PetroNeft Resources plc ANNUAL REPORT & ACCOUNTS FOR THE YEAR ENDED 31ST DECEMBER 2006 9 3 7 1 2 7 7 6 5 0 : s r e t n i r P n r e d o M y b t n i r P d n a n g i s e D www.petroneft.com Pile Driving for Lineynoye 7 Rig Platform Sawmill on Lineynoye 7 Drilling Site Construction of Well Site Facilities and Rig at Lineynoye In its short history, PetroNeft has already added significant value to its assets and built a strong team with a clear strategy. A primary objective of the Company is to create value for our shareholders by commencing oil production in the Company’s “Core Area”, Licence 61 in the Tomsk Oblast of the Russian Federation, in 2009. G. David Golder Chairman PetroNeft Resources plc ANNUAL REPORT & ACCOUNTS FOR THE YEAR ENDED 31ST DECEMBER 2006 C O N T E N T S Licence 61 Location Tomsk Oblast, Russia 6 0 0 2 s t n u o c c A l a i c n a n i F d n a t r o p e R l a u n n A c p l s e c r u o s e R t f e N o r t e P 2 Highlights of 2006/2007 Corporate Information Directors Chairman's Statement Overview of Operations Report of Directors Independent Auditors’ Report Statement of Accounting Policies 3 4 5 6 8 14 18 20 Consolidated Income Statement Consolidated Balance Sheet Group Statement of Changes in Equity Company Balance Sheet Cash Flow Statement Notes on Financial Statements Notice of Annual General Meeting Form of Proxy 22 23 24 25 26 27 35 36 This report contains Forward-Looking Statements, identified by such words as “believe”, “could”, “estimate”, “intend”, “may” and “will”. Forward-Looking Statements are based upon current expectations and are subject to change, risks and uncertainties. Shareholders in the United States should be aware that the ordinary shares have not been and will not be registered under the United States Securities Act 1933 as amended. HIGHLIGHTS OF 2006/2007 FINANCIAL HIGHLIGHTS l Private placement US$8 million completed February 2006. raising in l Admission to AIM and IEX on Markets September 27, 2006, raising a further US$15.5 million. completed l London Natixis Broker appointed as joint Broker with Davy. OPERATIONAL HIGHLIGHTS l Drilling completed on Lineynoye No. 6 well, the first of the 2006/2007 three well drilling programme. l Tungolskoye No. 4 well commenced drilling in May 2007. l Preliminary Development Feasibility Study, including planned pipeline development and funding requirements on the Lineynoye and Tungolskoye Oil Fields, was completed in February 2007. l Pipeline Design, Survey and Approvals Contract awarded. l Acquisition of 540 line kms of new high resolution 2D seismic data was completed on March 15, 2007. A further programme of 500 kms is planned for Winter 2007/2008 season. P e t r o N e f t r R e s o u c e s p c A n n u a l l R e p o r t i a n d F n a n c a i l A c c o u n t s 2 0 0 6 3 CORPORATE INFORMATION I N O T A M R O F N I E T A R O P R O C DIRECTORS G. DAVID GOLDER DENNIS FRANCIS DAVID SANDERS DESMOND BURKE VAKHA SOBRALIEV THOMAS HICKEY REGISTERED OFFICE/ SOLICITORS c/o O'Donnell Sweeney Eversheds One Earlsfort Centre Earlsfort Terrace Dublin 2 SECRETARY David Sanders NOMINATED ADVISOR IEX ADVISOR AND BROKER Davy 49 Dawson Street Dublin 2 LONDON BROKER Natixis Capital House 85, King William Street London EC4 AUDITORS LHM Casey McGrath Chartered Certified Accountants 6 Northbrook Road Dublin 6 Ireland P.R. ADVISORS College Hill Associates Ltd 78 Cannon Street London EC4 BUSINESS ADDRESS Modeshill Mullinahone Co. Tipperary BANKERS JP Morgan Chase Bank 9709 Bellaire Boulevard Houston Texas 77036 USA AIB Bank 1/3 Lower Baggot Street Dublin 2 Ireland REGISTERED NUMBER 408101 Website: www.petroneft.com AIM/IEX : PTR/P8ET 6 0 0 2 s t n u o c c A l i a c n a n F d n a i t r o p e R l l a u n n A c p s e c u o s e R r t f e N o r t e P 4 D I R E C T O R S US; Petroleum & Natural Gas Engineer 34 years’ industry experience in oil and gas industry with Marathon Oil Company and others. Former Senior Vice President, Marathon Oil Company. Former Executive Vice President –Upstream, Sakhalin Energy Investment Company. US; Geophysical Engineer and Geologist 30 years with Marathon Oil Company. Headed Marathon’s Business Development Activities in Russia from 1989. Director Sakhalin Energy Investment Company. World wide experience as senior oil executive. G. DAVID GOLDER Non-Executive Chairman DENNIS FRANCIS Chief Executive Officer US; Lawyer, Engineer Irish; Geologist 30 years’ industry experience. 15 years with Marathon Oil Company. In Russia was involved in, Sakhalin II, Priobskoye, KMOC projects. 30 years’ Minerals Industry experience and 20 years experience in International Equity Markets. DAVID SANDERS Executive Director, Company Secretary and General Legal Counsel DESMOND BURKE Executive Director of Planning and Investor Relations Irish; Accountant and Business Executive Chief Financial Officer and Director of Tullow Oil plc. Formerly of ABN AMRO Corporate Finance (Ireland) Limited. Russian; Mining Engineer and Economics 30 years’ experience in West Siberian Petroleum Industry General Director Tomskburneftegaz, LLC - Drilling & Support Services Company in Tomsk Region. THOMAS HICKEY Non-Executive Director VAKHA A. SOBRALIEV Non-Executive Director P e t r o N e f t r R e s o u c e s p c A n n u a l l R e p o r t i a n d F n a n c a i l A c c o u n t s 2 0 0 6 5 CHAIRMAN’S STATEMENT G. DAVID GOLDER Non-Executive Chairman Dear Shareholder, I am pleased to report a year of excellent progress for PetroNeft in 2006. Since PetroNeft’s formation in 2005, the Board and Management have worked steadily to maximise the value of the Group’s acreage in Western Siberia and to develop the Company’s access to long term equity and debt capital to fund its operations and field development plan. TECHNICAL DEVELOPMENT The primary objective of the Company is to create value for our shareholders by commencing oil production in the Company’s “Core Area”, Licence 61 in the Tomsk Oblast of the Russian Federation, in 2009. In order to meet this objective, drilling has commenced on the first two wells of a three well 2006/2007 winter programme which is designed to confirm reservoir parameters and to expand the Company’s reserve base. An initial Feasibility Study for the Lineynoye and Tungolskoye Oil Fields has already been completed. This will save time in the funding and development process towards first production. the development of the next several months there will be Over continuous movement towards this objective. Most notably test results will be completed. Ongoing discussions will continue with finance providers. Contracts will be awarded on infrastructure and approvals. The results of wells will allow us to refine the Feasibility Study to a “Bankable” stage and to progress through the field development’s planning and permitting phases later this year and next. FINANCIAL DEVELOPMENT Admission to the AIM and IEX markets was key to this, raising $15.5 million in September 2006. The IPO introduced the Company to and increased our profile within international capital markets, which in turn has created numerous valuable relationships which are being actively developed. In the long term, PetroNeft aims to fund its business through a suitable mixture of debt and equity, enabling an acceleration of development activity thereby maximising returns to shareholders. The wider business environment, both within Russia and on international oil markets, remains positive and supports the Company’s development objectives. EXPLORATION The Company is focusing exploration on the wider Licence 61 area in order to define and increase our reserve base in the area. Extensive seismic surveys are being used to refine established Prospects and to detect new ones. This winter has seen an additional acquisition of 540 line kms of 2D seismic. This work will lead to additional exploration activity in future years. Furthermore, we are constantly studying New “Core Areas”, both in the Tomsk Region and elsewhere within the Russian Federation, that would add value to PetroNeft by increasing and diversifying the asset base. These must obviously pass the Company’s 6 0 0 2 s t n u o c c A l i a c n a n F d n a i t r o p e R l l a u n n A c p s e c u o s e R r t f e N o r t e P 6 strict screening process before we make any decision on a transaction. Development of the Company’s human resources also continues. Plans are in place to appoint a Chief Financial Officer for the Company in the near future. Our Russian management team in Tomsk has already been strengthened with a number of new technical and appointments environmental disciplines. legal, the in FORWARD STRATEGY is based on a deep strategy PetroNeft’s understanding of the oil and gas business in Russia, a commitment to the maximisation of local content and employment and the application of rigorous technical, commercial and financial investment screening criteria. Historically, exploration and development activity in Russia has been driven by Major Oil Companies or State Enterprises and targeted towards the discovery and development of large fields. This approach, while effective in respect of major projects, can result in smaller accumulations being overlooked. As a result very attractive opportunities exist for smaller companies