ORCA EXPLORATION GROUP INC.
2012 Annual Report
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ORCA EXPLORATION GROUP INC.
is an international public company engaged in hydrocarbon exploration,
development and supply of gas in Tanzania and oil appraisal and gas
exploration in Italy. Orca Exploration trades on the TSXV under the
trading symbols ORC.B and ORC.A.
Financial and Operating HigHligHts . . . . . . 1
cHairman & ceO’s letter tO sHareHOlders . . . . . . 3
management’s discussiOn & analysis . . . . . . 12
management’s repOrt . . . . . . 42
auditOrs’ repOrt . . . . . . 43
cOnsOlidated Financial statements . . . . . . 44
nOtes tO tHe cOnsOlidated Financial statements . . . . . . 48
cOrpOrate inFOrmatiOn . . . . . . 71
glOssary
Thousands of standard cubic feet
Millions of standard cubic feet
Billions of standard cubic feet
Trillions of standard cubic feet
mcf
MMcf
Bcf
Tcf
MMcfd Millions of standard cubic feet per day
MMbtu Millions of British thermal units
HHV
LHV
High heat value
Low heat value
Proven reserves
Proven and probable reserves
Kilowatt hour
Megawatt
US dollars
1P
2P
Kwh
MW
US$
CDN$ Canadian dollars
bar
Fifteen pounds pressure per square inch
Financial and Operating HigHligHts
US$’000 except where otherwise stated
Financial
Revenue
Profit before taxation
Operating netback (US$/mcf)
Cash and cash equivalents
Working capital (1)
Shareholders’ equity
Earnings per share - basic (US$)
Earnings per share - diluted (US$)
Funds flow from operating activities
Funds per share from operating activities - basic (US$)
Funds per share from operating activities - diluted (US$)
Net cash flows from operating activities
Net cash flows per share from operating activities - basic (US$)
Net cash flows per share from operating activities - diluted (US$)
Outstanding shares (‘000)
Class A shares
Class B shares
Options
Operating
Additional Gas sold (MMcf) - industrial
Additional Gas sold (MMcf) - power
Additional Gas sold (MMcfd) - industrial
Additional Gas sold (MMcfd) - power
Additional Gas sold (MMcfd)
Average price per mcf (US$) - industrial
Average price per mcf (US$) - power
additiOnal gas grOss recOverable reserves
tO end OF licence (Bcf) (2)
Proved
Probable
Proved plus probable
net present value, discOunted at 10% (US$ million) (2)
Proved
Proved plus probable
year ended/as at 31 decemBer
2012
2011
Change
77,259
35,454
2.82
16,047
46,820
45,893
15,320
2.05
34,680
56,006
125,935
106,659
0.53
0.52
45,949
1.33
1.30
30,568
0.88
0.86
1,751
32,892
1,922
3,813
16,832
10.4
46.0
56.4
9.30
3.18
429
60
489
354
386
0.23
0.22
22,658
0.65
0.63
4,577
0.13
0.13
1,751
32,746
3,057
2,742
14,722
7.5
40.3
47.8
10.05
2.77
469
79
548
328
351
68%
131%
38%
(54%)
(16%)
18%
130%
136%
103%
105%
106%
568%
577%
562%
0%
0%
(37%)
39%
14%
39%
14%
18%
(7%)
15%
(9%)
(24%)
(11%)
8%
10%
(1) Working capital as at 31 December 2012 includes a TANESCO receivable of US$33.3 million (2011: US$24.2 million) and a net Songas receivable of
US$5.9 million (2011 : US$0.7 million).
(2) Based on report prepared by Orca Exploration’s independent reserve evaluator McDaniel & Associates Consultants Ltd. dated effective December 31, 2012,
which was prepared in accordance with definitions, standards and procedures contained in the Canadian Oil and Gas Evaluation Handbook.
1
ORCA EXPLORATION GROUP INC. 2012 ANNUAL REPORT
2
HigHligHts
• Orca Exploration operated its Tanzania Songo Songo
gas field at maximum plant and pipeline capacity
resulting in record operating and financial results.
• Profit after tax for the year was a record US$18.3
million, or US$0.52 per share diluted, up 130%
over 2011.
• An 18% increase in gas sales volumes plus a 10%
increase in the average gas price, together with higher
cost recoveries as a result of capital spending combined
to double funds flow from operations over 2011 to a
record US$45.8 million, or US$1.30 per share diluted.
• Capital spending in 2012 was US$54.7 million
(2011: US$18.1 million) of which US$38 million was
expended on SS-11 drilling and completion, US$7.9
million on preparation for SS-12 and Songo Songo
West drilling, and US$7.5 million on the unsuccessful
La Tosaca exploration well in Italy.
• Given TANESCO and Songas non-payments, record
funds flow did not translate to cash -- balances at the
end of 2012 were US$16.0 million, down 54% from
2011, net of US$54.7 million in capital spending
during the year and including US$6.0 million in
bank borrowings. Accordingly, the Company has
incorporated a going concern note into its 2012
Consolidated Financial Statements.
• Working capital was US$46.8 million, which included
a US$33.3 million receivable from TANESCO – at
the end of the year the Company had drawn US$6.0
million of a US$10.0 million senior debt facility which
was set up in Q3 to assist in financing TANESCO
receivables.
• Average gas prices up 10% in 2012 to US$4.31/Mcf
(2011: US$3.92/Mcf), industrial gas prices were down
7.5% in 2012 to US$9.31/Mcf from changes in the
sales mix, and average power sector gas prices increased
15% over 2011 to US$3.18/mcf from US$2.77/mcf,
pursuant to the PGSA and ARGA.
• Current TANESCO receivable is US$49.3 million, or
about US$0.90 per share on a net basis – Government
of Tanzania has raised US$600 million in debt and
US$100 million in World Bank budget support finance
and assured the Company that arrears will be paid from
these proceeds.
• Songo Songo PSA and GNT issues remain unresolved,
however the Company has continued to work in
cooperation with the Government and has tabled a
PSA amendment for the Government’s consideration.
• Establishing commercial terms for future incremental
gas sales is a key condition to the Company’s
commitment to Songo Songo development – the
Company has recently entered into discussions with
TPDC concerning a gas sales agreement.
• Government of Tanzania succeeded in arranging a
US$1.2 billion project financing with the China Exim
Bank to deliver a major natural gas infrastructure
expansion project which was inaugurated in
November 2012 and is expected to be completed by
the end of 2014.
• On 1st November 2012, the Government of Tanzania
issued a draft natural gas policy which contemplates
a restructuring of TPDC, strategic participation
throughout the upstream, midstream and
downstream sectors, ownership and control over gas
infrastructure and setting domestic natural gas prices
– at the request of the Government, the Company
submitted its views on the draft policy and a second
draft policy is expected in the near future.
• The La Tosca well in the Longastrino exploration
block in the Po Valley, Northern Italy was drilled in
August and has been plugged and abandoned having
encountered gas shows - Orca has earned a 70%
working interest and, subject to government approval,
operatorship of the block. The Company intends to
review the technical and drilling data to determine
whether or not to continue exploration on the block.
The offshore Italy Elsa appraisal well is now expected
to be drilled in 2014.
• With the completion of SS-11, brought onstream
in October 2012, the Company has substantially
upgraded the quality of its wellbore portfolio.
Subsequent to bringing SS-11 onstream, the SS-9
and SS-3 wells were taken off production leaving the
field producing at maximum capacity and having no
redundancy.
• Songo Songo gas reserves remain solid with a 9%
decrease in Songo Songo’s Total Proved Additional
Gas reserves to the end of the license period, with
no change on a life of field basis; total Additional
Gas production of 20.6 Bcf during the year; an 11%
decrease in the Proved plus Probable Additional Gas
reserves on a Gross Company life of license basis
from 548.5 Bcf to 489.3 Bcf. The decrease is primarily
due to the delay in the expansion project which has
moved probable reserves into possible reserves on
a life of licence basis. NPV10% 2P was estimated at
US$386 million.
ORCA EXPLORATION GROUP INC.2012 ANNUL REPORT cHairman & ceO’s letter tO
tHe sHareHOlders
increased gas sales and profitability
To meet constant high demand for natural gas production throughout 2012, Orca Exploration operated its
Tanzania Songo Songo gas field at maximum plant and pipeline capacity resulting in record operating and
financial results. Profit after tax for the year was a record US$18.3 million, or US$0.52 per share diluted, up
130% over 2011. Income included a US$8.3 million write down of costs associated with the unsuccessful
La Tosca, Italy well.
The increase in gas sales volumes plus a 10% increase in the average gas price, together with higher cost
recoveries as a result of capital spending during the year, combined to double funds flow from operations
over 2011 to a record US$45.9 million, or US$1.30 per share diluted. Taking out capital cost recoveries,
funds from operations in 2012 would have been approximately US$25 million, or US$0.70 per share. The
difficulty was that given the TANESCO non-payments, this funds flow did not translate to cash. Capital
spending in 2012 was US$54.7 million (2011: US$18.1 million) of which US$38 million was expended on
SS-11 drilling and completion, US$7.9 million on preparation for SS-12 and Songo Songo West drilling,
and US$7.5 million on the unsuccessful La Tosaca exploration well in Italy. Cash balances at the end of
2012 were US$16.0 million, down 54% from 2011, net of capital spending during the year and including
US$6.0 million in bank borrowings. Working capital was US$47.3 million, which included a US$33.3
million receivable from TANESCO. At the end of the year the Company had drawn US$6.0 million of a
US$10.0 million senior debt facility which was set up in Q3 to assist in financing TANESCO receivables.
Average natural gas sales prices were up 10% in 2012 to US$4.31/Mcf from US$3.92/Mcf the year
prior, largely a result of higher prices provided under the Portfolio Gas Sales Agreement (“PGSA”) with
TANESCO. While world energy prices were flat year over year, industrial gas prices were down 7.5% in
2012 to US$9.31/Mcf from changes in the sales mix. Average power sector gas prices increased 15% over
2011 to US$3.18/mcf from US$2.77/mcf, a result of a step change in the wellhead price in July (after an
annual 2% indexation) as provided under the PGSA and ARGA from US$2.06/MMbtu to US$2.76/
MMbtu.
Aided by the drilling and completion of the high productivity SS-11 well at mid-year, the Company
posted record Additional Gas production of 56.4 million cubic feet per day (“MMcfd”) in 2012, up 18%
over 2011. High margin industrial sales volumes increased by 39% to 10.4 MMcfd (2011: 7.5 MMcfd).
Demand for power increased gas sales to the power sector by 14% to 46.0 MMcfd (2011: 40.3 MMcfd).
a challenging year
Despite these achievements, 2012 was the most challenging year the Company has ever faced. Tanzania’s
state-owned utility TANESCO has not stayed current, let alone paid down arrears for natural gas
production, leaving Orca currently with US$49.3 million in receivables from TANESCO.
Orca recognizes that increasing natural gas development is at the core of Tanzania’s energy strategy.
But even with all the offshore exploration in the country, significant new gas production in Tanzania is
still years away. This leaves Orca as substantially the only producer of natural gas in Tanzania, currently
supplying 99% of gas production, which in turn powers some 50% of the national power grid. This is a
position of great responsibility and Orca continues to work closely with the Government of Tanzania
in seeking solutions to resolve outstanding financial issues and move natural gas development at Songo
Songo forward.
3
ORCA EXPLORATION GROUP INC. 2012 ANNUAL REPORT 4
At the same time Orca’s responsibility to its shareholders is also of the highest priority. Considerable
uncertainty still hangs over the Company and management’s top priority is to de-risk the business by
reducing that uncertainty. Equity markets have given us this message loud and clear. The market currently
capitalises our Tanzania business, net of working capital, at approximately US$35 million, less than
one-year’s cash flow. This is unacceptable for all concerned. To restore confidence and secure a future which
addresses profitability and still maintains its responsibilities to the people of Tanzania, your Company is
working closely with the Government towards a full and fair resolution of all outstanding issues including:
•
•
•
the collection of TANESCO arrears and security over future payments;
resolution of all Government Negotiating Team (“GNT”) matters; and
resolution of commercial terms affecting future incremental gas sales.
de-risking the business
TANESCO receivables, the largest single issue facing the Company, must be fairly and quickly resolved.
Going into 2012 TANESCO owed the Company US$24.2 million. Over much of the year, TANESCO
receivables stayed at approximately this level. However by the end of 2012, TANESCO was unable to stay
current and the receivable had grown to US$33.3 million. Today, TANESCO owes the Company US$49.3
million. Net of obligations relating to this amount, the net TANESCO receivable equates to approximately
US$0.90 per share, or roughly 40% of the Company’s current market capitalisation.
Whilst the Company can currently maintain operations from industrial gas sales alone, it does require
payments from TANESCO to comply with our obligations to pay VAT and Excise Tax to the Tanzania
Revenue Authority (“TRA”) against TANESCO invoices. Without payments from TANESCO Orca may
need to reduce operations to avoid accumulating any further liabilities with the TRA.
tanescO receivables -- common ground exists for a solution
Orca Exploration is completely aligned with the Government of Tanzania insofar as we agree that a viable
state utility is a critical component to delivering on Tanzania’s industrialization and economic growth
strategies. Despite TANESCO’s current financial situation we also remain confident that power prices
reflecting the real cost of service in the country, together with a changing fuel mix weighted towards
natural gas, can restore the state utility to a viable business model by the time the pipeline expansion is
commissioned in 2014.
In this situation the Government has not been idle. One of the major accomplishments of the Government
of Tanzania in 2012 was to arrange the financing of a US$1.2 billion natural gas infrastructure project,
critical to delivering natural gas to markets, and specifically to power generation hubs. The Government
has also been working diligently to arrange financing to address its budget needs and deal with the
TANESCO arrears, which not only affect Orca, but indeed ripple through the entire Tanzania economy.
Recently, the Government closed a US$600 million debt financing in international capital markets and
further received US$100 million in a first tranche of a World Bank Tanzania budget support package. We
have been assured by the Government that it is their intention to repay all of the TANESCO arrears from
these proceeds and that a significant payment would be made to the Company in the near future. Prompt
payment of the TANESCO arrears will clear a critical condition in our ability to proceed with additional
Songo Songo development.
ORCA EXPLORATION GROUP INC.2012 ANNUL REPORT CHAIRMAN & CEO’S LETTER TO THE SHAREHOLDERS resolution of psa issues
The dispute over the Songo Songo Production Sharing Agreement (“PSA”) and other matters have cast a
shadow over the Company since allegations were made in November 2011. Following the establishment
of a Government Negotiating Team (“GNT”) in February 2012, the Company entered into discussions
culminating in negotiation sessions during July 2012. Out of this came a framework for an agreement on
several major issues including PSA profit sharing ratios, Tanzania Petroleum Development Corporation
(“TPDC”) back-in rights, TANESCO payments, downstream unbundling and disputed cost pool
recoveries. While a full resolution was not achieved by the end of the year as originally envisaged, the
Company has continued discussions in good faith and in April 2013 Orca proposed an amendment to the
PSA, which is now in front of the Government for its consideration.
ensuring future economic viability
Before making commitments for further development at Songo Songo, the Company needs to establish
that the commercial terms of future gas sales will ensure economic viability. Currently the government’s
Natural Gas Infrastructure Project is contemplating allocating additional gas from Songo Songo and
Mnazi Bay to power markets in the Dar es Salaam area. The project, which we understand is financed
on a standalone basis, will require the repayment of loans to come exclusively from tariffs revenues
derived from the pipeline and infrastructure. Accordingly, transportation and processing tariffs will be
an important component of the cost of delivering gas to the markets, and in turn will have an impact on
both the net back price to gas producers and the delivered gas price to TANESCO as the power producer.
To deliver the lowest cost power to Tanzanians, the Government has the objective of purchasing gas at
the lowest possible price, whilst the producers will be seeking a price which will deliver the appropriate
economic returns. Bridging these differing objectives will be the subject of negotiations between the
producers and TPDC in its capacity as gas aggregator. With the support of the Ministry of Energy and
Mines (“MEM”) the Company has recently entered into negotiations with TPDC for Additional Gas
sales.
natural gas infrastructure project initiated
During the year, the Government of Tanzania succeeded in arranging a US$1.2 billion project financing
with the Export-Import Bank of China to deliver a major infrastructure expansion project. The 532km
Mnazi Bay to Dar es Salaam Gas Pipeline Project is planned to tie into expanded Songo Songo facilities
onshore at Somanga Funga and provide Orca with much needed process and pipeline capacity expansion
for Songo Songo gas.
On 8 November 2012, His Excellency Jakaya Kikwete, President of the United Republic of Tanzania,
formally commissioned the start of pipeline construction. The Company has had initial technical
consultations with project manager and Songo Songo partner TPDC in mid-November and consultations
are ongoing. The Company’s current objective is to have approximately 190 MMcfd of total gas (or
approximately 150 MMcfd Additional Gas sales) onstream by the end of 2014. A field development plan is
being prepared for discussion with TPDC. Approximately 120 MMcfd would be expected to be dedicated
to the expanded facilities and pipeline, with the balance to be processed and transported through the
existing Songas facilities.
5
ORCA EXPLORATION GROUP INC. 2012 ANNUAL REPORT 6
tanzania natural gas policy development
In November 2012, the Government of Tanzania issued a draft natural gas policy for review and
consultation. Natural gas discoveries in the country, reported by the Government at 36 TCF of resources,
have accelerated the need for Tanzania to develop a comprehensive framework for natural gas exploration
and development. From a policy perspective, the Government of Tanzania is seeking to participate across
the upstream, mid-stream and downstream sectors of the industry through a national oil company and to
regulate the industry through a new regulatory body.
The Government’s objective is also to promote the development of facilities for natural gas processing,
liquefaction, transportation, storage and distribution. To achieve this, the draft policy contemplates
a restructured TPDC, acting as a national aggregator of natural gas, owning and managing natural gas
infrastructure. The draft policy does not contemplate a market-driven gas price structure, but rather a
government role in establishing “an appropriate pricing structure” which can both encourage economic
use of the system capacities as well as provide incentives for promoting investment.
The policy also contemplates strategic involvement by the government in the LNG value chain and the
promotion of efficient LNG production. As part of the government’s role, as stewards of the country’s
national resources, the draft policy also addresses the management of natural gas revenues, local content,
community & social responsibilities and issues of transparency and accountability.
The Oil and Gas Association of Tanzania (“OGAT”), of which Orca is a member, has prepared a submission
on behalf of industry on the draft policy. The Company also submitted its own views on the draft policy
at the request of the Government of Tanzania, recognizing that Orca is the principal producer of natural
gas currently and for the near-to-medium term. The Government has been considering the views of the
Company and many other stakeholders and international parties and is expected to release a second draft
policy in the near future.
ORCA EXPLORATION GROUP INC.2012 ANNUL REPORT CHAIRMAN & CEO’S LETTER TO THE SHAREHOLDERS OperatiOns
tanzania
Operationally the Company substantially upgraded the quality of its wellbore inventory at Songo Songo
during the year. SS-11 was drilled as a directional well from onshore Songo Songo Island and was completed
in May 2012. The well entered the top Neocomian reservoir at a 40 degree angle at its highest position
in the Songo Songo field. A total of 352 meters of total gas reservoir was encountered and extensive new
reservoir data was acquired during the drilling of the well.
During the third quarter Orca brought SS-11 on-stream maintaining and strengthening field deliverability.
SS-11 is currently producing approximately 38 MMcfd of natural gas through a six-inch diameter Technip
Coflexip® pipe laid along the seabed to achieve an efficient natural cooling of the gas stream prior to the
plant inlet. The installation involved developing innovative solutions to a number of engineering challenges
which were met entirely by local Tanzanian contractors and suppliers who delivered the project on budget
and in approximately one-third the time of other solutions.
SS-11 is an important addition to the production wellbore inventory of Songo Songo. Subsequent to
bringing SS-11 onstream, the SS-9 well was taken off production. A debottlenecking of the gas gathering
infrastructure is currently underway with the objective of increasing the productive potential of SS-11 to
over 40 MMcfd.
The SS-9 well, which was producing approximately 30 MMcfd, was planned to be shut in and used only
as spare capacity until SS-12 could be drilled. During Q3, rising casing annulus pressures resulting from a
tubing leak dictated that SS-9 be permanently suspended. After suspending SS-9, similar tubing integrity
issues also dictated suspending SS-3. Whilst the quality of existing producing wells is much improved,
there is currently no redundant capacity in the facility or pipeline until shut in wells can be worked over
and/or additional wells can be drilled in the field.
italian operations
In the Longastrino Block in the Po Valley region of Northern Italy the La Tosca farm-in well was spud on 7
August 2012 and reached total depth of 2,335 metres and was plugged and abandoned in early September
having encountered gas shows. The drilling indicated a more limited reservoir sand development than
expected from earlier extrapolation of data from nearby wells. Total cost of the well to the Company was
US$7.5 million, which together with past costs was written off during the year. As a result of the drilling,
the Company has earned a 70% working interest and once approved as the new operator, Orca intends to
review the technical and drilling data to determine whether to continue exploration on the block.
During the year, the Elsa offshore Italy opportunity cleared an important regulatory hurdle. Legislative
Decree 83/2012 (the “Decree”), published on 26 June 2012 was approved by both houses of the Italian
Parliament with no substantial modifications. On 12 August 2012, the Decree became law. The new
legislation removes uncertainty concerning exploration, development and production activities in Italian
waters clearing the way for a new drilling application. A well is now expected to be drilled following
finalisation of an environmental impact study currently expected in 2014. Orca will not be liable to any
costs associated with the drilling of Elsa-2 until a rig contract is signed.
Management and board changes
Three new executive appointments were made during the year and two new directors were elected in
June 2012. Beer van Straten was named Chief Operating Officer replacing Dale Rollins who resigned in
March 2012. Mr. van Straten is responsible for the Company’s field operations including future large scale
development and exploration drilling programmes in Tanzania. Robert S. Wynne was appointed Chief
Financial Officer & Director in June 2012 following the resignation of Nigel Friend who had been a valued
member of Orca’s management team for the past seven years. In October 2012, David K. Roberts was
appointed as Orca’s Vice President Operations and Tanzania Country Manager based in Dar es Salaam.
William H. Smith was also elected to the Board of Directors in June 2012.
