date 10 July 2017 Vesting Date 10 July 2019 Exercise Date A$ $0.03 Expiry Date 31 December 2021 a) Options The options outstanding at 31 December 2018 are detailed below. Grant Date Expiry Date Exercise Price A$ Balance at start of year Granted during year Expired during year Exercised during year Balance at end of year 25 August 2016(1) 10 July 2017(2) 16 February 2018(1) 16 April 2018(2) 16 April 2018(2) 18 June 2018(2) 26 September 2018(3) 26 September 2018(1) 26 September 2018(4) 26 September 2018(3) 25 August 2019 30 December 2021 31 January 2020 30 December 2021 30 December 2021 30 December 2022 26 September 2020 31 July 2020 31 December 2021 26 October 2020 $0.03 $0.03 $0.03 $0.03 $0.03 $0.032 $0.032 $0.03 $0.03 $0.03 1,000,000 13,000,000 - - - - - - - - 14,000,000 - - 5,000,000 3,000,000 3,000,000 17,000,000 375,000,000 10,000,000 120,000,000 6,000,000 539,000,000 - - - - - - - - - - - - - - - - - - - - - - 1,000,000 13,000,000 5,000,000 3,000,000 3,000,000 17,000,000 375,000,000 10,000,000 120,000,000 6,000,000 553,000,000 (1) Options granted in lieu of cash payment for fees for services rendered to the Company (2) Options granted pursuant to Employee Share Plan. The plan provides for vesting restrictions on minimum period of employment (3) The options were granted to certain sophisticated and professional investors by way of a two tranche placement of shares with attaching 1:2 options (4) Options granted to Macquarie as part of the debt restructure (Note 17) b) Expenses arising from share based payment transactions Year ending - 31 December 2018 The share based payments during the year have been recognised as follows: Expense relating to issued options based on a pro-rata portion of the vesting period - - Recognised directly against issued capital as a cost associated with the share - Recognised directly against debt as a cost of arranging finance A$203,574 A$195,000 A$1,560,000 Year ending - 31 December 2017 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$8,150. 64 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 25. SEGMENT INFORMATION The Empire Group has two reportable segments as described below. Information reported to the Empire Group’s chief executive officer for the purpose of resource allocation and assessment of performance is more significantly focused on the category of operations. Reportable segment (loss)/profit before tax (9,489,992) (14,784,209) 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 - Write-back of ARO - Gain on disposal - Lease expiration costs Oil & Gas Investments Other Eliminations Total 2018 2017 2018 2017 2018 2017 2018 2017 2018 2017 14,252,216 13,942,325 195,993 171,409 - - - - - - - - 2,107,836 (75,555) (1,861,358) (1,203,455) - - - - - - 14,252,216 13,942,325 2,303,829 95,854 (11,351,350) (15,988,296) 1,785 1,976 970,846 523,715 (5,428,696) (4,517,774) - - 64,218 (8,386) 4,697 (970,846) (523,715) 66,003 6,673 (4,703) 970,846 523,715 (4,466,236) (3,998,762) (15,751,583) (19,980,384) 60,070,048 75,415,798 15,357,468 3,932,327 3,930,486 349,300 (15,286,888) (3,854,327) 64,071,114 75,843,098 43,364,383 55,580,121 - - (1,608,357) (2,931,443) (16,586,509) (13,654,019) 1,642,361 - - - (142,500) (142,500) - - - - - - - - - - - - - - - - - - - - - - - - - - (109,165) (11,726) - - - - - - - - - - - - - - (109,858) (143,988) - - - - - - - - - - - - 43,364,383 55,580,121 - - - - - - - - - - - - (1,717,522) (2,943,169) (16,586,509) (13,654,019) 1,642,361 - - - (142,500) (142,500) (526,706) (502,900) (627,054) (529,239) - - 992,163 (2,658,321) 65 Non-cash items included in Finance costs: - Asset retirement obligation accretion (526,706) (502,900) - Discount on debt & overriding royalty interest (627,054) (529,239) - Fair value gain/(loss) on forward commodity contracts - - Capital expenditure 1,102,021 (2,514,333) EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 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. Information reported to the Chief Operating Decision Maker (CODM) allows resource to be allocated and subsequent performance to be analysed. This is reviewed on a monthly basis. The Empire Group’s reportable segments under AASB 8 and reviewed by the CODM 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 Group USA (eliminated on consolidation). Revenue is derived from the sale of the investments. • Other - includes all centralised administration costs and 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 generated from the sale of oil and gas to external customers is derived from operations in the USA. The majority