ShaMaran Petroleum Corp.
Annual Report 2012

Plain-text annual report

ShaMaran Petroleum Corp (cid:4)(cid:374)(cid:374)(cid:437)(cid:258)(cid:367)(cid:3)(cid:90)(cid:286)(cid:393)(cid:381)(cid:396)(cid:410) For the year ended December 31, 2012 SHAMARAN PETROLEUM CORP.  MANAGEMENT DISCUSSION AND ANALYSIS  For the year ended December 31, 2012  ________________________________________________________________________________________  Management’s discussion and analysis (“MD&A”) of the financial and operating results of ShaMaran Petroleum Corp.  (“ShaMaran” together with its subsidiaries the “Company”) is prepared as of March 15, 2013. The MD&A should be read  in conjunction with the audited consolidated financial statements for the year ended December 31, 2012 together with  the accompanying notes.  The  financial  statements  of  the  Company  have  been  prepared  in  accordance  with  International  Financial  Reporting  Standards  (“IFRS”)  as  issued  by  the  International  Accounting  Standards  Board.  Unless  otherwise  stated  herein  all  currency amounts indicated as “$” in this MD&A are expressed in thousands of United States Dollars.  Overview  ShaMaran  is  a  Canadian‐based  oil  and  gas  company  with  a  20.1%  direct  interest  in  the  Atrush  petroleum  property  located  in  Kurdistan  in  Northern  Iraq  (“Kurdistan”).  The  Company  is  currently  in  the  pre‐production  stages  of  its  appraisal and development program relating to the Atrush oil discovery on this petroleum property. ShaMaran trades  on the TSX Venture Exchange and the NASDAQ OMX First North Exchange (Stockholm) under the symbol “SNM”.  Highlights          The Company announced on February 4, 2013 an increase of 35% in Best Estimate 2C Contingent Resources (gross)  for  the  Atrush  Block,  from  465.6  MMBOE  at  December  31,  2011  to  627.3 MMBOE  at  the  end  of  2012.   The   estimates were provided by an independent qualified resources evaluator, McDaniel & Associates Consultants Ltd.,  in a Detailed Property Report prepared as at December 31, 2012.  On November 7, 2012 General Exploration Partners Inc (“GEP”), then operator of the Atrush Block and acting on  behalf of the Contractor Group under the Atrush Block Production Sharing Contract, submitted to the Atrush Block  Management Committee a Declaration of Commercial Discovery with effect from November 7, 2012.  The Atrush‐2 appraisal well was spudded on May 23, 2012 and a total depth of 1,750 meters was reached ahead of  schedule  on  July  10,  2012.  Following  the  conclusion  of  the  comprehensive  well  testing  program  the  Company  announced on September 13, 2012 that the main reservoir in Atrush‐2 produced a combined flow rate from three  separate  cased  hole  tests  of  more  than  42,200  barrels  of  oil  per  day  ("bopd")  and  that  additional  oil  resources  were confirmed in two additional formations.  The  Company  announced  on  August  20,  2012  that  it  sold  its  entire  20%  direct  interest  in  the  Taza  production  sharing contract (“PSC”) to a subsidiary of Total S.A. for a $48 million purchase price plus a reimbursement of costs  incurred on joint operations from April 1, 2012 until the closing date.  The Company signed final binding agreements with the Kurdistan Regional Government (“KRG”) in January 2012 to  relinquish the 60% working interests previously held in each of the Arbat and Pulkhana PSCs. An amount of $25  million was paid in January 2012 to the KRG as relinquishment fees to fulfill all outstanding financial commitments  on  these  two  blocks.  The  agreements  relieve  the  Company  of  any  further  obligations  under  these  PSCs.  Disappointing testing results from the Pulkhana 9 well led the Company to this decision.  In  August  2012  the  Company  repaid  in  full  the  short  term  loan  of  $10  million  which  had  been  obtained  in  April  2012 from two related parties.  At December 31, 2012 the Company had a cash balance of $41.2 million and working capital of $29.6 million.  On March 12, 2013 the Contractor entities to the Atrush Block PSC were notified by the KRG that it had exercised  its option to acquire a 25% Government Interest in accordance with the provisions of the Atrush Block PSC.  1                  Operations in Kurdistan  The Company holds a 20.1% direct interest in the Atrush Block petroleum property which is located in Kurdistan in the  northern extension of the Zagros Folded Belt adjacent to several major oil discoveries. The area is currently undergoing  a major exploration and development campaign by internationally recognised mid to large sized oil companies.  In the twelve months ended December 31, 2012 the Company completed a strategic realignment of its asset portfolio  and acquired control of GEP which holds the Company’s interest in the Atrush Block. In addition, significant progress  was made on the appraisal and development program in the Atrush Block with a Declaration of Commercial Discovery  submitted to the Atrush Block Management Committee on November 7, 2012.  In January 2012 ShaMaran signed a final binding agreement to relinquish to the KRG the 60% working interests which it  then held in each of the Arbat and Pulkhana PSCs. Under the terms of the agreement the PSC for each of the Pulkhana  and  Arbat  blocks  was  terminated  whereby  ShaMaran's  interests  in  both  PSCs  are  relinquished  and  the  Company  has  been relieved of any further obligations under these PSCs.   The  Company  announced  on  August  20,  2012  that  it  had  sold  its  entire  20%  direct  interest  in  the  Taza  Block  to  a  subsidiary of Total S.A.  At this time the Taza‐1 exploration well had been drilled to a depth of approximately 1,650m,  which  was  above  the  target  reservoirs.   This   asset  realignment  has  relieved  the  Company  from  the  remaining  work  program obligations of the Pulkhana, Arbat and Taza Blocks, provided ShaMaran with a solid financial position and cash  resources, and enables the Company to focus its activities and resources on the appraisal and development program  now in progress on the Atrush Block.  The Atrush‐2 appraisal well was drilled to total depth from May 2012 to July 2012 followed by a comprehensive well  testing program. On September 13, 2012 the Company announced the results of the testing program indicating that the  main reservoir produced a total flow rate of more than 42,200 bopd and that additional oil resources were confirmed in  two  additional  formations.  After  the  conclusion  of  operations  on  Atrush‐2  the  drilling  rig  was  moved  to  the  Atrush‐1  discovery  well  to  do  a  workover  which  was  completed  in  November  2012.  The  drilling  rig  will  now  be  moved  to  the  Atrush‐3 appraisal well which is expected to be spudded in March 2013.  GEP completed two principal transactions in December 2012 (the “Transactions”) resulting in the December 31, 2012  sale  of  a  53.2%  direct  interest  in  the  Atrush  Block  to  TAQA  Atrush  B.V.  (“TAQA”),  a  subsidiary  of Abu  Dhabi  National  Energy Company PJSC, and the December 31, 2012 repurchase from Aspect of the entire 66.5% shareholding interest  which  Aspect  held  in  GEP.  As  a  result  of  the  Transactions  ShaMaran  Ventures B.V.,  a  100%  owned  subsidiary  of  the  Company,  became  the  sole  remaining  shareholder  of  GEP  and  the  Company  has  therefore  acquired  control  of  GEP  which then held a 26.8% direct interest in the Atrush Block. Following the March 12, 2013 exercise by the KRG of its  option to acquire a 25% PSC interest the Company’s interest in this PSC is 20.1%.  Atrush Block  The Atrush Block is located approximately 85 km northwest of Erbil, the capital of the Kurdish administered part of Iraq,  and is 269 square kilometers in area.  The topography is similar to the Shaikan Block to the south which had a major  discovery reported by Gulf Keystone Petroleum Ltd in January 2010.  Immediately to the north of the Atrush Block is the  Sarsang block where Hillwood International Energy also made an oil discovery in the Swara Tika‐1 well. To the east is the  Kalegran‐operated  Akri‐Bijeel  block  which  also  has  discoveries.  The  structures  located  on  the  block  contain  multiple  stacked  oil  reservoirs  in  the  Cretaceous,  Jurassic  and  Triassic  sections  and  due  to  a  high‐degree  of  fracturing  have  demonstrated very high production rates.  In addition to the proven Atrush Jurassic oil discovery the Atrush Block has  additional  exploration  upside  in  the  shallower  Cretaceous  reservoirs,  a  northern  extension  of  the  Atrush  oil  accumulation at the Jurassic level into the Swara Tika structure, and the deeper Triassic Kurra Chine “C” (“KCC”).  In  August  2010  the  Company  acquired  a  33.5%  shareholding  in  GEP  which  then  held  an  80%  working  interest  in  the  Atrush Block PSC, with the remaining 20% third party interest (“TPI”) being held by the KRG. In October 2010 Marathon  Oil  Corporation  (“Marathon”)  was  assigned  the  20%  TPI  in  the  PSC.  On  December  31,  2012  GEP  sold  a  53.2%  direct  interest in the Atrush Block to TAQA who also assumed from GEP the operatorship of the Block, and repurchased the  entire  66.5%  shareholding  which  Aspect  held  in  GEP,  leaving  the  Company  with  a  100%  shareholding  interest  in  GEP  which then held a 26.8% direct interest in the PSC. The Company’s direct interest in the PSC was 20.1% after the KRG  exercised its option to participate, explained in the following paragraph.  2          On March 12, 2013 the Contractor entities to the Atrush Block PSC were notified by the KRG that it had exercised its  option to acquire a 25% Government Interest in accordance with the provisions of the Atrush Block PSC. The KRG now  participates as a Contractor Entity with a 25% undivided interest in the petroleum operations and all the other rights,  duties, obligations and liabilities of the Contractor in the PSC and becomes liable for its share of the petroleum costs  incurred on or after the first commercial declaration date.   Fiscal terms under the PSC include a 10% royalty, a variable profit split, based on a percentage share to the KRG and a  capacity building payment equal to 30% of profit oil (produced oil, less royalty and cost oil) to be paid to the KRG. GEP  has the right to recover costs using up to 40% of the available oil (produced oil less royalty oil) and 55% of the produced  gas.  GEP  acquired  143  km  of  2D  seismic  data  over  the  Atrush  Block  in  2008.  The  first  exploration  well  was  spudded  on  October  5,  2010  and  a  total  depth  of  3,400  meters  was  reached  on  January  21,  2011.  A  comprehensive  well  testing  program  consisting  of  ten  drill  stem  tests  (“DSTs”)  commenced  on  January  30,  2011  and  was  completed  on  April  3,  2011. Following notification to the KRG of a major Jurassic oil discovery on April 4, 2011 GEP submitted an Appraisal  Work  Program  consisting  of  3D  seismic,  appraisal  wells  and  studies  and  a  possible  installation  of  an  extended  test  facility to conduct production testing in the field.   3D seismic acquisition operations commenced on the block in July 2011 and were completed on August 11, 2012 with  3D seismic data now covering the entire Atrush block.  Final processing of the complete 3D seismic survey is expected in  the first quarter of 2013.  The Atrush‐2 appraisal well was spudded on May 23, 2012 and drilled to a planned total depth of 1,750m in the Butmah  formation  ahead  of  schedule  on  July  10,  2012.  The  Company  announced  on  September  13,  2012  the  results  of  the  comprehensive  Atrush‐2  well  testing  program  which  confirmed  through  three  separate  DSTs  the  Atrush‐1  Jurassic  oil  discovery  in  the  Barsarin‐Sareglu‐Alan‐Mus  (“BSAM”)  reservoir.    The  combined  test  rate  for  the  three  BSAM  DSTs,  constrained  by  surface  testing  equipment,  was  over  42,200  bopd  (approximately  27  degree  API)  and  confirms  the  significant potential for production from the highly fractured BSAM reservoir.  An additional two DSTs conducted on the  Jurassic Adaiyah (cased hole) and Butmah (open hole) formations confirmed them to be oil bearing. GEP submitted in  October  2012  to  the  Ministry  of  Natural  Resources  of  Kurdistan  an  Atrush‐2  Discovery  Report  giving  notice  of  the  additional Discovery.  In  September  2012  the  drilling  rig  was  moved  from  the  Atrush‐2  well  to  the  Atrush‐1  discovery  well  drilled  in  2011.  A workover on this well was completed in November 2012.  On November 7, 2012 GEP and Marathon, collectively being the Contractor under the Atrush Block PSC, submitted to  the Atrush Block Management Committee a Declaration of Commercial Discovery (“DCD”) with effect from November 7,  2012 under Clause 12.6 (a) of the PSC. The DCD was submitted together with an Appraisal Report covering the Atrush  field. The Operator (TAQA) is currently in the process of preparing a Field Development Plan which will be submitted to  the Atrush Block Management Committee within 180 days following the DCD.  On  February  4,  2013  the  Company  announced  an  increase  of  35%  in  Best  Estimate  2C  Contingent  Resources  for  the  Atrush  Block,  from  465.6  MMBOE  at  December  31,  2011  to  627.3  MMBOE  at  the  end  of  2012.  The  estimates  were  provided by an independent qualified resources evaluator, McDaniel & Associates Consultants Ltd. (“McDaniel”), in a  Detailed  Property  Report  prepared  as  at  December  31,  2012  in  accordance  with  standards  set  out  in  the  Canadian  National Instrument NI 51‐101 and Canadian Oil and Gas Evaluation Handbook (“COGEH”). McDaniel estimates take into  account  the  results  of  the  Atrush‐2  well  (including  the  additional  discovery  in  the  Butmah  formation)  and  remapping  based on the recently acquired 3D seismic. In addition the Triassic Kurra Chine C is a new Prospective Resource for 2012  based on 3D seismic and reported results from nearby wells.  Preparation work is continuing to enable the drilling rig to move from the Atrush‐1 location to the Atrush‐3 appraisal  well  location.  Construction  work  is  almost  complete  to  provide  road  access  to  the  Atrush‐3  location  which  is  approximately  9km  east  of  Atrush‐1.  Atrush‐3  is  expected  to  spud  in  March  2013.  The  Atrush‐3  well  is  an  important  stepout from the previous two Atrush wells with the overall objective to establish contingent resources in the eastern  part of the Atrush structure.  Refer also to discussion under “Commitments” in this MD&A.  3            Taza Block  On August 20, 2012 the Company announced that it had sold to a subsidiary of Total S.A. its 20% interest in the Taza  Block PSC.  The Taza Block is a 511 square kilometer exploration area located in the south of Kurdistan immediately northeast of  the Pulkhana Block.  Prior to the sale of its interest in Taza the Company held a 20% direct interest in the production sharing contract. Oil  Search  Iraq  Limited  (“OSIL”),  the  operator,  held  a  60%  working  interest  in  the  PSC  and  the  KRG  held  a  20%  working  interest in the PSC with costs carried by ShaMaran and OSIL. The Company had previously been a party to an option  agreement in respect of the Taza Block with the KRG and OSIL. ShaMaran and OSIL exercised their option to convert  that agreement into the PSC.  The Taza‐1 exploration well was spudded on July 3, 2012 and by August 20, 2012, the date the Company announced the  sale  of  its  interest  in  Taza,  the  well  was  drilled  to  a  depth  of  depth  of  approximately  1,650m  which  was  above  the  reservoir targets.  Pulkhana Block  Operations  were  discontinued  in  the  Pulkhana  block  after  disappointing  test  results  from  the  Pulkhana  9  well.  