7
ORCA EXPLORATION GROUP INC. 2012 ANNUAL REPORT 8
Mr. van Straten is a senior international oil and gas industry executive with over 25 years of high level
exploration, production and commercial experience in the North Sea, Middle East and Africa. He has been
associated with Orca since June 2010. From 1999 to 2006 Mr. Wynne and Mr. Roberts were instrumental
in managing PanOcean Energy’s growth in Gabon from 400 bopd to 20,000 bopd, and Mr. Smith brings
additional hands on experience that helped to realise the PanOcean success.
corporate social responsibility
With a 20-year history in Tanzania, the Company feels strongly about giving back to the communities in
which we operate. Building upon its existing high impact social development projects, designed to deliver
sustainable enhancements to the Songo Songo and Kilwa District communities, Orca has continued to
expand its Corporate Social Responsibility Programme in Tanzania during the year. Focussed on the
communities’ critical educational and health needs, Orca has committed in excess of US$250,000 to its
existing projects, which include enhancement of teaching facilities on Songo Songo Island; continuation
of teacher development by sponsoring future staff through teacher training colleges in Dar es Salaam;
sponsoring a further 10 students from Songo Songo through secondary education in Dar es Salaam; and
continuing to provide routine healthcare and health awareness training to the Island’s people. Potentially
with increased impact however, Orca has contributed a further US$130,000 in 2012 to the design and
delivery of a bespoke technology-based English Language course to selected secondary schools in the
Kilwa District. The six-week intensive training course is delivered, critically, at the start of a child’s
secondary education and is designed to aide learning for students transitioning from a primary, Kiswahili-
based curriculum to a secondary, English-based curriculum. Extremely encouraging test results from pilot
courses suggest the course delivers a dramatic increase in a child’s ability to learn and with it significant
enhancement of a child’s prospects beyond graduation. The Company’s intent is to continue to roll-out
the course across other schools in the district in the next two to three years.
the will to create solutions
Orca and its predecessors have had a 20-year history in Tanzania, successfully partnering with the
Government and the World Bank to create the first natural gas-to-electricity development and the first
industrial gas market in East Africa. Comparatively recently a tremendous wealth of natural gas resources
has been discovered in Tanzania and the country is now faced with new challenges in realizing and
protecting this wealth for its people and future generations. The potential to realize such a prize has placed
significant pressure on the Government of Tanzania to establish policies and frameworks to guide the
fledgling industry and maximize the benefits that can follow. Our new Orca team is working in a spirit
of cooperation and collaboration with the new leadership in the Ministry of Energy and Minerals to
find a way to better align our interests and remove impediments to development and growth. We remain
optimistic that the will exists amongst all stakeholders to create equitable long-term solutions.
W. David Lyons
Chairman & CEO
26 April 2013
ORCA EXPLORATION GROUP INC.2012 ANNUL REPORT CHAIRMAN & CEO’S LETTER TO THE SHAREHOLDERS gas reserVes
In accordance with National Instrument 51-101 Standards of Disclosure for Oil and Gas Activities, the
independent petroleum engineers, McDaniel & Associates Ltd. prepared a report dated April 2013 that
assessed the Orca Exploration natural gas reserves based on information on the Songo Songo Field and
Songo Songo North as at 31 December 2012 (the “McDaniel Report”). A summary of the remaining
Additional Gas reserves on a life of license and life of field basis are presented below. The Total Proved
(1P) and Proved plus Probable (2P) reserves are based on production to the end of the license period
(October 2026).
During the course of 2012 no significant geological or geophysical data has been acquired on or close to
the Songo Songo field that might allow a re-assessment of the volumetric gas initially in place (“GIIP”)
and reserves. On a Gross Company basis there has been a 9% decrease in Songo Songo’s Total Proved
Additional Gas reserves to the end of the license period, with no change on a life of field basis, with a total
Additional Gas production of 20.6 Bcf during the year. There has been a 11% decrease in the Proved plus
Probable Additional Gas reserves on a Gross Company life of license basis from 548.5 Bcf to 489.3 Bcf.
The decrease is primarily due to the delay in the expansion project which has moved probable reserves
into possible reserves on a life of licence basis.
The gross and net Company Additional Gas reserves to end of license are as follows:
sOngO sOngO
additiOnal gas reserves
tO OctOber 2026 (Bcf)
Independent reserves evaluation
Proved producing
Proved undeveloped
Total proved (1P)
Probable
Total proved and probable (2P)
2012
2011
Gross (1)
Net (2)
Gross
Net
280.0
149.2
429.2
60.1
489.3
181.2
87.8
269.0
37.3
306.3
316.3
152.8
469.1
79.4
548.5
215.4
82.2
297.6
48.9
346.5
(1)
(2)
Gross equals the gross reserves that are available for the Company after estimating the effect of the TPDC back in (see below).
Net equals the economic allocation of the Gross reserves to the Company as determined in accordance with the Production Sharing Agreement.
sOngO sOngO
additiOnal gas reserves
tO end OF Field liFe (Bcf)
Independent reserves evaluation
Proved Producing
Proved Undeveloped
Total Proved (1P)
Probable
Total Proved and Probable (2P)
2012
2011
Gross (1)
Net (2)
Gross
Net
492.6
54.2
546.8
111.4
658.2
314.8
34.6
349.4
68.2
417.6
539.8
6.5
546.3
127.6
673.9
355.0
0.4
355.4
79.2
434.6
(1)
(2)
Gross equals the gross reserves that are available for the Company after estimating the effect of the TPDC back in (see below).
Net equals the economic allocation of the Gross reserves to the Company as determined in accordance with the Production Sharing Agreement.
9
ORCA EXPLORATION GROUP INC. 2012 ANNUAL REPORT 10
The McDaniel Report has assumed that TPDC will exercise its right to ‘back in’ to the field development
by contributing 20% of the costs of the future wells, including SS-10 and SS-11, and a proportion of the
infrastructure and operating costs, in return for a 20% increase in the profit share for the production
emanating from these wells. McDaniel has taken the view that this ‘back in’ right should be treated as a
TPDC working interest and therefore the Gross reserves have been adjusted for the volumes of Additional
Gas that are allocated to TPDC for their working interest share. The implications and workings of the
‘back in’ are currently being discussed with MEM as part of the conclusion of the GNT process and may
lead to future modifications in the way the Gross Company reserves are calculated.
For the purpose of calculating the Gross Additional Gas reserves, McDaniel has assumed in its 2P case
that 162 Bcf (2011: 171 Bcf) or an average of 13.5 Bcf per annum will be required to meet the demands
of the Protected Gas users from 1 January 2013 to 31 July 2024. During 2012, the Protected Gas users
consumed 14.4 Bcf.
The principal assumptions used by McDaniel in its evaluation of the Tanzanian PSA are as follows:
Year
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
2025
2026
Additional
Gas Price
1P
Gross Additional
Gas Volumes
1P
Additional
Gas Price
2P
Gross Additional
Gas Volumes
2P
US$/mcf
4.84
4.91
6.27
6.34
6.42
6.51
6.60
6.69
6.78
6.87
6.96
7.06
7.18
7.27
MMcfd
50.97
53.44
129.97
129.97
129.97
129.97
129.97
115.68
94.97
78.25
62.56
64.97
71.97
64.11
US$/mcf
4.84
4.92
6.06
6.17
6.29
6.40
6.50
6.60
6.70
6.83
6.95
7.06
7.15
7.29
2P MMcfd
53.45
55.99
134.92
134.92
134.92
134.92
134.92
134.92
122.76
102.74
86.53
86.98
96.75
79.30
ORCA EXPLORATION GROUP INC.2012 ANNUL REPORT OPERATIONS REPORT present value of reserves
The estimated value of the Songo Songo reserves on a life of license basis based on the assumptions on
production and pricing are as follows:
US$ millions
Proved Producing
Proved Undeveloped
Total Proved (1P)
Probable
Total Proved and Probable (2P)
2012
2011
5%
10%
15%
5%
10%
15%
312.8
148.5
461.3
51.9
513.2
226.2
127.7
353.9
31.6
385.5
172.0
107.5
279.5
19.4
298.9
301.3
139.2
440.5
39.9
480.4
209.3
118.9
328.2
22.8
351.0
152.4
99.2
251.6
13.5
265.1
There has been a 10% increase on the 2P present value at a 10% discount basis from US$351 million to
US$386 million on a life of licence basis. The increase is due to several factors: the increase in industrial
sales prices to reflect the correlation between the price of Brent and Heavy Fuel Oil (the alternative fuel
against which gas prices are set for industrial customers) and the increase in the Power price to reflect the
current terms under which volumes in excess of 36 MMcfd are invoiced to the Power sector, the increase
in cost of operations and the level of capital expenditure together with the timing of capital expenditure.
These factors together have led to a positive increase in the present value of cash flows in excess of the
absolute increase in cash flow as a result of the timing of Additional Profit Tax payments.
11
ORCA EXPLORATION GROUP INC. 2012 ANNUAL REPORT 12
management’s discussiOn
& analysis
FOrWard lOOKing statements
THIS MD&A OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS SHOULD BE READ IN CONJUNCTION
WITH THE AUDITED CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO FOR YEAR ENDED 31
DECEMBER 2012. THIS MD&A IS BASED ON THE INFORMATION AVAILABLE ON 26 APRIL 2013.
CERTAIN STATEMENTS IN THIS MD&A INCLUDING (I) STATEMENTS THAT MAY CONTAIN WORDS SUCH
AS “ANTICIPATE”, “COULD”, “EXPECT”, “SEEK”, “MAY”, “INTEND”, “WILL”, “BELIEVE”, “SHOULD”, “PROJECT”,
“FORECAST”, “PLAN” AND SIMILAR EXPRESSIONS, INCLUDING THE NEGATIVES THEREOF; (II) STATEMENTS
THAT ARE BASED ON CURRENT EXPECTATIONS AND ESTIMATES ABOUT THE MARKETS IN WHICH ORCA
EXPLORATION GROUP INC., ITS SUBSIDIARIES AND AFFILIATES (COLLECTIVELY, “ORCA EXPLORATION”,
OR THE “COMPANY” OPERATES AND (III) STATEMENTS OF BELIEF, INTENTIONS AND EXPECTATIONS
ABOUT DEVELOPMENTS, RESULTS AND EVENTS THAT WILL OR MAY OCCUR IN THE FUTURE, CONSTITUTE
“FORWARD-LOOKING STATEMENTS” AND ARE BASED ON CERTAIN ASSUMPTIONS AND ANALYSIS MADE BY
ORCA EXPLORATION. FORWARD-LOOKING STATEMENTS IN THIS MD&A INCLUDE, BUT ARE NOT LIMITED
TO, STATEMENTS WITH RESPECT TO FUTURE CAPITAL EXPENDITURES, INCLUDING THE AMOUNT, NATURE
AND TIMING THEREOF, NATURAL GAS PRICES AND DEMAND.
SUCH FORWARD-LOOKING STATEMENTS ARE SUBJECT TO IMPORTANT RISKS AND UNCERTAINTIES,
WHICH ARE DIFFICULT TO PREDICT AND THAT MAY AFFECT ORCA EXPLORATION’S OPERATIONS,
INCLUDING, BUT NOT LIMITED TO: THE IMPACT OF GENERAL WORLD ECONOMIC CONDITIONS AND
SPECIFCALLY IN TANZANIA, ITALY AND CANADA; INDUSTRY CONDITIONS, INCLUDING THE ADOPTION
OF NEW ENVIRONMENTAL, SAFETY AND OTHER LAWS AND REGULATIONS AND CHANGES IN HOW THEY
ARE INTERPRETED AND ENFORCED; SANCTITY OF CONTRACT; VOLATILITY OF OIL AND NATURAL GAS
PRICES; OIL AND NATURAL GAS PRODUCT SUPPLY AND DEMAND, RIG AVAILABILITY; RISKS INHERENT IN
ORCA EXPLORATION’S ABILITY TO GENERATE SUFFICIENT CASH FLOW FROM OPERATIONS, THIRD PARTY
FINANCE OR ASSETS SALES TO MEET ITS CURRENT AND FUTURE OBLIGATIONS; INCREASED COMPETITION;
THE FLUCTUATION IN FOREIGN EXCHANGE OR INTEREST RATES; STOCK MARKET VOLATILITY; COST POOL
AUDITS AND OTHER FACTORS, MANY OF WHICH ARE BEYOND THE CONTROL OF ORCA EXPLORATION.
ORCA EXPLORATION’S ACTUAL RESULTS, PERFORMANCE OR ACHIEVEMENTS COULD DIFFER MATERIALLY
FROM THOSE EXPRESSED IN, OR IMPLIED BY, THESE FORWARD-LOOKING STATEMENTS AND, ACCORDINGLY,
NO ASSURANCE CAN BE GIVEN THAT ANY OF THE EVENTS ANTICIPATED BY THE FORWARD-LOOKING
STATEMENTS WILL TRANSPIRE OR OCCUR, OR IF ANY OF THEM DO TRANSPIRE OR OCCUR, WHAT BENEFITS
ORCA EXPLORATION WILL DERIVE THEREFROM. SUBJECT TO APPLICABLE LAW, ORCA EXPLORATION
DISCLAIMS ANY INTENTION OR OBLIGATION TO UPDATE OR REVISE ANY FORWARD-LOOKING STATEMENTS,
WHETHER AS A RESULT OF NEW INFORMATION, FUTURE EVENTS OR OTHERWISE. ALL FORWARD-LOOKING
STATEMENTS CONTAINED IN THIS DOCUMENT ARE EXPRESSLY QUALIFIED BY THIS CAUTIONARY
STATEMENT.
ORCA EXPLORATION GROUP INC.2012 ANNUL REPORT
nOn-gaap Measures
THE COMPANY EVALUATES ITS PERFORMANCE USING A NUMBER OF NON-GAAP (GENERALLY ACCEPTED
ACCOUNTING PRINCIPLES) MEASURES. THESE NON-GAAP MEASURES ARE NOT STANDARDISED AND
THEREFORE MAY NOT BE COMPARABLE TO SIMILAR MEASUREMENTS OF OTHER ENTITIES.
•
•
•
•
FUNDS FLOW FROM OPERATING ACTIVITIES IS A TERM THAT REPRESENTS CASH FLOW
FROM OPERATIONS BEFORE WORKING CAPITAL ADJUSTMENTS. IT IS A KEY MEASURE AS IT
DEMONSTRATES THE COMPANY’S ABILITY TO GENERATE CASH NECESSARY TO ACHIEVE
GROWTH THROUGH CAPITAL INVESTMENTS.
OPERATING NETBACKS REPRESENT THE PROFIT MARGIN ASSOCIATED WITH THE PRO-
DUCTION AND SALE OF ADDITIONAL GAS AND IS CALCULATED AS REVENUES LESS PRO-
CESSING AND TRANSPORTATION TARIFFS, GOVERNMENT PARASTATAL’S REVENUE SHARE,
OPERATING AND DISTRIBUTION COSTS FOR ONE THOUSAND STANDARD CUBIC FEET OF
ADDITIONAL GAS. THIS IS A KEY MEASURE AS IT DEMONSTRATES THE PROFIT GENERATED
FROM EACH UNIT OF PRODUCTION, AND IS WIDELY USED BY THE INVESTMENT COMMUNITY.
FUNDS PER SHARE FROM OPERATING ACTIVITIES IS CALCUALATED ON THE BASIS OF
THE FUNDS FLOW FROM OPERATIONS DIVIDED BY THE WEIGHTED AVERAGE NUMBER OF
SHARES.
NET CASH FLOWS PER SHARE FROM OPERATING ACTIVITIES IS CALCULATED AS CASH
FLOW FROM OPERATIONS DIVIDED BY THE WEIGHTED AVERAGE NUMBER OF SHARES.
ADDITIONAL INFORMATION REGARDING ORCA EXPLORATION GROUP INC. IS AVAILABLE UNDER THE
COMPANY’S PROFILE ON SEDAR AT www.sedar.com.
backgrOund
Tanzania
Orca Exploration Group Inc.’s (together with its subsidaries and affiliates, “Orca Exploration”, or the “Company”)
principal operating asset is its interest in a Production Sharing Agreement (“PSA”) with the Tanzania Petroleum De-
velopment Corporation (“TPDC”) and the Government of Tanzania in the Republic of Tanzania. This PSA covers the
exploration, development, production and marketing of certain gas from the Songo Songo gas field.
The gas in the Songo Songo field is divided between Protected Gas and Additional Gas. The Protected Gas is owned by
TPDC and is sold under a 20-year gas agreement (until July 2024) to Songas Limited (“Songas”). Songas is the owner of
the infrastructure that enables the gas to be delivered to Dar es Salaam, which includes a gas processing plant on Songo
Songo Island, 232 kilometres of pipeline to Dar es Salaam and a 16 kilometre spur to the Wazo Hill Cement Plant.
Songas utilizes the Protected Gas (maximum 45.1 MMcfd) as feedstock for its gas turbine electricity generators at
Ubungo, for onward sale to the Wazo Hill cement plant and for electrification of some villages along the pipeline route.
Orca Exploration receives no revenue for the Protected Gas delivered to Songas and operates the field and gas process-
ing plant on a ‘no gain no loss’ basis.
Orca Exploration has the right under the PSA to produce and market all gas in the Songo Songo field in excess of the
Protected Gas requirements (“Additional Gas”).
Italy
During 2010 Orca Exploration farmed in to an oil appraisal block in the Adriatic Sea in Italy and to a gas exploration
prospect in the Po Valley in Northern Italy. In early August 2012, the operator of the La Tosca well in the Po Valley
commenced drilling operations. On 27 August 2012 the well was plugged and abandoned having reached total depth,
the gas shows encountered and data obtained during drilling having not warranted completion and testing of the well.
The costs of the well have been written off in the current period.
Orca has earned a 70% working interest in the block and, subject to government approval, operatorship of the block.
The Company intends to review the technical and drilling data to determine whether to continue exploration on the block.
13
ORCA EXPLORATION GROUP INC. 2012 ANNUAL REPORT 14
principal terms OF tHe tanzanian psa and related agreements
The principal terms of the Songo Songo PSA and related agreements are as follows:
Obligations and restrictions
(a) The Company has the right to conduct petroleum operations, market and sell all Additional Gas produced and
share the net revenue with TPDC for a term of 25 years expiring in October 2026.
(b) The PSA covers the two licenses in which the Songo Songo field is located (“Discovery Blocks”). The Proven
Section is essentially the area covered by the Songo Songo field within the Discovery Blocks.
(c) No sale of Additional Gas may be made from the Discovery Blocks if in Orca Exploration’s reasonable judgment
such sales would jeopardise the supply of Protected Gas. Any Additional Gas contracts entered into are subject to
interruption. Songas has the right to request that the Company and TPDC obtain security reasonably acceptable
to Songas prior to making any sales of Additional Gas from the Discovery Block to secure the Company’s and
TPDC’s obligations in respect of Insufficiency (see (d) below).
(d) “Insufficiency” occurs if there is insufficient gas from the Discovery Blocks to supply the Protected Gas
requirements or is so expensive to develop that its cost exceeds the market price of alternative fuels at Ubungo.
Where there have been third party sales of Additional Gas by Orca Exploration and TPDC from the Discovery
Blocks prior to the occurrence of the Insufficiency, Orca Exploration and TPDC shall be jointly liable for the
Insufficiency and shall satisfy its related liability by either replacing the Indemnified Volume (as defined in (e)
below) at the Protected Gas price with natural gas from other sources; or by paying money damages equal to
the difference between: (a) the market price for a quantity of alternative fuel that is appropriate for the five
gas turbine electricity generators at Ubungo without significant modification together with the costs of any
modification; and (b) the sum of the price for such volume of Protected Gas (at US$0.55/Mmbtu) and the
amount of transportation revenues previously credited by Songas to the state electricity utility, the Tanzania
Electric Supply Company (“TANESCO”), for the gas volumes.
(e) The “Indemnified Volume” means the lesser of the total volume of Additional Gas sales supplied from the
Discovery Blocks prior to an Insufficiency and the Insufficiency Volume. “Insufficiency Volume” means the
volume of natural gas determined by multiplying the average of the annual Protected Gas volumes for the three
years prior to the Insufficiency by 110% and multiplied by the number of remaining years (initial term of 20
years) of the power purchase agreement entered into between Songas and TANESCO in relation to the five gas
turbine electricity generators at Ubungo from the date of the Insufficiency.
Access and development of infrastructure
(f) The Company is able to utilise the Songas infrastructure including the gas processing plant and main pipeline
to Dar es Salaam. Access to the pipeline and gas processing plant is open and can be utilised by any third party
who wishes to process or transport gas. Ndovu Resources Limited, with support from TPDC and the Ministry
of Energy and Mines (“MEM”), has indicated that they wish to tie into the gas processing plant on Songo Songo
Island and sell up to 10 MMcfd from their Kiliwani North field. The Tanzania Natural Gas Infrastructure Project
contemplates additional processing and transportation capacity on Songo Songo to handle these additional gas
volumes. Access has not yet been granted and it is not clear when, or if, this will occur.
Songas is not required to incur capital costs with respect to additional processing and transportation facilities
unless the construction and operation of the facilities are, in the reasonable opinion of Songas, financially viable.
If Songas is unable to finance such facilities, Songas shall permit the seller of the gas to construct the facilities
at its expense, provided that, the facilities are designed, engineered and constructed in accordance with good
pipeline and oilfield practices.
ORCA EXPLORATION GROUP INC.2012 ANNUL REPORT MANAGEMENT’s dIsCUssION & ANALysIs
Revenue sharing terms and taxation
(g) 75% of the gross revenues less processing and pipeline tariffs and direct sales taxes in any year (“Net Revenues”)
can be used to recover past costs incurred. Costs recovered out of Net Revenues are termed “Cost Gas”.
The Company pays and recovers costs of exploring, developing and operating the Additional Gas with two ex-
ceptions: (i) TPDC may recover reasonable market and market research costs as defined under the PSA (US$1.1
million as at 31 December 2012 for marketing costs that have been incurred by TPDC since start up); and (ii)
TPDC has the right to elect to participate in the drilling of at least one well for Additional Gas in the Discovery
Blocks for which there is a development program as detailed in an Additional Gas plan (“Additional Gas Plan”)
as submitted to the Ministry of Energy and Minerals subject to TPDC being able to elect to participate in a de-
velopment program only once and TPDC having to pay a proportion of the costs of such development program
by committing to pay between 5% and 20% of the total costs (“Specified Proportion”). If TPDC does not notify
the Company within 90 days of notice from the Company that the MEM has approved the Additional Gas Plan,
then TPDC is deemed not to have elected. If TPDC elects to participate, then it will be entitled to a rateable
proportion of the Cost Gas and their profit share percentage increases by the Specified Proportion for that de-
velopment program.
TPDC has indicated that they wish to exercise their right to ‘back in’ to the field development. The implica-
tions and workings of the ‘back in’ have been discussed with the Government Negotiation Team (“GNT”) and
there may be the need for reserve and accounting modifications once these discussions are concluded. For the
purpose of the reserves certification as at 31 December 2012, it has been assumed that they will ‘back in’ for 20%
for all future new wells and other developments and this is reflected in the Company’s net reserve position.
(h) On 27 February 2009, the energy regulator, Energy and Water Utility Regulatory Authority (“EWURA”), issued
an order that saw the introduction of a flat rate tariff of US$0.59/mcf from 1 January 2010. The Company’s
long-term gas price to the power sector as set out in the initialed Amended and Restated Gas Agreement
(“ARGA”) and the Portfolio Gas Sales Agreement (“PGSA”) is based on the price of gas at the wellhead. As
a consequence, the Company is not impacted by the changes to the tariff paid to Songas or other operators in
respect of sales to the power sector.
During Q2 2011, the Company signed a Re-rating Agreement with TANESCO and Songas to run the gas pro-
cessing plant at levels of up to 110 MMcfd (the pipeline and pressure requirements at the Ubungo power plant
restrict the infrastructure capacity to a maximum of 102 MMcfd). Under the terms of the Re-rating Agreement,
the Company effectively pays an additional tariff of US$0.30/mcf for sales between 70 MMcfd and 90 MMcfd
and US$0.40/mcf for volumes above 90 MMcfd in addition to the tariff of US$0.59/mcf payable to Songas as
set by the energy regulator, EWURA.