who can combine financial strength and technical expertise with local knowledge. The PetroNeft Board and the Company’s regional management has over 150 years experience in including a detailed doing business in Russia, field development, knowledge of geology, environmental, permitting arrangements and This has enabled commercial opportunities. PetroNeft to secure access to high quality acreage and staff, to access services and supplies in a competitive market and to maintain control over the execution of our work programmes. The combination of these skills and the large potential of the Company’s acreage means the outlook for 2007 and beyond is very exciting. CONCLUSION In its short history, PetroNeft has already added significant value to its assets and built a strong team with a clear strategy. None of this would have been possible without the dedication of our personnel and the support of our shareholders. I offer my gratitude for your confidence in and loyalty to the business and management to date, and hope that you will continue to support the Company for many years to come. Sincerely, G. David Golder Chairman 23rd May 2007 P e t r o N e f t r R e s o u c e s p c A n n u a l l R e p o r t i a n d F n a n c a i l A c c o u n t s 2 0 0 6 7 OVERVIEW OF OPERATIONS LINEYNOYE NO. 6 – MUD LOGGING UNIT The Licence contains two proven oil fields, Lineynoye and Tungolskoye, that were discovered in the early 1970s. to fully seismic involving many GENERAL PetroNeft’s objective of bringing its known oil fields in the Tomsk Oblast of Western Siberia to full pipeline production in 2009 is now the main focus of the Company’s operations. This is a complex project management process, individual activities running in parallel, all aiming for project completion in the third quarter of 2009. These activities surveys and delineation and include exploration drilling the characteristics of the oil reservoirs, environmental studies on all aspects of the project, pipeline design and route investigation studies, a Feasibility Study to establish the most economical production system, and infrastructure development at the production sites to ensure all weather access in difficult ground conditions. All aspects of the development must pass a rigorous approvals and permitting process under Oblast and Federal Law. Compliance with these laws is a primary aim of the Company. A further objective of the Company is to expand and reclassify the oil reserves within its 100% owned Licence 61 through drilling and seismic surveys. understand sandstones. THE OIL FIELDS There are two known oil fields on Licence 61, Lineynoye and Tungolskoye. Both are typical of the perimeter zone of the prolific Western Siberian Oil and Gas Basin, in that they are aerially extensive, low to intermediate permeability fields, contained in gently dipping, four- way dip closed anticlinal structures. The reservoir sediments are Jurassic aged These reservoirs typically require water injection, artificial permeability enhancement (such as horizontal wells or fracture stimulation) and properly matched lift systems (electrical submersible or rod pumps) to maximise production rates and recoveries. The source rock for the oil is the overlying Bazhenov Shale, the base of which is an excellent seismic reflector, making for relatively simple identification of the potential oil bearing structures. The oil fields were discovered and drilled by a State Exploration Enterprise in the early 1970s, but were regarded as too small for development at that time. Reserves and Exploration Resources of both oil fields and the extensive Prospects and Potential Prospects on Licence 61, as established by US Petroleum Consultants Ryder Scott, are shown in Table 1. TABLE 1 Lineynoye and Tungolskoye Oil Fields; Proved (P1) + Probable (P2) Possible (P3) Total (P1+P2+P3) Twenty Prospects and Five Potential Prospects (Leads); Possible (P3) Exploration Resources (P4) Total (P1+P2+P3+P4) 33.5 million barrels 37.1 million barrels 70.6 million barrels 253 million barrels 100 million barrels 424 million barrels Note – 67 million bbls of the above P3 Reserves are within the West Lineynoye Prospect which will be drilled this season (Lineynoye No. 7 well). 6 0 0 2 s t n u o c c A l i a c n a n F d n a i t r o p e R l l a u n n A c p s e c u o s e R r t f e N o r t e P 8 DRILLING Due to unusually warm weather conditions in Western Siberia this winter there was some delay in getting all necessary equipment to the drill sites per the Company’s original schedule. We anticipated using one of the drilling rigs to drill two locations. As a result of the weather delays a third drilling rig was mobilised to drill the Lineynoye No. 7 well to ensure that all three wells are completed on schedule. The positive outcome of this delay is that the Company will have three rigs available (rather than the original two) for minimal additional cost and near to site for the winter 2007/2008 drilling programme. At time of writing, one delineation well, Lineynoye No. 6, (Figures 1 and 2) has been completed on the Lineynoye Oil Field and flow testing is in progress. Preliminary Electrical Log results are shown in Figure 2, giving a net oil pay of 11.2 metres. The well deviated 190 metres to the southwest during drilling, but structural results are as predicted by the seismic interpretation. An important result is that the data indicates that the oil water contact (owc) is at -2,430.5 metres subsea which is 10 metres lower than the previous conditional owc interpreted for the field. The reservoir zone has been cored (with 99% recovery) and fluid samples taken. Further tests will be carried out to confirm the rock characteristics properties and flow potential for production. The Company is pleased with the test results thus far as we have confirmed or exceeded the Preliminary Feasibility Study at this location. reservoir properties used the in Lineynoye Field Geologic Model West Lineynoye Prospect A second delineation well, Tungolskoye No. 4 is underway on the Tungolskoye Oil Field (Figure 4). Target depth for this well is 3,100 metres with the reservoir depth predicted at 2,490 metres. Test results are expected in July 2007. West Lineynoye, a high impact prospect, is estimated by Ryder Scott to contain Possible Reserves of approximately 67 million barrels of oil. The third rig which was mobilised to the site for this well is currently being assembled and is now expected to commence drilling in June. The principal target horizons for this well are again the Upper Jurassic sandstone reservoirs, starting at a depth of 2,375 metres. The total planned depth for the well is approximately 2,750 metres and it is anticipated that the well will be drilled, logged and tested within of approximately commencement. days 70 It should be noted that the Lineynoye No. 5 well tested oil from 2.3 metres of net pay just above the oil water contact on the eastern end of this prospect in 1974. A successful Lineynoye No. 7 well could triple the Proved and Probable reserve base of the Company over the next year. Once the drilling programme is completed, a full re- evaluation of the reserves on the Licence will be carried out by US Petroleum Consultants Ryder Scott. The results of these wells and the results of the new seismic data (see below), will be used to finalise the Development Feasibility Study and will lead to a development decision in September 2007. P e t r o N e f t r R e s o u c e s p c A n n u a l l 7 R e p o r t Figure 1 Lineynoye Geological Model with Drill Locations showing the Lineynoye Oil Field Reservoir and potential reservoirs of the Lineynoye West Prospect 2007 Wells Pre PetroNeft Wells Lineynoye Oil Field A c c o u n t s 2 0 0 6 9 i a n d F n a n c a i l OVERVIEW OF OPERATIONS Figure 2 Lineynoye No. 6 - Initial Log Interpretation and testing programme Figure 3 Development of Seismic Coverage over Licence 61. SEISMIC PROGRAMME The 2006/2007 winter seismic programme, to acquire an additional 540 kms of high resolution 2D seismic data, was completed on schedule on March 15, 2007. Final results of be programme will the available in June 2007. This programme was designed to upgrade the definition of known prospects and leads on the Licence. The results will be used in designing the 2007/2008 winter drilling programme and will also be used in the Final Development Feasibility Study. The Company now acquired 1,055 kms of 2D seismic data which fulfils the Licence obligation to acquire 1,000 line kms of seismic data in the first three years of the Licence. A further 500 km survey is planned for 2007/2008 winter season. (Figure 3) has 6 0 0 2 s t n u o c c A l i a c n a n F d n a i t r o p e R l l a u n n A c p s e c u o s e R r t f e N o r t e P 10 DEVELOPMENT FEASIBILITY STUDY INFRASTRUCTURAL DEVELOPMENT A Preliminary Feasibility Study for the development of the Export Pipeline Lineynoye and Tungolskoye Oil Fields was completed by a In May 2007, the Company entered into a contract with Russian Research Institution (SNIIGGMS) in February 2007. ETC Service LLC for the design, survey and approval of an The purpose of the study was to evaluate the oil reserves export pipeline from the Lineynoye and Tungolskoye