The  Pulkhana Block PSC was fully relinquished to the KRG with an effective date of January 17, 2012.  The Pulkhana Block is a 529 square kilometer appraisal/development area located in southern Kurdistan.  Prior to relinquishing this PSC the Company was the operator of the project with a 60% direct interest in the production  sharing  contract.   Petoil  Petroleum  and  Petroleum  Products  International  Exploration  and  Production  Inc.  retained  a  20% interest in the PSC and the KRG held the remaining 20%.  Arbat Block  On January 17, 2012 the Company completed the relinquishment to the KRG of the Arbat Block PSC.  The Arbat Block is a 973 square kilometer exploration area located in eastern Kurdistan.  Prior to relinquishing this PSC the Company was the operator of the project and held a 60% direct interest in the PSC  with  the  KRG  holding  a  20%  interest  and  the  remaining  20%  a  third  party  interest  which  the  KRG  has  the  option  to  assign to a third party or parties.  4                        Selected annual information  The following is a summary of selected annual financial information for the Company:  For the year ended December 31,  2012 2011  2010 (In $000s, except per share data)  Continuing operations  General and administrative expense  Share based payments expense  Depreciation and amortisation expense  Share of income / (loss)  of associate  Relinquishment costs  Impairment recovery / (loss)  Gain on sale of asset  Gain on fair valuation of net assets of subsidiary  Finance cost   Finance income  Income tax expense  Net income / (loss) from continuing operations  Discontinued operations  Expenses  Gain on sale of asset  Net loss from discontinued operations  Net income / (loss)  Basic income / (loss) in $ per share:  Continuing operations  Discontinued operations  Diluted income / (loss) in $ per share:  Continuing operations  Discontinued operations  Total assets  Working capital surplus  Shareholders’ equity  Common shares outstanding (x 1,000)  (594) (570) (139) (27) ‐ ‐ ‐ ‐ (1,353) 2,631 (81) (133) (1,037) 77 (960) (1,093) ‐ ‐ ‐ ‐ ‐ ‐ (2,852) (8) (183) 129,000 (25,732) 1,814 1,100 102,735 (719) 359 (89) 205,425 (61) ‐ (61) (1,082)  (264)  (221)  (271)  ‐  (207,504)  ‐  ‐  (1,777)  518  (137)  (210,738)  (1,279)  1,078  (201)  205,364 (210,939)  (0.31)  ‐  (0.31)  (0.31)  ‐  (0.31)  0.25 ‐ 0.25 0.25 ‐ 0.25 2012 345,554 29,628 331,376 810,984 As at December 31,  2011  151,239  29,798  125,259  807,894  2010 256,489 44,009 235,518 623,182 5                                                                                                                          Summary of principal changes in annual information  The Company has reported net income in 2012 of $205 million which was primarily comprised of income from associate  of $129 million related to the sale by GEP on December 31, 2012 of a 53.2% interest in the Atrush Block and by the gain  of $103 million relating to the fair valuation as required by IFRS of GEP’s net assets and liabilities acquired (together, the  “Fair Value Increase”) offset by $25.7 million of relinquishment fees and other costs relating to the termination of the  Pulkhana and Arbat Block PSCs in January 2012. Also during the year the Company sold the 20% direct interest which it  held  in  the  Taza  Block  PSC  for  net  proceeds  of  $53.3  million  resulting  in  a  net  gain  of  $1.1  million.   The  total  assets  reported at the end of the year 2012 have increased by $194 million which was mainly due to recording the Fair Value  Increase of $232 million relating to the Atrush Block oil and gas assets and net cash out on other operating and investing  activities of $38 million.  Results of continuing operations  The Company’s continuing operations are compromised of an exploration and development program on a petroleum  property  located  in  the  Kurdistan  Region  of  Iraq  which  is  currently  in  the  pre‐production  stages  and  generates  no  revenue. The expenses and income items of continuing operations are explained in detail as follows:  General and administrative expenses  In $000  Salaries and benefits  Management and consulting fees  Sponsorship expense  General and other office expenses  Listing costs and investor relations  Travel expenses  Legal, accounting and audit fees  General and administrative expense incurred  Expenses and PSC overhead capitalized as E&E assets Net general and administrative expenses  For the year ended December 31, 2011 2012 2,710 885 ‐ 637 271 406 415 5,324 (2,472) 2,852 3,623 1,459 1,025 1,159 643 413 300 8,622 (7,540) 1,082 The  Company  capitalizes  as  exploration  and  evaluation  (“E&E”)  assets  those  general  and  administrative  expenses  incurred  supporting  E&E  activities  which  relate  to  direct  interests  held  in  production  sharing  contracts  as  well  as  exploration overhead charges in accordance with PSC terms on properties operated by the Company. The PSCs which  govern petroleum properties in Kurdistan allow for the operating company to include within petroleum costs an annual  exploration  overhead  charge  calculated  on  a  sliding  scale  percentage  of  annual  exploration  costs.  The  exploration  overhead charge qualifies under the terms of the PSCs as recoverable petroleum costs to be recovered from a portion  of available petroleum production. The Company has capitalized no general and administrative expenses subsequent to  the sale of its interest in the Taza Block PSC in August 2012 as it held no direct interests in production sharing contracts  for the remainder of the year.  The  decrease  in  general  and  administrative  expenses  incurred  and  capitalized  in  the  year  ended  December  31,  2012  relative to the amounts incurred and capitalized over the comparable periods of the prior year is primarily due to the  relinquishment  in  January  2012  of  its  two  operated  blocks,  Arbat  and  Pulkhana  as  well  as  the  sale  of  Taza  Block  in  August 2012, which resulted in a decrease overall in the Company’s technical and support activities during the reporting  periods.  6                                                                                      Share based payments expense  In $000  Share based payments expense  For the year ended December 31, 2011 2012 8 264 The share based payments expense results from the vesting of stock options granted in the years 2010 and 2011. No  stock options have been granted during the year ended December 2012 (year 2011: 25,000 and year 2010: 1,390,000).  The Company uses the fair value method of accounting for stock options granted to directors, officers, employees and  consultants whereby the fair value of all stock options granted is recorded as a charge to operations. The fair value of  common share options granted is estimated on the date of grant using the Black‐Scholes option pricing model.  Depreciation and amortization  In $000  Depreciation and amortisation  For the year ended December 31, 2011 2012 183 221 Depreciation and amortisation corresponds to cost of use of the furniture and IT equipment at the Company’s technical  and administrative offices located in Switzerland and Kurdistan.  Share of income / (loss) of associate  In $000  Income / (loss) from investment in associate  For the year ended December 31, 2011 2012 129,000 (271) The  income  from  investment  in  associate  relates  to  the  Company’s  pro‐rata  portion  of  the  net  income  of  GEP  in  conducting  petroleum  operations  on  the  Atrush  Block  in  Kurdistan.  The  income  of  associate  in  the  current  year  substantially all has resulted from a gain on the sale to TAQA on December 31, 2012 of a 53.2% interest in the Atrush  Block PSC.  Relinquishment costs  In $000  Relinquishment fees  Costs to wind up Pulkhana and Arbat operations Total relinquishment costs  For the year ended December 31, 2011 2012 25,000 732 25,732 ‐ ‐ ‐ Under the terms of the January 17, 2012 agreements to relinquish the Pulkhana and Arbat Block PSCs the Company paid  to the KRG on January 25, 2012 a total of $25 million in fees which relieves the Company of all further obligations under  the PSCs, including its remaining minimum financial commitments under the first exploration sub periods which were  $50 million in total prior to relinquishing the PSCs. These fees are non‐recoverable and have therefore been expensed  together with all costs associated with winding up operations on these blocks.  7                                                              Impairment losses / (recovery)  In $000  Write down of inventory to net realizable value  Impairment loss / (recovery) on E&E assets  Impairment loss / (recovery) on PP&E  Impairment loss / (recovery)  For the year ended December 31, 2011 2012 578 (2,347) (45) (1,814) 1,243 205,862 399 207,504 The write down of inventory is primarily due to the liquidation and restocking of certain drilling inventories which will  no  longer  be  used  in  the  Pulkhana  and  Arbat  Block  drilling  programs  due  to  their  cancellation.  The  Company  has  released  excess  accrued  costs  which  were  capitalized  as  exploration  and  evaluation  (“E&E”)  assets  resulting  in  a  recovery in the current reporting periods of impairment losses previously recognized. The impairment loss / (recovery)  on  property  plant  and  equipment  (“PP&E”)  items  during  the  reporting  periods  were  due  to  changes  in  previous  estimates  of  net  realizable  value  which  have  occurred  in  the  course  of  liquidating  assets  relating  to  the  relinquished  blocks.  Gain on sale of assets  In $000  Net proceeds on sale of asset  Costs of intangible assets and PP&E sold  Gain on sale of assets  For the year ended December 31, 2011 2012 53,266 (52,166) 1,100 ‐ ‐ ‐ In August 2012 the Company sold the 20% direct interest which it held in the Taza Block PSC. The net proceeds on sale  of asset was comprised of $48 million purchase price proceeds plus a reimbursement of $5.8 million in costs incurred on  the Taza block work program since April 1, 2012 less transaction related costs of $0.5 million.  Gain on fair valuation of nets assets of subsidiary  In $000  Fair valuation of net assets of subsidiary  For the year ended December 31, 2011 2012 102,735 ‐ GEP completed two principal transactions in December 2012 (the “Transactions”) resulting in the December 31, 2012  sale of a 53.2% direct interest in the Atrush Block to TAQA and the December 31, 2012 repurchase from Aspect of the  entire  66.5%  shareholding  interest  which  Aspect  held  in GEP.  As  a  result  of  the  Transactions  ShaMaran  Ventures  B.V  became the sole remaining shareholder of GEP and the Company has therefore acquired control of GEP.  The acquisition has been accounted for using the acquisition method in accordance with IFRS 3 which requires that the  Company  records  the  fair  value  on  the  date  of  acquisition  of  the  net  identifiable  assets  and  liabilities  of  GEP  and  consolidates these amounts with the other assets and liabilities of the Company. As the acquisition date coincides with  the balance sheet date there has been no incremental income or expense associated with the acquisition in the current  year.  The Company has recorded a gain on the fair valuation of net assets of subsidiary in the amount of $102.7 million which  is the difference between the $299.7 million fair value of net identifiable assets acquired and liabilities assumed and the  $197.0 million book value of investment in associate at acquisition of control.  8                                              The fair values of assets acquired and liabilities assumed in the acquisition of GEP are as follows:  In $000  Fair value of previously held equity interest in GEP  Cash  Other current assets  Property, plant and equipment  Intangible assets ‐ exploration and evaluation Accounts payable and accrued expenses  Provisions  Deferred liability  Fair value of net identifiable assets acquired and liabilities assumed  Finance cost  In $000  Interest expense on equity based finance fee  Foreign exchange loss  Guarantee fees  Total finance cost  299,680 10,137 117 163 300,523 (6,140) (120) (5,000) 299,680 For the year ended December 31, 2011 2012 719 ‐ ‐ 719 ‐ 862 915 1,777 The interest expense on equity based finance fee relates to a loan entered into with two investment companies who  jointly are principal shareholders of the Company. Under the terms of the loan the investment companies received an  aggregate of 3,000,000 common shares of the Company issued on April 2, 2012 at $0.24 per share as an equity based  finance fee.  The  foreign  exchange  losses  reported  in  the  year  2011  resulted  primarily  from  holding  cash  and  cash  equivalents  denominated in Canadian dollars while the Canadian dollar weakened during the reporting periods against the United  States dollar which is the reporting currency of the Company.  The Company incurred fees in the year 2011 in respect of a guarantee of the minimum financial obligations under the  Pulkhana and Arbat PSCs. The guarantee which was provided to the KRG by a related company on behalf of ShaMaran  became effective on August 29, 2009. As a result of having relinquished the Pulkhana and Arbat Blocks the guarantee is  no longer required by the Company resulting in no expense in the year 2012.  Finance income  In $000  Interest income  Foreign exchange gain  Total finance income  For the year ended December 31, 2011 2012 26 333 359 518 ‐ 518 Interest income represents bank interest earned on cash and investments in marketable securities. The decrease in the  amounts reported in the year 2012 relative to the amount reported in the same periods of the year 2011 is primarily  due to lower average cash balances held throughout the period.  The  foreign  exchange  gain  results  primarily  from  holding cash  and  cash  equivalents  denominated  in  Canadian  dollars  while  the  Canadian  dollar  strengthened  during  the  reporting  period  against  the  United  States  dollar  which  is  the  reporting currency of the Company.  9                                                          Income tax expense  In $000  Income tax expense  For the year ended December 31, 2011 2012 89 137 Income  tax  expense  relates  to  provisions  for  income  taxes  on  service  income  generated  in  Switzerland  which  is  determined on the basis of the cost of the services. The amount reported in the year 2012 has decreased relative to the  amounts reported in the comparable periods of 2011 due to less service costs incurred to support the lower levels of  exploration activity undertaken in the reporting periods.    Results of discontinued operations  The main components of discontinued operations are explained as follows:  Expenses  In $000  Legal, accounting and audit fees  General and other office expenses  Asset retirement obligation  Management and consulting fees  Total expenses  For the year ended December 31, 2011 2012 32 29 ‐ ‐ 61 137 61 1,078 3 1,279 The  decrease  in  fees  and  expenses  in  the  year  2012  relative  to  the  amounts  incurred  in  the  year  2011  is  due  to  the  reduction  in  activity  associated  with  the  Company’s  United  States  based  operations  following  the  sale  in  2009  of  substantially  all  of  the  properties  located  there.  The  professional  and  general  fees  which  the  Company  continues  to  incur are related to the decommissioning and windup of its remaining interests in the United States.   Gain on sale of asset  In $000  Deferred purchase price proceeds  Total gain on sale of asset  For the year ended December 31, 2011 2012 ‐ ‐ 1,078 1,078 In April 2011 the Company received deferred purchase price proceeds of $1,078 relating to the 2009 sale of an oil and  gas asset located in the United States.   