The Re-rating Agreement expired 31 December 2012; the terms of an extension are currently under discus-
sion with Songas, TANESCO and TPDC. The Company has been advised by MEM that Songas has agreed to
continue the Re-Rating Agreement until September 2013.
(i) The cost of maintaining the wells and flowlines is split between the Protected Gas and Additional Gas users in
proportion to the volume of their respective sales. The cost of operating the gas processing plant and the pipeline
to Dar es Salaam is covered through the payment of the pipeline tariff.
(j) Profits on sales from the Proven Section (“Profit Gas”) are shared between TPDC and the Company, the pro-
portion of which is dependent on the average daily volumes of Additional Gas sold or cumulative production.
The Company receives a higher share of the net revenues after cost recovery, based on the higher the cumulative
production or the average daily sales. The Profit Gas share is a minimum of 25% and a maximum of 55%.
15
ORCA EXPLORATION GROUP INC. 2012 ANNUAL REPORT
16
Average daily sales
of Additional Gas
Cumulative sales
of Additional Gas
TPDC’s share
of Profit Gas
Company’s share
of Profit Gas
MMcfd
0 - 20
> 20 <= 30
> 30 <= 40
> 40 <= 50
> 50
Bcf
0 – 125
> 125 <= 250
> 250 <= 375
> 375 <= 500
> 500
%
75
70
65
60
45
%
25
30
35
40
55
For Additional Gas produced outside of the Proven Section, the Company’s Profit Gas share is 55%.
Where TPDC elects to participate in a development program, their profit share percentage increases by the
Specified Proportion (for that development program) with a corresponding decrease in the Company’s percent-
age share of Profit Gas.
The Company is liable to income tax. Where income tax is payable, there is a corresponding deduction in the
amount of the Profit Gas payable to TPDC.
(k) Additional Profits Tax (“APT”) is payable where the Company has recovered its costs plus a specified return out
of Cost Gas revenues and Profit Gas revenues. As a result: (i) no APT is payable until the Company recovers
its costs out of Additional Gas revenues plus an annual return of 25% plus the percentage change in the United
States Industrial Goods Producer Price Index (“PPI”); and (ii) the maximum APT rate is 55% of the Company’s
Profit Gas when costs have been recovered with an annual return of 35% plus PPI return. The PSA is, therefore,
structured to encourage the Company to develop the market and the gas fields in the knowledge that the profit
share can increase with larger daily gas sales and that the costs will be recovered with a 25% plus PPI annual
return before APT becomes payable. APT can have a significant negative impact on the project economics if
only limited capital expenditure is incurred.
Operatorship
(l) The Company is appointed to develop, produce and process Protected Gas and operate and maintain the Songas
gas production facilities and processing plant, including the staffing, procurement, capital improvements,
contract maintenance, maintain books and records, prepare reports, maintain permits, handle waste, liaise with
the Government of Tanzania and take all necessary safe, health and environmental precautions all in accordance
with good oilfield practices. In return, the Company is paid or reimbursed by Songas so that the Company
neither benefits nor suffers a loss as a result of its performance.
(m) In the event of loss arising from Songas’ failure to perform and the loss is not fully compensated by Songas, Orca
Exploration, or insurance coverage, then Orca Exploration is liable to a performance and operation guarantee
of US$2.5 million when (i) the loss is caused by the gross negligence or wilful misconduct of the Company, its
subsidiaries or employees, and (ii) Songas has insufficient funds to cure the loss and operate the project.
Consolidation
The companies that are being consolidated are:
Company
Orca Exploration Group Inc.
Orca Exploration Italy Inc.
Orca Exploration Italy Onshore Inc.
PAE PanAfrican Energy Corporation
PanAfrican Energy Tanzania Limited
Incorporated
British Virgin Islands
British Virgin Islands
British Virgin Islands
Mauritius
Jersey
Orca Exploration UK Services Limited
United Kingdom
ORCA EXPLORATION GROUP INC.2012 ANNUL REPORT MANAGEMENT’s dIsCUssION & ANALysIs
results FOr tHe year ended 31st decemBer 2012
Operating VOlumes
The sales volumes for the year were 20,645 MMcf or 56.4 MMcfd. This represents an overall increase of 18% over the
previous year. The Company’s sales volumes were split between the industrial and power sectors as follows:
Operating vOluMes
Gross sales volume (MMcf)
Industrial sector
Power sector
Total volumes
Gross daily sales volume (MMcfd)
Industrial sector
Power sector
Total daily sales volume
2012
2011
3,813
16,832
20,645
10.4
46.0
56.4
2,742
14,722
17,464
7.5
40.3
47.8
Industrial sector
Industrial sales volume increased by 39% to 3,813 MMcf from 2,742 MMcf in 2011. The overall increase is
predominately a consequence of increased sales to Kioo Glass as a result of the full year supply of Additional Gas for
that company’s own power generation which commenced in September 2011. Sales of Additional Gas to the Wazo Hill
cement plant operated by the Tanzanian Portland Cement Company (“TPCC”) nearly doubled as a consequence of
bringing Kiln 4 back into operation late in 2011. Industrial sales for the year averaged 10.4 MMcfd (2011: 7.5 MMcfd).
Power sector
Power sector sales volumes increased by 14% to 16,832 MMcf or 46.0 MMcfd, compared to 14,722 MMcf or 40.3
MMcfd in 2011. The increase is a result of continued decline in the use of hydro-generation due to the low levels
of rainfall experienced during 2011/12 and a general increase in electricity demand. In order to meet the increased
demand the Symbion power plant was re-commissioned in July 2011 and was in operation throughout 2012.
Capacity constraints
The increase in volume in 2012 is a result of the plant re-rating which occurred in June 2011, pursuant to which the
capacity of the Songas plant was increased to 102 MMcfd. The re-rating agreement which was signed between the
Company, Songas and TPDC, expired on 31 December 2012. The parties to the agreement have since cooperated in
good faith to maintain the plant at the re-rated capacity. At such a time as the terms of the re-rating agreement cease,
plant capacity will be restored to the original 70 MMcfd, which will result in a material reduction in the Company’s
sales volumes of Additional Gas.
sOngO sOngO deliVeraBility
As at 31 December 2012, the Company had a production capacity of approximately 113 MMcfd, restricted to 102
MMcfd by the available infrastructure.
The new production well SS-11 was successfully brought on stream on 3rd October 2012 and is currently producing
approximately 38 MMcfd. As planned SS-9, which was producing approximately 30 MMcfd, has been suspended.
The Company has also permanently suspended SS-3 as a result of production tubing integrity issues and rising casing
annulus pressures. The condition of SS-4 is being monitored and it may have to be suspended in the future.
The Company plans to make up the production shortfall with additional volumes from SS-10 and SS-11. As a result no
material change in field production levels of approximately 98 MMcfd is currently anticipated. There will, however, be
no redundant capacity in the facility or pipeline until additional wells can be drilled in the field and facilities expanded.
A loss or material reduction in the production of any given well will have a material adverse effect on the total produc-
tion and funds flow from operations of the Company.
17
ORCA EXPLORATION GROUP INC. 2012 ANNUAL REPORT
18
Production equipment originally installed in the SS-9, SS-5, SS-4 and SS-3 wells drilled by TPDC between 1976
and 1983 has reached the end of its useful life. To expand field productive capacity, upon successful settlement of the
outstanding TANESCO receivable situation, the Company plans to rework and recomplete these wells by the end of
2014. The SS-10 well was drilled by the Company in 2007 and SS-11 was drilled in 2012. Plans for an additional de-
velopment well, SS-12, as well as the reworking and recompletion of existing wells, have been placed on hold until the
re-negotiation of certain terms of the Songo Songo PSA and related issues arising from the GNT discussions have been
fully resolved as well as the significant outstanding TANESCO receivable having been collected, substantive progress
on the Tanzania Natural Gas Infrastructure Project and financing.
cOmmOdity prices
The commodity prices achieved in the different sectors during the quarter are shown in the table below:
US$/mcf
Average sales price
Industrial sector
Power sector
Weighted average price
2012
2011
9.30
3.18
4.31
10.05
2.77
3.92
Industrial sector
The average gas price for the year was US$9.30/mcf (2011: US$10.05/mcf). In the context of essentially flat energy
prices over 2011, the overall decrease in price achieved during the year is a consequence of a relative increase in the
level of Additional Gas sales to Wazo Hill to 1.5 Bcf (2011: 0.75 Bcf). The sales to the Wazo Hill cement plant are
priced by reference to imported coal (the company’s alternative fuel supply) and accordingly are priced relatively lower
than the rest of the Company’s industrial customers.
Power sector
The average sales price to the power sector was US$3.18/mcf for the year, compared to US$2.77/mcf in 2011. The
15% increase is the result of a step change in the wellhead price, a component of the price to the power sector, from
US$2.06/MMbtu to US$2.76/MMbtu with effect from 1st July 2012 as provisioned in the PGSA and ARGA. The
ARGA and PGSA provide for indexation at the lower of US CPI and 2% with effect from each 1st July.
Operating reVenue
Under the terms of the Songo Songo PSA, Orca Exploration is responsible for invoicing, collecting and allocating the
revenue from Additional Gas sales.
Orca Exploration is able to recover all costs incurred on the exploration development and operations of the project out
of 75% of the Net Revenues (“Cost Gas”). Any costs not recovered in any period are carried forward for recovery out
of future revenues. Once the cost pool has been recovered TPDC will again be able to recover its past marketing costs,
being an estimated US$1.1 million accrued to date in accordance with the terms of the PSA. TPDC marketing costs
are treated as a reduction to Orca Exploration’s Cost Gas entitlement.
The Additional Gas sales volumes throughout the year were in excess of 50 MMcfd entitling the Company to a 55%
share of “Profit Gas” (Revenue less cost recovery share of revenue). The corresponding shares for 2011 were Q1 35%,
Q2 40% and 55% for both Q3 and Q4.
From January 2011, a significant proportion of the gas production was from the SS-10 well, which has been deemed
“backed into” by TPDC. As a result TPDC’s profit share increased by 20% for the production attributable to SS-10.
The same approach has been taken with respect to SS-11. The implications and workings of the ‘back in’ have been
discussed with the GNT, but further discussion is required to finalise the arrangement by way of an amendment to
the PSA.
ORCA EXPLORATION GROUP INC.2012 ANNUL REPORT MANAGEMENT’s dIsCUssION & ANALysIs
Orca Exploration was allocated a total of 87.0% in 2012 (2011: 73.7%) of the Net Revenues as follows:
US$’000
Gross sales revenue
Gross tariff for processing plant and pipeline infrastructure
Gross revenue after tariff (“Net Revenues”)
Analysed as to:
Company Cost Gas
Company Profit Gas
Company operating revenue
TPDC share of revenue
2012
89,053
(15,290)
73,763
53,473
10,719
64,192
9,571
73,763
2011
68,394
(11,672)
56,722
29,215
12,579
41,794
14,928
56,722
The Company’s total revenues for the year amounted to US$77,259 after adjusting the Company’s operating revenue of
US$64,192 by:
i)
adding US$16,530 for income tax in the current year – the Company is liable for income tax in Tanzania, but the
income tax is recoverable out of TPDC’s Profit Gas when the tax is payable and to account for this, revenue is
adjusted to reflect the current year income tax charge or loss; and
ii)
subtracting US$3,463 for the deferred effect of Additional Profits Tax – this tax is considered a royalty and is
netted against revenue.
Revenue presented on the Consolidated Statement of Comprehensive Income may be reconciled to the operating revenue
as follows:
US$’000
Industrial sector
Power sector
Gross sales revenue
Processing and transportation tariff
TPDC share of revenue
Company operating revenue
Additional Profits Tax
Current income tax adjustment
Revenue
2012
2011
35,463
53,590
89,053
(15,290)
(9,571)
64,192
(3,463)
16,530
77,259
27,562
40,832
68,394
(11,672)
(14,928)
41,794
(2,527)
6,626
45,893
The 68% increase in revenue compared to 2011 is the result of several factors. An 18% increase in sales volumes and a
10% increase in weighted average gas prices have contributed to an overall increase together with a significant increase
in Cost Gas, reducing TPDC’s share of Profit Gas as a consequence of a high level of capital investment during the year.
19
ORCA EXPLORATION GROUP INC. 2012 ANNUAL REPORT
20
prOcessing and transpOrtatiOn tariFF
Since early 2011, the Company has paid a flat rate regulated gas processing and transportation tariff of US$0.59/mcf to
Songas. Under the terms of the gas contracts with the power sector, the Company will pass on any increase or decrease
in the EWURA approved charges to its customers. This protocol insulates Orca Exploration from any increases in the
gas processing and pipeline infrastructure costs.
During Q2 2011, the Company signed a Re-rating Agreement with TANESCO and Songas to run the gas processing
plant at levels of up to 110 MMcfd (the pipeline and pressure requirements at the Ubungo power plant restrict the
infrastructure capacity to a maximum of 102 MMcfd). Under the terms of this agreement, the Company effectively
pays an additional tariff of US$0.30/mcf for sales between 70 MMcfd and 90 MMcfd and US$0.40/mcf for volumes
above 90 MMcfd in addition to the regulated tariff of US$0.59/mcf payable to Songas. The charge for the additional
tariff was US$3.1 million for the year, a 121% increase over US$1.4 million paid in 2011.
prOductiOn and distriButiOn eXpenses
The well maintenance costs are allocated between Protected and Additional Gas based on the proportion of their
respective sales during the year. The total costs for the maintenance for the year was US$1,008 (2011: US$1,453) of
which US$594 (2011: US$806) was allocated for the Additional Gas. The 2012 well maintenance costs also includes
US$360 relating to corrosion studies.
Other field and operating costs include an apportionment of the annual PSA licence costs, regulatory fees and some
costs associated with the evaluation of the reserves and the cost of personnel that are not recoverable from Songas.
Distribution costs represent the direct cost of maintaining the ringmain distribution pipeline and pressure reduction
station (security, insurance and personnel).
In the context of the GNT negotiations and the recently announced draft Natural Gas Policy, TPDC and MEM have
indicated that they wish Orca Exploration to unbundle the downstream distribution business in Tanzania. The meth-
odology for this is currently being discussed with the government and may lead to future modifications to the accounts.
These costs are summarized in the table below:
US$’000
Share of well maintenance
Other field and operating costs
Ringmain distribution costs
Production and distribution expenses
2012
954
1,744
2,698
3,255
5,953
2011
806
2,829
3,635
2,453
6,088
ORCA EXPLORATION GROUP INC.2012 ANNUL REPORT MANAGEMENT’s dIsCUssION & ANALysIs Operating netBacKs
The netback per mcf before general and administrative costs, overheads, tax and APT may be analysed as follows:
US$’000
Gas price – industrial
Gas price – power
Weighted average price for gas
Processing and transportation tariff
TPDC share of revenue
Net selling price
Well maintenance and other operating costs
Ringmain distribution pipeline
Operating netback
2012
9.30
3.18
4.31
(0.74)
(0.46)
3.11
(0.13)
(0.16)
2.82
2011
10.05
2.77
3.92
(0.67)
(0.85)
2.40
(0.21)
(0.14)
2.05
The operating netback increased by 38% from US$2.05/mcf to US$2.82/mcf in 2012, a result of higher volumes, higher
weighted average gas prices and increased recoveries of Cost Gas from higher capital expenditures during the year.
The 10% increase in the weighted average selling price from US$3.92/mcf to US$4.31/mcf in 2012 is partly a conse-
quence of a change in the sales mix resulting in lower average industrial prices, offset by a 39% increase in Industrial
gas volumes, and partly the result of a 15% increase in the Power price as a consequence of contractual step change in
wellhead price during the year.
TPDC’s share of revenue in 2012 decreased as a result of capital investment which entitled the Company to claim 75% of
Net Revenues as Cost Gas for most of the year, before allocating Profit Gas. This was not the case in 2011 when the cost
pool had been fully recovered, which also allowed TPDC to recover US$1.4 million in past marketing costs.
The 38% reduction in the well maintenance and other operating costs on a per mcf basis is primarily the result of higher
sales volumes during the year.
general and administratiVe eXpenses
The administrative expenses (“G&A”) may be analysed as follows:
US$’000
Employee & related costs
Office costs
Marketing costs including legal fees
Reporting, regulatory and corporate
2012
9,441
3,903
1,283
3,362
17,989
2011
8,949
2,952
2,192
1,347
15,440
The G&A includes the costs of running the natural gas distribution business in Tanzania which is recoverable as Cost
Gas and is relatively fixed in nature. G&A averaged approximately US$1.50 million per month in 2012 compared to
US$1.29 million in 2011. G&A per mcf decreased to US$0.87/mcf (2011: US$0.88/mcf) the result of increased sales
volumes.
21
ORCA EXPLORATION GROUP INC. 2012 ANNUAL REPORT 22
The main variances for the year are summarized below:
Employee & related costs
The 5.5% increase in employee and related costs over 2011 relate primarily to the payment of severance, as well as
retention, contractual and performance bonuses and consulting fees arising from the change of substantially all senior
management positions during the year.
Office costs
The increase is primarily due to the establishment of an Orca UK Services office.
Marketing costs and legal fees
The decrease in marketing and legal fees compared to 2011 is a consequence of finalizing the PGSA and the associated
legal fees which was signed at the end of Q2 2011.
Reporting, regulatory and corporate costs
The increase of US$2.0 million is due to a tax penalty of US$0.3 million and an increase of US$1.6 million in directors
fees during the year, which amount includes fees and bonuses paid to the Chairman & Chief Executive Officer and the
Chief Financial Officer & Director.
Stock based compensation
The breakdown of the costs incurred in relation to stock based compensation is detailed in the table below:
US$’000
Stock options
Stock appreciation rights
2012
720
432
1,152
2011
1,171
(320)
851
A total of 1,922,400 stock options were issued and outstanding at the end of 2012 compared to 3,057,400 at the end
of 2011, a result of exercise, expiries and relinquishments over the year. A total of 400,000 stock options were issued
during 2012 with an exercise price of CDN$3.18, a five-year term and immediate vesting at the date of grant. A total
one off charge of US$0.7 million was recorded in relation to these options.
A total of 745,000 stock appreciation rights were outstanding at the end of 2012 compared to 1,005,000 at the end of
2011, the reduction a result of expiries and relinquishments over the year. In August 2012, 100,000 rights were issued
with an exercise price of CDN$2.70, a five year term and vest in three equal instalments, the first third on the anniversa-
ry of the grant date. A further 330,000 were issued in December 2012 at a price of CDN$2.35 and vested immediately.
As stock appreciation rights are settled in cash, they are re-valued at each reporting date using the Black-Scholes option
pricing model. As at 31 December 2012, the following assumptions were used for the valuation of stock options and
stock appreciation rights: stock volatility between 53% and 71%, a risk free interest rate of 1.50% and a closing stock
price of CDN$3.00. A total charge of US$0.4 million was recorded in the year, principally as a consequence of issuing
330,000 rights which vested immediately.
ORCA EXPLORATION GROUP INC.2012 ANNUL REPORT MANAGEMENT’s dIsCUssION & ANALysIs net Finance cOsts
The movement in net financing costs is summarized in the table below:
US$’000
Finance incOMe
Interest income
Foreign exchange gain
Finance charges
Loan interest and related financing costs
Foreign exchange loss
net Finance cOsts
2012
2011
23
93
116
(315)
(412)
(727)
(611)
5
80
85
(100)
(938)
(1,038)
(953)
The increase in loan interest and related financing costs year over is a result of the Company drawing down $6.0 million
of a bank facility in September 2012.
taXatiOn
income tax
Under the terms of the PSA with TPDC and the Government of Tanzania, the Company is liable for income tax in
Tanzania at the corporate tax rate of 30%. However, where income tax is payable, this is recovered from TPDC by
deducting an amount from TPDC’s profit share. This is reflected in the accounts by increasing the Company’s revenue by
the appropriate amount.
As at 31 December 2012, there were temporary differences between the carrying value of the assets and liabilities for
financial reporting purposes and the amounts used for taxation purposes under the Income Tax Act 2004. Applying
the 30% Tanzanian tax rate, the Company has recognised a deferred tax liability of US$20.4 million (2011: US$15.2
million) which represents an additional deferred future income tax charge of US$5.2 million for the year (2011: US$2.4
million). This tax has no impact on cash flow until it becomes a current income tax at which point the tax is paid to the
Commissioner of Taxes and recovered from TPDC’s share of Profit Gas.
additional profits tax
Under the terms of the PSA, in the event that all costs have been recovered with an annual return of 25% plus the percentage
change in the United States Industrial Goods Producer Price Index (“PPI”), an Additional Profits Tax (“APT”) is payable.
The Company provides for APT by forecasting the total APT payable as a proportion of the forecast Profit Gas over the
term of the PSA. The effective APT rate of 31.8% (2011: 20%) was then applied to Profit Gas of US$10.7 million in 2012
(2011: US$12.6 million). Accordingly, US$3.5 million (2011: US$2.5 million) has been netted off revenue for the year
ended 31 December 2012.
Management does not anticipate that any APT will be payable in 2013, as the forecast revenues will not be sufficient
to cover the un-recovered costs brought forward as inflated by 25% plus the PPI percentage change and the forecast
expenditures for 2013. The actual APT that will be paid is dependent on the achieved value of the Additional Gas sales
and the quantum and timing of the operating costs and capital expenditure program.
The APT can have a significant negative impact on the Songo Songo project economics as measured by the net present value
of the cash flow streams. Higher revenue in the initial years leads to a rapid payback of the project costs and consequently
accelerates the payment of the APT that can account for up to 55% of the Company’s profit share. Therefore, the terms of
the PSA rewards the Company for taking higher risks by incurring capital expenditure in advance of revenue generation.
23
ORCA EXPLORATION GROUP INC. 2012 ANNUAL REPORT
24
depletiOn and depreciatiOn
The Natural Gas Properties are depleted using the unit of production method based on the production for the period as
a percentage of the total future production from the Songo Songo proven reserves. As at 31 December 2012 the proven
reserves as evaluated by the independent reservoir engineers, McDaniel & Associates Consultants Ltd., were 429.1 Bcf,
after TPDC ‘back-in’, on a life of licence basis. A depletion expense of US$8,968 (2011: US$8,092) on total annual pro-
duction of 20.65 Bcf (2011: 17.5 Bcf) yields an average depletion charge of US$0.43/mcf for the year (2011: US$0.47/
mcf). The reduction in per mcf depletion charge is primarily the result of an increase in sales volumes over 2011.
Non-Natural Gas Properties are depreciated as follows:
Leasehold improvements
Computer equipment
Vehicles
Fixtures and fittings
Over remaining life of the lease
3 years
3 years
3 years
carrying amOunt OF assets
Capitalised costs are periodically assessed to determine whether it is likely that such costs will be recovered in the
future. To the extent that these capitalised costs are unlikely to be recovered in the future, they are impaired and
recorded in the statement of comprehensive income (loss). In Q3 the Company recognised impairment of the La
Tosca exploration well and has expensed the total cost of US$8.3 million when it was determined that the well did not
have commercially viable quantities of mineral resources. The residual cost represents equipment with a resale value
which the Company intends to realise.
Funds generated By OperatiOns
Funds from operations before working capital changes were US$45.9 million for the year ended 31 December 2012
(2011: US$22.7 million). Removing the contribution of capital cost recoveries for the year, funds from operations in
2012 would have been approximately US$25 million, or US$0.70 per share.