of the Company’s producing assets are located in the USA. The Company has exploration oil and gas tenements in the Northern Territory, Australia. Major customers Revenues from two major customers of the Empire Group’s Oil & Gas segment represents approximately $9,012,547 (2017: two major customers $8,229,774) 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: • A Underwood • B W McLeod (to 30 August 2018) • D H Sutton • L Tang • P Espie • J Gerahty ii. Directors’ Shareholdings Number of shares held by the Company Directors Director Balance at 1 January 2018 A Underwood B W McLeod D H Sutton L Tang P Espie J Gerahty - 24,229,999 734,295 - - - Acquired during period through Capital Raisings 13,000,000 - - - 7,500,000 122,450,000 Acquired on Market - - - - 1,000,000 - Other changes during period Balance at 31 December 2018 4,500,000 (24,229,999)1 - - - - 17,500,000 - 734,295 - 8,500,000 122,450,000 1 Mr B W McLeod resigned from his positions on 30 August 2018. 66 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 26. RELATED PARTY DISCLOSURES (Continued) 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 B W McLeod A Underwood D H Sutton L Tang P Espie J Gerahty Balance at 1 January 2018 5,000,000 - - - - - Granted during year in accordance with Employee Option Plan 6,000,000 6,000,000 2,000,000 2,000,000 - - Granted during the year in connection with Capital Raising - 2,500,000 - - 3,750,000 55,625,000 Exercised during year Expiring during year Balance at 31 December 2018 Vested exercisable at 31 December 2018 - - - - - - - - - - - - 11,000,000 8,500,000 2,000,000 2,000,000 3,750,000 55,625,000 - - - - - - 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 D H Sutton L Tang A Underwood No. of options 6,000,000 2,000,000 2,000,000 6,000,000 Exercise Price A$ $0.03 $0.03 $0.03 $0.03 Expiry Date 31 December 2022 31 December 2022 31 December 2022 31 December 2020 iii. Transactions with Key Management Personnel 1) B W McLeod was a director and shareholder of Eastern & Pacific Capital Pty Limited. During the year the Empire Group incurred the following transactions payable under the service agreement: - Management consultant fees* - Termination payout** - Bonus payment *of this amount $174,510 was paid during the financial period and the remaining balance paid in the first quarter of 2019 **of this amount $112,185 was paid during the financial period and the remaining balance paid in the first quarter of 2019 2) Aggregate amounts payable to Directors and their related Companies at balance date: - Eastern & Pacific Capital 2018 $ 2017 $ 253,269 362,100 - 365,489 - 31,063 - Management consultant fees accrued/payable from prior years 287,642 145,135 3) A Underwood is a director and CEO of the Company and wholly- owned subsidiary Imperial Oil & Gas Pty Limited. The Empire Group paid the following transactions to Mr Underwood: - Management consulting fees - Director fees 4) J Warburton is a director of wholly-owned subsidiary Imperial Oil & Gas Pty Limited. The Empire Group paid the following transaction to Professor Warburton:: Advisory fees - - Director fees 210,010 - - - 9,928 13,462 - 17,550 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. 67 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 26. RELATED PARTY DISCLOSURES (Continued) c. Investments in Controlled Companies Country of Incorporation Class of Share Controlling Empire Group Empire Energy Group Limited Australia Interest Held December 2018 % December 2017 % 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 Sydney Partnership 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. Cobalt Energy Pty Ltd and Imperial Energy Pty Ltd were wound up after the end of the Financial Year. 68 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 27. NOTES TO THE STATEMENT OF CASH FLOWS December 2018 $ December 2017 $ (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 4,157,175 908,318 (b) Reconciliation of profit after income tax expense to net cash flows from operating activities (Loss) for the period after income tax expense (15,530,294) (20,107,246) Adjustments for non-cash items: Depreciation & amortisation expense Impairment of property, plant & equipment Write-back of Asset Retirement Obligation Impairment of available for sale assets and related receivables (Gain)/loss on disposal of property, plant & equipment Expiration of leases Discount on debt Asset retirement obligation accretion Share-based payment expense 1,717,523 16,586,509 (1,642,361) - (33,234) 142,500 105,854 526,706 226,092 2,943,375 13,578,466 - 