10                                                    Selected quarterly information  The following is a summary of selected quarterly financial information for the Company:  (In $000s, except per share data)  For the quarter ended  Dec 31 2012 Sep 30 2012 Jun 30 2012 Mar 31 2012 Dec 31  2011  Sep 30 2011 Jun 30 2011 Mar 31 2011 Continuing operations  General and admin. (expense) / rec.  Share based payments (expense) / rec.  Depreciation and amortisation  Share of income / (loss) of associate  Relinquishment costs  Impairment recovery / (loss)  Gain on sale of asset  Gain on fair valuation of assets  Finance cost   Finance income  Income tax expense  Net inc. / (loss) from continuing ops.  Discontinued operations  Expenses  Gain on sale of asset  Net loss from discontinued ops.  (1,497) ‐ (40) 129,209 ‐ 1,255 ‐ 102,735 (24) ‐ (26) 231,612 1 ‐ 1 (512) (2) (46) (97) ‐ (138) 1,100 ‐ (393) 1 (11) (98) (12) ‐ (12) (459) (8) (48) (46) ‐ 945 ‐ ‐ (360) 25 (28) (384) 2 (49) (66) (25,732) (248) ‐ ‐ ‐ 391 (24) (283)  (21)  (55)  11  ‐  (207,504)  ‐  ‐  (251)  552  (31)  21 (26,110) (207,582)  (13) ‐ (13) (37) ‐ (37) (34)  ‐  (34)  202 (70) (58) (173) ‐ ‐ ‐ ‐ (2,780) 147 (32) (2,764) (46) ‐ (46) Net income / (loss)  231,613 (110) 8 (26,147) (207,616)  (2,810) Basic income / (loss) in $ per share:  Continuing operations  Discontinued operations  Diluted income / (loss) in $ per share:  Continuing operations  Discontinued operations  0.29 ‐ 0.29 0.29 ‐ 0.29 ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ (0.03) ‐ (0.03) (0.03) ‐ (0.03) (0.28)  ‐  (0.28)  (0.28)  ‐  (0.28)  ‐ ‐ ‐ ‐ ‐ ‐ (837) (114) (56) (30) ‐ ‐ ‐ ‐ (229) 367 (33) (932) (1,121) 1,078 (43) (975) ‐ ‐ ‐ ‐ ‐ ‐ (164) (59) (52) (79) ‐ ‐ ‐ ‐ (227) 1,162 (41) 540 (78) ‐ (78) 462 ‐ ‐ ‐ ‐ ‐ ‐ Summary of principal changes in fourth quarter information  In  the  fourth quarter  of  2012  work  on  the  Atrush  Block  development program  continued  and  the  Company  acquired  control of GEP. The net income in the fourth quarter was primarily driven by the sale by GEP in December 2012 of a  53.2%  interest  in  the  Atrush  Block  resulting  in  significant  income  from  associate  and  by  the  gain  on  fair  valuation  of  GEP’s net assets as required by IFRS due to the acquisition by the Company of control of GEP in December 2012.  Off‐balance sheet arrangements  The Company has no off‐balance sheet arrangements.  11                                                                                              Outstanding share data  The  common  shares  of  the  Company  outstanding  at  December  31,  2012  and  at  the  date  of  this  MD&A  were  810,983,860,  an  increase  from  the  number  outstanding  at  January 1,  2012  by 3,000,000  common shares  which were  issued at CAD 0.24 per share to two related parties as an equity based financing fee in accordance with the terms of a  debenture financing concluded on April 2, 2012. Refer also to the related party disclosures in the next section of this  MD&A.  There were 2,623,334 stock options outstanding at December 31, 2012 under the Company’s employee incentive stock  option plan which is a decrease of 610,000 from the number outstanding at January 1, 2012. During the year 2012 there  were  no  stock  options granted  (2011:  25,000), 450,000  stock  options  expired  (2011: nil),  160,000  stock  options were  forfeited (2011: 50,000), and no stock options were exercised (2011: 1,301,666). There has been no further movement  in stock options from December 31, 2012 to the date of this MD&A.  The Company has no warrants outstanding.  Related party transactions  In $000  Namdo Management Services Ltd.  Mile High Holdings Ltd.  McCullough O’Connor Irwin LLP  Vostok Naphta Investment Ltd.  Lundin family  Lundin Petroleum AB  Total  Purchases of services during the year 2012 2011   Amounts owing at the reporting dates 2011 2012 314 37 95 26 719 524 361   103   56   24   ‐   2,176   28 19 22 ‐ ‐ 75 7 19 14 ‐ ‐ 78 1,715 2,720   144 118 Namdo Management Services Ltd. is a private corporation owned by a shareholder of the Company which has provided  corporate administrative support and investor relation services to the Company.  Mile  High  Holdings  Ltd.  is  a  private  corporation  associated  with  a  shareholder  of  the  Company  which  has  provided  transportation services to the Company in relation to its fundraising activities.  McCullough O’Connor Irwin LLP is a law firm in which an officer of the Company is a partner which has provided legal  services to the Company.  Vostok  Naphta  Investment  Ltd.  is  a  corporation  traded  on  the  NASDAQ  OMX  Nordic  Exchange  in  Stockholm  (trading  symbol VNIL SDB) associated with a shareholder of the Company and which has provided investor relations services to  the Company in relation to its fundraising activities in Sweden.   The Company received a $10 million loan from the Lundin family through two investment companies who jointly are  principal  shareholders  of  the  Company  (the  "Lenders").  In  connection  with  the  loan  the  Company  has  issued  to  the  Lenders  an  aggregate  of  3,000,000  common  shares  of  the  Company.  The  fair  value  of  the  shares  issued  has  been  expensed as a finance cost. The loan was repaid in full in August 2012.  The Company receives services from various subsidiary companies of Lundin Petroleum AB (“Lundin”), a shareholder of  the Company. Lundin charges during the year ended December 31, 2012 of $524 (2011: $2,176) were comprised of G&G  and other technical service costs of $138 (2011: $195), reimbursement for Company travel and related expenses of $1  (2011:  $611),  office  rental,  administrative  and  building  services  of  $385  (2011:  $455).  In  the  year  2011  the  Company  paid $915 to Lundin relating to a guarantee provided to the KRG on behalf of the Company.  Included  within  general  and  administrative  expenses  for  the  year  2011  are  contributions  totaling  $1,025  made  to  a  charitable foundation whose chairman is a major shareholder of the Company. Funds from this charity, in part, are used  for  community  investment  activity  in  Kurdistan.  No  contributions  were  made  by  the  Company  to  this  charitable  foundation in the year 2012.  12                 All  transactions  with  related  parties  are  in  the  normal  course  of  business  and  are  made  on  the  same  terms  and  conditions as with parties at arm’s length.  Liquidity and capital resources  Working capital at December 31, 2012 was $29.6 million compared to $29.8 million at December 31, 2011.  The overall cash position of the Company decreased by $7.9 million during the year 2012 compared to a decrease in  cash  of  $9.6  million  during  the  year  2011.  The  main  components  of  the  movement  in  funds  are  discussed  in  the  following paragraphs.  The operating activities of the Company during the year 2012 resulted in a decrease in the cash position by $42.9 million  compared to an increase by $10.5 million in the year 2011. Payments to the KRG totaling $25 million in accordance with  the terms of the agreements to relinquish the Pulkhana and Arbat Blocks as well as a decrease by $16.5 million in the  accounts payable and accrued expense balances are the main reasons for the decrease in the year to date 2012 cash  position  due  to  operating  activities.  The  remaining  decrease  of  $1.4  million  was  attributable  to  cash  expenses  from  continuing operations and others movements in working capital.  Net cash inflows from investing activities during year 2012 were $34.6 million compared to cash outflows in the amount  of $119.7 million in the year 2011. The main components of cash inflows in 2012 were net proceeds of $53.3 million  received on the sale of the Taza Block and other property plant and equipment, $5 million cash held back from Aspect  as  security  for  potential  settlement  by  GEP  of  costs  owed  by  Aspect  and  a  $1.3  million  reimbursement  of  intangible  costs, and cash outflows due to spending of $16.1 million on the Atrush Block appraisal work program, $6.2 million on  Taza Block exploration costs and $2.9 million on operational and support costs.   The Company received $10 million in cash from finance activities during the nine months of 2012 through an April 2012  debenture  financing  agreement  with  two  investment  companies  who  jointly  are  principal  shareholders  of  the  Company. The loan was repaid in full in August 2012.  The investment companies received an equity based financing fee  in respect of the loan which has been expensed as a finance cost and which had no effect on the cash position of the  Company.   The  share  based  payments  reserve  increased  by  $8  in  the  year  2012  (2011:  decrease  of  $140)  due  to  share  based  payments expense of $8 incurred during the period ($2011: $264). There were no stock options exercised during this  period (2011: 1,301,666 options exercised at cost of $404). When options are granted the Black‐Scholes option value  method is used to calculate a value for the stock options. When the options are exercised the applicable amounts of  share based payments are transferred from the share based payments reserve to share capital.  The  Company  does  not  currently  generate  revenues  and  corresponding  cash  flows  from  its  oil  exploration  and  development operations. The Company has relied upon the issuance of common shares, and proceeds from asset sales  and loans to finance its ongoing oil exploration, development and acquisition activities. The Company believes that based  on the forecasts and projections they have prepared and a number of financing initiatives which are being pursued the  Company  and  its  subsidiaries  will  have  resources  sufficient  to  satisfy  contractual  obligations  and  commitments  under  agreed  work  programs.  Although  the  Company  is  confident  that  it  will  be  able  to  raise  sufficient  funds  there  is  no  assurance  at  the  date  these  financial  statements  were  approved  that  these  financing  initiatives  will  be  successful.   Continuing operations are dependent on discovery of economic oil and gas reserves and ultimately on the attainment of  profitable operations.   Commitments  Production Sharing Contracts (“PSCs”)  ShaMaran holds 100% of the issued shares of GEP which held at December 31, 2012 a 26.8% working interest in the  Atrush  Block  PSC,  with  TAQA  then  holding  a  53.2%  interest  and  Marathon  holding  the  remaining  20%  interest.  On  March 12, 2013 the KRG exercised its option to acquire a 25% interest in the PSC subsequent to which the Company  holds a 20.1% direct interest in the PSC.  13                   At  December  31,  2012  GEP  was  responsible  for  26.8%  of  the  costs  incurred  in  executing  the  exploration  and  development work programs on the Atrush Block.  The  PSC  contemplates  minimum  financial  commitments  during  the  first  exploration  sub‐period  and  also  requires  the  Contractor  to fund certain community  development, personnel,  training,  environmental,  and  technological  assistance  projects during the period over which the contract is in effect. All qualifying petroleum costs incurred by the Contractor  shall  be  recovered  from  a  portion  of  available  petroleum  production,  defined  under  the  terms  of  the  PSC.  All  modifications to the PSC are subject to the approval of the KRG.  As at December 31, 2012 the outstanding commitments of the Company were as follows:                                                                  As at December 31,  2013 4,767 103 4,870 2014 2015 Thereafter ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ Total 4,767 103 4,870 Atrush Block  Office and other  Total commitments  Financial Instruments  The  Company’s  financial  instruments  consist  of  cash,  cash  equivalents,  short‐term  investments,  accounts  receivable,  accounts payable, accrued expenses and net payable to joint venture partner.  Cash, cash equivalents and short‐term investments are designated as held for trading and are therefore carried at fair  value, with unrealized gains or losses recorded in interest income.  The fair values of cash, cash equivalents, accounts receivable, accounts payable, accrued expenses and net payable to  joint  venture  partner  approximate  carrying  values  because  of  the  short‐term  nature  of  these  instruments.  The  fair  values of short‐term investments are determined directly by reference to quoted market prices.  The Company is exposed in varying degrees to a variety of financial instrument related risks.  Credit Risk  Credit  risk  is  the  risk  of  financial  loss  to  the  Company  if a  customer  or  counterparty to  a  financial  instrument fails  to  meet  its  contractual  obligations.  The  Company  manages  its  credit  risk  through  monitoring  counterparty  ratings  and  credit limits.  The Company is mainly exposed to credit risk on its cash and cash equivalents and accounts receivable.  To manage this risk the Company maintains its excess cash on account in instruments having a minimum credit rating of  R‐1 (mid) or better (as measured by Dominion Bond Rate Services) or the equivalent thereof according to a recognized  bond rating service.  Accounts  receivable  are  primarily  from  joint  venture  partners  in  the  oil  and  gas  industry  and  are  subject  to  normal  industry credit risks. Joint venture receivables are typically collected within one to two months of the joint venture bill  being  issued  to  the  partner.  The  Company  mitigates  risks  arising  from  joint  venture  receivables  by  obtaining  partner  approval of capital expenditures prior to starting a project.   Liquidity Risk  Liquidity risk is the risk that the Company will incur difficulties meeting its financial obligations as they become due.  The  Company’s approach to managing liquidity is to ensure, as far as possible, that it will have sufficient liquidity to meet its  liabilities when due, without incurring unacceptable losses or risk harm to the Company’s reputation.  The Company prepares annual capital expenditure budgets, which are regularly monitored and updated as considered  necessary.  The  Company  requires  authorizations  for  expenditure  on  both  operating  and  non‐operating  projects  to  further manage capital expenditures.  14                              Market Risk  Market  risk  is  the  risk  that  changes  in  market  prices,  such  as  foreign  exchange  rates,  commodity  prices  and  interest  rates,  will  affect  the  Company’s  net  earnings  or  the  value  of  financial  instruments.  The  objective  of  market  risk  management is to manage and control market risk exposures within acceptable limits, while maximizing returns.  The  significant  market  risk  exposures  to  which  the  Company  is  exposed  are  foreign  currency,  commodity  price  and  interest rate risks.  Foreign  currency  risk  –  The  Company  maintains  a  substantial  portion  of  its  cash  in  Canadian  dollars;  however,  the  Company’s operations are conducted predominantly in United States dollars.  The Company’s operating results and cash  flows are affected to varying degrees by the changes in the Canadian dollar relative to the United States dollar.  The  Company has not entered into any agreements or purchased any instruments to hedge possible currency risks.  Commodity price risk – The prices that the Company may receive for its crude oil and natural gas production may have a  significant impact on its revenue and cash inflows from operating activities. Any significant price decline in commodity  prices  would  adversely  affect  the  amount  of  funds  available  for  capital  reinvestment  purposes.   At   this  time  the  Company does not use derivative financial instruments to manage its exposure to this risk.  Interest rate risk – The Company’s bank accounts earn interest income at variable rates.  