fields and the economics of the oil fields, and it will be used as to the Transneft regional pipeline at the Raskino pumping part of the approval process required for development in station. The contract also includes the design and the Tomsk Oblast and the Russian Federation. As stated approvals for the custody transfer point at the Transneft above, the results of all three wells and some of the current regional pipeline tie-in point. The award of this contract is seismic acquisition will be incorporated into a Final a critical step in the ultimate development and Feasibility Study, which will be used for approval of the commercialisation process in respect of current and project and to assist the Company in seeking potential future discoveries on Licence 61. Award of this development financing. contract maintains the development schedule for commencement of construction in the winter of 2008/2009 The Company intends to finalise and sanction the and first year round production starting in 2009. development plan for the Lineynoye and Tungloskoye fields by September 2007. A primary objective of the All Weather Roads Company is to commence year round oil production via The Company plans to develop an all weather road an export pipeline from the Licence 61 “Core Area” in system within Licence 61 in order to facilitate easier access 2009. and movement of equipment during the production phase of the project and the continuing exploration programme. This will involve the re-building of at least one bridge and the construction of all weather roads. There will also be continued development of staff housing and catering facilities in the production areas. P e t r o N e f t r R e s o u c e s p c A n n u a l l R e p o r t i a n d F n a n c a i l A c c o u n t s 2 0 0 6 11 OVERVIEW OF OPERATIONS BUSINESS DEVELOPMENT CONCLUSION While the Company’s primary focus is developing the Licence 61 “Core Area”, other business opportunities that can meet the Company’s strict technical and commercial screening process are also being sought. The Company’s long term business strategy is to leverage its current resources and knowledge base to add reserves to its existing Core Area and to develop other Core Areas in the Former Soviet Union. 2007 and 2008 promise to be exciting years for the Company, with drilling results and other development milestones expected on a regular basis. Considering the exploration upside of Licence 61, the existing Proved and Probable reserves, and the Company’s strong international and local management team, the future of PetroNeft looks very bright. Lineynoye No 6 Rig Construction 6 0 0 2 s t n u o c c A l i a c n a n F d n a i t r o p e R l l a u n n A c p s e c u o s e R r t f e N o r t e P 12 OBJECTIVES AND WORK PROGRAM FOR 2007/2008 OBJECTIVES l To develop two proven oil fields to production in the near term. l To determine the full upside reserve potential of the Licence and expand production from these reserves. TOWARD PRODUCTION l Pipeline Design, Survey and Approvals Contract awarded. l Feasibility Study on production to be completed in third quarter. l Decision to Sanction Development Project in third quarter. l Agree Debt Facility for Development Project. l Tender for Pipeline Procurement and Construction. TOWARD RESERVE EXPANSION P e t r o N e f t r R e s o u c e s p c A n n u a l l l Three high value exploration/delineation wells to be drilled on the R e p o r t North Korchegskaya Prospect, the West Lobe of the Tungolskoye Oil Field and West Lineynoye or other prospects, depending on the final interpretation of the 2006/2007 seismic data. l 500 line kms seismic survey to define further drilling prospects and leads. i a n d F n a n c a i l A c c o u n t s 2 0 0 6 13 Report of Directors The Directors present their report and the financial statements for the year ended 31 December 2006. PRINCIPAL ACTIVITY AND BUSINESS REVIEW The principal activities of the Group are that of hydrocarbon exploration and appraisal. The Group was established to acquire and develop, directly or indirectly, oil and gas exploration, development and production interests in Russia and other countries of the Former Soviet Union (FSU). A detailed business review is included in the operational review. RESULTS AND DIVIDENDS The loss for the period after providing for depreciation and taxation amounted to US$993,343 (2005 - US$(260,414)). The Directors do not recommend payment of a final dividend. PRINCIPAL RISKS AND UNCERTAINTIES There are a number of risks and uncertainties which could have an impact on the Group’s long-term performance. Risks and uncertainties facing the Group include but are not limited to: l Availability and cost of drilling rigs, related services and qualified personnel; the absence of which could lead to delays in the work programme. 6 0 0 2 s t n u o c c A incurred l The Group holds cash in Euros but a substantial amount of exploration and development costs are in Russian Rubles and US Dollars. An adverse movement in exchange rates would increase the US Dollar cost of the work programme. However in January 2007 the Group entered into hedging arrangements in respect of its currency risks relating to the 2006/07 drilling program thereby fixing the exchange rates at which it will incur these costs. l The Group’s principal assets are located in Russia and as a result the Group may be subject to political, economic and other uncertainties that could impact the economic viability of the Group’s assets. The Group has a risk management structure in place which is designed to identify, manage and mitigate business risk. Risk assessment and evaluation is an essential part of the Company’s internal control system. DIRECTORS In accordance with the Articles of Association, Dennis Francis and David Sanders retire by rotation and, being eligible, offer themselves for re-election. DIRECTORS AND THEIR INTERESTS The Directors and Secretary who held office during the period had no interest, other than those shown below, in the shares of the Company. DIRECTORS G. David Golder Dennis Francis David Sanders* Desmond Burke POSITION As at 30-APR-07 Non-Executive Chairman 3,165,458 Chief Executive Executive Director Executive Director 20,289,617 4,180,605 5,304,204 Vakha Alvievich Sobraliev Non-Executive Director 22,915,047 Thomas Hickey Non-Executive Director 665,000 * Company Secretary Ordinary shares Ordinary shares Ordinary shares As at 31-DEC-06 2,944,458 20,289,617 4,180,605 5,304,204 22,650,052 585,000 As at 1-JAN-06 2,409,050 19,754,210 4,047,205 4,967,204 14,743,386 250,000 l i a c n a n F d n a i t r o p e R l l a u n n A c p s e c u o s e R r t f e N o r t e P 14 In addition to the above the Company granted Share Options to the Directors during the year as follows Director G.David Golder Dennis Francis David Sanders Desmond Burke Vakha Alvievich Sobraliev Thomas Hickey No. of Options 440,000 880,000 880,000 660,000 440,000 440,000 Exercise price €0.295 €0.295 €0.295 €0.295 €0.295 €0.295 These options will vest subject to the achievement of a number of separate performance conditions, principally associated with the successful appraisal and ultimate development of the Lineynoye and Tungolskoye Fields. The earliest vesting date will be the 27th September 2007, in respect of up to 55% of options. SIGNIFICANT SHAREHOLDERS So far as the Directors are aware, the names of the persons other than the Directors who, directly or indirectly, are interested in 3% or more of the Issued Share Capital are as follows: Shareholder No. of shares held RAB Octane Fund Limited Davycrest Nominees Limited Vidacos Nominees Limited 37,607,377 32,747,683 11,812,803 % 21.29% 18.54% 6.69% FUTURE DEVELOPMENTS The main asset of the Company is a 100% interest in an approximately 5,000 km2 oil and gas licence in the Tomsk Oblast, held through wholly owned subsidiary, Stimul-T. The licence contains two previously drilled and tested oil fields, Tungolskoye and Lineynoye, which PetroNeft has targeted for rapid development. It is also estimated that substantial further reserves could be contained in a number of defined exploration prospects on the Licence. Turnkey Drilling Contracts are in place to drill three wells as part of the work programme commencing in the winter of 2006/2007. Two of these wells, Lineynoye No. 6 and Tungolskoye No. 4, are delineation wells on the existing fields and the third well, Lineynoye No. 7, is a high impact exploration well on the West Lineynoye Prospect. The drilling results from these three wells will be used to update the Preliminary Feasibility Study as a basis to sanction the Development Project and acquire development financing. The Company’s primary objective is to establish a rapid development plan for oil production on the Licence and to achieve year round oil production via an export pipeline in 2009. A major seismic survey consisting of the acquisition of 540 kms of 2D data was completed in March 2007 with the objective of further defining the structure of the two established oil fields and other prospects and leads. The plan is to utilise the existing drilling rigs to drill three additional high impact exploration/ delineation wells commencing in the winter 2007/2008. DIRECTORS’ RESPONSIBILITIES The Directors are responsible for preparing the Director’s Report and Financial Statements. The Directors have chosen to prepare accounts for the Group in accordance with International Financial Reporting Standards (IFRS). International Accounting Standard 1 requires that financial statements present fairly for each year the Group’s financial position, financial performance and cash flows. This requires the faithful representation of the effects of transactions, other events and conditions in accordance with the definitions and recognition criteria for assets, liabilities, income and expenses set out in the International Accounting Standards Board’s ‘Framework for the preparation and presentation of Financial Statements’. In virtually all circumstances, a fair presentation will be achieved by compliance with all the applicable International Financial Reporting Standards. Directors are also required to: l properly select and apply accounting policies; l present information, including accounting policies, in a manner that provides relevant, reliable, comparable and understandable information; l provide additional disclosures when compliance with the specific requirements in International Financial Reporting Standards is insufficient to enable users to understand the impact of particular transactions, other events and conditions on the entity’s financial position and financial performance; and l prepare the financial statements on the going concern basis unless it is inappropriate to presume that the Group will continue in business. The Directors are responsible for keeping proper accounting records which disclose with reasonable accuracy at any time the financial position of the Company and to enable them to ensure that the financial statements comply with the Companies Acts 1963 to 2006 and all regulations to be construed as one with those acts. They are also responsible for safeguarding the assets of the Company and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities. P e t r o N e f t r R e s o u c e s p c A n n u a l l R e p o r t i a n d F n a n c a i l A c c o u n t s 2 0 0 6 15 CORPORATE GOVERNANCE The Directors are committed to maintaining the highest standards of corporate governance commensurate with the size, stage of development and financial status of the Group. BOARD: The Company currently has six Directors, comprising three executive Directors and three non-executive Directors. The Board met formally on 11 occasions during 2006. An agenda and supporting documentation was circulated in advance of each meeting. All the Directors bring independent judgement to bear on issues affecting the Group and all have full and timely access to information necessary to enable them to discharge their duties. The Directors have a wide and varying array of experiences in the industry. Each year, at the Annual General Meeting, one-third of the Directors shall retire and the Company may fill the office by electing another person or the retiring Director, if willing to act. This year Dennis Francis and David Sanders retire as Directors and put themselves forward for re-election. Any Director appointed by the Board to fill a vacancy during the year is subject to election at the next Annual General Meeting the date of appointment. following The following committees deal with the specific aspects of the Group affairs: the THE REMUNERATION COMMITTEE This Committee comprises three non-executive Directors, G. David Golder, Thomas Hickey and Vakha Sobraliev. It determines the contract terms, remuneration and other benefits of the executive Directors, Chairman Remuneration and Committee met on two occasions during the year. non-executive Directors. The Remuneration Committee Report The group’s policy on senior executive remuneration is designed to attract and retain people of the highest calibre who can bring their experience and independent views to the policy, strategic decisions and governance of the group. In setting remuneration levels, the Remuneration Committee takes into consideration the remuneration practices of other companies of similar size and scope. A key philosophy is that staff must be properly rewarded and motivated to perform interests of the shareholders. Bonuses for Executive Directors are based on various performance targets such as shareholder return and individual performance. Remuneration during the year ended 31 December 2006 was as follows: in the best Executive Directors Dennis Francis David Sanders Desmond Burke Non-Executive Directors G. David Golder Thomas Hickey Vakha Sobraliev Basic US$ Bonus US$ 2006 Total US$ 2005 Total US$ 134,834 117,333 101,626 353,793 82,396 75,507 44,930 202,833 36,135 28,538 14,435 79,108 - - - - 217,230 192,840 146,556 556,626 36,135 28,538 14,435 79,108 15,730 15,729 15,729 47,188 3,404 2,722 1,361 7,487 432,901 202,833 635,734 54,675 the AUDIT COMMITTEE: three non-executive This Committee comprises Directors, G. David Golder, Thomas Hickey and Vakha Sobraliev. The external auditors have the opportunity to meet with members of the Audit Committee without executive management present at least once a year. The duties of the Committee include the review of the accounting principles, policies and practices adopted in preparing the financial statements, external compliance matters and the review of the Group’s financial results. NOMINATIONS COMMITTEE: Given the current size of the Group a Nominations is not considered necessary. The Board Committee reserves to itself the process by which a new Director is appointed. 6 0 0 2 s t n u o c c A l i a c n a n F d n a i t r o p e R l l a u n n A c p s e c u o s e R r t f e N o r t e P 16 COMMUNICATIONS: The Group maintains regular contact with shareholders through publications such as the annual and half-year report and via press releases and the Group’s website, www.petroneft.com. The Directors are responsive to shareholder enquiries throughout the year. The Board regards the Annual General Meeting as a particularly important opportunity for shareholders, Directors and management to meet and exchange views. INTERNAL CONTROL The Directors have overall responsibility for the Group’s internal control and have delegated system of responsibility for the implementation of this system to executive management. This system includes financial controls that enable the Board to meet its responsibilities for the integrity and accuracy of the Group’s accounting records. The Group’s system of internal financial control provides reasonable, though not absolute assurance that assets are safeguarded, transactions authorised and recorded properly and that material errors or irregularities are either prevented or detected within a timely period. Having made appropriate enquiries the Directors consider that the financial, operational and compliance controls and risk management operated effectively during the period covered by the financial statements and up to the date on which the financial statements were signed. system of internal The internal control system includes the following key features, which have been designed to provide internal financial control appropriate to the Group’s businesses: l Budgets are prepared for approval by the Board. l Expenditure and income are compared to previously approved budgets. l A detailed investment approval process which requires Board approval of all major capital projects and regular review of the physical performance and expenditure on these projects. taken by the Directors BOOKS OF ACCOUNT to ensure The measures compliance with the requirements of Section 202, Companies Act 1990, regarding proper books of account are the implementation of necessary policies and procedures for recording transactions, the employment of competent accounting personnel with appropriate expertise and the provision of adequate resources to the financial function. The books of account of the Company are maintained at One Earlsfort Centre, Earlsfort Terrace, Dublin 2. AUDITORS The auditors, LHM Casey McGrath, have indicated their willingness to continue in office in accordance with the provisions of Section 160(2) of the Companies Act, 1963. On behalf of the Board P e t r o N e f t Dennis Francis Director Date: 23rd May 2007 Desmond Burke Director Date: 23rd May 2007 r R e s o u c e s p c A n n u a l l R e p o r t i a n d F n a n c a i l A c c o u n t s 2 0 0 6 17 Independent Auditors’ Report INDEPENDENT AUDITORS’ REPORT TO THE SHAREHOLDERS OF PETRONEFT RESOURCES plc books of account have been kept by the Company; whether, at the balance sheet date, there exists a financial situation requiring the convening of an We have audited the financial statements of PetroNeft extraordinary general meeting of the Company; and Resources Plc for the year ended 31 December 2006 on whether the information given in the Directors’ Report is pages 22 to 34. These financial statements have been consistent with the financial statements. In addition, we prepared under the accounting policies set out on page state whether we have obtained all the information and 20 to 21. explanations necessary for the purposes of our audit and whether the financial statements are in agreement with This report is made