75,553 76,675 142,500 529,236 502,900 6,157 Unrealised loss/(gain) on forward commodity contracts Operating loss before changes in working capital and provisions (2,391,765) (292,470) 1,701,187 (551,197) Change in Trade and other receivables Change in Prepayments and other current assets Change in Inventories Change in Trade and other payables Change in Provisions (215,286) (165,678) (86,072) 492,782 5,516 31,262 (222,320) 200,298 4,066 (466,300) 5,303 (478,953) Net cash flows used in operating activities (261,208) (1,030,150) (c) Non-Cash Financing and Investing Activities During the current financial the following non cash financing and investing activities occurred: There were a number of share-based payments during the year. Refer to Note 24. 69 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 27. NOTES TO THE STATEMENT OF CASH FLOWS (Continued) During the previous financial year the following non cash financing and investing activities occurred: The Company granted 17,693,153 ordinary fully paid shares to 153 Fish Capital Pte Ltd in connection with the capital raising conducted by Sanston Securities in February 2017 in lieu of cash payment of A$141,545 for services rendered, at a deemed issued price of $0.008 per share. The Company granted 13,544,567 ordinary fully paid shares to 153 Fish Capital Pte Ltd in connection with the capital raising conducted by Sanston Securities in June 2017 in lieu of cash payment of A$108,357 for services rendered under a capital raising mandate, at a deemed issued price of $0.008 per share. 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: - - 1,000,000 options exercisable @ A$0.028 expiring 25/08/2019 13,000,000 options exercisable @ A$0.03 expiring 31/12/2021 A$4,000 A$4,150 A$8,150 (d) Reconciliation of Liabilities arising from Financing Activities Balance at 1 January 2018 Financing Cashflows Options and refinance costs Amortisation of deferred finance costs Debt to Equity Balance at 31 December 2018 36,976,225 (7,878,490) (1,622,048) 963,814 (4,000,000) 24,439,501 Interest bearing borrowings 28. EARNINGS PER SHARE Basic earnings per share (cents per share) Diluted earnings per share (cents per share) 2018 (1.05) (1.05) 2017 (2.13) (2.13) Profit/loss used in the calculation of basic and diluted earnings per share (15,867,054) (20,107,246) Weighted average number of ordinary shares on issue used in the calculation of basic earnings per share 1,508,836,694 944,413,550 Weighted average number of potential ordinary shares used in the calculation of diluted earnings per share 1,508,836,694 944,413,550 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. 70 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 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 for the period Total Comprehensive Income 2018 $ 2017 $ 3,588,600 58,155,325 1,473,516 1,473,516 298,297 42,797,593 1,392,274 1,392,274 (94,163,284) (78,415,334) (575,677) 7,946,386 (1,547,184) (191,846) (233,644) 33,138,185 (55,627,064) (575,677) 5,877,345 (1,346,396) (166,540) (228,254) 34,030,457 (40,824,399) 2,152,473 892,357 581,293 1,686,676 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. The Company has not increased the maximum amount that can be paid to directors for many years. The appropriate level for payments for Directors is currently under review by reference to market practice for comparable ASX listed companies. If the company seeks to increase the limit on remuneration payable to non-executive directors, shareholder approval will be sought. 71 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 31. DIRECTORS AND EXECUTIVE OFFICERS REMUNERATION (Continued) 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 December 2018 Cash salary and fees Bonus payments Non- monetary Post- employment benefits Super contributions Long-term benefits Termination Payment Long service leave Share/ option based payments* Total $ Directors B W Mcleod A Underwood D H Sutton L Tang P Espie J Gerahty J Warburton Executives A Boyer 253,269 210,010 - 14,958 2,172 2,172 23,391 219,520 - - - - - - - - 15,599 - - - - - - 72,362 - - 14,958 - - - - - 362,100 - - - - - - - - - - - - - - 49,328 680,296 57,218 267,228 10,428 25,386 10,428 25,386 - - - 2,172 2,172 23,391 11,957 303,839 * 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 $108,884 the non-cash loss on options relating to the above directors that expired over the year was $53,276. The net non-cash cost of options issued to the above directors and executives for the year was $55,608. Short term benefits December 2017 Cash