US$’000
Profit after taxation
Adjustments (i)
Funds flow from operating activities
Working capital adjustments (i)
Net cash flows from operating activities
Net cash flows used in investing activities
Net cash flows from/(used in) financing activities
Increase in cash and cash equivalents
Effect of change in foreign exchange
Net decrease in cash and cash equivalents
(i) See consolidated statement of cash flows
2012
2011
18,329
27,620
45,949
(15,381)
30,568
(55,388)
5,980
(18,840)
207
(18,633)
7,986
14,672
22,658
(18,081)
4,577
(14,584)
(681)
(10,688)
(151)
(10,839)
The 103% increase in funds from operations over 2011 is due primarily to the 54% increase in operating revenue.
The increase in operating revenue is not reflected in the overall cash and cash equivalents as a consequence of
TANESCO’s inability to pay its invoices together with the high level of capital expenditure incurred during the year.
The post-tax profit adjustment includes US$8.3 million relating to a non-cash adjustment associated with the impair-
ment of the La Tosca well in Longastrino, Italy.
ORCA EXPLORATION GROUP INC.2012 ANNUL REPORT MANAGEMENT’s dIsCUssION & ANALysIs capital eXpenditures
Capital expenditures amounted to US$54.7 million during the year (2011: US$18.1 million). The capital expenditure
may be analysed as follows:
US$’000
Geological and geophysical and well drilling
Pipelines and infrastructure
Power development
Other equipment
2012
53,059
785
182
669
54,695
2011
16,475
1,158
37
465
18,135
geological and geophysical and well drilling
During the year the Company drilled and tied in the SS-11 development well at a cost of US$37.6 million including
demobilization costs. Prior to suspension of the 2012 drilling programme additional costs of US$4.4 million were
incurred on materials required for the drilling of the SS-12 development well, and a further US$3.5 million was spent
on materials and a site survey for the Songo Songo West offshore exploration well.
A further US$7.5 million was spent drilling the La Tosca exploration well on the Longastrino block in the Po Valley in
northern Italy; the well was unsuccessful and the costs have been written off in the current year.
pipelines and infrastructure
A total of US$0.38 million was incurred during the year on the installation of new customers and enhancing existing
customer connections.
An additional US$0.4 million was incurred during the year on the continued expansion of compressed natural gas
(“CNG”) facilities at Mikocheni.
WOrKing capital
Working capital as at 31 December 2012 was US$46.8 million (31 December 2011: US$56.0 million) and may be
analysed as follows:
Cash and cash equivalents
TANESCO receivable
Songas receivable
Other debtors
Trade and other receivables
Taxation receivable
Prepayments
Trade and other payables
Bank loan
Taxation payable
Working capital(1)
2012
16,047
33,256
14,283
25,956
73,495
14,692
246
104,480
45,496
5,842
6,322
46,820
2011
34,680
24,226
3,720
12,402
40,348
5,880
302
81,210
22,801
–
2,403
56,006
Note (1) Working capital as at 31 December 2012 includes a TANESCO receivable of US$33.3 million (2011: US$24.2 million) and a net Songas receivable of
US$5.9 million (2011: US$0.7 million).
Working capital as at 31 December 2012 was down 16% over 2011, primarily as a result of 2012 capital expenditure.
25
ORCA EXPLORATION GROUP INC. 2012 ANNUAL REPORT
26
At 31 December 2012 the majority of the Company’s cash was held in Tanzania. There are no restrictions in Tanzania
for converting Tanzania Shillings into US dollars.
Trade and other receivables at 31 December 2012 comprise trade receivables US$60.3 million (2011: US$35.7
million) and other receivables US$13.2 million (2011: US$4.6 million). Of the trade receivables US$33.3 million
(2011: US$24.2 million) relates to sales to TANESCO. The increase in other receivables, relates principally to an
increase in the amount due from Songas for operation of the gas processing plant and associated projects. The tax
related receivable represents an additional share of revenue based on the current tax charge. The tax charge for the
year ended 31 December 2012 is US$11.9 million (2011: US$4.9 million), this sum grossed for income tax at 30%, is
recovered from TPDC once the tax has been paid.
The Company obtains 59% of its operating revenue from Songas and TANESCO. Songas’ financial security is heavily
reliant on the payment of capacity and energy charges by TANESCO. TANESCO is dependent on the Government of
Tanzania for some of its funding. Despite having a history of delayed payments, TANESCO has previously settled in
full the outstanding balance subsequent to each quarter end. During the year, there has been no substantive progress
on payment of arrears owed by TANESCO. During the year, TANESCO failed to remain current and accordingly
the TANESCO receivable grew to US$33.3 million (including arrears of US$28.4 million) by 31 December 2012, an
increase of 38% year over year. As at the date of this report the TANESCO receivable is US$49.3 million (including
arrears of US$43.0 million). Subsequent to the end of the year, in April 2013, the Government of Tanzania raised
approximately US$600 million in international credit markets as well as a received World Bank budget support
package of US$100 million, the first of three tranches of World Bank funding. The Government of Tanzania has
assured the Company that a portion of the proceeds of these financings will be used to repay all of the outstanding
arrears of TANESCO. In the event that Company does not collect from TANESCO the outstanding receivables during
the current year and TANESCO continues to be unable to pay the Company for subsequent 2013 gas deliveries, the
Company will need additional funding for its ongoing operations. There are no guarantees that such additional funding
will be available when needed, or will be available on suitable terms.
At the end of 2012, Songas owed the Company US$23.4 million, whilst the Company owed Songas US$17.5 million;
there is no legal right to offset these amounts. The net Songas receivable was US$5.9 million (2011: US$0.7 million).
As at 31 December 2012, the Company has US$45.5 million of financial liabilities with regards to trade and other
payables (2011: US$22.8 million) of which US$17.5 million was due to Songas (2011: US$5.8 million). The financial
liabilities are payable as follows: US$38.5 million is due within one to three months, nil is due within three to six
months, and US$7.1 million is due within six to twelve months. The Company has a current taxation liability of US$6.3
million payable within three months.
BanK lOan
In September 2012, the Company closed a US$10 million 18-month bridge loan facility with a Tanzanian bank to
finance the Company’s working capital requirements in Tanzania. The facility is secured by an assignment of accounts
receivable and a fixed and floating charge on the assets of the Company. As at 31 December the Company had drawn
down US$6.0 million under the facility and paid US$0.2 million in financing fees. Subsequent to year-end, in March
2013, the Company drew down the remaining US$4.0 million under the line. Principal amounts drawn under the
facility are repayable in 12 equal monthly instalments which commenced in March 2013. Interest is payable monthly
at three-month US LIBOR plus 8%. An additional interest rate of 2% will be applied for any period in which the
TANESCO receivable is greater than 240-days.
ORCA EXPLORATION GROUP INC.2012 ANNUL REPORT MANAGEMENT’s dIsCUssION & ANALysIs Future OperatiOns
These financial statements have been prepared on a going concern basis. The going concern basis of presentation
assumes that the Company will continue in operation for the foreseeable future and be able to realize its assets and
discharge its liabilities and commitments in the normal course of business.
The ability of the Company to continue as a going concern is dependent on the Company’s ability to collect its
receivables from government entities to fund ongoing operations and the exploration and development program. The
continued deterioration of the financial position of the state utility, TANESCO, has created uncertainty whether the
Company will be able to collect sufficient cash to continue operations and meet its commitments. The immediate need
to collect from its debtors may create significant doubt about the Company’s ability to continue as a going concern.
The financial statements do not reflect adjustments that would be necessary if the going concern assumption were not
appropriate. If the going concern basis were not appropriate for these financial statements, then adjustments would be
necessary in the carrying amounts of assets and liabilities, the reported revenues and expenses, and the balance sheet
classifications used.
The Company generates in excess of 59% of its operating revenue from sales to the power sector companies, Songas and
TANESCO. Songas’ financial security is heavily reliant on the payment of capacity and energy charges by TANESCO.
TANESCO is dependent on the Government of Tanzania for some of its funding. Prior to 2012, despite having a
history of delayed payments, TANESCO had settled in full the outstanding balance subsequent to each quarter end.
At 31 December 2012, TANESCO owed the Company US$33.3 million (including arrears of US$28.4 million)
compared to US$24.2 million (including arrears of US$20.2 million) as at 31 December 2011. Subsequent to the
end of the year, the Company has received US$1.0 million and, as of the date of this report, the arrears total US$43.0
million.
At the end of 2012, Songas owed the Company US$23.4 million, whilst the Company owed Songas US$17.5 million;
there is no legal right to offset these amounts. Subsequent to the end of the year, the Company has neither received nor
paid any amounts in settlement of these balances.
During 2012, there has been no substantive progress on payment of arrears owed by TANESCO and as well the
state utility failed to remain current. Subsequent to the end of the year, in April 2013, the Government of Tanzania
has informed the Company that it raised approximately US$600 million in international credit markets as well as
having received a World Bank budget support package of US$100 million, the first of an expected three tranches of
World Bank funding. The Government of Tanzania has assured the Company that a portion of the proceeds of these
financings will be used to repay all of the outstanding arrears of TANESCO. In the event that Company does not
collect from TANESCO the outstanding receivables at December 31, 2012 and TANESCO continues to be unable
to pay the Company for subsequent 2013 gas deliveries, the Company will need additional funding for its ongoing
operations within three to four months of the date of this report. There are no guarantees that such additional funding
will be available when needed, or will be available on suitable terms.
During 2012, to help alleviate the funding gap caused by the delays in TANESCO payments the Company put in place
a US$10 million facility with a bank in Tanzania. As at 31 December 2012, the Company had drawn down US$6.0
million of this facility, incurring financing charges of US$0.2 million. Subsequent to the end of the year, the Company
drew the remaining US$4.0 million under the facility. Repayments commenced in March 2013.
27
ORCA EXPLORATION GROUP INC. 2012 ANNUAL REPORT 28
sHareHOlders’ equity and Outstanding sHare data
There were 34.6 million shares outstanding as at 31st December 2012 which may be analysed as follows:
Number of shares (‘000)
shares Outstanding
Class A shares
Class B shares
cOnvertible securities
Options
Fully diluted Class A and Class B shares
Weighted average
Class A and Class B shares
Convertible securities
Stock options
Weighted average diluted Class A and Class B shares
The movement in Class B shares during the year is analysed in the table below:
Number of shares (‘000)
As at 1 January
Stock options exercised
Normal course issuer bid
As at 31 December
2012
2011
1,751
32,892
34,643
1,922
36,565
1,751
32,746
34,497
3,057
37,554
34,642
34,656
811
35,453
1,176
35,832
2012
32,746
150
(4)
32,892
2011
32,939
–
(193)
32,746
As at 26 April 2013, there were a total of 32,892,015 Class B shares and 1,751,195 Class A shares outstanding.
stOck OptiOns
Thousands of options or cDN$
Outstanding as at 1 January
Forfeited/Expired
Exercised
Issued
2012
2011
Options
Exercise Price
Options
Exercise Price
3,057
1.00 to 13.55
2,557
1.00 to 13.55
(1,385)
4.75 to 13.55
(150)
400
1.00
3.18
–
–
500
3,057
–
–
3.60 to 4.75
1.00 to 13.55
Outstanding as at 31 December
1,922
1.00 to 3.60
ORCA EXPLORATION GROUP INC.2012 ANNUL REPORT MANAGEMENT’s dIsCUssION & ANALysIs
The weighted average remaining life and weighted average exercise prices of options at 31 December 2012 were as
follows:
Exercise Price
(cDN$)
Number Outstanding
as at
31 December 2012
Weighted Average
Remaining
Contractual Life
(years)
Number Exercisable
as at
31 December 2012
Weighted Average
Exercise Price
(cDN$)
1.00
3.18
3.60
1,272
400
250
1,922
1.66
4.29
3.75
1,272
400
250
1,922
1.00
3.18
3.60
There were 400,000 new stock options issued during the year with an exercise price of CDN$3.18. The stock option
issued fully vested on 31 December 2012 and have a term of five years. A total charge of US$0.7 million has been
recognised for the year in relation to the stock options and is included in General & Administrative expenses.
stOck appreciatiOn rights
Thousands of stock appreciation rights or CDN$
2012
2011
Outstanding as at 1 January
Expired
Granted (i)
Outstanding as at 31 December (ii)
SAR Exercise Price
1,005
4.20 to 13.55
(690)
8.70 to 13.55
430
745
2.35 to 2.70
2.35 to 5.30
SAR
1,005
Exercise Price
4.20 to 13.55
–
–
–
–
1,005
4.20 to 13.55
(i) A total of 100,000 stock appreciation rights were issued in August 2012 with an exercise price of CDN$2.70. These rights have a term of five years and vest in
three equal instalments, the first third vesting on the anniversary of the grant date. A further 330,000 stock appreciation rights were issued in December 2012 at
CDN$2.35 which vested immediately. There is no maximum liability associated with these rights.
The Company records a charge to the income statement using the Black-Scholes fair valuation option pricing model
every reporting period with a resulting liability being recognised in trade and other payables. In the valuation of both
the stock options and stock appreciation rights at the reporting date, the following assumptions have been made: a risk
free rate of interest of 1.50%; stock volatility of 53% to 71%; a 0% dividend yield; 0% forfeiture; and a closing stock
price of CDN$3.00 per share.
As at 31 December 2012, a total accrued liability of US$0.6 million (2011: US$0.2 million) has been recognised in
relation to the stock appreciation rights. The liability increased by US$0.4 million during the year reflects the issue of
additional stock appreciation rights, many of which vested immediately.
29
ORCA EXPLORATION GROUP INC. 2012 ANNUAL REPORT 30
cOntractual OBligatiOns and cOmmitted capital inVestment
cOntractual ObligatiOns
Protected Gas
Under the terms of the original gas agreement for the Songo Songo project (“Gas Agreement”), in the event that there
is a shortfall/insufficiency in Protected Gas as a consequence of the sale of Additional Gas, then the Company is liable
to pay the difference between the price of Protected Gas (US$0.55/MMbtu) and the price of an alternative feedstock
multiplied by the volumes of Protected Gas up to a maximum of the volume of Additional Gas sold (85.7 Bcf as at 31
December 2012). The Company did not have a shortfall during the reporting period does not anticipate a shortfall
arising during the licence period.
The Gas Agreement may be superseded by an initialled ARGA. The ARGA provides clarification of the Protected Gas
volumes and removes all terms dealing with the security of the Protected Gas and the consequences of any insuffi-
ciency to a new Insufficiency Agreement (“IA”). The IA specifies terms under which Songas may demand cash security
in order to keep them whole in the event of a Protected Gas insufficiency. Once the new IA is signed, it will govern the
basis for determining security. Under the provisional terms of the IA, when it is calculated that funding is required,
the Company shall fund an escrow account at a rate of US$2/MMbtu on all industrial Additional Gas sales out of its
and TPDC share of revenue, and TANESCO shall contribute the same amount on Additional Gas sales to the power
sector. The funds provide security for Songas in the event of an insufficiency of Protected Gas. The Company is actively
monitoring the reservoir and, supported by the report of its independent engineers, does not anticipate that a liability
will occur in this respect.
Re-rating Agreement
During Q2 2011, the Company signed a re-rating agreement with TANESCO and Songas (the “Re-Rating Agreement”)
to increase the gas processing capacity to a maximum of 110 MMcfd (the pipeline and pressure requirements at
the Ubungo power plant restrict the infrastructure capacity to a maximum of 102 MMcfd). Under the terms of the
Re-rating Agreement, the Company effectively pays an additional tariff of US$0.30/mcf for sales between 70 MMcfd
and 90 MMcfd and US$0.40/mcf for volumes above 90 MMcfd in addition to the tariff of US$0.59/mcf payable to
Songas as set by the energy regulator, EWURA.
Under the terms of this agreement, the Company agreed to indemnify Songas for damage to its facilities caused by
the re-rating, up to a maximum of US$15 million, but only to the extent that this was not already covered by indem-
nities from TANESCO or Songas’ insurance policies. The Re-rating Agreement expired 31 December 2012 and the
matter of increased capacity, whether by new or amended agreements, is currently under discussion with Songas and
TANESCO. In the interim, the Company has been advised by MEM that Songas has agreed to continue the Re-Rating
Agreeement until September 2013.
Portfolio Gas Sales Agreement
On 17 June 2011, a long term (to June 2023) PGSA was signed between Orca Exploration and TANESCO. Under
the PGSA, Orca is obligated, subject to infrastructure capacity, to sell a maximum of approximately 37 MMcfd for use
in any of TANESCO’s current power plants except those operated by Songas at Ubungo. Under the agreement, the
current basic wellhead gas price of US$2.82/mcf is due to increase to approximately US$2.88/mcf on 1 July 2013.
Operating leases
The Company has two office rental agreements. One in Dar es Salaam which expires on 30 November 2013 at an annual
rental of US$238 and one in Winchester (UK) which expires on 25 September 2022 at an annual rental of GBP35
(US$58) per annum for the first two years and GBP71 (US$115) thereafter. Both are recognised in the General and
Administrative expenses.
ORCA EXPLORATION GROUP INC.2012 ANNUL REPORT MANAGEMENT’s dIsCUssION & ANALysIs capital cOMMitMents
Italy
On 31 May 2010, the Company signed an agreement with Petroceltic International plc (“Petroceltic”) to farm in on
Petroceltic’s Central Adriatic B.R268.RG Permit offshore Italy. The farm-in commits the Company to fund 30% of the
Elsa-2 appraisal well up to a maximum of US$11.5 million to earn a 15% working interest in the permit. Thereafter,
the Company will fund all future costs relating to the well and the permit in proportion to its participating interest.
The Company has also agreed to pay Petroceltic fifteen per cent (15%) of the back costs in relation to the well up to a
maximum of US$0.5 million.
Petroceltic was due to spud the Elsa-2 well prior to 31 October 2010, but the Italian government passed a decree,
following the blowout of the Macondo well in the U.S., that prevented the drilling in the Italian seas within five nautical
miles of the coastline and within 12 nautical miles around the perimeter of protected Marine Parks. In view of this,
Petroceltic suspended the permit until such time as the Ministry of Environment issued a decree of environmental
compatibility for the drilling program. Legislative Decree 83/2012 (the “Decree”), was published on 26 June 2012 and
was approved by both houses of the Italian Parliament with no substantial modifications. On 12th August, the Decree
became law following publication in the Italian Official Journal. The new law modifies restrictions on offshore oil and
gas exploration and production originally introduced by DLGS 128/2010 in August 2010. The well is now expected to
be drilled following finalisation of an environmental impact study currently expected in 2014. Orca will not be liable
to any costs associated with the drilling of Elsa-2 until a rig contract is signed.
There are no further capital commitments in Italy.
Songo Songo
There are no contractual commitments for capital expenditure at Songo Songo. Any significant additional capital ex-
penditure in Tanzania remains dependent on TANESCO payments being brought up to date, the satisfactory conclu-
sion of the GNT issues, material progress on infrastructure expansion, the conclusion of commercial terms and the
subsequent raising of finance. Significant additional capital expenditure will be required to enable the Songo Songo
field to produce 190 MMcfd in line with the anticipated infrastructure expansion.
31
ORCA EXPLORATION GROUP INC. 2012 ANNUAL REPORT 32
cOntingencies
Downstream unbundling
In connection with the GNT negotiations and the recently announced draft Natural Gas Policy, TPDC and MEM
have indicated that they wish Orca Exploration to unbundle the downstream distribution business in Tanzania. The
methodology for this has been discussed with the GNT along with other issues. The Company anticipates further
negotiations will be necessary before this matter is concluded.
Access to infrastructure
Ndovu Resources Limited, with support from TPDC and MEM, has indicated that they wish to tie into the gas pro-
cessing plant on Songo Songo Island and sell up to 10 MMcfd from their Kiliwani North field. The Tanzania Natural
Gas Infrastructure Project contemplates additional processing and transportation capacity on Songo Songo to handle
these additional gas volumes. Access has not yet been granted and it is not clear when, or if, this will occur.
TPDC Back in
TPDC has indicated that they wish to exercise its right under the PSA to ‘back in’ to the Songo Songo field develop-
ment. The implications and workings of the ‘back in’ have been discussed with the GNT along with other issues.
The issues are not yet fully resolved, however, there may be the need for additional reserve and accounting modifica-
tions once these discussions are concluded. For the purpose of the reserves certification as at 31 December 2012, it
was assumed that they will ‘back in’ for 20% for all future new drilling activities and other developments and this is
reflected in the Company’s net reserve position.
Cost recovery
The Company’s cost pool in Tanzania was recovered early in Q2 2011 resulting in a reduction in the percentage of net
revenue attributable to the Company. During the current year the level of Cost Gas increased significantly as a conse-
quence of drilling the SS-11 well, however, the cost pool was recovered in Q4 2012.
TPDC conducted an audit of the historic cost pool and in 2011 disputed approximately US$34 million of costs that
had been allocated to the cost pool from 2002 through to 2009. The Company contends that the disputed costs were
appropriately incurred on the Songo Songo project in accordance with the terms of the PSA. This matter was not
resolved during the year in conjunction with the GNT negotiations and while the Company remains confident that
the final outcome will be satisfactory, it is prepared to utilise the extensive dispute resolution mechanisms outlined in
the PSA if necessary. This matter has had no impact on the results for the year.
Taxation
During the year, the Company received an assessment for additional withholding tax from the Tanzanian Revenue
Authority (TRA), which together with interest and penalties totals approximately US$2.0 million. The Company con-
sidered the assessment to be without merit and appealed to the Tax Revenue Appeals Board. The Tax Revenue Appeals
Board considered the appeal in March 2013 and upheld the assessment. The Company will now pursue the case with
the Tax Revenue Appeals Tribunal and if necessary the Court of Appeal of Tanzania.
related party transactiOns
One of the non-executive Directors is a partner at a law firm. During the year, the Company incurred US$0.4 million
(2011: US$0.2 million) to this firm for services provided. The transactions with this related party were made at the
exchange amount. As at 31 December 2012 the Company has a total of US$0.2 million recorded in trade and other
payables in relation to the related party. Each of the Chief Executive Officer and the Chief Financial Officer provide
services to the Company through consulting agreements with personal services companies. During the year, the
Company incurred fees and bonus compensation of US$0.1 million and US$0.2 million to the Chief Executive Officer
and the Chief Financial Officer respectively (2011: US$0.2 million and US$ nil respectively).