solely to the Company’s members as a the books of account. body in accordance with the requirements of the Companies Acts 1963 to 2006. Our audit work has been We report to the shareholders if, in our opinion, any undertaken so that we might state to the Company’s information specified by law regarding Directors’ members those matters that we are required to state to remuneration and Directors’ transactions is not given and, them in the audit report and for no other purpose. To the where practicable, include such information in our report. fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the Company We read the other information contained in the annual or the Company’s members as a body for our audit work, report and consider whether it is consistent with the for this report, or for the opinions we have formed. audited financial statements. The other information comprises only the Report of the Directors, the Chairman’s RESPECTIVE RESPONSIBILITIES OF DIRECTORS AND AUDITORS As described on page 15 the Company’s Directors are Statement and the Operations Overview. We consider the implications for our report if we become aware of any apparent misstatements or material inconsistencies with responsible for the preparation of financial statements in the financial statements. Our responsibilities do not extend accordance with applicable law and International to any other information. Financial Reporting Standards. Our responsibility is to audit the financial statements in BASIS OF OPINION We conducted our audit in accordance with International accordance with relevant legal and regulatory Standards on Auditing (UK and Ireland) issued by the requirements and International Standards on Auditing (UK Auditing Practices Board. An audit includes examination, and Ireland). on a test basis, of evidence relevant to the amounts and disclosures in the financial statements. It also includes an We report to you our opinion as to whether the financial assessment of the significant estimates and judgements statements give a true and fair view, in accordance with made by the Directors in the preparation of the financial International Financial Reporting Standards and are statements, and whether the accounting policies are properly prepared in accordance with the Companies appropriate to the Company’s circumstances, Acts. We also report to you whether, in our opinion, proper consistently applied and adequately disclosed. 6 0 0 2 s t n u o c c A l i a c n a n F d n a i t r o p e R l l a u n n A c p s e c u o s e R r t f e N o r t e P 18 We planned and performed our audit so as to obtain all Group. The financial statements are in agreement with the the information and explanations which we considered books of account. necessary in order to provide us with sufficient evidence to give reasonable assurance that the financial statements In our opinion the information given in the Directors’ report are free from material misstatement, whether caused by is consistent with the financial statements. fraud or other irregularity or error. In forming our opinion we also evaluated the overall adequacy of the presentation The net assets of the Company, as stated in the Balance of information in the financial statements. Sheet on page 25, are more than half of the amount of its INTANGIBLE ASSETS In forming our opinion, we have considered called up share capital and, in our opinion, on that basis there did not exist at 31 December 2006 a financial the situation which under Section 40(1) of the Companies adequacy of the disclosures made in Note 8 to the (Amendment) Act 1983 may require the convening of an financial statements in relation to the Directors’ extraordinary meeting of the Company. assessment of the carrying value of the Group’s intangible assets, amounting to $10,639,292. Our opinion is not qualified in this respect. OPINION In our opinion the financial statements: l give a true and fair view, in accordance with Chartered Certified Accountants LHM Casey McGrath International Financial Reporting Standards, of the Registered Auditors state of the Group and Parent Company’s affairs as at 6 Northbrook Road the 31 December 2006 and of its loss and cash flows for Dublin 6 the period then ended. Ireland l have been properly prepared in accordance with the Companies Acts 1963 to 2006 and all regulations to be Date: 23rd May 2007 construed as one with those acts. We have obtained all the information and explanations we consider necessary for the purposes of our audit. In our opinion proper books of account have been kept by the P e t r o N e f t r R e s o u c e s p c A n n u a l l R e p o r t i a n d F n a n c a i l A c c o u n t s 2 0 0 6 19 Statement of Accounting Policies The following accounting policies have been applied consistently in dealing with items which are considered material in relation to the Company's financial statements. TAXATION Income tax expense represents the sum of the tax currently payable and deferred tax. The tax currently payable is based on taxable profits for the year. Taxable profits differ from profit as reported in the income statement because it excludes items of income or expense that are taxable or deductible in other years and it further excludes items that are never taxable or deductible. The Groups is calculated using tax rates that have been enacted or substantively enacted by the balance sheet date. for current liability tax Deferred taxation is recognised in respect of all timing differences that have originated but not reversed at the balance sheet date where transactions have occurred at that date that will result in an obligation to pay more, or a right to pay less or to receive more, taxation. Deferred taxation is measured on an undiscounted basis at the taxation rates that are anticipated to apply in the periods in which the timing differences reverse, based on taxation rates and legislation which are enacted or substantively enacted at the balance sheet date. ACCOUNTING CONVENTION The financial statements are prepared in accordance with International Financial Reporting Standards under the historic cost convention. In accordance with the provisions of Section 3(2) of the Companies (Amendment) Act 1986 the Profit and Loss of the Company is not presented separately. DEVELOPMENT COSTS The Group adopts the successful efforts method of accounting for exploration and appraisal costs. All licence acquisition, exploration and evaluation costs are initially capitalised in cost centres by well, field or exploration area, as appropriate. Directly attributable administration costs and interest payable are capitalised insofar as they relate to specific exploration and development activities. Pre-licence costs are expensed in the period in which they are incurred. 6 0 0 2 s t n u o c c A These costs are then written off unless commercial reserves have been established or the determination process has not been completed and there are no indications of impairment. TANGIBLE FIXED ASSETS AND DEPRECIATION Tangible fixed assets are stated at cost or valuation, less accumulated depreciation. Depreciation is provided at rates calculated to write off the cost less residual value of each asset over its expected useful life, as follows: Land and buildings Furniture and Fittings Motor Vehicles - Straight Line over 30 years - 20% Straight line - 20% Straight line l i a c n a n F d n a i t r o p e R l l a u n n A c p s e c u o s e R r t f e N o r t e P 20 FOREIGN CURRENCIES Monetary assets and liabilities denominated in foreign SHARE BASED PAYMENTS Equity-settled share-based payments to employees and currencies are translated into US Dollars at contract rates others providing similar services are measured at the fair where the amounts payable or receivable are covered by value of the equity instrument at the grant date in forward contracts. Other monetary assets and liabilities accordance with IFRS 2. Fair value is measured by use of are translated into US Dollars at rates of exchange ruling at a binomial model. The expected life used in the model has the balance sheet date. Exchange gains and losses are been adjusted, based on management’s best estimate, dealt with in the profit and loss account. for the effects of non-transferability, exercise restrictions IMPAIRMENT OF TANGIBLE AND INTANGIBLE ASSETS EXCLUDING GOODWILL At each balance sheet date, the Group reviews the and behavioural considerations. Further details on how the fair value of equity-settled share based transactions has been determined can be found in note 23. carrying amounts of its tangible and intangible assets to The fair value determined at the grant date of the equity- determine whether there is any indication that those settled share-based payments is expensed on a straight- assets have suffered an impairment loss. If such indication line basis over the vesting period, based on the Group’s exists, the recoverable amount of the asset is estimated in estimate of shares that will eventually vest. order to determine the extent of the impairment loss (if any). Where it is not possible to estimate the recoverable Equity-settled share-based payment transactions with amount of an individual asset, the Group estimates the other parties