salary and fees Bonus payments Non- monetary Post- employment benefits Super contributions Long-term benefits Long service leave Share/option based payments* Total $ Directors B W McLeod K A Torpey D H Sutton L Tang J Warburton Executives A Boyer 365,489(1) 7,555 - 7,555 16,999 31,063(2) - - - - 25,791 - - - - - 718 15,110 - - - - - - - 1,206 - - - - 423,549 8,273 15,110 7,555 16,999 - 219,018 63,513 (1) Includes accrued $145,135 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 $19,058 the non-cash loss on options relating to the above directors that expired over the year was $32,462. The net non-cash cost of options issued to the above directors and executives for the year was $(13,404). (2) In relation to a bonus issued in December 2014. 3141 - - 282,772 72 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 32. AUDITORS’ REMUNERATION Audit Services Auditors of the Company – Nexia Sydney Partnership: 2018 $ 2017 $ Audit and review of financial reports 77,681 88,922 Other auditors: Audit and review of financial reports 174,000 177,000 Other services Auditors of the Company – Nexia Sydney Partnership: Taxation services Other auditors: Taxation services 251,681 265,922 7,484 11,713 374 7,858 20,106 31,819 33. MATTERS SUBSEQUENT TO BALANCE DATE 1) On 12 December 2018 the Company announced that on 10 December 2018 it received notice under section 249D of the Corporations Act 2001 (Cth), from Global Energy & Resources Development Limited (“GERD”), a shareholder owning greater than 5% of the Company’s issued capital, requesting the directors of the Company to call and arrange to hold a general meeting of the members of the Company. The purpose was to consider the following resolutions: 1) that each and every one of the present directors be removed from his or her office of director of the Company; 2) that each of Edward Jacobson, Joseph Graham, James Hulme and Bruce Garlick be appointed as a director of the Company. On 6 February 2019 an Extraordinary General Meeting was conducted to consider the GERD resolutions. Shareholders voted against all resolutions other than the removal of Linda Tang, which shareholders voted in favour of. 2) On 6 February 2019 the Company appointed Professor John Warburton as Non-Executive Director of the Board. 3) On 5 February 2019 the Company appointed Mr Paul Espie AO as Non-Executive Chairman and Mr David Sutton resigned as Interim Chairman and returned to the role of Non-Executive Director. 4) On 6 March 2019 the Company announced that pursuant to its strategy to reduce debt through the sale of US assets, that it had received a number of proposals which the Directors were considering. That process is ongoing and shareholders will be provided further updates at the appropriate time. 5) At 31 December 2018, the Company was in breach of the interest coverage covenant under the Credit Facility, which required a ratio of 1.8. This was due to several temporary factors including the fact that the Company’s oil production was unhedged in Q4 2018 and therefore impacted by low oil prices (over 90% is hedged at $66.50 / bbl in 2019), poor weather conditions in Kansas which negatively impacted production rates and sales (offset by strong results of workover and recompletion program) and a higher loan balance early in the quarter which resulted in higher interest expense than is now incurred on the reduced loan balance. Macquarie Bank Limited formally waived this breach on 26 March 2019. 6) There were no other matters or circumstances that have arisen since 31 December 2018 that has significantly affected or may significantly affect: • • • the operations, in financial years subsequent to 31 December 2018, of the Empire Group; or the results of those operations; or the state of affairs in financial years subsequent to 31 December 2018 of the Empire Group. 73 EMPIRE ENERGY GROUP LIMITED and its controlled entities NOTES TO THE FINANCIAL STATEMENTS for the year ended 31 December 2018 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 21 to 25, 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 2018 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 Officer and the Chief Financial Controller for the year ended 31 December 2018. Signed in accordance with a resolution of the directors. Alexander Underwood Managing Director Date: 29 March 2019 74 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 2018, 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 2018 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. 