The Company’s future interest  income is exposed to changes in short‐term rates.    Risks and Uncertainties  The  majority  of  ShaMaran’s  assets  are  located  in  Kurdistan.   ShaMar an  operates  in  areas  which  are  under  foreign  governmental  sovereignty  and  is  therefore  subject  to  political,  economic,  and  other  uncertainties  associated  with  foreign  operations,  which  include  (but  are  not  limited  to)  the  exposure  of  the  Company  to  changes  in  general  government policies and legislation, change in the energy policies or in their administration, changes in fiscal terms of a   production sharing contract with the government, inability to export the petroleum produced under contract, adverse  determinations or rulings by governmental authorities, nationalization, currency fluctuations and devaluations, as well  as risks of loss due to civil strife, acts of war, guerrilla activities and insurrections.  Political Issues  The  political  and  security  situation  in  Iraq  is  not  settled  and  is  volatile.  There  are  outstanding  political  issues  and  differences between the various political factions in Iraq. These differences could adversely impact ShaMaran’s interests  in Kurdistan.  In addition, certain borders of Kurdistan remain the subject of final determination, the result of which may  have an adverse effect on ShaMaran’s assets.  Uncertainty of title   Although  the  Company  conducts  title  reviews  prior  to  acquiring  an  interest  in  a  property,  such  reviews  do  not  guarantee  or  certify  that  an  unforeseen  defect  in  the  chain  of  title  will  not  arise  that  may  call  into  question  the  Company’s  interest  in  the  production  sharing  contracts.  Any  uncertainty  with  respect  to  one  or  more  of  the  Company’s production sharing contracts could have a material adverse effect on the Company’s business, prospects  and results of operations.  Legislative Issues  All  contracts  in  Kurdistan  are  issued  under  the  Oil  and  Gas  Law  of  The  Kurdistan  Region  ‐ Iraq.    No   federal  Iraqi  legislation has been enacted by the Iraq Council of Ministers (Cabinet) and Council of Representatives (Parliament).  The  lack  of  legislation,  or  the  enactment  of  federal  legislation  contradictory  to  Kurdistan  Region  legislation,  could  have  a  material adverse impact on ShaMaran’s interests in the region.   15                              Marketing, Markets and Transportation  The  export  of  oil  and  gas  from  Kurdistan  remains  subject  to  uncertainties  which  could  have  an  adverse  impact  on  ShaMaran’s ability to export and market such oil and gas.  Further, ShaMaran’s ability to market its oil and gas may also  depend  upon  its  ability  to  secure  transportation  and  delivery,  in  view  of  related  issues  such  as  the  proximity  of  its  potential production to pipelines and processing facilities. Potential government regulation relating to price, quotas and  other aspects of the oil and gas business could also have an adverse impact.    Exploration, Development and Production Risks  Oil and gas operations involve geological, technical and commercial risks.  ShaMaran’s success will depend on its ability  to find, appraise, develop and commercially produce oil and gas resources and reserves. Future oil and gas exploration  may involve risks relating to dry holes, wells which do not produce sufficient petroleum to return a profit after drilling,  operating and other costs.  In addition, operations can be effected by drilling hazards, environmental damage, and other  field  operating  conditions  which  could  adversely  affect  production  and  increase  the  cost  of  operations.  Diligent  operations can  contribute  to  maximizing  production  rates  over  time  but  production delays  and  declines  from  normal  field operating conditions cannot be eliminated and can adversely affect revenue and cash flow levels.  Project Risks  ShaMaran’s ability to execute projects and market oil and gas will depend upon numerous factors beyond ShaMaran’s  complete control.  Factors such as obtaining approvals from relevant authorities, issues relating to security in the area  of operation, adverse legislation in Kurdistan and/or Iraq, the regulation of the oil and gas industry by various levels of  government and governmental agencies in Kurdistan and/or Iraq could adversely impact the execution of ShaMaran’s  projects.  Substantial Capital Requirements  ShaMaran  anticipates  making  substantial  capital  expenditures  in  the  future  for  the  acquisition,  exploration,  development and production of oil and gas reserves.  ShaMaran’s results will impact its access to the capital necessary  to  undertake or  complete  future  drilling and  development  programs.  ShaMaran’s  ability  to  access  the  equity  or debt  markets  in  the  future  may  be  affected  by  any  prolonged  market  instability.   There  can  be  no  assurance  that  debt  or  equity  financing,  or  future  cash  (if  any)  generated  by  operations,  would  be  available  or  sufficient  to  meet  these  requirements  or  for  other  corporate  purposes  or,  if  debt  or  equity  financing  is  available,  that  it  will  be  on  terms  acceptable to ShaMaran.  The inability of ShaMaran to access sufficient capital for its operations could have a material  adverse effect on ShaMaran’s financial condition, results of operations and prospects.  Additional Funding Requirements  ShaMaran’s cash balances may not be sufficient to fund its ongoing activities at all times.  From time to time, ShaMaran  may require additional financing in order to carry out its oil and gas acquisition, exploration and development activities.   Failure to obtain such financing on a timely basis could cause ShaMaran to forfeit its interest in certain properties, miss  certain acquisition opportunities and reduce or terminate its operations. ShaMaran’s ability to access the equity or debt  markets in the future may be affected by any prolonged market instability.  Dilution  ShaMaran  may  make  future  acquisitions  or  enter  into  financings  or  other  transactions  involving  the  issuance  of  securities of ShaMaran which may be dilutive to the existing shareholders.  16                                      Accounting Policies and Critical Accounting Estimates  Use of Estimates  The  consolidated  financial  statements  of  the  Company  have  been  prepared  by  management  using  International  Financial Reporting Standards (“IFRS”).  In preparing financial statements, management makes informed judgments and  estimates that affect the reported amounts of assets and liabilities as of the date of the financial statements and affect  the reported amounts of revenues and expenses during the period.  Specifically, estimates were utilized in calculating  depletion,  asset  retirement  obligations,  fair  values  of  assets  on  acquisition  of  control,  share‐based  payments,  amortisation and impairment write‐downs.  Actual results could differ from these estimates and differences could be  material.  Accounting for Oil and Gas Operations  The  Company  follows  the  successful  efforts  method  of  accounting  for  its  oil  and  gas  operations.  Under  this  method  acquisition costs of oil and gas properties, costs to drill and equip exploratory wells that find proved reserves and costs  of drilling and equipping development wells are capitalized and subject to annual impairment testing.  Exploration well costs are initially capitalized and, if subsequently determined to have not found sufficient reserves to  justify  commercial  production,  are  charged  to  exploration  expense.  Exploration  well  costs  that  have  found  sufficient  reserves to justify commercial production, but whose reserves cannot be classified as proved, continue to be capitalized  as  long  as  sufficient  progress  is  being  made  to  assess  the  reserves  and  economic  viability  of  the  well  and  or  related  project.   Capitalized costs of proved oil and gas properties are depleted using the unit of production method based on estimated  gross  proved  reserves  of  petroleum  and natural  gas  as  determined  by  independent  engineers.  Successful  exploratory  wells  and  development  costs  and  acquired  resource  properties  are  depleted  over  proved  developed  reserves.  Acquisition  costs  of  unproved  reserves  are  not  depleted  or  amortized  while  under  active  evaluation  for  commercial  reserves.  Costs associated with significant development projects are depleted once commercial production commences.  A revision to the estimate of proved reserves can have a significant impact on earnings as they are a key component in  the calculation of depreciation, depletion and accretion.  Producing properties and significant unproved properties are assessed annually, or more frequently as economic events  dictate, for potential impairment. The impairment test is initially based on undiscounted future cash flows from proved  and  risk  adjusted  probable  reserves.   If  an  impairment  is  identified,  fair  value  is  calculated  as  the  present  value  of  estimated expected discounted cash flows from proved and risk‐adjusted probable reserves.  Any impairment loss is the  difference between the carrying value of the petroleum property and its fair value.  Therefore, if it is determined that  the estimated fair value is less than the net carrying amount, a write‐down to the oil and gas property’s fair value is  recognized during the period, with a charge to earnings.  Estimates of future cash flows used in the evaluation of impairment of assets are performed based on risk assessments  on  field  and  reservoir  performance  and  include  assumptions  regarding  commodity  prices,  discount  rates  and  future  costs.  A substantial portion of the Company’s exploration and development activities are conducted jointly with others.  The Company engaged McDaniel to evaluate 100% of the Company’s reserves and resource data at December 31, 2012.  The  conclusions  of  this  evaluation  have  been  presented  in  a  Detailed  Property  Report  which  has  been  prepared  in  accordance with standards set out in the Canadian National Instrument NI 51‐101 and COGEH.  17                    The Company’s crude oil and natural gas contingent resources for the Company’s Atrush asset as of December 31, 2012  were estimated to be as follows:  COMPANY GROSS ‐ CONTINGENT RESOURCES ESTIMATED  As of December 31, 2012  MBBL, MMCF (1) (2) (3) (4)  Crude Oil (Mbbl)  Natural Gas (MMcf)  Total (Mboe)  Low  Estimate  (1C) 78,905 14,499 81,321 Best  Estimate  (2C) 122,253 23,044 126,093 High  Estimate  (3C) 191,039 37,568 197,301 Mean (2) Estimate 130,219 24,939 134,375     There is no certainty that it will be commercially viable to produce any portion of the resources.  The statistical mean is provided in addition to the standard 1C, 2C and 3C resources categories.  Diluted Company Gross resources assuming a 25 percent Government back‐in are based on a 20.1 percent working interest share of the property gross  resources. This option was exercised by the KRG on March 12, 2013.  6 Mcf is equivalent to 1 boe.  COMPANY GROSS ‐ PROSPECTIVE RESOURCES ESTIMATED  As of December 31, 2012  MBBL, MMCF (1) (2) (3) (4)  Crude Oil (Mbbl)  Condensate (Mbbl)  Natural Gas (MMcf)  Total (Mboe)  Unrisked Low  Estimate 6,009 857 13,179 9,063 Unrisked  Best  Estimate 12,103 5,362 42,857 24,608 Unrisked  Mean  Estimate 14,057 9,313 62,190 33,735 Unrisked  High  Estimate 24,393 22,357 135,123 69,270 Risked (2)  Mean  Estimate 2,910 1,252 8,450 5,570  There  is  no  certainty  that  any  portion  of  the  resources  will  be  discovered.  If  discovered,  there  is  no  certainty  that  it  will  be  economically  viable  or  technically feasible to produce any portion of the resources.   These are partially risked prospective resources that have been risked for chance of discovery, but have not been risked for chance of development.   Diluted Company Gross resources assuming a 25 percent Government back‐in are based on a 20.1 percent working interest share of the property gross  resources. This option was exercised by the KRG on March 12, 2013.   6 Mcf is equivalent to 1 boe.  In summary, the changes in Gross Contingent Resources for the Atrush field by category between 2011 and 2012 are  (MMBOE):  2011  2012  % change  Low  Estimate  (1C) 55.4 81.3 +46% Best  Estimate  (2C) 93.6 126.1 +35% High  Estimate  (3C) 163.4 197.3 +21% Mean Estimate 103.1 134.4 +30% The estimation of reserves and resources is subjective. Forecasts are based on engineering data, future prices, expected  future  rates  of  production  and  the  timing  of  capital  expenditures,  all  of  which  are  subject  to  uncertainties  and  interpretations.  18                            Outlook  The outlook to the end of the year 2013 is as follows:   Atrush Block  The Operator (TAQA) is currently in the process of preparing a Field Development Plan (“FDP”) which is required to be  submitted  to  the  Atrush  Block  Management  Committee  within  180  days  following  the  Declaration  of  Commercial  Discovery, submitted on November 7, 2012. The FDP will outline the revised general forward plan for the block.  The Atrush‐3 appraisal well is expected to spud during March 2013. The well is located approximately 5km east of the  Atrush‐2 well. The drilling rig will be moved from the Atrush‐1 well site to the Atrush‐3 location. The Atrush‐3 well is an  important stepout from the previous two Atrush wells. In particular, the well is targeting the Oil Water Contact / Free  Water Level in the reservoir section.  There  are  plans  to  drill  two  additional  wells  in  2013.  Technical  discussions  on  the  final  location  of  the  Atrush‐4  and  Atrush‐5 wells are underway.   The  3D  seismic  acquisition  program  which  covered  the  entire  Atrush  block  and  adjoining  Swara  Tika  discovery  in  the  Sarsang Block was completed on August 11, 2012. Final processing of the complete 3D seismic survey is expected in the  first quarter of 2013. Further processing is expected during 2013 with the specific purpose on enhancing the data for  the development drilling program.  New Ventures  As part of its normal business the Company continues to evaluate new opportunities in the MENA region.   Budget  The Board of Directors approved a budget for the year 2013 which includes net capital spending on the Atrush Block  appraisal program and G&A support and corporate costs totaling $30.8 million.  General   The  security  situation  in  Kurdistan  remains  stable  with  no  major  reported  incidents.  The  region  is  seeing  a  rapid  development  in  infrastructure  and  a  significant  increase  in  the  availability  of  oil  and  gas  services  in  the  country.  A  number of major international oil companies, including Exxon, Chevron, Total and Gazprom, have acquired properties in  Kurdistan over the last year. In addition, there have been a number of recent and significant discoveries in this region  now undergoing appraisal and development.  19                                  Forward‐Looking Statements  This  report  contains  forward‐looking  statements  concerning  anticipated  developments  on  the  Company’s  operations;  the  adequacy  of  the  Company’s  financial  resources;  financial  projections,  including,  but  not  limited  to,  estimates  of  capital and operating costs, production rates, commodity prices, exchange rates, net present values; and other events  and conditions that may occur in the future.  Forward‐looking statements are frequently, but not always, identified by  the  words  such  as  “expects,”  “anticipates,”  “believes,”  “intends,”  “estimates,”  “potential,”  “possible,”  “budget”  and  similar  expressions,  or  statements  that  events,  conditions  or  results  “will,”  “may,”  “could,”  or  “should”  occur  or  be  achieved.  