are measured at the fair value of the goods recoverable amount of the cash-generating unit to which and services received, except where the fair value the asset belongs. CONSOLIDATED ACCOUNTS The Group Financial Statements consolidate the results of the Company and its wholly owned subsidiary Stimul-T from the date of acquisition under the acquisition method. cannot be estimated reliably, in which case they are measured at the fair value of the equity instruments granted, measured at the date the entity obtains the goods or the counterparty renders the service. SHARE ISSUE EXPENSES AND SHARE PREMIUM ACCOUNT Costs of share issues are written off against the premium arising on the issues of share capital. P e t r o N e f t r R e s o u c e s p c A n n u a l l R e p o r t i a n d F n a n c a i l A c c o u n t s 2 0 0 6 21 CONSOLIDATED INCOME STATEMENT for the year ended 31 December 2006 YEAR ENDED PERIOD ENDED 31 December 2006 31 December 2005 Note US$ US$ 1 3 2 5 (1,070,950) 25,262 (1,045,688) 66,249 (13,904) (241,331) - (241,331) (19,083) (993,343) (260,414) 0.75 c 0.53 c 0.29c 0.29c Administrative expenses Other income Operating loss Interest receivable Interest payable and similar charges Retained loss for the period Loss per share: Basic Diluted There are no recognised gains or losses other than those disclosed above and there have been no discontinued activities in the current or preceding periods. On behalf of the Board Dennis Francis Director Date:23rd May 2007 Desmond Burke Director Date: 23rd May 2007 6 0 0 2 s t n u o c c A l i a c n a n F d n a i t r o p e R l l a u n n A c p s e c u o s e R r t f e N o r t e P 22 CONSOLIDATED BALANCE SHEET as at 31 December 2006 Non-Current Assets Property, plant and equipment Other intangible assets Other assets Current Assets Trade and other receivables Cash and cash equivalents Total Assets Equity and Liabilities Capital and Reserves Called up share capital Share premium account Reserves Profit and loss account Equity attributable to equity holders of the parent Current Liabilities Trade and other payables Total Liabilities AS AT AS AT 31 December 2006 31 December 2005 Note US$ US$ 7 8 10 11 12 15 16 16 16 18 13 328,521 10,639,292 3,689,480 14,657,293 43,792 12,872,316 12,916,108 169,937 6,093,657 - 6,263,594 451,323 256,208 707,531 27,573,401 6,971,125 2,132,436 26,048,130 219,197 (1,253,757) 27,146,006 427,395 427,395 1,052,260 4,861,880 - (260,414) 5,653,726 1,317,399 1,317,399 Total Equity and Liabilities 27,573,401 6,971,125 P e t r o N e f t On behalf of the Board Dennis Francis Director Date: 23rd May 2007 Desmond Burke Director Date: 23rd May 2007 r R e s o u c e s p c A n n u a l l R e p o r t i a n d F n a n c a i l A c c o u n t s 2 0 0 6 23 GROUP STATEMENT OF CHANGES IN EQUITY for the year ended 31 December 2006 Loss for the period Dividends Net proceeds of equity share issue YEAR ENDED PERIOD ENDED 31 December 2006 31 December 2005 US$ US$ (993,343) - (993,343) 22,266,426 21,273,083 (260,414) - (260,414) 5,914,140 5,653,726 6 0 0 2 s t n u o c c A l i a c n a n F d n a i t r o p e R l l a u n n A c p s e c u o s e R r t f e N o r t e P 24 COMPANY BALANCE SHEET as at 31 December 2006 AS AT AS AT 31 December 2006 31 December 2005 Note US$ US$ Non-Current Assets Property, plant and equipment Other intangible assets Current Assets Trade and other receivables Cash and cash equivalents Total Assets Equity and Liabilities Capital and Reserves Called up share capital Share premium account Reserves Profit and loss account 7 8 11 12 15 16 16 3,526 425,075 428,601 14,330,217 12,838,880 27,169,097 27,597,698 2,132,436 26,048,130 219,197 (946,814) 4,446 411,851 416,297 6,367,313 12,478 6,379,791 6,796,088 1,052,260 4,861,880 - (220,238) Equity Shareholders’ Funds 27,452,949 5,693,902 Current Liabilities Trade and other payables Total Liabilities Total Equity and Liabilities 13 144,749 144,749 27,597,698 1,102,186 1,102,186 6,796,088 P e t r o N e f t r R e s o u c e s p c A n n u a l l R e p o r t i a n d F n a n c a i l A c c o u n t s 2 0 0 6 25 CASH FLOW STATEMENT for the year ended 31 December 2006 YEAR ENDED PERIOD ENDED 31 December 2006 31 December 2005 US$ US$ Net loss before interest and income tax (1,045,688) (241,331) Adjustments for: Share based payments charge Depreciation for - Property, plant and equipment 219,197 17,725 - 910 Operating profit before working capital changes (808,766) (240,421) Decrease/(Increase) in trade receivables (Decrease)/Increase in trade payables Cash generated from operations Interest received/(paid) Net cash flow from operating activities Investing activities Purchase of property, plant and equipment Purchase of other intangible assets Payment for other assets 407,531 (890,004) (1,291,239) 52,345 (1,238,894) (176,309) (4,545,635) (3,689,480) (451,323) 1,317,399 625,655 (19,083) 606,572 (170,847) (6,093,657) – Net cash used in investing activities (8,411,424) (6,264,504) Cash flows from financing activities Proceeds from issue of share capital Net cash received from financing activities Net increase in cash and cash equivalents 6 0 0 2 s t n u o c c A 22,266,426 22,266,426 12,616,108 Cash and Cash equivalents at the beginning of the period 256,208 5,914,140 5,914,140 256,208 - Cash and cash equivalents at the end of the period 12,872,316 256,208 l i a c n a n F d n a i t r o p e R l l a u n n A c p s e c u o s e R r t f e N o r t e P 26 NOTES ON AND FORMING PART OF THE FINANCIAL STATEMENTS for the year ended 31 December 2006 1. OPERATING LOSS Operating loss is stated after charging/(crediting): Depreciation of tangible assets Net Foreign Exchange Gains Auditors’ remuneration (See below) Audit Services Statutory Audit Taxation and other services Compliance services Total YEAR ENDED 31 Dec. 2006 US$ PERIOD ENDED 31 Dec. 2005 US$ 17,725 (337,199) 66,000 32,500 33,500 66,000 910 - 22,000 22,000 - 22,000 Further fees totalling US$ 19,500 (2005 - US$6,000) in respect of non-audit services associated with share issues have been set against share premium 2. FINANCE COSTS On loans and overdrafts 3. INTEREST RECEIVABLE Interest receivable 4. EMPLOYEES Number of employees The average monthly numbers of employees (including the directors) during the period was: Directors Senior Management Support Staff Employment costs (Including directors) Wages and salaries Social Insurance costs 4.1. Directors’ emoluments Remuneration and other emoluments 13,904 13,904 66,249 66,249 5 3 8 16 US$ 734,440 17,071 751,511 635,734 635,734 19,083 19,083 - - 5 - - 5 US$ 88,230 - 88,230 54,674 54,674 P e t r o N e f t r R e s o u c e s p c A n n u a l l R e p o r t i a n d F n a n c a i l A c c o u n t s 2 0 0 6 27 NOTES ON AND FORMING PART OF THE FINANCIAL STATEMENTS for the year ended 31 December 2006 Continued 5. LOSS PER ORDINARY SHARE Basic loss per ordinary share amounts are calculated by dividing net loss for the period attributable to ordinary equity holders of the parent by the weighted average number of shares outstanding during the period. Diluted loss per ordinary share amounts are calculated by dividing net loss for the period attributable to ordinary equity holders of the parent by the weighted average number of ordinary shares outstanding during the period plus the weighted average number of ordinary shares that would be issued if employee and other share options were converted into ordinary shares. Earnings Net loss attributable to equity shareholders Effect of dilutive potential ordinary shares YEAR ENDED 31 Dec. 2006 US$ (993,343) - PERIOD ENDED 31 Dec. 2005 US$ (260,414) - Diluted net loss attributable to equity shareholders (993,343) (260,414) Number of Shares Basic weighted average number of shares 132,796,503 90,098,470 Dilutive potential ordinary shares 53,313,755 - Diluted weighted average number of shares 186,110,258 90,098,470 Loss per share: Basic Diluted 6. INCOME TAX EXPENSE Current year taxation Corporation Tax (12.5%) 0.75 c 0.53 c 0.29c 0.29c - - The tax assessed for the period is lower than the standard rate of corporation tax of 12.5%. The differences are explained below: Loss on Ordinary Activities before Tax (993,343) (260,414) Loss on Ordinary Activities multiplied by the standard rate of corporation tax of 12.5% (124,168) (32,552) Effects of: Depreciation in excess of Capital Allowances for the year Losses available for carry forward Tax charge for the year - 124,168 - - 32,552 - 6 0 0 2 s t n u o c c A l i a c n a n F d n a i t r o p e R l l a u n n A c p s e c u o s e R r t f e N o r t e P 28 NOTES ON AND FORMING PART OF THE FINANCIAL STATEMENTS for the year ended 31 December 2006 7. TANGIBLE ASSETS Group Land and buildings US$ Cost Additions - Acquired on acquisition of a subsidiary 159,500 At 1 January 2006 Additions At 31 December 2006 Depreciation Charge for the period At 1 January 2006 Charge for the year At 31 December 2006 Net book values 159,500 109,813 269,313 532 532 8,805 9,337 Fixtures & fittings US$ 4,599 6,748 11,347 - 11,347 378 378 2,270 2,648 Motor vehicles US$ - - - 66,496 66,496 - - 6,650 6,650 Total US$ 4,599 166,248 170,847 176,309 347,156 910 910 17,725 18,635 At 31 December 2006 259,976 8,699 59,846 328,521 At 31 December 2005 158,968 10,969 - 169,937 Company Cost