ORCA EXPLORATION GROUP INC.2012 ANNUL REPORT MANAGEMENT’s dIsCUssION & ANALysIs summary quarterly results
The following is a summary of the results for the Company for the last eight quarters:
2012
2011
Q4
Q3
Q2
Q1
Q4
Q3
Q2
Q1
(US$’000
except where otherwise stated)
Financial
Revenue
20,712
22,425
16,915
17,207
17,500
10,457
8,296
Profit/(loss) after taxation
Operating netback (US$/mcf)
5,504
3.01
1,266
3.14
5,167
2.56
6,392
2.55
5,267
2.41
(54)
1.78
383
1.80
9,640
2,390
2.16
Working capital
46,820
37,730
38,689
47,063
56,006
58,369
57,070
55,759
Shareholders’ equity
125,935
120,204
118,938
113,051
106,659
101,563
100,956
100,573
Profit/(loss) per share –
basic (US$)
Profit/(loss) per share –
diluted (US$)
capital expenditures
Geological and geophysical
and well drilling
Pipeline and infrastructure
Power development
Other equipment
Operating
Additional Gas sold –
industrial (MMcf)
Additional Gas sold –
power (MMcf)
Average price per mcf –
industrial (US$)
Average price per mcf –
power (US$)
0.15
0.04
0.15
0.19
0.15
0.00
0.01
0.07
0.15
0.04
0.15
0.18
0.15
0.00
0.01
0.07
2,160
14,749
17,732
18,418
10,989
3,463
(258)
(15)
562
261
22
1
563
84
86
219
91
20
11
22
239
421
–
41
1,124
364
11
94
899
362
4
91
1,127
1,022
829
835
786
719
688
550
4,417
4,270
4,172
3,973
4,521
4,442
2,965
2,794
8.56
9.21
10.14
9.63
9.94
10.47
10.28
9.42
3.61
3.55
2.80
2.72
2.97
2.76
2.64
2.62
The principal developments in Q4 2012 were as follows:
•
Sales volume for the quarter of 5,544 MMcf (Q4 2011: 5,307 MMcf) or 60.3 MMcfd (Q4 2011: 57.6 MMcf)
which represents the best quarter since sales began in 2004. Gross sales revenue amounted to US$24.7 million.
• The new production well SS-11 was brought onstream at the beginning of the quarter and is currently producing
approximately 38 MMcfd of natural gas.
• The SS-9 well was taken off production and suspended, permanently. The well, which was producing approx-
imately 30 MMcfd, has been permanently suspended due to a tubing leak resulting in rising casing annulus
pressures. SS-3 was subsequently suspended on the basis of tubing integrity issues.
•
On 1st November 2012, the Government of Tanzania issued a draft natural gas policy for review and consultation
among the various stakeholders. At the request of MEM, the Company has submitted its comments in writing.
33
ORCA EXPLORATION GROUP INC. 2012 ANNUAL REPORT
34
selected Financial inFOrmatiOn
Selected annual financial information derived from the audited consolidated financial statements for the years ended
31 December 2010, 2011 and 2012 is set out below:
US$’000s except per share amounts
Revenue
Funds flow from operating activities
Net cash flows from operating activities
Profit after taxation
Total assets
Profit per share:
Basic (US$)
Diluted (US$)
2012
77,259
45,949
30,568
18,329
2011
45,893
22,658
4,577
7,986
2010
38,808
20,836
15,534
10,011
212,244
151,844
124,408
0.53
0.52
0.23
0.22
0.33
0.31
Revenue increased by 68% to US$77.3 million in 2012 from US$45.9 million in 2011. The sales volumes were 18%
higher in 2012 than 2011, with the weighted average price increasing from US$3.92/mcf to US$4.31/mcf. In 2012,
current taxation of US$11.6 million was payable (2011: US$4.6 million) which in accordance with the terms of the
PSA is recoverable from TPDC. Consequently revenue in 2012 has been uplifted by the gross amount of US$16.5
million (2011: US$6.6 million)
The level of industrial volumes increased by39% to 3,813 MMcf in 2012 from 2,742 MMcf in 2011, mainly as a conse-
quence of the increase in sales to Kioo Limited and Wazo Hill. The level of power volumes increased by 14% to 16,832
MMcf (2011: 14,722 MMcf. The increase in power sales is attributable to more reliance on natural gas to generate
electricity, increased generation and infrastructure capacity.
Revenue increased by 18% to US$45.9 million in 2011 from US$38.8 million in 2010. The increase was a result of
an increase in production volumes of 30% together with a 5% increase in the weighted average realized price from
US$3.74/mcf in 2010 to US$3.92/mcf in 2011.
Funds from operations before working capital changes increased by 103% from US$22.7 million in 2011 to US$45.9
million in 2012 as a consequence of increased sales revenue. The funds from operations before working capital changes
increased by 8% from US$20.8 million in 2010 to US$22.7 million in 2011 as a consequence of increased sales revenue,
the impact of which was reduced by an increase in the level of general and administrative expenses.
ORCA EXPLORATION GROUP INC.2012 ANNUL REPORT MANAGEMENT’s dIsCUssION & ANALysIs
Business risKs
Operating hazards and uninsured risks
The business of Orca Exploration is subject to all of the operating risks normally associated with the exploration for,
and the production, storage, transportation and marketing of oil and gas. These risks include blowouts, explosions,
fire, gaseous leaks, downhole design and integrity, migration of harmful substances and oil spills, any of which could
cause personal injury, result in damage to, or destruction of, oil and gas wells or formations or production facilities
and other property, equipment and the environment, as well as interrupt operations. In addition, all of Orca Explora-
tion’s operations will be subject to the risks normally incident to drilling of natural gas wells and the operation and
development of gas properties, including encountering unexpected formations or pressures, premature declines of
reservoirs, blowouts, equipment and tubing failures and other accidents, sour gas releases, uncontrollable flows of oil,
natural gas or well fluids, adverse weather conditions, pollution and other environmental risks. Drilling conducted by
Orca Exploration overseas will involve increased drilling risks of high pressures and mechanical difficulties, including
stuck pipe, collapsed casing and separated cable. The impact that any of these risks may have upon Orca Exploration
is increased due to the fact that Orca Exploration currently only has one producing property. Orca Exploration will
maintain insurance against some, but not all, potential risks; however, there can be no assurance that such insurance
will be adequate to cover any losses or exposure for liability. The occurrence of a significant unfavourable event not
fully covered by insurance could have a material adverse effect on Orca Exploration’s financial condition, results of op-
erations and cash flows. Furthermore, Orca Exploration cannot predict whether insurance will continue to be available
at a reasonable cost or at all.
Foreign Operations
Orca Exploration’s operations and related assets are located in Italy and Tanzania which may be considered to be
politically and/or economically unstable. Exploration or development activities in Tanzania and Italy may require
protracted negotiations with host governments, national oil companies and third parties and are frequently subject
to economic and political considerations, such as, the risks of war, actions by terrorist or insurgent groups, expropria-
tion, nationalization, renegotiation or nullification of existing contracts and production sharing agreements, taxation
policies, foreign exchange restrictions, changing political conditions, international monetary fluctuations, currency
controls and foreign governmental regulations that favour or require the awarding of drilling contracts to local con-
tractors or require foreign contractors to employ citizens of, or purchase supplies from, a particular jurisdiction. In
addition, if a dispute arises with foreign operations, Orca Exploration may be subject to the exclusive jurisdiction of
foreign courts.
In Tanzania the, the state retains ownership of the minerals and consequently retains control of, the exploration and
production of hydrocarbon reserves. Accordingly, these operations may be materially affected by the government
through royalty payments, export taxes and regulations, surcharges, value added taxes, production bonuses and other
charges. The Government of Tanzania tabled a draft Natural Gas Policy in 2012, which policy contemplates greater
government control over the industry and in some areas conflicts with the Company’s rights under the Songo Songo
PSA. There can be no assurance that the rights of the Company under the PSA will be grandfathered with respect to
any future natural gas legislation arising from this policy.
Orca’s development properties and its current proved natural gas reserves located offshore on the Songo Songo Island
in Tanzania, are subject to regulation and control by the government of Tanzania and certain of its national and para-
statal organizations including the energy regulator, EWURA and TPDC. Orca Exploration and its predecessors have
operated in Tanzania for a number of years and believe that it has reasonably good relations with the current Tanzanian
government. However, there can be no assurance that present or future administrations or governmental regulations in
Tanzania will not materially adversely affect the operations or future cash flows of Orca Exploration.
The Tanzania Revenue Authority (“TRA”) is responsible for the collection of taxes in Tanzania. The TRA is not party
to the Songo Songo PSA and there is no assurance that the TRA will consider itself bound by its terms. Accordingly,
there is a risk that the TRA will take interpretations of issues distinct from the PSA and result in assessments, penalties
and fines which have not been contemplated by the Company and result in additional costs which are not recoverable
under the PSA. The TRA has significant powers in Tanzania and is capable of causing the Company’s operations in
that country to cease.
35
ORCA EXPLORATION GROUP INC. 2012 ANNUAL REPORT 36
The Company requires additional gas processing and transportation infrastructure to allow additional development
and the ultimate monetisation of the Company’s reserves through additional gas sales. In 2012, the Government of
Tanzania announced a US$1.2 billion natural gas infrastructure expansion project, the scope of which would provide
sufficient capacity to process and transport the necessary volumes of gas. There has to date been limited discussions
of commercial terms for such facilities and there is no assurance that the Company’s gas could be processed and trans-
ported to markets on economic terms.
psa negotiations
In February 2012 on the recommendation of MEM, the Government announced that it was establishing a negotiat-
ing team, the GNT, to discuss a number of issues raised in parliament in relation to the Company’s Songo Songo PSA
with TPDC. In Tanzania, government negotiating teams are a common mechanism to negotiate with business. The
scope of the GNT was to discuss a number of points that were raised by the Parliamentary Committee for Energy into
the workings of the PSA. This included, but is not limited to, TPDC back in rights, profit sharing arrangements, the
unbundling of the downstream assets, cost recovery and Orca’s management of the upstream operations. After making
submissions to the GNT, the Company commenced discussions in April 2012 and further in July 2012. In July 2012,
Parliament dissolved the Parliamentary Committee for Energy and Minerals on the grounds of alleged widespread cor-
ruption and abuse of power. A Parliamentary team formed to investigate the allegations subsequently cleared Members
of Parliament of any wrong doing. In July 2012, an agreement in principle was been reached on a number of major
points to resolve the issues. The GNT has completed its mandate and the responsibility for finalisation, documenta-
tion and implementation has moved back to MEM. The agreement in principal contemplated completion this process
by the end of 2012. As at the date of this report, a number of conditions precedent have not been fulfilled and a
number of issues remain to be fully resolved and documented, including an agreed form of amendment to the PSA.
The outcome of these negotiations could have a significant impact on the operations of the Company, which cannot
be estimated at this time.
additional Financing
Depending on future exploration, development, and marketing plans, and the status of the TANESCO and Songas
receivables situation, Orca Exploration may require additional financing. The ability of Orca Exploration to arrange
such financing in the future will depend in part upon the prevailing capital market conditions as well as the business
performance of Orca Exploration. There can be no assurance that Orca Exploration will be successful in its efforts to
arrange additional financing on terms satisfactory to Orca Exploration. If additional financing is raised by the issuance
of shares from treasury of Orca Exploration, control of the Company may change and shareholders may suffer addi-
tional dilution.
From time to time Orca Exploration may enter into transactions to acquire assets or the shares of other companies.
These transactions may be financed partially or wholly with debt, which may temporarily increase Orca Exploration’s
debt levels above industry standards.
industry conditions
The oil and gas industry is intensely competitive and Orca Exploration competes with other companies which possess
greater technical and financial resources. Many of these competitors not only explore for and produce oil and natural
gas, but also carry on refining operations and market petroleum, natural gas products and other products on an interna-
tional basis. Oil and gas production operations are also subject to all the risks typically associated with such operations,
including premature decline of reservoirs and invasion of water into producing formations. Currently, Orca Explora-
tion operates the Songo Songo natural gas property and has interests in two permits in Italy. There is a risk that in the
future either the operatorship could change and the property operated by third parties or operations may be subject
to control by national oil companies, Songas, or parastatal organisations and, as a result, Orca Exploration may have
limited control over the nature and timing of exploration and development of such properties or the manner in which
operations are conducted on such properties.
ORCA EXPLORATION GROUP INC.2012 ANNUL REPORT MANAGEMENT’s dIsCUssION & ANALysIs The marketability and price of natural gas which may be acquired, discovered or marketed by Orca Exploration will
be affected by numerous factors beyond its control. There is currently no developed natural gas market in Tanzania
and no infrastructure with which to serve potential new markets beyond that being constructed by Orca Exploration
and Songas. The ability of Orca Exploration to market any natural gas from current or future reserves in Tanzania may
depend upon its ability to develop natural gas markets in Tanzania and the surrounding region, obtain access to the
necessary infrastructure to deliver sales gas volumes, including acquiring capacity on pipelines which deliver natural
gas to commercial markets. Orca Exploration is also subject to market fluctuations in the prices of oil and natural gas,
uncertainties related to the delivery and proximity of its reserves to pipelines and processing facilities and extensive
government regulation relating to prices, taxes, royalties, land tenure, allowable production, the export of oil and gas
and many other aspects of the oil and gas business. Orca Exploration is also subject to a variety of waste disposal,
pollution control and similar environmental laws.
The oil and natural gas industry is subject to varying environmental regulations in each of the jurisdictions in which
Orca Exploration may operate. Environmental regulations place restrictions and prohibitions on emissions of various
substances produced concurrently and oil and natural gas and can impact on the selection of drilling sites and facility
locations, potentially resulting in increased capital expenditures.
additional gas
Orca Exploration has the right, under the terms of the PSA, to market volumes of Additional Gas subject to satisfying
the requirements to deliver Protected Gas to Songas.
There is a risk that Songas could interfere in Orca Exploration’s ability to produce, transport and sell volumes of Ad-
ditional Gas if Orca Exploration’s obligations to Songas under the Gas Agreement are not met. In particular, Songas has
the right to request reasonable security on all Additional Gas sales.
The Government of Tanzania has released a draft Natural Gas Policy in November 2012, which policy contemplates
TPDC becoming sole aggregator of natural gas in the country. This policy objective conflicts with the Company’s prior
right under the PSA to directly market Additional Gas, and there is a risk that this prior right will not be recognized
and that the Company’s ability to maximise revenue on Additional Gas sales may be impaired by a requirement to sell
gas to TPDC as aggregator.
replacement of reserves
Orca Exploration’s natural gas reserves and production and, therefore, its cash flows and earnings are highly dependent
upon the Company developing and increasing its current reserve base and discovering or acquiring additional reserves.
Without the addition of reserves through exploration, acquisition or development activities, Orca Exploration’s
reserves and production will decline over time as reserves are depleted. To the extent that cash flow from operations is
insufficient and external sources of capital become limited or unavailable, the Company’s ability to make the necessary
capital investments to maintain and expand its oil and natural gas reserves will be impaired. There can be no assurance
that Orca Exploration will be able to find and develop or acquire additional reserves to replace production at com-
mercially feasible costs.
asset concentration
Orca Exploration’s natural gas reserves are currently limited to one producing property, the Songo Songo field, and the
production potential from this field is limited to four wells. There has been limited production from the Songo Songo
field to date. There is no assurance that Orca Exploration will have sufficient deliverability through the existing wells
to provide additional natural gas sales volumes, and that there may be significant capital expenditures associated with
any remedial work, workovers, or new drilling required to achieve deliverability. In addition, any difficulties relating
to the operation or performance of the field would have a material adverse effect on Orca Exploration. The Company
is currently producing the existing wells at maximum capacity. There will, however, be no redundant capacity
in the facility or pipeline until additional wells can be drilled in the field and facilities expanded. A loss
or material reduction in the production of any given well will have a material adverse effect on the total
production and funds flow from operations of the Company. The Italian licences in which Orca has an interest
are currently in the exploration phase of their cycle and it may be several years before Orca is able to obtain a revenue
stream from these assets.
37
ORCA EXPLORATION GROUP INC. 2012 ANNUAL REPORT 38
environmental and Other regulations
Extensive national, state, and local environmental laws and regulations in foreign jurisdictions will affect nearly all of
Orca Exploration’s operations. These laws and regulations set various standards regulating certain aspects of health
and environmental quality, provide for penalties and other liabilities for the violation of such standards and establish
in certain circumstances obligations to remediate current and former facilities and locations where operations are or
were conducted. In addition, special provisions may be appropriate or required in environmentally sensitive areas of
operation. There can be no assurance that Orca Exploration will not incur substantial financial obligations in connec-
tion with environmental compliance. Significant liability could be imposed on Orca Exploration for damages, cleanup
costs or penalties in the event of certain discharges into the environment, environmental damage caused by previous
owners of property purchased by Orca Exploration or non-compliance with environmental laws or regulations. Such
liability could have a material adverse effect on Orca Exploration. Moreover, Orca Exploration cannot predict what en-
vironmental legislation or regulations will be enacted in the future or how existing or future laws or regulations will be
administered or enforced. Compliance with more stringent laws or regulations, or more vigorous enforcement policies
of any regulatory authority, could in the future require material expenditures by Orca Exploration for the installation
and operation of systems and equipment for remedial measures, any or all of which may have a material adverse effect
on Orca Exploration. As party to various licenses, Orca Exploration has an obligation to restore producing fields to a
condition acceptable to the authorities at the end of their commercial lives.
While management believes that Orca Exploration is currently in compliance with environmental laws and regulations
applicable to Orca Exploration’s operations in Tanzania and Italy, no assurances can be given that Orca Exploration
will be able to continue to comply with such environmental laws and regulations without incurring substantial costs.
Orca Exploration’s petroleum and natural gas operations are subject to extensive governmental legislation and regula-
tion and increased public awareness concerning environmental protection.
No provision has been recognised for future decommissioning costs in Tanzania which are anticipated to be minimal
as it is forecast that there will still be commercial gas reserves once Orca Exploration relinquishes the license in 2026.
Orca Exploration expects that the cost of complying with environmental legislation and regulations will increase in
the future. Compliance with existing environmental legislation and regulations has not had a material effect on capital
expenditures, earnings or competitive position of Orca Exploration to date. Although management believes that Orca
Exploration’s operations and facilities are in material compliance with such laws and regulations, future changes in
these laws, regulations or interpretations thereof or the nature of its operations may require the Company to make
significant additional capital expenditures to ensure compliance in the future.
volatility of Oil and gas prices and Markets
Orca Exploration’s financial condition, operating results and future growth will be dependent on the prevailing prices
for its natural gas production. Historically, the markets for oil and natural gas have been volatile and such markets are
likely to continue to be volatile in the future. Prices for oil and natural gas are subject to large fluctuations in response
to relatively minor changes to the demand for oil and natural gas, whether the result of uncertainty or a variety of addi-
tional factors beyond the control of Orca Exploration. Any substantial decline in the prices of oil and natural gas could
have a material adverse effect on Orca Exploration and the level of its natural gas reserves. Additionally, the economics
of producing from some wells may change as a result of lower prices, which could result in a suspension of production
by Orca Exploration.
No assurance can be given that oil and natural gas prices will be sustained at levels which will enable Orca Exploration
to operate profitably. From time to time Orca Exploration may avail itself of forward sales or other forms of hedging
activities with a view to mitigating its exposure to the risk of price volatility. The terms of the industrial gas supply
contracts were extended in 2008 for a period of five years. These contracts contain pricing caps and floors that limit the
industrial downside price to US$7.38/mcf. The Company also entered into fixed price contracts with TANESCO and
Songas for the supply of Additional Gas to the power sector. The steps taken by the Company in 2008 were important
steps in mitigating the exposure to price volatility.
ORCA EXPLORATION GROUP INC.2012 ANNUL REPORT MANAGEMENT’s dIsCUssION & ANALysIs The Songo Songo field was the first gas field to be developed in East Africa and was followed by a commercial gas discovery
in the south of Tanzania at Mnazi Bay. The Company is the only supplier of gas into the main demand centre of Dar es
Salaam and has therefore been able to negotiate industrial gas sales contracts with gas prices that are at a discount to the
lowest cost alternative fuels in Dar es Salaam, namely HFO and coal.
There has an increase in exploration activity in Tanzania, which has yielded significant discoveries of natural gas that
could, when developed, lead to increased competition for gas markets and lower gas prices in the future.
In addition, various factors, including the availability and capacity of oil and gas gathering systems and pipelines, the effect
of foreign regulation of production and transportation, general economic conditions, changes in supply due to drilling
by other producers and changes in demand may adversely affect Orca Exploration’s ability to market its gas production.
uncertainties in estimating reserves and Future net cash Flows
There are numerous uncertainties inherent in estimating quantities of proved and probable reserves and cash flows to be
derived therefrom, including many factors beyond the control of Orca Exploration. The reserve and cash flow informa-
tion contained herein represents estimates only. The reserves and estimated future net cash flow from Orca Exploration’s
properties have been independently evaluated by McDaniel & Associates Consultants Ltd. These evaluations include a
number of assumptions relating to factors such as initial production rates, production decline rates, ultimate recovery of
reserves, timing and amount of capital expenditures, marketability of production, crude oil price differentials to bench-
marks, future prices of oil and natural gas, operating costs, transportation costs, cost recovery provisions and royalties,
TPDC “back-in” methodology and other government levies that may be imposed over the producing life of the reserves.
These assumptions were based on price forecasts in use at the date of the relevant evaluations were prepared and many
of these assumptions are subject to change and are beyond the control of Orca Exploration. Actual production and cash
flows derived therefrom will vary from these evaluations, and such variations could be material.
title to properties
Although title reviews have been done and will continue to be done according to industry standards prior to the purchase
of most oil and natural gas producing properties or the commencement of drilling wells, such reviews do not guarantee
or certify that an unforeseen defect in the chain of title will not arise to defeat the claim of Orca Exploration which could
result in a reduction of the revenue received by Orca Exploration.
acquisition risks
Orca Exploration intends to acquire natural gas infrastructure and possibly additional oil and gas properties. Although
Orca Exploration performs a review of the acquired properties that it believes is consistent with industry practices, such
reviews are inherently incomplete. It generally is not feasible to review in depth every individual property involved in
each acquisition. Ordinarily, Orca Exploration will focus its due diligence efforts on the higher valued properties and will
sample the remainder. However, even an in depth review of all properties and records may not necessarily reveal existing
or potential problems, nor will it permit a buyer to become sufficiently familiar with the properties to assess fully their
deficiencies and capabilities. Inspections may not be performed on every well, and structural or environmental problems,
such as ground water contamination, are not necessarily observable even when an inspection is undertaken. Orca Explo-
ration may be required to assume pre-closing liabilities, including environmental liabilities, and may acquire interests in
properties on an “as is” basis. There can be no assurance that Orca Exploration’s acquisitions will be successful.
reliance on key personnel
Orca Exploration is highly dependent upon its executive officers and key personnel. The unexpected loss of the services
of any of these individuals could have a detrimental effect on Orca Exploration. Orca Exploration does not maintain key
life insurance on any of its employees or officers.
controlling shareholder
W. David Lyons, the Company’s Chairman, and Chief Executive Officer is the beneficial controlling shareholder of Orca
Exploration and holds approximately 99.5% of the outstanding Class A shares and approximately 16.7% of the Class B
shares. Consequently, Mr. Lyons is the beneficial holder of approximately 20.8% of the equity (22.4% fully diluted) and
controls 59.3% of the total votes of Orca Exploration.