Information  concerning  the  interpretation  of  drill  results  and  reserve  estimates  also  may  be  deemed  to  be  forward‐looking statements, as such information constitutes a prediction of what might be found to be present if and  when a project is actually developed. Forward‐looking statements are statements about the future and are inherently  uncertain,  and  actual  achievements  of  the  Company  or  other  future  events  or  conditions  may  differ  materially  from  those reflected in the forward‐looking statements due to a variety of risks, uncertainties and other factors, including,  without limitation, those described in this MD&A.  The Company’s forward‐looking statements are based on the beliefs, expectations and opinions of management on the  date the statements are made and the Company assumes no obligation to update such forward‐looking statements in  the future.  For the reasons set forth above, investors should not place undue reliance on forward‐looking statements.  Additional Information  Additional information related to the Company is available on SEDAR at www.sedar.com and on the Company’s web‐ site at www.shamaranpetroleum.com.    20                  Auditor’s Report 15 March 2013 Independent Auditor’s Report To the Shareholders of ShaMaran Petroleum Corp To the Shareholders of ShaMaran Petroleum Corp ShaMaran Petroleum Corp., which We have audited the accompanying consolidated financial statements of ShaMaran We have audited the accompanying consolidated financial statements of comprise the consolidated balance sheet as at 31 December 2012 and 31 December 2011 and the Consolidated comprise the consolidated balance sheet as at 31 December 2012 and 31 December 2011 and the Consolidated comprise the consolidated balance sheet as at 31 December 2012 and 31 December 2011 and the Consolidated Statement of Comprehensive Income, Consolidated Statement of Changes in Equity and Consolidated Statement of Comprehensive Income, Consolidated Statement of Changes in Equity and Consolidated Statement of Comprehensive Income, Consolidated Statement of Changes in Equity and Consolidated Statement of Cash Flows for the years ended 31 December 2012 and 31 December 2011, and the related notes years ended 31 December 2012 and 31 December 2011, and the related notes years ended 31 December 2012 and 31 December 2011, and the related notes including a summary of significant accounting policies and other explanatory information. including a summary of significant accounting policies and other explanatory information. including a summary of significant accounting policies and other explanatory information. Management’s responsibility for the consolidated financial statements Management’s responsibility for the consolidated financial statements le for the preparation and fair presentation of these consolidated financial statements Management is responsible for the preparation and fair presentation of these consolidated financial statements le for the preparation and fair presentation of these consolidated financial statements and for such internal control as management in accordance with International Financial Reporting Standards, and for such internal control as management in accordance with International Financial Reporting Standards dated financial statements that are free from determines is necessary to enable the preparation of consolidated financial statements that are free from determines is necessary to enable the preparation of consoli material misstatement, whether due to fraud or error. material misstatement, whether due to fraud or error. Auditor’s responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We in accordance with Canadian Generally Accepted Auditing Standards. Those standards in accordance with Canadian Generally Accepted Auditing Standards. Those standards conducted our audits in accordance with Canadian Generally Accepted Auditing Standards. Those standards require that we comply with ethical requirements and plan and perform the audits to obtain reasonable require that we comply with ethical requirements and plan and perform the audits to obtain reasonable require that we comply with ethical requirements and plan and perform the audits to obtain reasonable from material misstatement. assurance about whether the consolidated financial statements are free from material misstatement. assurance about whether the consolidated financial statements are free An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor’s judgment, including the consolidated financial statements. The procedures selected depend on the auditor’s judgment, including the consolidated financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud the risks of material misstatement of the consolidated financial statements, whether due to fraud the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the consolid ated financial statements in order to design audit procedures 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 that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness 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 appropria teness of accounting policies used 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 and the reasonableness of accounting estimates made by management, as well as evaluating the overall and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. presentation of the consolidated financial statements. is sufficient and appropriate to provide a We believe that the audit evidence we have obtained in our audits is sufficient and appropriate to provide a We believe that the audit evidence we have obtained in our audits basis for our audit opinion. PricewaterhouseCoopers LLP, 1 Embankment Place, London WC2N 6RH PricewaterhouseCoopers LLP, 1 Embankment Place, London WC2N 6RH T: +44 (0) 20 7583 5000, F: +44 (0) 20 7822 4652, www.pwc.co.uk T: +44 (0) 20 7583 5000, F: +44 (0) 20 7822 4652, www.pwc.co.uk liability partnership registered in England with registered number OC303525. The registered office of PricewaterhouseCoopers LLP is a limited liability partnership registered in England with registered number OC303525. The registered office of liability partnership registered in England with registered number OC303525. The registered office of PricewaterhouseCoopers LLP is 1 Embankment Place, London WC2N 6RH. PricewaterhouseCoopers LLP is authorised and regulated by the Financial Services PricewaterhouseCoopers LLP is 1 Embankment Place, London WC2N 6RH. PricewaterhouseCoopers LLP is authorised and regulated by PricewaterhouseCoopers LLP is 1 Embankment Place, London WC2N 6RH. PricewaterhouseCoopers LLP is authorised and regulated by Authority for designated investment business. 21Opinion In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated 2012 and 31 December 2011 and its financial balance sheet of ShaMaran Petroleum Corp. as at 31 December 2012 and 31 December 2011 and its financial balance sheet of ShaMaran Petroleum Corp. as at 31 December performance and its cash flows for the years ended 31 December 2012 and 31 December 2011 in accordance performance and its cash flows for the years ended 31 December 2012 and 31 December 2011 in accordance performance and its cash flows for the years ended 31 December 2012 and 31 December 2011 in accordance with International Financial Reporting Standards. with International Financial Reporting Standards. going concern Emphasis of matter – going concern In forming our opinion on the financial statements , which is not modified, we have considered the adequacy of n the financial statements, which is not modified, we have considered the adequacy of the disclosures made in Note 2 to the financial statements concerning the Company’s ability to continue as a the disclosures made in Note 2 to the financial statements concerning the Company’s ability to continue as a the disclosures made in Note 2 to the financial statements concerning the Company’s ability to continue as a be able to raise sufficient funds, there is no Although the Company is confident that it will be able to raise sufficient funds, there is no going concern. Although the Company is confident that it will assurance that financing initiatives which the company will pursue will be successful. The lack of sufficient assurance that financing initiatives which the company will pursue will be successful. The lack of sufficient assurance that financing initiatives which the company will pursue will be successful. The lack of sufficient committed funding for the next 12 months from the date of approval of the financial statements ind committed funding for the next 12 months from the date of approval of the financial statements indicates the committed funding for the next 12 months from the date of approval of the financial statements ind existence of a material uncertainty which may cast significant doubt about the Company’s ability to continue as existence of a material uncertainty which may cast significant doubt about the Company’s ability to continue as existence of a material uncertainty which may cast significant doubt about the Company’s ability to continue as a going concern. The financial statements do not include the adjustments that would result if the Company was a going concern. The financial statements do not include the adjustments that would result if the Company a going concern. The financial statements do not include the adjustments that would result if the Company going concern. unable to continue as a going concern. PricewaterhouseCoopers LLP Chartered Accountants London PricewaterhouseCoopers LLP, 1 Embankment Place, London WC2N 6RH PricewaterhouseCoopers LLP, 1 Embankment Place, London WC2N 6RH T: +44 (0) 20 7583 5000, F: +44 (0) 20 7822 4652, www.pwc.co.uk T: +44 (0) 20 7583 5000, F: +44 (0) 20 7822 4652, www.pwc.co.uk liability partnership registered in England with registered number OC303525. The registered office of PricewaterhouseCoopers LLP is a limited liability partnership registered in England with registered number OC303525. The registered office of liability partnership registered in England with registered number OC303525. The registered office of PricewaterhouseCoopers LLP is 1 Embankment Place, London WC2N 6RH. PricewaterhouseCoopers LLP is authorised and regulated by the Financial Services PricewaterhouseCoopers LLP is 1 Embankment Place, London WC2N 6RH. PricewaterhouseCoopers LLP is authorised and regulated by PricewaterhouseCoopers LLP is 1 Embankment Place, London WC2N 6RH. PricewaterhouseCoopers LLP is authorised and regulated by Authority for designated investment business. 22SHAMARAN PETROLEUM CORP. Consolidated Statement of Comprehensive Income (Expressed in thousands of United States Dollars, except for per share data) ______________________________________________________________________________ Note For the year ended December 31, 2011 2012 Expenses from continuing operations General and administrative expense Share based payments expense Depreciation and amortisation expense Share of income / (loss) of associate Impairment recovery / (loss) Gain on fair valuation of net assets of subsidiary Gain on sale of asset Relinquishment costs Income / (loss) before finance items and income tax expense Finance cost Finance income Net finance loss Income / (loss) before income tax expense Income tax expense Net income / (loss) from continuing operations Discontinued operations Loss from discontinued operations Net income / (loss) for the year Other comprehensive income / (loss): Currency translation differences Total other comprehensive income / (loss) 6 20 16 8 16 9 7 10 11 12 13 (2,852) (8) (183) 129,000 1,814 102,735 1,100 (25,732) 205,874 (719) 359 (360) 205,514 (89) 205,425 (61) 205,364 26 26 (1,082) (264) (221) (271) (207,504) - - - (209,342) (1,777) 518 (1,259) (210,601) (137) (210,738) (201) (210,939) (23) (23) Total comprehensive income / (loss) for the year 205,390 (210,962) Income / (loss) in dollars per share: Continuing operations Basic and diluted Discontinued operations Basic and diluted Continuing and discontinued operations Basic and diluted 19 19 0.25 - 0.25 (0.31) - (0.31) The accompanying notes are an integral part of these consolidated financial statements. 23 SHAMARAN PETROLEUM CORP. Consolidated Balance Sheet (Expressed in thousands of United States Dollars) ______________________________________________________________________________ As at December 31, Note 2012 2011 Assets Non-current assets Intangible assets Property, plant and equipment Investment in associate Current assets Other current assets Inventories Other receivables Cash and cash equivalents Assets associated with discontinued operations Total assets Liabilities Current liabilities Accounts payable and accrued expenses Current tax liabilities Deferred liability Non-current liabilities Provisions Liabilities associated with discontinued operations Total liabilities Equity Share capital Share based payments reserve Cumulative translation adjustment Accumulated deficit Total equity Total liabilities and equity 14 15 16 17 13 18 16 13 19 303,549 257 - 303,806 127 198 204 41,216 41,745 3 45,836 382 51,835 98,053 647 3,328 105 49,085 53,165 21 345,554 151,239 7,027 90 5,000 12,117 120 120 1,941 14,178 534,068 3,836 8 (206,536) 331,376 345,554 23,245 122 - 23,367 - - 2,613 25,980 533,349 3,828 (18) (411,900) 125,259 151,239 The accompanying notes are an integral part of these consolidated financial statements. The financial statements were approved by the Board of Directors and authorized for issue on March 15, 2013 and signed on its behalf: /s/Cameron Bailey J. Cameron Bailey, Director /s/Keith Hill Keith C. Hill, Director 24 SHAMARAN PETROLEUM CORP. Consolidated Statement of Changes in Equity (Expressed in thousands of United States Dollars) ______________________________________________________________________________ Share capital Share based payments reserve Cumulative translation adjustment Accumulated deficit Total Balance at January 1, 2011 432,506 3,968 5 (200,961) 235,518 Total comprehensive loss for the year - - (23) (210,939) (210,962) Transactions with owners in their capacity as as owners: Private placements Transaction costs Share based payments expense Share options exercised Balance at December 31, 2011 Total comprehensive income for the year Transactions with owners in their capacity as as owners: Equity based finance fee Share based payments expense 101,953 (2,175) - 1,065 100,843 533,349 - 719 - 719 - - 264 (404) (140) 3,828 - - 8 8 Balance at December 31, 2012 534,068 3,836 - - - - - - - - - - 101,953 (2,175) 264 661 100,703 (18) (411,900) 125,259 26 205,364 205,390 - - - 8 - - - 719 8 727 (206,536) 331,376 The accompanying notes are an integral part of these consolidated financial statements. 25 SHAMARAN PETROLEUM CORP. Consolidated Statement of Cash Flows (Expressed in thousands of United States Dollars) ______________________________________________________________________________ Note 9 10 10,11 8 20 16 16 16 Operating activities Net income / (loss) from continuing operations Adjustments for: Gain on sale of asset Interest income Interest expense on equity based finance fee Foreign exchange (gain) / loss Depreciation and amortisation expense Income tax Impairment (recovery) / loss Share based payments expense Share of (income) / loss of associate Gain on fair valuation of net assets of subsidiary Capitalized expenses Changes in trade and other receivables Changes in other current assets Changes in inventories Changes in accounts payable and accrued expenses Changes in provisions Cash used in discontinued operations Net cash (outflows to) / inflows from operating activities Investing activities Net proceeds on sale of intangible assets Purchases of intangible assets Proceeds on reimbursement of intangible costs Net proceeds on sale of property, plant and equipment Purchases of property, plant and equipment Investment in associate Deferred liability Interest received on cash deposits Cash provided by discontinued operations Net cash inflows from / (outflows to) investing activities Financing activities Net proceeds on issuance of shares Net cash inflows from financing activities Effect of exchange rate changes on cash and cash equivalents Change in cash and cash equivalents Cash and cash equivalents, beginning of the year Cash and cash equivalents, end of the year For the year ended December 31, 2011 2012 205,425 (210,738) (1,100) (26) 719 (333) 183 (32) (1,814) 8 (129,000) (102,735) - (99) 520 2,552 (16,550) 120 (715) (42,877) 52,671 (8,395) 1,250 802 (595) (16,110) 5,000 26 - 34,649 - - 359 (7,869) 49,085 41,216 - (518) - 862 221 19 207,504 264 271 - (1,656) 19 (200) (1,915) 18,089 - (1,682) 10,540 - (100,087) - - (735) (20,467) - 518 1,078 (119,693) 100,439 100,439 (885) (9,599) 58,684 49,085 The accompanying notes are an integral part of these consolidated financial statements. 