Additions At 1 January 2006 Additions At 31 December 2006 Depreciation Charge for the period At 1 January 2006 Charge for the period At 31 December 2006 Net book values At 31 December 2006 At 31 December 2005 Land and buildings US$ Fixtures & fittings US$ Motor vehicles US$ - - - - - - - - - - 4,599 4,599 - 4,599 153 153 920 1,073 3,526 4,446 - - - - - - - - - Total US$ 4,599 4,599 - 4,599 153 153 920 1,073 3,526 4,446 P e t r o N e f t r R e s o u c e s p c A n n u a l l R e p o r t i a n d F n a n c a i l A c c o u n t s 2 0 0 6 29 NOTES ON AND FORMING PART OF THE FINANCIAL STATEMENTS for the year ended 31 December 2006 8. INTANGIBLE ASSETS Group Cost Additions Acquired on Acquisition of a subsidiary At 1 January 2006 Additions At 31 December 2006 Net book values At 31 December 2006 At 31 December 2005 Company Cost Additions At 1 January 2006 Additions At 31 December 2006 Net book values At 31 December 2006 At 31 December 2005 Development Costs US$ 516,348 5,577,309 6,093,657 4,545,635 10,639,292 10,639,292 6,093,657 Development Costs US$ 411,851 411,851 13,224 425,075 425,075 411,851 Total US$ 516,348 5,577,309 6,093,657 4,545,635 10,639,292 10,639,292 6,093,657 Total US$ 411,851 411,851 13,224 425,075 425,075 411,851 The amounts for Development costs represent active exploration projects. These amounts will be written off to the Income Statement as exploration costs unless commercial reserves are established or the determination process is not completed and there are no indications of impairment. The outcome of ongoing exploration, and therefore whether the carrying value of Development assets will be ultimately be recovered, is inherently uncertain. 9. SUBSIDIARIES Details of the Company’s Subsidiaries at 31 December 2006 are as follows: Name of Subsidiary Country of registration or incorporation Proportion of Ownership Interest Proportion of Voting power held Principal Activity Stimul-T Russian Federation 100% 100% Oil and Gas exploration 6 0 0 2 s t n u o c c A l i a c n a n F d n a i t r o p e R l l a u n n A c p s e c u o s e R r t f e N o r t e P 30 NOTES ON AND FORMING PART OF THE FINANCIAL STATEMENTS for the year ended 31 December 2006 10. OTHER NON-CURRENT ASSETS Group Prepayments 11. TRADE AND OTHER RECEIVABLES Group Other debtors Prepayments Company Amounts owed by Group undertakings Other debtors Prepayments and accrued income 2006 US$ 3,689,480 3,689,480 2006 US$ - 43,792 43,792 2006 US$ 14,286,425 - 43,792 14,330,217 2005 US$ - - 2005 US$ 57,713 393,610 451,323 2005 US$ 6,309,600 57,713 - 6,367,313 The Directors consider that the carrying amount of trade and other receivables approximates their fair value. 12. CASH AND CASH EQUIVALENTS Group Cash at Bank and in Hand Company Cash at Bank and in Hand 13. TRADE AND OTHER PAYABLES Group Trade creditors Other taxes and social welfare costs Directors' accounts Other creditors Accruals and deferred income Company Directors' accounts Other taxes and social welfare costs Accruals and deferred income 2006 US$ 12,872,316 12,872,316 2006 US$ 12,838,880 12,838,880 2006 US$ 277,671 19,053 - - 130,671 427,395 2006 US$ - 14,077 130,672 144,749 2005 US$ 256,208 256,208 2005 US$ 12,478 12,478 2005 US$ 17,758 64,679 930,000 2,776 302,186 1,317,399 2005 US$ 800,000 - 302,186 1,102,186 The Directors consider that the carrying amount of trade payables approximates their fair value. Trade creditors and accruals principally comprise amounts outstanding for trade purchases and ongoing costs. P e t r o N e f t r R e s o u c e s p c A n n u a l l R e p o r t i a n d F n a n c a i l A c c o u n t s 2 0 0 6 31 NOTES ON AND FORMING PART OF THE FINANCIAL STATEMENTS for the year ended 31 December 2006 Acquiree’s Carrying amount US$ Fair value Adjustment US$ 166,248 5,464,104 437,781 150,995 (6,332,333) (113,205) - 113,205 - - - 113,205 14. ACQUISITION OF SUBSIDIARY - 2005 Net Assets acquired: Property, plant and equipment Development costs Trade and other receivables Bank and cash balances Trade and other payables Total consideration, satisfied by cash Net cash inflow arising on acquisition: Cash consideration paid Cash and cash equivalents acquired 15. SHARE CAPITAL - GROUP AND COMPANY Authorised 300,000,000 Ordinary shares of €0.01 each AAllllootttteedd,, ccaalllleedd uupp aanndd ffuullllyy ppaaiidd eeqquuiittyy 176,625,258 (2005 - 90,098,478) Ordinary shares of €0.01 each 2006 US$ 3,503,700 3,503,700 2,132,436 2,132,436 Fair value US$ 166,248 5,577,309 437,781 150,995 (6,332,333) - Nil - 150,995 150,995 2005 US$ 3,503,700 3,503,700 1,052,260 1,052,260 16. EQUITY RESERVES 2006 At 1 January 2006 Premium on issue of shares Retained loss for the period Share based payment charge Share premium account US$ 4,861,880 21,186,250 - - Profit and loss account US$ (260,414) - (993,343) - Other Reserves US$ - - - 219,197 Total US$ 4,601,466 21,186,250 (993,343) 219,197 At 31 December 2006 26,048,130 (1,253,757) 219,197 25,013,570 2005 Premium on issue of shares Retained loss for the period 4,861,880 - - (260,414) At 31 December 2005 4,861,880 (260,414) - - - 4,861,880 (260,414) 4,601,466 The issue costs of the share placings of US$1,222,707 (2005 - US$ 289,294) have been written off against the share premium account. 6 0 0 2 s t n u o c c A l i a c n a n F d n a i t r o p e R l l a u n n A c p s e c u o s e R r t f e N o r t e P 32 NOTES ON AND FORMING PART OF THE FINANCIAL STATEMENTS for the year ended 31 December 2006 17. LOSS OF HOLDING COMPANY As permitted by Section 3(2) of the Companies (Amendment) Act 1986 the parent Company’s profit and loss account has not been included in these financial statements. The parent Company’s loss after tax, including dividends receivable and before dividends payable, was US$726,576 (2005 - (US$220,238)). 18. RECONCILIATION OF MOVEMENTS IN SHAREHOLDERS’ FUNDS Group Opening shareholders’ funds Loss for the period Share based payment charge Net proceeds of equity share issue Net addition to shareholders’ funds 2006 US$ 5,653,726 (993,343) 219,197 22,266,426 21,492,280 2005 US$ - (260,414) - 5,914,140 5,653,726 Closing shareholders’ funds 27,146,006 5,653,726 Company Opening shareholders’ funds Loss for the period Share based payment charge Net proceeds of equity share issue Net addition to shareholders’ funds 5,693,902 (726,576) 219,197 22,266,426 21,759,047 - (220,238) - 5,914,140 5,693,902 Closing shareholders’ funds 27,452,949 5,693,902 19. CAPITAL COMMITMENTS Details of capital commitments at the accounting date are as follows: Contracted for but not provided in the financial statements Authorised by the Directors but not yet contracted for 2006 US$ 2005 US$ 8,066,482 2,000,000 - - The commitments relate to future payments due under drilling, seismic and feasibility study contracts entered into by the Company during 2006 which are due to complete in 2007. 20. RELATED PARTY TRANSACTIONS P e t r o N e f t r R e s o u c e s p c A n n u a l l Transactions between PetroNeft Resources Plc and its subsidiary Stimul-T have been eliminated on consolidation and are not disclosed in this note. Details of transactions between the Group and other related parties are disclosed below. R e p o r t Dennis Francis is a Director and significant shareholder of PetroNeft Resources Plc. During the period, Dennis Francis advanced the Group amounts totalling US$ 930,000. Interest of US$13,904 was paid on this amount. At 31 December 2006, PetroNeft Resources Plc owed Dennis Francis an amount of US$NIL (2005 - US$ 930,000). In February 2006 Stimul-T entered into a contract with Nizhnevartovskservis (“the Contractor”) for the drilling of 3 wells. The contract is a “Turnkey” contract under which the Contractor assumes substantially all liabilities in relation to the health and safety, environmental and other risks associated with drilling operation. The total value of the contract is approximately US$10.47 million. Vakha Alvievich Sobraliev, a director and significant shareholder of PetroNeft Resources Plc, is the principal of Nizhnevartovskservis. Payments totalling US$4,224,040 were made in 2006. i a n d F n a n c a i l A c c o u n t s 2 0 0 6 33 NOTES ON AND FORMING PART OF THE FINANCIAL STATEMENTS for the year ended 31 December 2006 21. GROSS CASH FLOWS Returns on investments and servicing of finance Interest paid Interest received Capital expenditure Payments to acquire intangible assets Payments to acquire tangible assets Payments to acquire other assets Financing Issue of ordinary share capital 22. GOING CONCERN Year ended 31 Dec 2006 US$ (13,904) 66,249 52,345 (4,545,635) (176,309) (3,689,480) (8,411,424) 22,266,426 22,266,426 Period ended 31 Dec 2005 US$ (2,840) - (2,840) (6,093,657) (170,847) - (6,264,504) 5,914,140 5,914,140 The financial statements are prepared under the assumption that the Group is a going concern on the basis that the Directors are satisfied that further funding, primarily through share placings, will be available to bring its projects to production. 