39
ORCA EXPLORATION GROUP INC. 2012 ANNUAL REPORT 40
critical accOunting estimates
In applying the Company’s accounting policies, which are described in Note 3 to the Audited Financial Statements,
management makes estimates and assumptions concerning the future. The resulting accounting estimates will, by defi-
nition, vary to the actual results. The estimates and assumptions that have a significant risk of causing a material adjust-
ment to the carrying amounts of assets and liabilities within the next financial year are discussed below:
i)
reserves
There are numerous uncertainties inherent in estimating quantities of proved and probable reserves and cash
flows to be derived therefrom, including many factors beyond the control of Orca Exploration. The reserve
and cash flow information contained herein represents estimates only. The reserves and estimated future net
cash flow from Orca Exploration’s properties have been independently evaluated by McDaniel & Associates
Consultants Ltd. These evaluations include a number of assumptions relating to factors such as initial production
rates, production decline rates, ultimate recovery of reserves, timing and amount of capital expenditures, mar-
ketability of production, abandonment provisions, crude oil price differentials to benchmarks, future prices of
oil and natural gas, operating costs, transportation costs, cost recovery provisions and royalties, TPDC “back-in”
methodology and other government levies that may be imposed over the producing life of the reserves. These
assumptions were based on price forecasts in use at the date of the relevant evaluations were prepared and many
of these assumptions are subject to change and are beyond the control of Orca Exploration.
Reserves are integral to the amount of depletion charged to the profit or loss.
ii)
explOratiOn and evaluatiOn assets
Under the Company’s accounting policy expenditures incurred on the exploration for, and evaluation of,
reserves are capitalized as intangible assets. These intangibles assets are then assessed for impairment when cir-
cumstances suggest that the carrying amount may exceed its recoverable value. Such circumstances include but
are not limited to:
•
•
•
•
•
•
the period for which the Company has the right to explore in the specific area has expired during the
period, or will expire in the near future, and is not expected to be renewed;
no further expenditure on exploration and evaluation is budgeted or planned;
no reserves have been encountered;
the evaluation of seismic data indicates that the reserves are unlikely to be of a commercial quantity;
the quantity of hydrocarbon reserves are deemed not to be of commercially viable quantities and the
entity has decided to discontinue further activities; and
sufficient data exists to indicate that, although a development in the specific area is likely to proceed, the
carrying amount of the exploration and evaluation asset is unlikely to be recovered in full from successful
development or by sale.
The assessment for impairment involves estimates as to (i) the likely future commerciality of the asset and when
such commerciality should be determined, (ii) future revenues and costs associated with the asset, and (iii) the
discount rate to be applied to such revenues and costs for the purpose of deriving a recoverable value.
Exploration and evaluation assets are assessed for impairment if (i) sufficient data exists to determine technical
feasibility and commercial viability, or (ii) facts and circumstances suggest that the carrying amount exceeds
the recoverable amount. For purposes of impairment testing, exploration and evaluation assets are grouped by
concession.
ORCA EXPLORATION GROUP INC.2012 ANNUL REPORT MANAGEMENT’s dIsCUssION & ANALysIs The technical feasibility and commercial viability of extracting a resource is considered to be determinable based
on several factors including the assignment of proven reserves. A review of each exploration license or field is
carried out, at least annually, to ascertain whether the project is technically feasible and commercially viable.
Upon determination of technical feasibility and commercial viability, intangible exploration and evaluation
assets attributable to those reserves are first tested for impairment and then reclassified from exploration and
evaluation assets to a separate category within property and equipment referred to as oil and natural gas interests.
iii) Fair value OF stOck based cOMpensatiOn
All stock options issued or stock appreciation rights granted by the Company have to be valued at their fair value.
In assessing the fair value of the equity based compensation, estimates have to be made as to (i) the volatility
in share price, (ii) risk free rate of interest, and (iii) the level of forfeiture. In the case of stock options, this fair
value is estimated at the date of issue and is not revalued, where as the fair value of stock appreciation rights is
recalculated at each reporting period.
iv) cOst recOverY
The Company is able to recover reasonable costs incurred on the development of the Songo Songo project out of
75% of the gross revenues less processing and pipeline tariffs (“Net Revenue”). There are inherent uncertainties
in estimating when costs have been recovered as the government has several years to review the reasonableness
of the costs.
v) receivables
The Company considers the Songas and TANESCO receivables to be collectable, despite being long overdue.
Both Songas and the Company have been impacted by TANESCO’s inability to pay. The combination of written
assurances from MEM backed by confirmation that the Government of Tanzania has raised substantial funding
which is intended for the settlement of TANESCO debts, give management confidence that these debts will be
recovered within a reasonable timeframe.
41
ORCA EXPLORATION GROUP INC. 2012 ANNUAL REPORT 42 management’s repOrt tO sHareHOlders
The accompanying consolidated financial statements of Orca Exploration Group Inc. are the responsibility of the
Directors. The financial and operating information presented in this annual report is consistent with that shown in the
consolidated financial statements.
The consolidated financial statements have been prepared by management, on behalf of the Board, in accordance with
the accounting policies disclosed in the notes to the consolidated financial statements. Where necessary, management
has made informed judgments and estimates in accounting for transactions which were not complete at the balance
sheet date. In the opinion of management, the consolidated financial statements have been prepared within accept-
able limits of materiality and are in accordance with International Financial Reporting Standards appropriate in the
circumstances.
Management, with the participation of the Chief Executive Officer and Chief Financial Officer, has evaluated the
effectiveness of the Company’s disclosure controls and procedures and has concluded that such disclosure controls
and procedures are effective.
Management maintains appropriate systems of internal controls. Policies and procedures are designed to give reason-
able assurance that transactions are properly authorised, assets are safeguarded and financial records are properly main-
tained to provide reliable information for the preparation of financial statements. An independent firm of Chartered
Accountants, as appointed by the Shareholders, audited the consolidated financial statements in accordance with the
Canadian Generally Accepted Auditing Standards and International Auditing Standards to enable them to express an
opinion on the fairness of the consolidated financial statements in accordance with International Financial Reporting
Standards.
The Board of Directors carries out its responsibility for the financial reporting and internal controls principally
through an Audit Committee. The committee has met with external auditors and Management in order to determine
if Management has fulfilled its responsibilities in the preparation of the consolidated financial statements. The
consolidated financial statements have been approved by the Board of Directors on the recommendation of the Audit
Committee.
W. David Lyons
Chairman and Chief Executive Officer
26 April 2013
Robert S. Wynne
Chief Financial Officer
26 April 2013
ORCA EXPLORATION GROUP INC.2012 ANNUL REPORT
auditOrs’ repOrt
to the shareholders of Orca exploration group inc.
We have audited the accompanying consolidated statements of Orca Exploration Group Inc., which comprise the
consolidated statements of financial position as at December 31, 2012 and December 31, 2011, the consolidated
statements of comprehensive income, changes in equity and cash flows for the year then ended, and notes, comprising
a summary of significant accounting policies and other explanatory information.
Management’s responsibility for the consolidated Financial statements
Management is responsible for the preparation and fair presentation of these financial statements in accordance with
International Financial Reporting Standards as issued by the International Accounting Standards Board, and for such
internal control as management determines is necessary to enable the preparation of consolidated financial statements
that are free from material misstatement, whether due to fraud or error.
auditors’ responsibility
Our responsibility is to express an opinion on these consolidated statements based on our audit. We conducted our
audit in accordance with Canadian generally accepted auditing standards and International Auditing Standards. Those
standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable
assurance about whether the consolidated financial statements are free from material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the
consolidated financial statements. The procedures selected depend on our judgment, including the assessment of
the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making
those risk assessments, we consider internal control relevant to the entity’s preparation and fair presentation of the
consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but
not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. An audit also includes
evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by
management, as well as evaluating the overall presentation of the consolidated financial statements.
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit
opinion.
Opinion
In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated financial
position of Orca Exploration Group Inc. as at December 31, 2012 and December 31, 2011, and its consolidated
financial performance and its consolidated cash flows for the years then ended in accordance with International
Financial Reporting Standards as issued by the International Accounting Standards Board.
emphasis of matter
Without modifying our opinion, we draw attention to Note 1 in the consolidated financial statements which describes
that the Company needs to collect its receivables to fund ongoing operations and its exploration and development
program. This condition, along with other matters as set forth in Note 1, indicates the existence of a material uncertainty
that may cast significant doubt about the Company’s ability to continue as a going concern.
Chartered Accountants
Calgary, Canada
April 26, 2013
43
ORCA EXPLORATION GROUP INC. 2012 ANNUAL REPORT 44
cOnsOlidated statement OF cOmpreHensiVe incOme
yEARs ENDED 31 DECEmbER
US$’000 except per share amounts
revenue
Cost of sales
Production and distribution expenses
Depletion expense
General and administrative expenses
Exploration asset impairment
Net finance costs
Profit before taxation
Taxation
Profit after taxation
Foreign currency translation gain from foreign operations
Total comprehensive income for the year
earnings per share
Basic (US$)
Diluted (US$)
Future operations (Note 1)
See accompanying notes to the consolidated financial statements.
NOTE
2012
2011
6, 7
77,259
45,893
(5,953)
(8,968)
62,338
(6,088)
(8,092)
31,713
(17,989)
(15,440)
(8,284)
(611)
35,454
(17,125)
18,329
89
18,418
–
(953)
15,320
(7,334)
7,986
–
7,986
0.53
0.52
0.23
0.22
13
12
9
10
17
17
ORCA EXPLORATION GROUP INC.2012 ANNUL REPORT
cOnsOlidated statement OF Financial pOsitiOn
As AT
US$’000
assets
Current assets
Cash and cash equivalents
Trade and other receivables
Taxation receivable
Prepayments
Non-current assets
Exploration and evaluation assets
Property, plant and equipment
Total assets
eQuitY and liabilities
Current liabilities
Trade and other payables
Bank loan
Taxation payable
Non-current liabilities
Deferred income taxes
Deferred additional profits tax
Total liabilities
eQuitY
Capital stock
Contributed surplus
Accumulated other comprehensive income
Accumulated income
Total equity and liabilities
See accompanying notes to the consolidated financial statements.
Contractual obligations and committed capital investment (Note 19)
Contingencies (Note 20)
NOTE
31 Dec 2012
31 Dec 2011
11
10
12
13
14
15
10
10
10
16
16,047
73,495
14,692
246
104,480
5,720
102,044
107,764
212,244
45,496
5,842
6,322
57,660
20,399
8,250
28,649
86,309
84,983
6,753
89
34,110
125,935
212,244
34,680
40,348
5,880
302
81,210
2,921
67,713
70,634
151,844
22,801
–
2,403
25,204
15,194
4,787
19,981
45,185
84,610
6,268
–
15,781
106,659
151,844
The consolidated audited financial statements were approved by the Board of Directors on 26 April 2013.
Director
Director
45
ORCA EXPLORATION GROUP INC. 2012 ANNUAL REPORT
46
cOnsOlidated statement OF casH FlOWs
yEARs ENDED 31 DECEmbER
US$’000
cash FlOWs FrOM Operating activities
Profit after taxation
Adjustment for:
Depletion and depreciation
Impairment of assets
Gain on disposable of vehicle
Stock-based compensation
Deferred income taxes
Deferred additional profits tax
Interest income
Unrealised loss on foreign exchange
Funds flow from operating activities
Increase in trade and other receivables
Increase in taxation receivable
Decrease in prepayments
Increase in trade and other payables
Increase in taxation payable
Net cash flows from operating activities
cash FlOWs used in investing activities
Exploration and evaluation expenditures
Property, plant and equipment expenditures
Interest received
Proceeds from sale of vehicle
(Decrease)/increase in trade and other payables
Net cash used in investing activities
cash FlOWs (used in)/FrOM Financing activities
Normal course issuer bid
Proceeds from exercise of options
Bank loan proceeds
Net cash flow from/(used in) financing activities
Decrease in cash and cash equivalents
Cash and cash equivalents at the beginning of the year
Effect of change in foreign exchange
Cash and cash equivalents at the end of the year
See accompanying notes to the consolidated financial statements.
NOTE
2012
2011
13
12
16
10
7, 10
9
12
13
9
16
15
18,329
7,986
9,281
8,284
–
1,152
5,205
3,463
(23)
258
8,389
–
(5)
851
2,385
2,527
(5)
530
45,949
22,658
(33,133)
(8,812)
56
22,589
3,919
30,568
(27,171)
(1,871)
107
10,451
403
4,577
(11,083)
(43,612)
(1,979)
(16,156)
23
–
5
5
(716)
3,541
(55,388)
(14,584)
(12)
150
5,842
5,980
(681)
–
–
(681)
(18,840)
(10,688)
34,680
207
16,047
45,519
(151)
34,680
ORCA EXPLORATION GROUP INC.2012 ANNUL REPORT
cOnsOlidated statement
OF cHanges in sHareHOlders’ equity
US$’000
Note
Balance as at 1 January 2012
Stock based compensation
Options exercised
Normal course issuer bid
Foreign currency translation
of foreign operations
Total comprehensive income
for the period
CAPITAL
sTOCk
CONTRIbUTED
sURPLUs
CUmULATIVE
TRANsLATION
ADjUsTmENT
ACCUmULATED
INCOmE
TOTAL
16
84,610
–
383
(10)
–
–
6,268
720
(233)
(2)
–
–
–
–
–
–
89
–
89
15,781
106,659
–
–
–
–
720
150
(12)
89
18,329
34,110
18,329
125,935
Balance as at 31 December 2012
84,983
6,753
US$’000
Note
Balance as at 1 January 2011
Stock based compensation
Normal course issuer bid
Total comprehensive income
for the period
Balance as at 31 December 2011
CAPITAL
sTOCk
CONTRIbUTED
sURPLUs
CUmULATIVE
TRANsLATION
ADjUsTmENT
ACCUmULATED
INCOmE
TOTAL
16
85,100
–
(490)
–
84,610
5,288
1,171
(191)
–
6,268
_
–
–
–
–
7,795
98,183
–
–
1,171
(681)
7,986
15,781
7,986
106,659
See accompanying notes to the consolidated financial statements.
47
ORCA EXPLORATION GROUP INC. 2012 ANNUAL REPORT
48
General Information
Orca Exploration Group Inc. (“Orca Exploration” or the “Company”) was incorporated on 28 April 2004 under the
laws of the British Virgin Islands. The Company produces and sells natural gas to the power and industrial sectors in
Tanzania and has gas and oil exploration interests in Italy.
The consolidated audited financial statements of the Company and its subsidiaries for the year ended 31 December
2012 were authorised for issue in accordance with a resolution of the directors on 26th April 2013.
1
Future OperatiOns
These financial statements have been prepared on a going concern basis. The going concern basis of presentation
assumes that the Company will continue in operation for the foreseeable future and be able to realize its assets
and discharge its liabilities and commitments in the normal course of business.
The ability of the Company to continue as a going concern is dependent on the Company’s ability to collect
its receivables from government entities to fund ongoing operations and the exploration and development
program. The continued deterioration of the financial position of the state utility, the Tanzanian Electrical
Supply Company (“TANESCO”), has created uncertainty as to whether the Company will be able to collect
cash to continue operations and meet its commitments. The immediate need to collect from its debtors may
create significant doubt about the Company’s ability to continue as a going concern.
The financial statements do not reflect adjustments that would be necessary if the going concern assumption
were not appropriate. If the going concern basis were not appropriate for these financial statements, then
adjustments would be necessary in the carrying amounts of assets and liabilities, the reported revenues and
expenses, and the balance sheet classifications.
The Company generates in excess of 59% of its operating revenue from sales to the power sector companies,
Songas Limited (“Songas”) and TANESCO. Songas’ financial security is heavily reliant on the payment of
capacity and energy charges by TANESCO. TANESCO is dependent on the Government of Tanzania for some
of its funding. Prior to 2012, despite having a history of delayed payments, TANESCO had settled in full the
outstanding balance subsequent to each quarter end.
At 31 December 2012, TANESCO owed the Company US$33.3 million (including arrears of US$28.4 million)
compared to US$24.2 million (including arrears of US$20.2 million) as at 31 December 2011. Subsequent to
the end of the year, the Company has received US$1.0 million and, as of the date of this report, the arrears total
US$43.0 million.
At the end of 2012, Songas owed the Company US$23.4 million, whilst the Company owed Songas US$17.5
million; there is no legal right to offset these amounts. Subsequent to the end of the year, the Company has
neither received nor paid any amounts in settlement of these balances.
During 2012, there has been no substantive progress on payment of arrears owed by TANESCO and further,
the state utility failed to remain current. Subsequent to the end of the year, in April 2013, the Government of
Tanzania informed the Company that it raised approximately US$600 million in international credit markets as
well as received a World Bank budget support package of US$100 million, the first of an expected three tranches
of World Bank funding. The Government of Tanzania has assured the Company that a portion of the proceeds of
these financings will be used to repay all of the outstanding arrears of TANESCO. In the event that Company does
not collect from TANESCO the outstanding receivables at December 31, 2012 and TANESCO continues to be
unable to pay the Company for subsequent 2013 gas deliveries, the Company will need additional funding for its
ongoing operations within three to four months from the date of this report. There are no guarantees that such
additional funding will be available when needed, or will be available on suitable terms.
During 2012, to help alleviate the funding gap caused by the delays in TANESCO payments the Company put in
place a US$10 million facility with a bank in Tanzania. As at 31 December 2012, the Company had drawn down
US$6.0 million of this facility, incurring financing charges of US$0.2 million. Subsequent to the end of the year,
the Company drew the remaining US$4.0 million under the facility. Repayments commenced in March 2013.
ORCA EXPLORATION GROUP INC.2012 ANNUL REPORT NOTEs TO ThE CONsOLIdATEd FINANCIAL sTATEmENTs 2 basis OF preparatiOn
These consolidated financial statements are measured and presented in US dollars. Management is required
to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of
contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and
expenses during the period. Actual results could differ from these estimates. See Note 4 – Use of Estimates and
Judgements.
A) Statement of Compliance
The consolidated financial statements have been prepared in accordance with International Financial
Reporting Standards (“IFRS”) issued by the International Accounting Standards Board (“IASB”).
B) Basis of consolidation
i)
Subsidiaries
The consolidated financial statements include the accounts of Orca Exploration Group Inc, and all
its wholly owned subsidiaries (collectively, “Orca Exploration” or the “Company”). Subsidiaries
are those enterprises controlled by the Company. The following companies have been consolidated
within the Orca Exploration financial statements:
subsidiary
Registered
Holding
Functional
currency
Orca Exploration Group Inc.
British Virgin Islands
Parent Company
US dollar
Orca Exploration Italy Inc.
British Virgin Islands
100%
Orca Exploration Italy Onshore Inc.
British Virgin Islands
100%
PAE PanAfrican Energy Corporation
Mauritius
PanAfrican Energy Tanzania Limited
Jersey
Orca Exploration UK Services Limited United Kingdom
100%
100%
100%
Euro
Euro
US dollar
US dollar
GB Sterling
ii)
Transactions eliminated upon consolidation
Inter-company balances and transactions, and any unrealised gains or losses arising from inter-com-
pany transactions, are eliminated in preparing the consolidated financial statements.
C) Foreign currency
i)
Foreign currency transactions
The functional currencies of Orca Exploration Italy Inc. and Orca UK Services are the Euro and
Sterling respectively. The assets and liabilities of these companies are translated into U.S. dollars at
the period-end exchange rate. The income and expenses of the companies are translated into U.S.
dollars at the average exchange rate for the period. Translation gains and losses are included in other
comprehensive income
ii)
Foreign currency translation
Orca Exploration Italy Inc. and Orca UK Services use the Euro and Sterling as their functional
currencies. The assets and liabilities of these companies are translated into U.S. dollars at the
period-end exchange rate. The income and expenses of the companies are translated into U.S.
dollars at the average exchange rate for the period. Translation gains and losses are included in other
comprehensive income.
49
ORCA EXPLORATION GROUP INC. 2012 ANNUAL REPORT 50
3 suMMarY OF signiFicant accOunting pOlicies
The accounting policies set out below have been applied consistently to all periods presented in these consoli-
dated financial statements, and have been applied consistently by the Company.
A) Exploration and evaluation of assets, property plant and equipment
i)
Exploration and evaluation assets
Exploration and evaluation costs are capitalised as intangible assets. Intangible assets includes lease
and license acquisition costs, geological and geophysical costs and other direct costs of exploration
and evaluation which the directors consider to be unevaluated until reserves are appraised to be
commercially viable and technologically feasible as commercial, at which time they are transferred
to property, plant and equipment following an impairment review and depleted accordingly. Where
properties are appraised to have no commercial value or are appraised at values less than book
values, the associated costs are treated as an impairment loss in the period in which the determina-
tion is made.
ii)
Property, plant and equipment
Property, plant and equipment comprises the Company’s tangible natural gas assets, development
wells, together with leasehold improvements, computer equipment, motor vehicles and fixtures
and fittings and are carried at cost, less any accumulated depletion, depreciation and accumulated
impairment losses. Cost includes purchase price and construction costs for qualifying assets.
Depletion of these assets commences when the assets are ready for their intended use. Only
costs that are directly related to the discovery and development of specific oil and gas reserves are
capitalised. The cost associated with tangible natural gas assets are amortised on a field by field
unit of production method based on commercial proven reserves. The calculation of the unit of
production amortisation takes into account the estimated future development cost of the field.
iii)
Impairment of exploration and evaluation assets, property, plant and equipment
At each balance sheet date, the Company reviews the carrying amounts of its property, plant and
equipment and intangible assets to determine whether there is any indication that those assets have
suffered an impairment loss. Individual assets are grouped together as a cash generating unit for
impairment assessment purposes at the lowest level at which there are identifiable cash flows that
are independent from other group assets. In the case of exploration and evaluation assets, this will
normally be at the Company’s field level. If any such indication of impairment exists, the Company
makes an estimate of its recoverable amount. The recoverable amount is the higher of fair value
less costs to sell and value in use. Where the carrying amount of a cash generating unit exceeds
its recoverable amount, the cash generating unit is considered impaired and is written down to
its recoverable amount. In assessing the value in use, the estimated future cash flows are adjusted
for the risks specific to the cash generating unit and are discounted to their present value with a
discount rate that reflects the current market indicators. Where an impairment loss subsequently
reverses, the carrying amount of the asset cash–generating unit is increased to the revised estimate
of its recoverable amount, but so that the increased carrying amount does not exceed the carrying
amount that would have been determined had no impairment loss been recognised for the cash
generating unit in prior years. A reversal of an impairment loss is recognised as income immediately.
ORCA EXPLORATION GROUP INC.2012 ANNUL REPORT NOTEs TO ThE CONsOLIdATEd FINANCIAL sTATEmENTs B) Operatorship
The Company operates the Songo Songo gas field, flow lines and gas processing plant. The Songas
wells, flowlines and gas plant are operated by the Company on behalf of Songas on a no cost no profit
basis. The cost of operating and maintaining the wells and flow lines is paid for by Orca Exploration
and Songas in proportion to the respective volumes of Protected Gas and Additional Gas sales.
The costs of operating and maintaining the wells and flow lines are reflected in the accounts to the
extent that the costs were incurred to accomplish Additional Gas sales. The cost of operating the gas
processing plant and pipeline to Dar es Salaam is paid by Songas. When there are Additional Gas
sales, a tariff is paid to Songas as compensation for using the gas processing plant and pipeline. This
tariff is netted against revenue.