26 SHAMARAN PETROLEUM CORP. Notes to the Consolidated Financial Statements For the year ended December 31, 2012 (Expressed in thousands of United States Dollars unless otherwise stated) ______________________________________________________________________________ 1. General Information ShaMaran Petroleum Corp. (“ShaMaran” and together with its subsidiaries the “Company”) is incorporated under the Business Corporations Act, British Columbia, Canada. The address of the registered office is Suite 2600 Oceanic Plaza, 1066 West Hastings Street, Vancouver, British Columbia V6E 3X1. The Company’s shares trade on the TSX Venture Exchange and NASDAQ OMX First North Exchange (Stockholm) under the symbol “SNM”. The Company is engaged in the business of oil and gas exploration and development, and is currently in the pre- production stages of an exploration and development campaign in respect of a petroleum property located in the Kurdistan Region of Iraq (“Kurdistan”). 2. Basis of preparation These consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (“IFRS”), as issued by the International Accounting Standards Board (“IASB”) and the IFRS Interpretations Committee, under the historical cost convention except for certain financial assets and financial liabilities that are recognized at fair value through profit or loss. The preparation of financial statements in conformity with IFRS requires the use of certain critical accounting estimates. It also requires management to exercise its judgment in the process of applying the Company’s accounting policies. The accounting policies applied in these consolidated financial statements are based on IFRS issued and outstanding at the date these financial statements were approved for issuance by the Board of Directors. These consolidated financial statements have been prepared on the going concern basis which assumes that the Company will be able to realize into the foreseeable future its assets and liabilities in the normal course of business as they come due. The ability of the Company to continue as a going concern and to successfully carry out its business plan is primarily dependent upon the continued support of its shareholders, the discovery of economically recoverable reserves, the resolution of remaining political disputes in Iraq and the ability of the Company to obtain additional financing to develop reserves. In the absence of current production revenues, the Company is currently dependent upon its existing financial resources which include $41.2 million of cash and cash equivalents as at December 31, 2012 to satisfy its obligations and finance its exploration and evaluation program in Kurdistan. Failure to meet these exploration and evaluation commitments could put the related license interests at risk of forfeiture. The Company believes that based on the forecasts and projections they have prepared and a number of financing initiatives which will be pursued as required the Company and its subsidiaries will have sufficient resources to satisfy its contractual obligations and commitments under the agreed work program over the next 12 months. Although the Company is confident that it will be able to raise sufficient funds there is no assurance at the date these financial statements were approved that these financing initiatives will be successful. The lack of sufficient committed funding for the next 12 months indicates a material uncertainty which may cast significant doubt over the Company’s ability to continue as a going concern. These consolidated financial statements do not include the adjustments that would result if the Company is unable to continue as a going concern. 27 SHAMARAN PETROLEUM CORP. Notes to the Consolidated Financial Statements For the year ended December 31, 2012 (Expressed in thousands of United States Dollars unless otherwise stated) ______________________________________________________________________________ 3. Significant accounting policies (a) Basis of consolidation The consolidated financial statements incorporate the financial statements of the Company and its subsidiaries, entities controlled by the Company. Control is achieved where the Company has the power to govern the financial and operating policies of an investee entity so as to obtain benefits from its activities. Subsidiaries are fully consolidated from the date on which control is obtained by the Company and are de-consolidated from the date that control ceases. Intercompany balances and unrealized gains and losses on intercompany transactions are eliminated upon consolidation. (b) Investments in associates Associates are entities over which the Company is in a position to exert significant influence but not control or joint control. Significant influence is the power to participate in the financial and operating policy decisions of the investee but not control or jointly control those policies. Investments in associates are accounted for using the equity method whereby investments are initially recognized at cost and subsequently adjusted by the Company’s share of the associate’s post acquisition profits or losses and movements in other comprehensive income. Losses of an associate in excess of the Company’s interest in that associate are recognized only to the extent that the Company has incurred legal or constructive obligations to make payments on behalf of the associate. Any excess of the cost of the acquisition over the Company’s share of the fair value of the identifiable assets and liabilities of the associate at the date of acquisition is recognized as goodwill. The goodwill is included within the carrying amount of the investment and is assessed for impairment as part of that investment. If the carrying value of the investment is greater than its recoverable amount the impairment loss is recognized directly in the statement of comprehensive income. Where a group company transacts with an associate of the Company unrealized gains are eliminated to the extent of the Company’s interest in the relevant associate. Unrealized losses are also eliminated unless the transaction provides evidence of impairment of the asset transferred in which case appropriate provision for impairment is made. The Company assesses at each year-end whether there is any objective evidence indicating that the carrying value of its interests in associates may exceed its recoverable amount. If impaired the carrying value of the Company’s investment in associates is written down to its estimated recoverable amount, the higher of the fair value less cost to sell and value in use with a provision for impairment recorded in the statement of comprehensive income during the period of impairment. (c) Interest in joint ventures A joint venture is a contractual arrangement whereby the Company and other parties undertake an economic activity that is subject to joint control. Where the Company undertakes its activities under joint venture arrangements directly, the Company’s share of jointly controlled assets and any liabilities incurred jointly with other joint ventures are recognized in the financial statements of the relevant company and classified according to their nature. Liabilities and expenses incurred directly in respect of interests in jointly controlled assets are accounted for on an accrual basis. Income from the sale or use of the Company’s share of the output of jointly controlled assets and its share of the joint venture expenses are recognized when it is probable that the economic benefit associated with the transactions will flow to/from the Company and the amount can be reliably measured. 28 SHAMARAN PETROLEUM CORP. Notes to the Consolidated Financial Statements For the year ended December 31, 2012 (Expressed in thousands of United States Dollars unless otherwise stated) ______________________________________________________________________________ (d) Business combinations The acquisition method of accounting is used to account for business combinations. The consideration transferred is measured at the aggregate of the fair values at the date of acquisition of assets given, liabilities incurred or assumed, and equity instruments issued by the Company in exchange for control of the acquiree. Acquisition related costs are expensed as incurred. The identifiable assets, liabilities and contingent liabilities that meet the conditions for recognition under IFRS 3 Business Combinations are recognized at their fair value at the acquisition date. If the Company acquires control of an entity in more than one transaction the related investment held by the Company immediately before the last transaction when control is acquired is considered sold and immediately repurchased at the fair value of the investment on the date of acquisition. Any difference between the fair value and the carrying amount of the investment results in income or loss recognized in the statement of comprehensive income. (e) Non-current assets held for sale and discontinued operations Non-current assets (or disposal groups) are classified as assets held for sale when their carrying amount is to be recovered principally through a sale transaction and a sale is considered highly probable. They are measured at the lower of carrying amount and fair value less costs to sell. The results of a component of the Company that represent a major line of business or geographical area of operations that has either been disposed of (by sale, abandonment or spin-off) or is classified as held for sale is reported as discontinued operations. The financial statements of the Company include amounts and disclosures pertaining to discontinued operations in accordance with IFRS 5 Non-current Assets Held for Sale and Discontinued Operations. (f) Foreign currency translation Functional and presentation currency Items included in the financial statements of each of the Company’s subsidiaries are measured using the currency of the primary economic environment in which the subsidiary operates (the “functional currency”). The functional and presentation currency of the Company is United States Dollars. The results and financial position of subsidiaries that have a functional currency different from the presentation currency are translated into the presentation currency as follows:  Assets and liabilities are translated at the closing exchange rate at the date of that balance sheet;  Income and expenses are translated at the average exchange rate for the period in which they were incurred as a reasonable approximation of the cumulative effect of rates prevailing on transaction dates; and  All resulting exchange differences are recognized in other comprehensive income as part of the cumulative translation reserve. Transactions and balances Transactions in currencies other than the functional currency are recorded in the functional currency at the exchange rates prevailing on the dates of the transactions or valuation where items are re-measured. At each balance sheet date, monetary assets and liabilities that are denominated in foreign currencies are translated at the rates prevailing at the balance sheet date. Exchange differences are recognized in the statement of comprehensive income during the period in which they arise. 29 SHAMARAN PETROLEUM CORP. Notes to the Consolidated Financial Statements For the year ended December 31, 2012 (Expressed in thousands of United States Dollars unless otherwise stated) ______________________________________________________________________________ (g) Exploration and evaluation costs and other intangible assets Exploration and evaluation assets The Company applies the full cost method of accounting for exploration and evaluation (“E&E”) costs in accordance with the requirements of IFRS 6 Exploration for and Evaluation of Mineral Resources. All costs of exploring and evaluating oil and gas properties are accumulated and capitalized to the relevant property contract area and are tested on a cost pool basis as described below. Pre-license costs: Costs incurred prior to having obtained the legal rights to explore an area are expensed directly to the statement of comprehensive income. Exploration and evaluation costs: All E&E costs are initially capitalized as E&E assets and include payments to acquire the legal right to explore, costs of technical services and studies, seismic acquisition, exploratory drilling and testing. Tangible assets used in E&E activities such as the Company’s vehicles, drilling rigs, seismic equipment and other property, plant and equipment (“PP&E”) used by the Company’s exploration function are classified as PP&E. To the extent that such tangible assets are consumed in exploring and evaluating a property the amount reflecting that consumption is recorded as part of the cost of the intangible asset. Such intangible costs include directly attributable overhead including the depreciation of PP&E utilized in E&E activities together with the cost of other materials consumed during the E&E phases such as tubulars and wellheads. E&E costs are not depreciated prior to the conclusion of appraisal activities. Treatment of E&E assets at conclusion of appraisal activities: E&E assets are carried forward until commercial development has been approved for a contractual area. The E&E assets are then assessed for impairment and the carrying value after any impairment loss is then reclassified as oil and gas assets within PP&E. E&E assets that are not capable of commercial development remain capitalized at cost less accumulated amortisation and are subject to the impairment test set out below. Such E&E assets are depreciated on a unit of production basis over the life of the commercial reserves attributed to the cost pool to which they relate. Other intangible assets Other intangible assets that have finite useful lives such as computer software licenses are measured at cost and amortized over their expected useful economic lives as follows:  Computer software 3 years (h) Property, plant and equipment (“PP&E”) Oil and gas assets Oil and gas assets comprise of development and production costs for areas where technical feasibility and commercial viability have been established and include any E&E assets transferred after conclusion of appraisal activities as well as costs of development drilling, completion, gathering and production infrastructure, directly attributable overheads, borrowing costs capitalized, and the cost of recognizing provisions for future restoration and decommissioning. Oil and gas costs are accumulated separately for each contract area. Depreciation of oil and gas assets: Oil and gas assets are depreciated using the unit of production method based on proved and probable reserves using estimated future prices and costs and taking into account future development expenditures necessary to bring those reserves into production. 