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. Key audit matter How our audit addressed the key audit matter Impairment of oil and gas properties Refer to note 14 (Oil and Gas properties and property, plant and equipment) At 31 December 2018, the Group has capitalised proved oil and gas assets of $45.7m. 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 Our procedures included, amongst others:  Assessing whether the external expert engaged by management to provide independent valuations were appropriately experienced and qualified;  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. 75 Key audit matter How our audit addressed the key audit matter 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 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 $1.8m 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 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 2018;  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. 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. 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 2018, 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 76 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. 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: www.auasb.gov.au/auditors_responsibilities/ar1.pdf. 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 21 to 25 of the directors’ Report for the year ended 31 December 2018. In our opinion, the Remuneration Report of Empire Energy Group Limited for the year ended 31 December 2018, 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: 29 March 2019, Sydney 77 EMPIRE ENERGY GROUP LIMITED and its controlled entities SHAREHOLDER INFORMATION ORDINARY SHARES a Substantial Shareholders as at 22 March 2019 (grouped) Name Macquarie Bank Limited Global Energy and Resources Development Limited Liangrove Media Pty Limited 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 339,513,666 247,660,000 122,450,000 % Holding 14.68 10.71 5.29 Holders 309 689 391 887 736 Number of Shares 118,245 1,930,691 2,934,910 35,291,461 2,272,808,869 % Holding 0.01 0.08 0.13 1.53 98.26 3,012 2,313,084,176 100.00 i ii Number of holders of less than a marketable parcel Percentage held by 20 largest holders 1,756 45.81 c Twenty Largest Shareholders grouped as at 22 March 2019 (ungrouped) Name Macquarie Bank Limited 1 Global Energy and Resources Development Limited 2 Liangrove Media Pty Limited 3 HSBC Custody Nominees (Australia) Limited 4 Macquarie Bank Limited 5 Elphinstone Holdings Pty Ltd 6 Mr Kooi Onn Chye 7 Cha Qian 8 Citicorp Nominees Pty Limited 9 10 Cheoy Lee Yachts Australia Pty Ltd 11 Mr Teik Tatt Oh 12 Grosvenor Equities Pty Ltd 13 Oracle Financial Planning Pty Ltd 14 Merrill Lynch (Australia) Nominees Pty Limited 15 Rhodes Capital Pty Ltd 16 Elphinstone Holdings Pty Ltd 17 Colowell Pty Ltd 18 Mrs Ching Ling Yong 19 20 RHB Securities Singapore Pte Ltd John Wardman & Associates Pty Ltd Number of Shares 285,847,000 247,660,000 122,450,000 68,068,552 53,666,666 50,000,000 46,433,625 42,000,000 28,986,953 25,000,000 25,000,000 23,599,558 21,000,000 20,357,480 20,149,998 20,000,000 19,500,000 19,200,000 18,964,861 18,713,308 % Holding 12.36 10.71 5.29 2.94 2.32 2.16 2.01 1.82 1.25 1.08 1.08 1.02 0.91 0.88 0.87 0.86 0.84 0.83 0.82 0.81 1,176,598,001 45.81 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. 79 EMPIRE ENERGY GROUP LIMITED and its controlled entities SHAREHOLDER INFORMATON (Continued) UNQUOTED SECURITIES AS AT 22 MARCH 2019 Class of unquoted securities No. of securities No. of holders - Unlisted options exercisable at $0.28 expiring 25 August 2019 - Unlisted options exercisable at $0.03 expiring 30 December 2021 - Unlisted options exercisable at $0.03 expiring 31 January 2020 - Unlisted options exercisable at $0.03 expiring 30 December 2021 - Unlisted options exercisable at $0.03 expiring 30 December 2021 - Unlisted options exercisable at $0.03 expiring 30 December 2022 - Unlisted options exercisable at $0.03 expiring 26 September 2020 - Unlisted options exercisable at $0.032 expiring 31 July 2020 - Unlisted options exercisable at $0.032 expiring 31 December 2021 - Unlisted options exercisable at $0.03 expiring 26 October 2020 1,000,000 13,000,000 5,000,000 3,000,000 3,000,000 17,000,000 375,000,000 10,000,000 120,000,000 6,000,000 Unlisted Performance Rights subject to certain preconditions being met 2,500,000 1 9 3 1 1 11 137 4 1 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 29 March 2019. Given the extensive list 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 80 

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