23. SHARE BASED PAYMENTS Under the share option scheme employees of the Group can receive conditional awards of share options depending on their performance, seniority and length of service. Options vest under the scheme subject to various milestones for the Company such as drilling, production and shareholder return. The following table illustrates the number and weighted average exercise prices (WAEP) of, and movements in, share options during the year. Outstanding as at 1 January Granted During the Year Exercised During the Year Outstanding at 31 December Exercisable at 31 December 2006 Number - 6,815,000 - 6,815,000 - 2006 WAEP - €0.297 - 2005 Number - - - 2005 WAEP - - - - - The inputs of the option valuation model were: Risk free interest rate Expected volatility Dividend yield 3.75% pa 46% 0% pa The Company recognised a total expense of US$ 219,194 (2005:NIL) in respect of Share Options. 24. APPROVAL OF FINANCIAL STATEMENTS The financial statements were approved by the Board on 23rd May 2007. . 6 0 0 2 s t n u o c c A l i a c n a n F d n a i t r o p e R l l a u n n A c p s e c u o s e R r t f e N o r t e P 34 Notice of Annual General Meeting Notice is hereby given that the Annual General Meeting of PetroNeft Resources plc will be held at the Herbert Park Hotel, Ballsbridge, Dublin 4 at 11.00 am on Friday 29th June 2007, for the purposes of considering and, if thought fit, passing, the following Resolutions of which Resolutions numbered 1, 2, 3, 4, 5 and 6 will be proposed as Ordinary Resolutions and Resolution numbered 6 will be proposed as a Special Resolution. ORDINARY BUSINESS 1. To receive, consider and adopt the accounts for the year ended 31st December 2006 together with the Directors’ and Auditors’ reports thereon. To re-elect Mr. Francis as a Director, who retires by rotation in accordance with Article 83 of the Articles of Association of the Company. To re-elect Mr. Sanders as a Director, who retires by rotation in accordance with Article 83 of the Articles of Association of the Company. To reappoint LHM Casey McGrath, Chartered Certified Accountants as Auditors and to authorise the Directors to fix the remuneration of the Auditors. SPECIAL BUSINESS 5. That the Authorised Share Capital of the Company be and is hereby increased by €3,000,000 by the creation of 300,000,000 ordinary shares of €0.01 each ranking pari passu in all respect with the existing Ordinary Shares and the Memorandum and Articles of Association of the Company be and are hereby amended accordingly. That the Directors be and are hereby empowered pursuant to Sections 23 and 24 (1) of the Companies (Amendment) Act, 1983 to allot equity securities (within the meaning of the said Section 23) for cash pursuant to the authority conferred by Article 5(a) of the Articles of Association of the Company as if the said Section 23 does not apply to any such allotment provided that this power shall be limited to the allotment of equity securities; in connection with the exercise of any options or warrants to subscribe granted by the Company; (including, without limitation any shares purchased by the Company pursuant to the provisions of the 1990 Act and 2. 3. 4. 6. a) b) held as Treasury Shares) in connection with any offer of securities, open for a period fixed by the Directors, by way of rights, open offer or otherwise in favour of ordinary shareholders and/or any persons having a right to subscribe for or convert securities into ordinary shares in the capital of the Company (including, without limitation, any person entitled to options under any of the Company’s share option schemes or any other person entitled to participate in any of the Company’s profit sharing schemes for the time being) and subject to such exclusions or other arrangements as the Directors may deem necessary or expedient in relation to legal or practical problems under the laws of, or the requirements of any recognised body or stock exchange in, any territory; and up to an aggregate nominal value equal to the nominal value of 10% of the Issued Share Capital of the Company from time to time: which authority shall expire on the earlier of the date of the next annual general meeting of the Company held after the date of passing of this Resolution and at the close of business on 29th September 2008, save that the Company may before such expiry make an offer or agreement which would or might require equity securities to be allotted after such expiry and the Directors may allot equity securities in pursuance of such offer or agreement as if the power conferred hereby had not expired. c) David E. Sanders Secretary for and on behalf of the Board. C/O O’Donnell Sweeney Eversheds One Earlsfort Centre Earlsfort Terrace Dublin 2 28th May 2007 P e t r o N e f t r R e s o u c e s p c A n n u a l l R e p o r t i a n d F n a n c a i l A c c o u n t s 2 0 0 6 35 ANNUAL GENERAL MEETING 2007 - FORM OF PROXY Name Address Shareholder reference number I/we appoint the following person (proxy) to vote on my/our behalf at the Annual General Meeting of the Company to be held at 11.00am on Friday 29th June 2007 at Herbert Park Hotel, Ballsbridge, Dublin 4. (Please indicate your choice in one box only) The Chairman of the meeting o Please leave this box blank if you wish to select someone other than the Chairman. Or The following person: Please leave this box blank if you have selected the Chairman. Do not insert your own name(s). To attend and vote on my/our behalf at the annual general meeting of PetroNeft Resources plc to be held at 11.00 am on Friday 29th June 2007 at Herbert Park Hotel, Ballsbridge, Dublin 4 and at any adjournment of the meeting. I/we would like my/our proxy to vote on the resolutions proposed at the meeting as indicated on this form. Unless otherwise instructed, the proxy may vote as he or she sees fit or abstain in relation to any business of the meeting. Insert ‘X’ in the space provided to indicate how you wish your vote be cast. For more details about each resolution please see the Notice of Annual General meeting on page 35 of the Annual Report 2006 Resolution 1. To receive, consider and adopt the accounts for the year ended 31st December 2006 together with the Directors’ and Auditors’ reports thereon. For Against o o 2. To re-elect Mr. Francis as a Director 3. To re-elect Mr. Sanders as a Director 4. To reappoint LHM Casey McGrath, as Auditors and to authorise the Directors to fix the remuneration of the Auditors. 5. 6. To increase the Authorised Share Capital of the Company By way of Special Resolution, to authorise the directors to allot equity securities pursuant to Sections 23 and 24 of the Companies (Amendment) Act, 1983. o o o o o o o o o o Signature Date Any one joint Shareholder may sign Please Return this form to Computershare Investor Services (Ireland) Limited, Heron House, Corrig Road, Sandyford Industrial Estate, Dublin 18 Notes 1. A member entitled to attend and vote is entitled to appoint a proxy (who need not be a member of the Company) to attend, speak and vote instead of him. 2. Forms of proxy, to be valid must be lodged with the Company’s Registrars, Computershare Investor Services (Ireland) Limited, Heron House, Corrig Road, Sandyford Industrial Estate, Dublin 18, no later than 48 hours before the time appointed for the meeting. If the appointer is a corporation, this Form of Proxy must be under its common seal or under the hand of an officer or attorney duly authorised. In the case of joint holders, the vote of the senior who tenders a vote, whether in person or by proxy, will be accepted to the exclusion of the vote of the other registered holder(s) and for this purpose, seniority shall be determined by the order in which names stand in the register of members. 3. Completion and return of the Form of Proxy will not preclude ordinary shareholders from attending and voting at the meeting should they wish to do so. 4. Pursuant to Regulation 14 of the Companies Act 1990 (Uncertificated Securities) Regulations 1996, only those shareholders on the Register of Shareholders at 11.00 am 27th June 2007 shall be entitled to attend and vote at the meeting in respect of the number of shares registered in their names at that time. If the meeting is adjourned by more than 48 hours, then to be so entitled, shareholders must be entered on the Company’s Register of Shareholders at the time which is 48 hours before the time appointed for holding the adjourned meeting or, if the Company gives notice of the adjourned meeting, at the time specified in that notice. This form, which is personalised, may only be used in respect of the shareholder of whom details are shown above. Any alteration to such details, or attempt to use the form in respect of any other shareholder, may render the Form invalid. 6 0 0 2 s t n u o c c A l i a c n a n F d n a i t r o p e R 5. Please retain this section of the form to gain admittance to the meeting A D M I S S I O N C A R D PetroNeft Resources plc Annual General Meeting 11.00 am on Friday 29th June 2007 Shareholder’s Signature-------------------------------------------------------------------------------------------------------------------------------------- Signature of Proxy -------------------------------------------------------------------------------------------------------------------------------------------------------- Location of the Annual General Meeting: Herbert Park Hotel, Ballsbridge, Dublin 4 l l a u n n A c p s e c u o s e R r t f e N o r t e P 36