30 SHAMARAN PETROLEUM CORP. Notes to the Consolidated Financial Statements For the year ended December 31, 2012 (Expressed in thousands of United States Dollars unless otherwise stated) ______________________________________________________________________________ Other property, plant and equipment Property, plant and equipment assets excluding oil and gas assets described above are carried at cost less accumulated depreciation and any recognized impairment loss. Cost includes expenditures that are directly attributable to the acquisition of the asset. Subsequent costs are included in the assets’ carrying value or recognized as a separate asset as appropriate only when it is probable that future economic benefits associated with the item will flow to the Company and the cost can be measured reliably. Repairs and maintenance costs are charged to the statement of comprehensive income during the period in which they are incurred. The carrying amount of an item of PP&E is derecognized on disposal or when no future economic benefits are expected from its use or disposal. The gain or loss arising on the disposal or retirement of an asset is determined as the difference between the sales proceeds and the carrying amount of the asset and is recognized in the statement of comprehensive income during the period. Depreciation and amortisation is provided to expense the cost of the PP&E assets on a straight-line basis over their estimated useful lives on the followed bases:  Furniture, fixtures and office equipment over 5 years  Computer and information technology assets over 3 years (i) Impairment of non-financial assets E&E assets and oil and gas assets are assessed for impairment when facts and circumstances suggest that the carrying amount may exceed its recoverable amount. Such indicators include:  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.  substantive expenditure on further exploration for and evaluation of mineral resources in the specific area is neither budgeted nor planned.  exploration for and evaluation of resources in the specific area have not led to the discovery of commercially viable quantities of mineral resources and the Company has decided to discontinue such activities in the specific area.  sufficient data exist to indicate that, although a development in the specific area is likely to proceed, the carrying amount of the E&E asset is unlikely to be recovered in full from successful development or by sale.  extended decreases in prices or margins for oil and gas commodities or products.  a significant downwards revision in estimated volumes or an upward revision in future development costs. For the purpose of impairment testing the assets are aggregated into cash generating unit (“CGU”) cost pools based on their ability to generate largely independent cash flows. The recoverable amount of a CGU is the greater of its fair value less costs to sell and its value in use. Fair value is determined to be the amount for which the asset could be sold in an arm’s length transaction. Fair value less costs to sell may be determined using discounted future net cash flows of proved and probable reserves using forecast prices and costs. Value in use is determined by estimating the present value of the future net cash flows expected to be derived from the continued use of the asset or CGU. Where conditions giving rise to the impairment subsequently reverse the effect of the impairment charge is also reversed as a credit to the statement of comprehensive income net of any depreciation that would have been charged since the impairment. (j) Revenue recognition Revenues from the sale of hydrocarbons are recognized when title passes to an external party and collection is reasonably assured which is normally upon delivery of products and customer acceptance. 31 SHAMARAN PETROLEUM CORP. Notes to the Consolidated Financial Statements For the year ended December 31, 2012 (Expressed in thousands of United States Dollars unless otherwise stated) ______________________________________________________________________________ Interest income is accrued on a time proportion basis by reference to the principal outstanding and at the effective interest rate applicable. (k) Taxation The income tax expense comprises current income tax and deferred income tax. The current income tax is the expected tax payable on the taxable income for the period. It is calculated on the basis of the tax laws enacted or substantively enacted at the balance sheet date and includes any adjustment to tax payable in respect of previous years. Deferred income tax is the tax recognized in respect of temporary differences between the carrying amounts of assets and liabilities in the financial statements and the corresponding tax bases and is accounted for using the balance sheet liability method. Deferred income tax liabilities are generally recognized for all taxable temporary differences and deferred income tax assets are recognized to the extent that it is probable that taxable profits will be available against which deductible temporary differences can be utilized. Deferred income tax is not recorded if it arises from the initial recognition of an asset or liability in a transaction other than a business combination that, at the time of the transaction, affects neither the accounting profit nor loss. Deferred income tax liabilities are recognized for taxable temporary differences arising on investments in subsidiaries and associates and interests in joint ventures except where the Company is able to control the reversal of the temporary difference and it is probable that the temporary difference will not reverse in the foreseeable future. The carrying amount of deferred tax assets is reviewed at each balance sheet date and reduced to the extent that it is no longer probable that sufficient taxable profits will be available to allow all or part of the asset to be recovered. Deferred income tax is calculated at the tax rates that are expected to apply in the year when the deferred tax liability is settled or the asset is realized. Deferred tax is charged or credited in the statement of comprehensive income except when it relates to items charged or credited directly to equity in which case the deferred tax is also recognized directly in equity. Deferred tax assets and liabilities are offset when there is a legally enforceable right to offset current tax assets against current tax liabilities and when they relate to income taxes levied by the same taxation authority and the Company intends to settle its current tax assets and liabilities on a net basis. (l) Inventories Inventories of drilling equipment and consumable materials, which normally include casing, tubing, downhole tools and wellhead equipment, which have not been charged to exploration and evaluation assets for a particular project, are stated at the lower of cost or net realizable value and determined on a first-in, first-out (“FIFO”) method. Net realizable value represents the estimated selling price less all estimated costs of completion and costs to be incurred in marketing, selling and distribution. (m) Financial instruments Financial assets and liabilities are recognized in the Company’s balance sheet when the Company becomes a party to the contractual provisions of the instrument. Financial assets are derecognized when the contractual rights to cash flows from the assets expire or the Company transfers the financial asset and substantially all the risks and rewards of ownership. The Company derecognizes financial liabilities when the Company’s obligations are discharged, cancelled or expire. Financial assets and liabilities are offset and the net amount reported in the balance sheet when there is a legally enforceable right to offset the recognized amounts and there is an intention to settle on a net basis or realize the asset and settle the liability simultaneously. 32 SHAMARAN PETROLEUM CORP. Notes to the Consolidated Financial Statements For the year ended December 31, 2012 (Expressed in thousands of United States Dollars unless otherwise stated) ______________________________________________________________________________ Classification and measurement The Company classifies its financial assets and liabilities at initial recognition in the following categories:  Financial assets and liabilities at fair value through profit or loss are those assets and liabilities acquired principally for the purpose of selling or repurchasing in the short-term and are recognized at fair value. Transaction costs are expensed in the statement of comprehensive income and gains or losses arising from changes in fair value are also presented in the statement of comprehensive income within other gains and losses in the period in which they arise. Financial assets and liabilities at fair value through profit or loss are classified as current except for the portion expected to be realized or paid beyond twelve months of the balance sheet date, which is classified as non-current.  Available-for-sale investments are non-derivative financial instruments that are designated in this category or not classified in any other category. They usually comprise marketable securities and investments in debt and equity securities. Available-for-sale investments are initially recognized and subsequently measured at fair value. Gains and losses arising from changes in the fair value are recognized in other comprehensive income. Available-for-sale investments are classified as non-current unless the investment matures within the next twelve months or management expects to dispose of them within twelve months. Interest on available-for-sale investments is calculated using the effective interest method and is recognized in the statement of comprehensive income within finance income. Dividends on available-for-sale equity instruments are recognized in the statement of comprehensive income as other gains and losses when the Company’s right to receive payment is established. When an available-for-sale investment is sold or impaired the accumulated gains or losses are moved from accumulated other comprehensive income to the statement of comprehensive income within other gains and losses.  Loans and receivables comprise of trade receivables and cash and cash equivalents and are financial assets with fixed or determinable payments that are not quoted on an active market and are generally included within current assets due to their short-term nature. Loans and receivables are initially recognized at fair value and are subsequently measured at amortized cost using the effective interest method less any provision for impairment.  Financial liabilities at amortized cost comprise of trade and other payables and are initially recognized at the fair value of the amount expected to be paid and are subsequently measured at amortized cost using the effective interest rate method. Financial liabilities are classified as current liabilities unless the Company has an unconditional right to defer settlement for at least 12 months after the balance sheet date. Impairment of financial assets At each reporting date the Company assesses whether there is objective evidence indicating that a financial asset is impaired including:  Significant financial difficulty of the issuer.  A breach of contract such as delinquency in interest or principal payments.  Active market for that financial asset disappears because of financial difficulties.  Observable data indicating that there is a measureable decrease in the estimated future cash flows from a portfolio of financial assets since the initial recognition of those assets. If evidence of impairment exists the Company recognizes an impairment loss in the statement of comprehensive income as follows:  Financial assets carried at amortized cost - the impairment loss is the difference between the amortized cost of the loan or receivable and the present value of the estimated future cash flows discounted using the instrument’s effective interest rate. 33 SHAMARAN PETROLEUM CORP. Notes to the Consolidated Financial Statements For the year ended December 31, 2012 (Expressed in thousands of United States Dollars unless otherwise stated) ______________________________________________________________________________  Available for sale financial assets – the impairment loss is the difference between the original cost of the asset and its fair value at the measurement date less any impairment losses previously recognized in the statement of comprehensive income. Impairment losses on financial assets carried at amortized cost are reversed in subsequent periods if the amount of the loss decreases and the decrease can be related objectively to an event occurring after the impairment was recognized. Impairment losses on available-for-sale equity investments are not reversed. (n) Cash and cash equivalents Cash and cash equivalents are comprised of cash on hand and demand deposits and other short-term liquid investments that are readily convertible to a known amount of cash with three months or less maturity. (o) Provisions Provisions are recognized when the Company has a present obligation, legal or constructive, as a result of a past event when it is probable that the Company will be required to settle the obligation and a reliable estimate can be made of the obligation. The amount recognized as a provision is the best estimate of the consideration required to settle the present obligation at the balance sheet date, taking into account the risks and uncertainties surrounding the obligation. When a provision is measured using the cash flow estimates to settle the present obligation its carrying amount is the present value of those cash flows. Decommissioning and site restoration Provisions for decommissioning and site restoration are recognized when the Company has a present legal or constructive obligation to dismantle and remove production, storage and transportation facilities and to carry out site restoration work. The provision is calculated as the net present value of the Company’s share of the expenditure expected to be incurred at the end of the producing life of each field using a discount rate that reflects the market assessment of the time value of money at that date. Unwinding of the discount on the provision is charged to the statement of comprehensive income within finance costs during the period. The amount recognized as the provision is included as part of the cost of the relevant asset and is charged to the statement of comprehensive income in accordance with the Company’s policy for depreciation and amortisation. Changes in the estimated timing of decommissioning and site restoration cost estimates are dealt with prospectively by recording an adjustment to the provision and a corresponding adjustment to the relevant asset. (p) Share-based payments The Company issues equity-settled share-based payments to certain directors, employees and third parties. The fair value of the equity settled share-based payments is measured at the date of grant and is expensed using the graded method of amortisation over the period in which the recipients become fully entitled to the equity instrument (the “vesting period”). The cumulative expense recognized for equity-settled share-based payments at each balance sheet date represents the Company’s best estimate of the number of equity instruments that will ultimately vest. The charge or credit for the period and the corresponding adjustment to contributed surplus during the period represents the movement in the cumulative expense recognized for all equity instruments expected to vest. The fair value of equity-settled share-based payments is determined using the Black-Scholes option pricing model. (q) Pension obligations Pensions are the most common long-term employee benefit. The pension schemes are funded through payments to insurance companies. The Company’s pension obligations consist of defined contribution plans. A defined contribution plan is a pension plan under which the Company pays fixed