C) Employment Benefits
i)
Pension
The Company does not operate a pension plan, but it does make defined contributions to the
statutory pension fund for employees in Tanzania. Obligations for contributions to the statutory
pension fund are recognised as an expense in the income statement as incurred.
ii)
Stock options
The stock option plan provides for the granting of stock options to directors, Company officers and
key personnel employees to acquire shares at an exercise price determined by the market value at
the date of grant. The exercise price of each stock option is determined at the closing market price of
the Class B shares on the day prior to the day of grant. Each stock option granted permits the holder
to purchase one Class B share at the stated exercise price. The Company records a charge to the
profit and loss account using the Black-Scholes fair valuation option pricing model. The valuation is
dependent on a number of estimates, including the risk free interest rate, the level of stock volatility,
together with an estimate of the level of forfeiture. The level of stock volatility is calculated with
reference to the historic traded daily closing share price at the date of issue.
iii)
Stock appreciation rights
Stock appreciation rights are issued to certain key managers, officers, directors and employees.
The fair value of stock appreciation rights is expensed in the profit and loss in accordance with the
service period. The fair value of the stock appreciation rights is revalued every reporting date with
the change in the value recognized in the income statement.
D) Asset retirement obligations
No provision has been made for future site restoration costs in Tanzania since the Company has currently
no legal or contractual or constructive obligation under the Songo Songo Production Sharing Agreement
(“PSA”) to restore the fields at the end of their commercial lives. At such a time as the Company may
be granted an extension of the term of the PSA which encompasses the end of the field life, or other
amendment to the PSA which requires the Company to do so, a provision will be made for future site
restoration costs.
51
ORCA EXPLORATION GROUP INC. 2012 ANNUAL REPORT 52
E) Revenue recognition, production sharing agreements and royalties
The Company recognises revenue related to Additional Gas sales when title passes to a customer. The
Company conducts operations jointly with the Tanzanian government and the Tanzania Petroleum
Development Corporation (“TPDC”), a “parastatal entity” in accordance with the PSA. Under this
agreement, the Company pays both its share and the parastatal’s share of operating, administrative and
capital costs. The Company recovers all reasonably incurred operating, administrative and capital costs
including the parastatal’s share of these costs from future revenues over several years (“Cost Gas”). The
parastatal’s share of operating and administrative costs, are recorded in operating and general and adminis-
trative costs when incurred and capital costs are recorded in ‘Property, plant and equipment’. All recoveries
are recorded as revenue in the year of recovery. The Company is entitled to a share of production in excess
of the Cost Gas (“Profit Gas”). Operating revenue represents the Company’s share of Cost Gas and Profit
Gas during the period.
F) Additional profits tax
Under the terms of the PSA, in the event that all costs have been recovered with an annual return of 25%
plus the percentage change in the United States Industrial Goods Producer Price Index, an additional
profits tax (“APT”) is payable to the Government of Tanzania. This tax is considered to be a royalty and is
netted against revenue. Deferred APT is provided for by forecasting the total APT payable as a proportion
of the forecast Profit Gas over the term of PSA license. The actual APT that will be paid is dependent on
the achieved value of the Additional Gas sales and the quantum and timing of the operating costs and
capital expenditure program.
G) Taxation
Income tax on the profit for the year comprises current and deferred tax. The Company is liable for
Tanzanian income tax, but this is recovered from TPDC through the profit-sharing arrangement. Where
current income tax is payable, the Company’s revenue is adjusted for the amount of current tax payable
and the income tax is shown as current tax. Deferred tax is provided using the balance sheet 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 or settlement of carrying amounts of assets and liabilities
using tax rates 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 benefits will
be realised.
H) Segmental reporting
The Company has interests in Tanzania and Italy.
I) Depreciation
Depreciation for non-natural gas properties is charged to the income statement on a straight line basis over
the estimated useful economic lives of each class of asset. The estimated useful lives are as follows:
Leasehold improvement
Over remaining life of the lease
Computer equipment
Vehicles
Fixtures and fittings
3 years
3 years
3 years
ORCA EXPLORATION GROUP INC.2012 ANNUL REPORT NOTEs TO ThE CONsOLIdATEd FINANCIAL sTATEmENTs J) Financial Instruments
Non-derivative financial instruments include cash and cash equivalents, trade and other receivables, and
trade and other payables. Non-derivative financial instruments are recognized initially at fair value plus
any directly attributable transaction costs.
The Company has reported cash and cash equivalents at fair value. Cash and cash equivalents are
comprised of cash on hand, term deposits held with banks, and other short-term highly liquid investments
with original maturities of three months or less. Bank overdrafts that are repayable on demand and form
an integral part of the Company’s cash management, whereby management has the ability and intent to
net bank overdrafts against cash, are included as a component of cash and cash equivalents for the purpose
of the statement of cash flows. The Company’s trade and other receivables, trade and other payables, are
classified as other non-derivative financial instruments. Subsequent to the initial recognition, other non-
derivative financial instruments are measured at amortized cost using the effective interest method, less
any impairment losses.
K) Contributed surplus
This is used to record two types of transactions:
(i) To recognise the fair value of equity settled stock based compensation expensed in the year.
(ii) To account for the difference between the aggregated book value of the shares purchased under the
normal course issuer bid and the actual consideration.
L) New accounting standards and interpretations
The following standards, amendments and interpretations applicable to the Company are in issue but not
yet effective and have not been early adopted in these consolidated financial statements.
new and amended standards effective for annual periods beginning on or after
IFRS 9
IFRS 10
IFRS 11
IFRS 12
Financial Instruments
Consolidated Financial Statements
Joint Arrangements and Consolidated Financial
Statements, Joint Arrangements and Disclosures of
Interests in Other Entities
Disclosure of Interests in Other Entities and Consolidated
Financial Statements, Joint Arrangements and Disclosures
of Interests in Other Entities
IFRS 13
Fair Value Measurement
IAS 28 (amendments) Investments in Associates and Joint Ventures
IAS 1 (amendments)
Investments in Associates and Joint Ventures
IAS 19 (amendments) Employee Benefits
IAS 32 and IFRS 7
(amendments)
Offsetting Financial Assets and Liabilities
January 1, 2015
January 1, 2013
January, 1 2013
January 1, 2013
January 1, 2013
January 1, 2013
January 1, 2013
January 1, 2013
January 1, 2013
The Company intends to adopt the interpretation in its financial statements for the annual period beginning
on January 1, 2013. The Company does not expect the adoption of the standards effective January 1, 2013
to have a material impact on the financial statements. The extent of the impact from the adoption of IFRS
9 has not been determined.
53
ORCA EXPLORATION GROUP INC. 2012 ANNUAL REPORT 54
4 use OF estiMates and JudgeMents
In applying the Company’s accounting policies, which are described in Note 3, management makes estimates
and assumptions concerning the future. The resulting accounting estimates will, by definition, vary to the actual
results. The estimates and assumptions that have a significant risk of causing a material adjustment to the carrying
amounts of assets and liabilities within the next financial year are discussed below:
I) Reserves
There are numerous uncertainties inherent in estimating quantities of proved and probable reserves and
cash flows to be derived therefrom, including many factors beyond the control of Orca Exploration. The
reserve and cash flow information contained herein represents estimates only. The reserves and estimated
future net cash flow from Orca Exploration’s properties have been independently evaluated by McDaniel
& Associates Consultants Ltd. These evaluations include a number of assumptions relating to factors such
as initial production rates, production decline rates, ultimate recovery of reserves, timing and amount of
capital expenditures, marketability of production, abandonment provisions, crude oil price differentials
to benchmarks, future prices of oil and natural gas, operating costs, transportation costs, cost recovery
provisions and royalties, TPDC “back-in” methodology and other government levies that may be imposed
over the producing life of the reserves. These assumptions were based on price forecasts in use at the date
of the relevant evaluations were prepared and many of these assumptions are subject to change and are
beyond the control of Orca Exploration.
Reserves are integral to the amount of depletion charged to the profit or loss.
II) Exploration and evaluation assets
Under the Company’s accounting policy expenditures incurred on the exploration for, and evaluation
of, reserves are capitalized as intangible assets. These intangibles assets are then assessed for impairment
when circumstances suggest that the carrying amount may exceed its recoverable value. Such circum-
stances include but are not limited to:
•
•
•
•
•
•
the period for which the Company has the right to explore in the specific area has expired during the
period, or will expire in the near future, and is not expected to be renewed;
no further expenditure on exploration and evaluation is budgeted or planned;
no reserves have been encountered;
the evaluation of seismic data indicates that the reserves are unlikely to be of a commercial quantity;
the quantity of hydrocarbon reserves are deemed not to be of commercially viable quantities and
the entity has decided to discontinue further activities; and
sufficient data exists to indicate that, although a development in the specific area is likely to proceed,
the carrying amount of the exploration and evaluation asset is unlikely to be recovered in full from
successful development or by sale.
The assessment for impairment involves estimates as to (i) the likely future commerciality of the asset
and when such commerciality should be determined, (ii) future revenues and costs associated with the
asset, and (iii) the discount rate to be applied to such revenues and costs for the purpose of deriving a
recoverable value.
Exploration and evaluation assets are assessed for impairment if (i) sufficient data exists to determine
technical feasibility and commercial viability, or (ii) facts and circumstances suggest that the carrying
amount exceeds the recoverable amount. For purposes of impairment testing, exploration and evaluation
assets are grouped by concession.
ORCA EXPLORATION GROUP INC.2012 ANNUL REPORT NOTEs TO ThE CONsOLIdATEd FINANCIAL sTATEmENTs The technical feasibility and commercial viability of extracting a resource is considered to be determinable
based on several factors including the assignment of proven reserves. A review of each exploration license
or field is carried out, at least annually, to ascertain whether the project is technically feasible and commer-
cially viable. Upon determination of technical feasibility and commercial viability, intangible exploration
and evaluation assets attributable to those reserves are first tested for impairment and then reclassified
from exploration and evaluation assets to a separate category within property and equipment referred to
as oil and natural gas interests.
III) Fair value of stock based compensation
All stock options issued or stock appreciation rights granted by the Company have to be valued at their fair
value. In assessing the fair value of the equity based compensation, estimates have to be made as to (i) the
volatility in share price, (ii) the risk free rate of interest, and (iii) the level of forfeiture. In the case of stock
options, this fair value is estimated at the date of issue and is not revalued, whereas the fair value of stock
appreciation rights is recalculated at each reporting period.
IV) Cost recovery
The Company is able to recover reasonable costs incurred on the development of the Songo Songo project
out of 75% of the gross revenues less processing and pipeline tariffs (“Net Revenue”). There are inherent
uncertainties in estimating when costs have been recovered as the government has several years to review
the reasonableness of the costs.
V) Receivables
The Company considers the Songas and TANESCO receivables to be collectable, despite being
long overdue. Both Songas and the Company have been impacted by TANESCO’s inability to pay.
The combination of written assurances from the Ministry of Energy and Minerals (“MEM”) backed
by confirmation from the Government that it has raised substantial funding which is intended for the
settlement of TANESCO debts, give management confidence that these debts will be recovered within a
reasonable timeframe.
The Company has a substantial “Tax Receivable” balance. This arises from the revenue sharing mechanism
within the PSA which entitles the Company to a share of revenue equivalent to its tax charge, grossed up
at the prevailing rate. This debtor is collected by way of an offset against TPDC’s share of revenue, as and
when the Company pays its tax.
55
ORCA EXPLORATION GROUP INC. 2012 ANNUAL REPORT 56
5 risk ManageMent
The Company, by its activities in oil and gas exploration, development and production, is exposed to the
risk associated with the unpredictable nature of the financial markets as well as political risk associated with
conducting operations in an emerging market. The Company seeks to manage its exposure to these risks
wherever possible.
I)
Foreign exchange risk
Foreign exchange risk arises when transactions and recognised assets and liabilities of the Company are
denominated in a currency that is not the U.S. dollar functional currency.
The Company operates internationally and is exposed to foreign exchange risk arising from currency
exposures to U.S. dollars. The main currencies to which the Company has an exposure are: Tanzanian
shillings, British pounds sterling, Euros and Canadian dollars.
The majority of the expenditure associated with the operation of the gas distribution system is
denominated in Tanzanian shillings. The majority of the consultants’ contracts are denominated in British
pounds sterling. All of the capital stock, equity financing and any associated stock based compensation are
denominated in Canadian dollars. All of the operational revenue and the majority of capital expenditure
are denominated in US dollars.
There are no forward exchange rate contracts in place.
A 10% increase in the U.S. dollars against the relevant foreign currency would result in an overall reduction
in working capital by US$1.9 million to US$44.9 million and a reduction in profit before tax to US$33.6
million. The sensitivity includes only outstanding foreign currency denominated monetary items and
adjusts their translation at period end for a 10% change in the foreign currency rates. A 10% sensitivity
rate is used when reporting foreign currency risk internally to key management personnel and represents
management’s assessment of the reasonable possible change in foreign exchange rates.
II) Commodity price risk
The Songo Songo gas field is the first gas field to be developed in East Africa. The Company has therefore
been able to negotiate industrial gas sales contracts with gas prices that are at a discount to the lowest cost
alternative fuels in Dar es Salaam, namely Heavy Fuel Oil (“HFO”) and coal. The price of HFO is exposed
to the volatility in the market price of crude oil.
III)
Interest rate risk
The Company has a medium term loan which is repayable in twelve instalments, beginning in March 2013.
The interest rate is defined in relation to LIBOR and the exposure to rate changes is considered minor.
IV) Credit risk
The Company is exposed to significant credit risk. All of the Company’s production is currently derived in
Tanzania. The sales are made to the power sector and the industrial sector. In relation to sales to the power
sector, the Company has a short-term contract with Songas for the supply of gas to the Ubungo power
plant and a contract with TANESCO to supply approximately 37 MMcfd to fire 147 MW of TANESCO
power generation. The contracts with Songas and TANESCO accounted for 59% of the Company’s
operating revenue during 2012 and US$47.5 million of the trade receivables at year-end. Songas itself is
heavily reliant on the payment of capacity and energy charges by TANESCO for its liquidity.
Although TANESCO has a long history of delayed payments, it has, in previous years settled in full
subsequent to the period end. However, during 2012, there has been a marked deterioration in the
situation. Despite the Company receiving numerous assurances from TANESCO and the Government of
Tanzania regarding payment, the outstanding balance has continued to grow. Since 31st December 2012,
the Company has received US$1.0 million from TANESCO. As at the date of this report TANESCO owes
the Company US$49.3 million.
ORCA EXPLORATION GROUP INC.2012 ANNUL REPORT NOTEs TO ThE CONsOLIdATEd FINANCIAL sTATEmENTs Sales to the industrial sector, currently 37 customers, are subject to an internal credit review to minimize
the risk of non-payment.
The Company is currently in discussions with TPDC concerning the commercial terms for the sale of
gas volumes associated with a planned expansion of Songo Songo production, the conditions for which
are described under V) below. The Company has no history with TPDC as a debtor. Any contract with
TPDC will expose the Company to additional credit risk with a parastatal entity in Tanzania. Management
intends to manage such credit exposure with risk insurance or other credit enhancement mechanisms.
V) Liquidity risk
Liquidity risk is the risk that the Company will not have sufficient funds to meet its liabilities. Cash
forecasts identifying liquidity requirements of the Company are produced on a regular basis. These are
reviewed to ensure sufficient funds exist to finance the Company’s current operational and investment
cash flow requirements. The Company has US$45.5 million of financial liabilities with regards to trade
and other payables identified in Note 14 of which US$38.5 million is due within one to three months, nil
is due within three to six months, and US$7.1 million is due within six to twelve months. The Company
has a current taxation liability of US$6.3 million payable within three months. Management forecasts
that, unless payment is secured from TANESCO over the next three to four months, the Company will
be unable to meet its current liabilities as they fall due through the use of existing cash balances and self
generated cash flows, and accordingly will require external financing, or a commensurate reduction in
operations to avoid the accumulation of unfunded liabilities.
Developing additional productive capacity at Songo Songo, including the drilling of the SS-12 development
well and the Songo Songo West exploration well, is dependent on (i) the receipt of outstanding overdue
payments of approximately US$43 million from TANESCO; (ii) satisfactory completion of all outstanding
issues relating to the Government Negotiating Team (“GNT”); (iii) completion of commercial terms
for the sale and transport of incremental gas volumes; (iv) reasonable assurance of completion of the
Government of Tanzania Natural Gas Infrastructure Project commissioned in November 2012; and (v)
financing. There is no assurance that financing will be available when the Company requires same, and on
reasonable terms and conditions.
VI) Capital risk management
The Company’s objectives when managing capital are to safeguard the Company’s ability to continue as
a going concern in order to provide returns for shareholders and benefits for other stakeholders and to
achieve an optimal capital structure to reduce the cost of capital. The level of risk currently in Tanzania
prohibits the optimisation of capital structure as many sources of traditional capital are unavailable. The
Company currently has a medium-term loan facility of US$10 million of which US$6 million had been
drawn at the year end. Subsequent to year end, the remaining US$4 million was drawn and repayments
commenced in March 2013.
57
ORCA EXPLORATION GROUP INC. 2012 ANNUAL REPORT 58
VII) Material uncertainty
In February 2012 on the recommendation of MEM, the Government announced that it was establishing a
negotiating team, the GNT, to discuss a number of issues raised in parliament in relation to the Company’s
Songo Songo PSA with TPDC and the Government of Tanzania. In Tanzania, government negotiating
teams are a common mechanism to negotiate with business. The scope of the GNT was to discuss a number
of points that were raised by the Parliamentary Committee for Energy into the workings of the PSA. This
included, but is not limited to, TPDC back in rights, profit sharing arrangements, the unbundling of the
downstream assets, cost recovery and Orca’s Exploration’s management of the upstream operations. After
making submissions to the GNT, the Company commenced discussions in April 2012 and further in July
2012, at which time an agreement in principle was been reached on a number of major points to resolve
the issues. The GNT has completed its mandate, and the responsibility for finalisation, documentation
and implementation has moved back to MEM. The agreement in principal contemplated completion this
process by the end of 2012. As at the date of this report, a number of conditions precedent have not been
met and a number of issues remain to be fully resolved and documented. The outcome of these negotia-
tions could have a significant impact on the operations of the Company, which cannot be estimated at
this time. The Company will continue to discuss these matters in good faith with the government and will
look to reach a satisfactory agreement that may lead to a material change in the economic terms of the
PSA. However, the Company reserves its rights to defend its position should no satisfactory agreement
be reached.
VIII) Evolving regulatory environment
The fiscal and regulatory environment for oil & gas exploration and development in Tanzania is in its
infancy. Following the discovery of significant offshore natural gas resources by international exploration
and development companies, there was pressure on the government to create a clear fiscal and regulatory
framework for the industry. In November 2012, the Government of Tanzania introduced a draft natural
gas policy for review and consultation amongst stakeholders. The draft policy contemplates, among other
things, a restructuring of TPDC, increasing government ownership and control over infrastructure and
resources, strategic involvement in the LNG value chain, the establishment of TPDC as monopoly gas
aggregator in the country, and the establishment of government controlled natural gas prices. The draft
policy as contemplated conflicts in a number of areas with the rights of the Company under the PSA and
has the potential, if implemented in its current form to materially affect the Company’s business.
The Company operates in jurisdictions with complex tax laws and regulations, which are evolving over
time. The Company has taken certain tax positions in its filings and these filings are subject to audit and
potential reassessment after the lapse of considerable time. Accordingly, the actual income tax impact may
differ significantly from that estimated and recorded by management.
ORCA EXPLORATION GROUP INC.2012 ANNUL REPORT NOTEs TO ThE CONsOLIdATEd FINANCIAL sTATEmENTs 6 segMent inFOrMatiOn
The Company has one reportable segment which is international exploration, development and production of
petroleum and natural gas. The Company currently has producing assets in Tanzania and exploration interests
in Italy.
US$’000
External revenue
2012
2011
Italy
Tanzania
Total
Italy
Tanzania
Total
–
77,758
77,259
Segment income/(loss)
(8,284)
26,613
18,329
Total assets
Total liabilities
Capital additions
834
714
211,410
212,244
85,595
86,309
7,531
47,164
54,695
Depletion & depreciation
–
9,281
Exploration assets impairment
8,284
–
9,281
8,284
7 revenue
US$’000
Operating revenue
Current income tax adjustment
Deferred additional profits tax
Revenue
–
–
911
4
911
–
–
45,893
45,893
7,986
7,986
150,933
151,844
45,181
17,224
8,389
–
45,185
18,135
8,389
–
years ended 31 decemBer
2012
64,192
16,530
(3,463)
77,259
2011
41,794
6,626
(2,527)
45,893
The Company’s total revenues for the year amounted to US$77,259 after adjusting the Company’s operating
revenue of US$64,192 by:
i)
ii)
adding US$16,530 for income tax for the current year. The Company is liable for income tax in Tanzania,
but the income tax is recoverable out of TPDC’s Profit Gas when the tax is payable. To account for this,
revenue is adjusted to reflect the current income tax charge or loss.
subtracting US$3,463 for the deferred effect of additional profits tax. This tax is considered a royalty and
is netted against revenue.
59
ORCA EXPLORATION GROUP INC. 2012 ANNUAL REPORT 60
8 persOnnel expenses
The average number of employees during the year was 48 (2011: 42). The costs are as follows:
US$’000
Wages and salaries
Social security costs
Other statutory costs
Stock based compensation
years ended 31 decemBer
2012
4,725
239
312
5,276
1,152
6,428
2011
4,745
677
312
5,734
851
6,585
The personnel stock based compensation is recorded under general and administrative expenses in the statement
of comprehensive income. The balance of personnel expenses for 2012 of US$5.3 million (2011: US$5.7
million) is recorded in distribution and production expenses and general administrative expenses at US$0.8
million (2011: US$1.1 million) and US$4.5 million (2011: US$4.6 million) respectively.
9 net Finance cOsts
US$’000
Finance incOMe
Interest income
Foreign exchange gain
Finance charges
Interest expense
Foreign exchange loss
Net finance costs
years ended 31 decemBer
2012
2011
23
93
116
(315)
(412)
(727)
(611)
5
80
85
(100)
(938)
(1,038)
(953)
ORCA EXPLORATION GROUP INC.2012 ANNUL REPORT NOTEs TO ThE CONsOLIdATEd FINANCIAL sTATEmENTs
10 taxatiOn
Under the terms of the PSA with TPDC and the Government of Tanzania, the Company is liable to pay income
tax at the corporate rate of 30% on profits generated in Tanzania. The amount paid is then recovered in full from
TPDC by adjusting its share of Profit Gas when the current tax liability is paid.
US$’000
Current tax
Deferred tax
years ended 31 decemBer
2012
11,920
5,205
17,125
2011
4,949
2,385
7,334
Total taxes of US$7.7 million have been paid during the year in relation to the settlement of the 2011 tax liability
and provisional payments for 2012. Total provisional tax payments of US$4.5 million were made in 2011.
TAX RATE RECONCILIATION
years ended 31 decemBer
US$’000
Profit before taxation
Provision for income tax calculated at the statutory rate of 30%
Add the tax effect of non-deductible income tax items:
Administrative and operating expenses
Exploration assets impairment
Financing charge
Stock- based compensation
Permanent differences
2012
35,454
10,636
2,953
2,485
29
346
675
17,125
2011
15,320
4,596
2,042
–
–
255
441
7,334
As at 31 December 2012, there were temporary differences between the carrying value of the assets and liabilities
for financial reporting purposes and the amounts used for taxation purposes. Accordingly a deferred tax liability
has been recognized for the year ended 31 December 2012.
A deferred tax asset of US$2.2 million in respect of Longastrino Italy E&E costs has not been recognised because
it is not probable that there will be future profits against which this can be utilised.
The deferred income tax liability includes the following temporary differences:
US$’000
Differences between tax base and carrying value of property,
plant and equipment
Income tax recoverable
Other liabilities
Employee bonuses
TPDC Additional Profit Gas
Additional Profits Tax
as at 31 decemBer
2012
2011
16,341
6,744
(109)
(102)
(2,475)
20,399
14,409
2,416
(145)
(50)
(1,436)
15,194
61
ORCA EXPLORATION GROUP INC. 2012 ANNUAL REPORT
62
Additional Profits Tax
Under the terms of the PSA, in the event that all costs have been recovered with an annual return of 25% plus
the percentage change in the United States Industrial Goods Producer Price Index (“PPI”), an Additional Profits
Tax (“APT”) is payable.
The Company provides for Deferred APT by forecasting the total APT payable as a proportion of the forecast
Profit Gas over the term of the PSA. The effective APT rate of 31.8% is then applied to Profit Gas of US$10.7
million in 2012 (2011: US$12.6 million), accordingly, US$3.5 million (2011: US$2.5 million) has been netted
off revenue for the year ended 31 December 2012.
Management does not anticipate that any APT will be payable in 2013, as the forecast revenues will not be
sufficient to cover the un-recovered costs brought forward as inflated by 25% plus the PPI percentage change
and the forecast expenditures for 2013. The actual APT that will be paid is dependent on the achieved value of
the Additional Gas sales and the quantum and timing of the operating costs and capital expenditure program.
Tax Receivable
The Company has a “Tax Receivable” balance of US$14,692 (2011: US$5,880). This arises from the revenue
sharing mechanism within the PSA which entitles the Company to a share of revenue equivalent to its tax charge,
grossed up at the prevailing rate. This debtor is collected by way of an offset against TPDC’s share of revenue, as
and when the Company pays its tax.
11 trade and Other receivables
US$’000
TANESCO
Songas
Other debtors
Trade receivables
Other receivables
aged analYsis
Current
>30 <60
>60 <90
>90
TANESCO
Songas
Other debtors
4,894
1,134
7,935
Trade receivables
13,963
5,655
992
2,491
9,138
5,321
1,114
1,816
8,251
17,386
11,043
549
28,977
years ended 31 decemBer
2012
33,256
14,283
12,791
60,330
13,165
73,495
2012
33,256
14,283
12,791
60,330
2011
24,226
3,720
7,767
35,713
4,635
40,348
2011
24,226
3,720
7,767
35,713
Subsequent to 31 December 2012, US$1.0 million has been received from TANESCO, and US$10.7 million
from other debtors. In addition to the trade receivable from Songas of US$14.3 million, an additional US$9.1
million is due from Songas with respect to Gas Plant operations, which is included in Other receivables.
The balance of other debtors which has yet to be collected relates to a take-or-pay obligation and is expected to
be received in the near future.
ORCA EXPLORATION GROUP INC.2012 ANNUL REPORT NOTEs TO ThE CONsOLIdATEd FINANCIAL sTATEmENTs
12 explOratiOn and evaluatiOn assets
US$’000
cOsts
As at 1 January 2012
Additions
Impairment
As at 31 December 2012
US$’000
cOsts
As at 1 January 2011
Additions
As at 31 December 2011
TANZANIA
Italy
Tanzania
Total
911
7,531
(8,284)
158
2,010
3,552
–
5,562
2,921
11,083
(8,284)
5,720
Italy
Tanzania
Total
–
911
911
942
1,068
2,010
942
1,979
2,921
The exploration and evaluation asset represents site survey costs and materials purchased in preparation for
the drilling of the first Songo Songo West well (“SSW-1”) prior to suspension of the 2012 drilling programme.
The SSW-1 well is part of the initial evaluation of the Songo Songo West prospect which is required to determine
the existence of proven and probable reserves.
ITALY
Pursuant to the terms of the Company’s Longastrino Block farm-in in the Po Valley Basin the Company spent
US$7.5 million during 2012 related to the drilling of the La Tosca exploration well. The well was unsuccessful
and the related accumulated costs were impaired. The residual cost represents equipment with a resale value
which the Company intends to realise.
63
ORCA EXPLORATION GROUP INC. 2012 ANNUAL REPORT 64
13 prOpertY, plant and eQuipMent
US$’000
cOsts
As at 1 January 2012
Additions
Disposals
96,014
42,944
–
As at 31 December 2012
138,958
depletiOn
and depreciatiOn
As at 1 January 2012
Charge for period
Depreciation on disposals
As at 31 December 2012
net bOOk values
28,833
8,968
–
37,801
Tanzania
Leasehold
improvements
Computer
equipment
Vehicles
Fixtures &
Fittings
Total
320
–
(64)
256
271
12
(64)
219
701
46
–
747
520
129
–
649
249
–
(47)
202
196
45
(47)
194
334
622
97,618
43,612
(6)
(117)
950
141,113
85
127
(6)
29,905
9,281
(117)
206
39,069
As at 31 December 2012
101,157
37
98
8
744
102,044
US$’000
cOsts
As at 1 January 2011
Additions
Disposals
As at 31 December 2011
depletiOn
and depreciatiOn
As at 1 January 2011
Charge for period
Depreciation on disposals
As at 31 December 2011
net bOOk value
Tanzania
Leasehold
improvements
Computer
equipment
Vehicles
Fixtures &
Fittings
Total
80,323
15,691
–
96,014
20,741
8,092
–
28,833
320
–
–
320
244
27
–
271
509
192
–
701
345
175
–
520
231
47
(29)
249
149
76
(29)
196
108
226
–
334
66
19
–
85
81,491
16,156
(29)
97,618
21,545
8,389
(29)
29,905
As at 31 December 2011
67,181
49
181
53
249
67,713
In determining the depletion charge, it is estimated by the independent reserve engineers that future development
costs of US$107.1 million (2011: US$127.8 million) will be required to bring the total proved reserves to
production. During the year the Company recognized depreciation of US$0.3 million (2011: US$0.3 million)
in General and Administrative expenses.
ORCA EXPLORATION GROUP INC.2012 ANNUL REPORT NOTEs TO ThE CONsOLIdATEd FINANCIAL sTATEmENTs 14 trade and Other paYables
US$’000
TPDC
Songas
Other trade payables
Trade payables
Accrued liabilities
Related party (Note 18)
as at 31 decemBer
2012
4,378
17,459
4,458
26,295
19,030
171
45,496
2011
(81)
5,823
12,993
18,735
3,912
154
22,801
The Company’s exposure to credit, currency and interest risk related to trade and other payables is disclosed in
Note 4.
15 bank lOan
In September 2012, the Company closed a US$10 million 18-month bridge loan facility with a Tanzania bank
to finance the Company’s working capital requirements in Tanzania. The facility is secured by an assignment of
accounts receivable and a fixed and floating charge on the assets of the Company. As at 31 December the Company
had drawn down US$6.0 million under the facility and paid US$0.2 million in financing fees. Subsequent to
year-end, in March 2013, the Company drew the remaining US$4.0 million. Principal amounts drawn under
the facility are repayable in 12 equal monthly instalments which commenced in March 2013. Interest is payable
monthly at three-month US LIBOR plus 8%. An additional interest rate of 2% will be applied for any period in
which the TANESCO receivable is greater than 240-days.
16 capital stock
a) Authorised
50,000,000
Class A Common Shares
No par value
100,000,000
Class B Subordinate Voting Shares
No par value
100,000,000
First Preference Shares
No par value
The Class A and Class B shares rank pari passu in respect of dividends and repayment of capital in the
event of winding-up. Class A shares carry twenty (20) votes per share and Class B shares carry one vote
per share. The Class A shares are convertible at the option of the holder at any time into Class B shares on
a one-for-one basis. The Class B shares are convertible into Class A shares on a one-for-one basis in the
event that a take-over bid is made to purchase Class A shares which must, by reason of a stock exchange
or legal requirements, be made to all or substantially all of the holders of Class A shares and which is not
concurrently made to holders of Class B shares.
65
ORCA EXPLORATION GROUP INC. 2012 ANNUAL REPORT
66
b) Changes in the capital stock of the Company were as follows:
Authorized and Issued Share Capital
Thousands of shares or US$’000
Authorised
class a shares
2012
Issued/
Repurchased
2011
Amount
Authorised
Issued
Amount
As at 1 January and 31 December
50,000
1,751
983
50,000
1,751
983
class b shares
As at 1 January
Stock options exercised
Normal course issuer bid
100,000
32,746
83,627
100,000
32,939
84,117
–
–
150
(4)
383
(10)
–
–
–
(193)
32,746
34,497
–
(490)
83,627
84,610
As at 31 December
100,000
32,892
84,000
100,000
Total shares as at 31 December
150,000
34,643
84,983
150,000
All of the issued capital stock is fully paid.
stOck OptiOns
2012
2011
Thousands of options or CDN$
Options
Exercise Price
Options
Exercise Price
Outstanding as at 1 January
3,057
1.00 to 13.55
2,557
1.00 to 13.55
Forfeited/Expired
(1,385)
4.75 to 13.55
Exercised
Issued
(150)
400
1.00
3.18
Outstanding as at 31 December
1,922
1.00 to 3.60
–
–
500
3,057
–
–
3.60 to 4.75
1.00 to 13.55
The weighted average remaining life and weighted average exercise prices of options at 31 December 2012 were
as follows:
Number outstanding
as at
31 Dec 2012
(‘000)
Weighted Average
Remaining
Contractual Life
(years)
Number Exercisable
as at
31 Dec 2012
(‘000)
Weighted Average
Exercise Price
(cDN$)
Exercise Price
(cDN$)
1.00
3.18
3.60
1,272
400
250
1,922
1.66
4.29
3.75
1,272
400
250
1,922
1.00
3.18
3.60
There were 400,000 new stock options issued during the year with an exercise price of CDN$3.18. The stock
options issued fully vested on 31 December 2012 and have a term of five years. A total charge of US$0.7 million
has been recognised for the year in relation to the stock options and is included in General & Administrative
expenses.
ORCA EXPLORATION GROUP INC.2012 ANNUL REPORT NOTEs TO ThE CONsOLIdATEd FINANCIAL sTATEmENTs stOck appreciatiOn rights
Thousands of stock appreciation
rights or CDN$
2012
2011
SAR
Exercise Price
sAR
Exercise Price
Outstanding as at 1 January
1,005
4.20 to 13.55
1,005
4.20 to 13.55
Expired
Granted (i)
Outstanding as at 31 December
(690)
8.7 to 13.55
430
745
2.35 to 2.70
2.35 to 5.30
–
–
–
–
1,005
4.20 to 13.55
(i)
A total of 100,000 stock appreciation rights were issued in August 2012 with an exercise price of CDN$2.70. These
rights have a term of five years and vest in three equal instalments, the first third vesting on the anniversary of the grant
date. A further 330,000 stock appreciation rights were issued in December 2012 with an exercise price of CDN$2.35
which vested immediately. There is no maximum liability associated with these rights.
The Company records a charge to the income statement using the Black-Scholes fair valuation option pricing
model every reporting period with a resulting liability being recognised in trade and other payables. In the
valuation of stock options and stock appreciation rights at the reporting date, the following assumptions have
been made: a risk free rate of interest of 1.50% stock volatility of 53% to 71%; 0% dividend yield; 0% forfeiture;
a closing stock price of CDN$3.00 per share.
As at 31 December 2012, a total accrued liability of US$0.6 million (2011: US$0.2 million) has been recognised
in relation to the stock appreciation rights. The liability increased by US$0.4 million during the year reflects the
issue of additional stock appreciation rights, many of which vested immediately.
17 earnings per share
The calculation of basic earnings per share is based on the profit after taxation and comprehensive income for the
year of US$18.3 million (2011: US$8.0 million) and a weighted average number of Class A and Class B shares
outstanding during the period of 34,641,593 (2011: 34,655,656).
In computing the diluted earnings per share, the dilutive effect of the stock options was 811,386 (2011:
1,176,161) shares. These are added to the weighted average number of common shares outstanding during the
year resulting in a diluted weighted average number of Class A and Class B shares of 35,452,979 for the year
ended 31 December, 2012 (2011: 35,831,817). No adjustments were required to the reported earnings from
operations in computing diluted per share amounts.
18 related partY transactiOns
One of the non-executive Directors is a partner at a law firm. During the year, the Company incurred US$0.4
million (2011: US$0.2 million) to this firm for services provided. The transactions with this related party were
made at the exchange amount. As at 31 December 2012 the Company has a total of US$ 0.2 million recorded
in trade and other payables in relation to the related party. Each of the Chief Executive Officer and the Chief
Financial Officer provide services to the Company through consulting agreements with personal services
companies. During the year, the Company incurred fees and bonus compensation of US$0.1 million and US$0.2
million to the Chief Executive Officer and the Chief Financial Officer respectively (2011: US$0.2 million and
US$ nil respectively). The full Chief Executive Officer’s remuneration is included in Directors Emoluments,
Note 21.
67
ORCA EXPLORATION GROUP INC. 2012 ANNUAL REPORT 68
19 cOntractual ObligatiOns and cOMMitted capital investMents
cOntractual OBligatiOns
Protected Gas
Under the terms of the original gas agreement for the Songo Songo project (“Gas Agreement”), in the event that
there is a shortfall/insufficiency in Protected Gas as a consequence of the sale of Additional Gas, the Company is
liable to pay the difference between the price of Protected Gas (US$0.55/MMbtu) and the price of an alternative
feedstock multiplied by the volumes of Protected Gas up to a maximum of the volume of Additional Gas sold
(85.7 Bcf as at 31 December 2012). The Company did not have a shortfall during the reporting period and,
supported by the work of its independent engineers, does not anticipate a shortfall arising during the term of
the PSA.
Re-rating Agreement
During Q2 2011, the Company signed a re-rating agreement with TANESCO and Songas (the “Re-Rating
Agreement”) to increase the gas processing capacity to a maximum of 110 MMcfd (the pipeline and pressure
requirements at the Ubungo power plant restrict the infrastructure capacity to a maximum of 102 MMcfd).
Under the terms of the Re-rating Agreement, the Company effectively pays an additional tariff of US$0.30/mcf
for sales between 70 MMcfd and 90 MMcfd and US$0.40/mcf for volumes above 90 MMcfd in addition to the
tariff of US$0.59/mcf payable to Songas as set by the energy regulator, EWURA.
Under the terms of this agreement, the Company agreed to indemnify Songas for damage to its facilities caused
by the re-rating, up to a maximum of US$15 million, but only to the extent that this was not already covered
by indemnities from TANESCO or Songas’ insurance policies. The Re-rating Agreement expired 31 December
2012 and the matter of increased capacity, whether by new or amended agreements, is currently under discussion
with Songas and TANESCO. In the interim, the Company has been advised by the MEM that Songas has agreed
to continue the Re-Rating Agreement until September 2013.
Portfolio Gas Sales Agreement
On 17 June 2011, a long term (to June 2023) Portfolio Gas Sales Agreement (“PGSA”) was signed between
the Company, TPDC and TANESCO. Under the PGSA, the Company is obligated, subject to infrastructure
capacity, to sell a maximum of approximately 37 MMcfd for use in any of TANESCO’s current power plants
except those operated by Songas at Ubungo. The basic wellhead gas price was increased from US$2.02/mcf to
US$2.70/mcf on 1 July 2012 pursuant to the terms of the contract.
Operating leases
The Company has two office rental agreements. One in Dar es Salaam which expires on 30 November 2013 at an
annual rental of US$238, and one in Winchester (UK) which expires on 25 September 2022 at an annual rental
of GBP 35 (US$58) per annum for the first two years and GBP71 (US$ 115) thereafter. Both are recognised in
the General and Administrative expenses.
US$’000
Less than one year
Between one and five years
as at 31 decemBer
2012
267
577
844
2011
222
92
314
ORCA EXPLORATION GROUP INC.2012 ANNUL REPORT NOTEs TO ThE CONsOLIdATEd FINANCIAL sTATEmENTs
capital cOmmitments
Italy
On 31 May 2010, the Company signed an agreement with Petroceltic International plc (“Petroceltic”) to farm
in on Petroceltic’s Central Adriatic B.R268.RG Permit offshore Italy. The farm-in commits the Company to fund
30% of the Elsa-2 appraisal well up to a maximum of US$11.5 million to earn a 15% working interest in the
permit. Thereafter, the Company will fund all future costs relating to the well and the permit in proportion to its
participating interest. The Company has also agreed to pay Petroceltic fifteen per cent (15%) of the back costs in
relation to the well up to a maximum of US$0.5 million.
Petroceltic was due to spud the Elsa-2 well prior to 31 October 2010, but the Italian government passed a
decree, following the blowout of the Macondo well in the U.S., that prevented the drilling in the Italian seas
within five nautical miles of the coastline and within 12 nautical miles around the perimeter of protected Marine
Parks. In view of this, Petroceltic suspended the permit until such time as the Ministry of Environment issued
a decree of environmental compatibility for the drilling program. Legislative Decree 83/2012 (the “Decree”)
was published on 26 June 2012 and was approved by both houses of the Italian Parliament with no substantial
modifications. On 12th August, the Decree became law following publication in the Italian Official Journal. The
new law modifies restrictions on offshore oil and gas exploration and production originally introduced by DLGS
128/2010 in August 2010.
The well is now expected to be drilled following finalisation of an environmental impact study currently expected
in 2014. Orca will not be liable to any costs associated with the drilling of Elsa-2 until a rig contract is signed.
There are no further capital commitments in Italy.
Songo Songo commitments
Any significant additional capital expenditure in Tanzania remains dependent on TANESCO payments being
brought up to date, the satisfactory conclusion of the GNT issues, conclusion of satisfactory commercial terms
for the sale and transportation of incremental gas volumes, substantive progress on infrastructure expansion
and the subsequent raising of finance. Currently there are no material commitments, although significant capital
expenditure will be required to enable the Songo Songo field to produce 190 MMcfd in line with the anticipated
infrastructure expansion.
20 cOntingencies
Downstream Unbundling
In connection with the GNT negotiations and the draft Natural Gas Policy, TPDC and MEM have indicated that
they wish Orca Exploration to unbundle the downstream distribution business in Tanzania. The methodology
for this has been discussed with the GNT along with other issues. The Company anticipates further negotiations
will be necessary before this matter is concluded.
Access to infrastructure
Ndovu Resources Limited, with support from TPDC and MEM, has indicated that they wish to tie into the gas
processing plant on Songo Songo Island and sell up to 10 MMcfd from their Kiliwani North field. The Tanzania
Natural Gas Infrastructure Project contemplates additional processing and transportation capacity on Songo
Songo to handle these additional gas volumes. Access has not yet been granted and it is not clear when, or if, this
will occur.
69
ORCA EXPLORATION GROUP INC. 2012 ANNUAL REPORT 70
TPDC Back in
TPDC has indicated its wish to exercise that Company’s right to ‘back in’ to the Songo Songo field development.
The implications and workings of the ‘back in’ have been discussed with the GNT along with other issues. The
issues are not yet fully resolved, however, and there may be the need for additional reserve and accounting modi-
fications once these discussions are concluded. For the purpose of the reserves certification as at 31 December
2012, it was assumed that TPDC will ‘back in’ for 20% for all future new drilling activities and other develop-
ments and this is reflected in the Company’s net reserve position.
Cost recovery
The Company’s cost pool in Tanzania was recovered early in Q2 2011 resulting in a reduction in the percentage
of net revenue attributable to the Company. During 2012 the level of Cost Gas increased significantly as a
consequence of drilling the SS-11 well, however the cost pool was fully recovered in Q4 2012.
TPDC conducted an audit of the historic cost pool and in 2011 disputed approximately US$34 million of costs
that had been allocated to the cost pool from 2002 through to 2009. The Company contends that the disputed
costs were appropriately incurred on the Songo Songo project in accordance with the terms of the PSA. This
matter was not resolved during the year and while the Company remains confident that the final outcome will be
satisfactory, it is prepared to utilise the extensive dispute resolution mechanisms outlined in the PSA if necessary.
This matter has had no impact on the results for the year.
Taxation
During the year, the Company received an assessment for additional withholding tax from the Tanzanian
Revenue Authority (TRA), which together with interest and penalties totals approximately US$2.0 million.
The Company considered the assessment to be without merit and appealed to the Tax Revenue Appeal Board.
The Tax Revenue Appeals Board considered the appeal in March 2013 and upheld the assessment. The Company
will now pursue the case with the Tax Revenue Appeal Tribunal and if necessary the Court of Appeal of Tanzania.
21 directOrs and OFFicers eMOluMents
US$’000
Directors
Directors
Officers
Officers
year
2012
2011
2012
2011
base
1,655
924
2,060
1,977
share based
Compensation
Expense
Total
402
2,567
–
924
750
3,280
851
3,408
bonus
510
–
470
580
The table above provides information on compensation relating to its officers and directors. Six officers and an
average of four non-executive directors comprised the key management personnel during the year ended 31
December 2012 (2011: six officers and six non-executive directors).
ORCA EXPLORATION GROUP INC.2012 ANNUL REPORT NOTEs TO ThE CONsOLIdATEd FINANCIAL sTATEmENTs cOrpOrate inFOrmatiOn
board of directors
W. David Lyons
Chairman and
Chief Executive Officer
Winchester
United Kingdom
David W. Ross
Non-Executive Director
Calgary, Alberta
Canada
William H. Smith
Non-Executive Director
Robert S. Wynne
Chief Financial Officer
Calgary, Alberta
Canada
Officers
W. David Lyons
Chairman and
Chief Executive Officer
Winchester
United Kingdom
Operating Office
PanAfrican Energy
Tanzania Limited
Barclays House, 5th Floor
Ohio Street, P.O. Box 80139
Dar es Salaam
Tanzania
Tel: + 255 22 2138737
Fax: + 255 22 2138938
international subsidiaries
PanAfrican Energy
Tanzania Limited
Barclays House, 5th Floor
Ohio Street, P.O. Box 80139
Dar es Salaam
Tanzania
Tel: + 255 22 2138737
Fax: + 255 22 2138938
engineering consultants
McDaniel & Associates
Calgary, Canada
lawyers
Burnet, Duckworth
& Palmer LLP
Calgary, Canada
Calgary, Alberta
Canada
Robert S. Wynne
Chief Financial Officer
Beer van Straten
Chief Operating Officer
Calgary, Alberta
Canada
Molkerum
Netherlands
registered Office
Orca Exploration
Group Inc.
P.O. Box 3152
Road Town
Tortola
British Virgin Islands
investor relations
Robert S. Wynne
Chief Financial Officer
RSWynne@orcaexploration.com
www.orcaexploration.com
PAE PanAfrican
Energy Corporation
1st Floor
Cnr St George/Chazal Streets
Port Louis
Mauritius
Tel: + 230 207 8888
Fax: + 230 207 8833
auditors
KPMG LLP
Calgary, Canada
transfer agent
CIBC Mellon
Trust Company
Toronto & Montreal, Canada
Orca Exploration Group Inc.
Orca Exploration Italy Inc.
Orca Exploration Italy Onshore Inc.
P.O. Box 3152,
Road Town
Tortola
British Virgin Islands
www.orcaexploration.com
ORCA EXPLORATION GROUP INC.
www.orcaexploration.com