contributions. The Company has no further payment obligations once the contributions have been paid. The contributions are recognized as an expense when they are due. 34 SHAMARAN PETROLEUM CORP. Notes to the Consolidated Financial Statements For the year ended December 31, 2012 (Expressed in thousands of United States Dollars unless otherwise stated) ______________________________________________________________________________ (r) Share capital Common shares are classified as equity. Incremental costs directly attributable to the issue of new shares or share options are shown in equity as a deduction, net of tax, from the proceeds. (s) Accounting standards issued but not yet applied IFRS 7: Financial Instruments: Disclosures – In 2011 IASB issued amendments to IFRS 7 Financial Instruments: Disclosures relating to disclosure requirements for the offsetting of financial assets and liabilities when offsetting is permitted under IFRS. The disclosure amendments are required to be adopted retrospectively for periods beginning January 1, 2013. IFRS 9: Financial Instruments: Classification and Measurement – In 2011 the IASB issued an amended version of IFRS 9 which provides additional guidance to classification and measurement of the Company’s financial assets, but will not have an impact on classification and measurements of financial liabilities. Due to the amendment in 2011, this standard is now required to be adopted for periods beginning January 1, 2015. IFRS 10: Consolidated Financial Statements – In 2011 the IASB issued IFRS 10 which provides additional guidance to determine whether an investee should be consolidated. The guidance applies to all investees, including special purpose entities. The standard is required to be adopted for periods beginning January 1, 2013. IFRS 11: Joint Arrangements – In 2011 the IASB issued IFRS 11 which presents a new model for determining whether an entity should account for joint arrangements using proportionate consolidation or the equity method. An entity will have to follow the substance rather than legal form of a joint arrangement and will no longer have a choice of accounting method. The standard is required to be adopted for periods beginning January 1, 2013. IFRS 12: Disclosure of Interests in Other Entities – In 2011 the IASB issued IFRS 12 which aggregates and amends disclosure requirements included within other standards. The standard requires a company to provide disclosures about subsidiaries, joint arrangements, associates and unconsolidated structured entities. The standard is required to be adopted for periods beginning January 1, 2013. Amendments to IFRS 10, 11 and 12 on Transition Guidance – In 2012 the IASB issued clarification that the date of initial application is the first day of the annual period in which IFRS 10 is adopted. Entities adopting IFRS 10 should assess control at the date of initial application; the treatment of comparative figures depends on this assessment. The amendment also requires certain comparative disclosures under IFRS 12 upon transition. The amendment is effective for annual periods beginning on or after January 1, 2013, consistent with IFRS 10, 11 and 12. IFRS 13: Fair Value Measurement – In 2011 the IASB issued IFRS 13 to provide comprehensive guidance for instances where IFRS requires fair value to be used. The standard provides guidance on determining fair value and requires disclosures about those measurements. The standard is required to be adopted for periods beginning January 1, 2013. IAS 27: Separate Financial Statements – The IASB issued amendments to IAS 27 Separate Financial Statements to coincide with the changes made in IFRS 10, but retains the current guidance for separate financial statements. IAS 28: Investments in Associates and Joint Ventures – The IASB issued amendments to IAS 28 Investments in Associates and Joint Ventures to coincide with the changes made in IFRS 10 and IFRS 11. IAS 32: Offsetting Financial Assets and Financial Liabilities – In 2011 the IASB issued amendments to IAS 32 clarifying the meaning of “currently has a legal enforceable right to set-off” and the application of the IAS 32 offsetting criteria to settlement systems which apply gross settlement mechanisms that are not simultaneous. These amendments are required to be adopted for periods beginning January 1, 2014. The Company is currently assessing the impact, if any, that the adoption of these standards will have on its financial statements. 35 SHAMARAN PETROLEUM CORP. Notes to the Consolidated Financial Statements For the year ended December 31, 2012 (Expressed in thousands of United States Dollars unless otherwise stated) ______________________________________________________________________________ 4. Critical accounting judgments and key sources of estimation uncertainty In the application of the Company’s accounting policies, which are described in note 3, management has made judgments, estimates and assumptions about the carrying amounts of the assets, liabilities, revenues, expenses and related disclosures. These estimates and associated assumptions are based on historical experience, current trends, and other factors that management believes to be relevant at the time these consolidated financial statements were prepared. Actual results may differ as future events and their effects cannot be determined with certainty and such differences could be material. Management reviews the accounting policies, underlying assumptions, estimates and judgments on an on-going basis to ensure that the financial statements are presented fairly in accordance with IFRS. The following are the critical judgments and estimates that management has made in the process of applying the Company’s accounting policies in these consolidated financial statements: (a) Oil and gas reserves The business of the Company is the exploration and development of oil and gas reserves in Kurdistan. Estimates of commercial oil and gas reserves are used in the calculations for impairment, depreciation and amortisation and decommissioning provisions. Changes in estimates of oil and gas reserves resulting in different future production profiles will affect the discounted cash flows used for impairment purposes, the anticipated date of site decommissioning and restoration, and the depreciation charges based on the unit of production method. In February 2013 the Company commissioned an independent reserves and resources report from McDaniel & Associates to estimate the Company’s reserves and resources at December 31, 2012. The reserves and resources estimates provided in the report were used in the calculations for impairment, depreciation and amortisation and decommissioning provisions within these consolidated financial statements. (b) Impairment of E&E and PP&E assets IAS 36 Impairment of Assets and IFRS 6 Exploration of and Evaluation of Mineral Resources require that a review for impairment be carried out if events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The recoverable amounts are determined with reference to value in use calculations. The key assumptions for the value in use calculations are those regarding production flow rates, discount rates, and fiscal terms under the Production Sharing Contracts governing the Company’s assets and expected changes to selling prices and direct costs during the period. These assumptions reflect management’s best estimates based on historical experiences, past practices and expectations of future changes in the oil and gas industry. (c) Decommissioning and site restoration provisions The Company recognizes a provision for decommissioning and site restoration costs expected to be incurred in order to remove and dismantle production, storage and transportation facilities and to carry out site restoration work. The provisions are estimated taking into consideration existing technology and current prices after adjusting for expected inflation and discounted using rates reflecting current market assessments of the time value of money and where appropriate, the risks specific to the liability. The Company makes an estimate based on its experience and historical data. Refer also to note 13. (d) Share-based payments The Company issues equity-settled share-based payments to certain directors, employees and third parties. In accordance with IFRS 2 Share-based payments, in determining the fair value of options granted, the Company has applied the Black-Scholes model and as a result makes assumptions for the expected volatility, expected life, risk- free rate, behavioral considerations and expected dividend yield. The fair value of options granted at December 31, 2012 is shown in note 20. 36 SHAMARAN PETROLEUM CORP. Notes to the Consolidated Financial Statements For the year ended December 31, 2012 (Expressed in thousands of United States Dollars unless otherwise stated) ______________________________________________________________________________ (e) Fair valuation of net assets of subsidiary acquired IFRS 3 Business Combinations requires the Company to record the fair value of the net assets and liabilities of General Exploration Partners Inc (“GEP”) on December 31, 2012, which is the date the Company acquired control of GEP. In determining the fair value the Company has considered a number of bases including the consideration exchanged on December 31, 2013, available prices of comparable assets, the net present value of estimated cash flows associated with the net assets and the asset value imputed by the public markets valuation, and relied on a number of assumptions and estimates including future oil prices, productive capacity of the oil and gas asset, costs to develop the oil and gas asset, relevant discount rates, and the probability of future taxes associated with the asset. 5. Business and geographical segments The Company operates in one business segment, the exploration and development of oil and gas assets, in one geographical segment, the Kurdistan Region of Iraq. As a result, in accordance with IFRS 8 Operating Segments, the Company has presented its financial information collectively for one operating segment. Refer to note 13 for disclosure of the Company’s discontinued operations. 6. General and administrative expenses General and administrative expenses incurred General and administrative expenses capitalized as E&E assets General and administrative expense For the year ended December 31, 2011 2012 5,324 (2,472) 2,852 8,622 (7,540) 1,082 The Company capitalizes as E&E assets those general and administrative expenses supporting E&E activities which relate to direct interests held in production sharing contracts. The Company has capitalized no general and administrative expenses subsequent to the sale of its interest in the Taza Block PSC in August 2012 as it held no direct interests in production sharing contracts for the remainder of the year. Refer also to notes 9 and 14. 7. Relinquishment costs Relinquishment fees Costs to windup Pulkhana and Arbat operations Total relinquishment costs For the year ended December 31, 2011 2012 25,000 732 25,732 - - - On January 17, 2012 the Company signed agreements with the KRG to relinquish the Pulkhana and Arbat Block PSCs. On January 25, 2012 the Company paid a total of $25 million to the KRG in accordance with the terms of the agreements relieving the Company of all further obligations under the PSCs including its remaining minimum financial commitments. Refer also to note 14. 37 SHAMARAN PETROLEUM CORP. Notes to the Consolidated Financial Statements For the year ended December 31, 2012 (Expressed in thousands of United States Dollars unless otherwise stated) ______________________________________________________________________________ 8. Impairment (recovery) / loss Write down drilling inventory to net realizable value Impairment (recovery) / loss on exploration and evaluation assets Impairment (recovery) / loss on property, plant and equipment Impairment (recovery) / loss For the year ended December 31, 2011 2012 578 (2,347) (45) (1,814) 1,243 205,862 399 207,504 The above indicated losses and recoveries relate to the Pulkhana and Arbat production sharing contract relinquishments. The Company has released excess accrued costs which were capitalized as exploration and evaluation (E&E) assets resulting in a recovery in the current year of impairment losses previously recognized. Refer also to notes 14, 15 and 17. 9. Gain on sale of asset In August 2012 the Company sold the 20% direct interest which it held in the Taza Block PSC. The gain on the sale of the Taza Block asset has been determined as follows: Net proceeds on sale of asset Costs of intangible assets and property, plant and equipment sold Gain on sale of asset For the year ended December 31, 2011 2012 53,266 (52,166) 1,100 - - - The net proceeds on sale of asset was comprised of a $48 million purchase price plus reimbursement of $5.8 million in costs incurred on the Taza Block work program since April 1, 2012 less transaction related costs of $0.5 million. Refer also to notes 14 and 15. 10. Finance cost Interest expense associated with equity based finance fee Foreign exchange loss Guarantee fees Total finance costs For the year ended December 31, 2011 2012 719 - - 719 - 862 915 1,777 The interest expense relates to a loan entered into with two investment companies who jointly are principal shareholders of the Company and represents the amortization of prepaid interest over the loan term. Refer also to note 23. For the year ended December 31, 2011 the foreign exchange loss of $862 resulted primarily from holding cash and cash equivalents denominated in Canadian dollars while the Canadian dollar weakened during the reporting year against the United States dollar which is the reporting currency of the Company. The guarantee fees related to a guarantee of the minimum financial obligations under the Pulkhana and Arbat PSCs which was provided to the KRG by a related company on behalf of the Company. As a result of having relinquished the Pulkhana and Arbat Blocks the guarantee is no longer required by the Company. 38 SHAMARAN PETROLEUM CORP. Notes to the Consolidated Financial Statements For the year ended December 31, 2012 (Expressed in thousands of United States Dollars unless otherwise stated) ______________________________________________________________________________ 11. Finance income Interest income Foreign exchange gain Total finance income For the year ended December 31, 2011 2012 26 333 359 518 - 518 Interest income represents bank interest earned on cash and investments in marketable securities. For the year ended December 31, 2012 the foreign exchange gain of $333 results primarily from holding cash and cash equivalents denominated in Canadian dollars while the Canadian dollar strengthened during the year against the United States dollar which is the reporting currency of the Company. 12. Taxation (a) Income tax expense The income tax expense reflects an effective tax rate which differs from Federal and Provincial statutory tax rates. The main differences are as follows: For the year ended December 31, 2011 2012 Income / (loss) from continuing operations before income tax Corporate income tax rate Computed income tax expense / (recovery) Increase / (decrease) resulting from: Non-taxable foreign exchange (gain) / loss Share issuance costs charged to share capital Non-deductible compensation expense Foreign tax rate differences Effect of change in tax rates Unrealized gain on fair valuation of assets Change in valuation allowance Effect of changes in foreign exchange rates Other Income tax expense from continuing operations 205,514 25.0% 51,379 (83) (180) 2 (5,247) 27 (25,684) (20,545) (160) 580 89 (210,601) 26.5% (55,809) 228 (583) 70 13,474 54 - 42,064 110 529 137 The Company’s income tax expense relates to a provision for income tax on service income generated in Switzerland, and is calculated at the effective tax rate of 25% prevailing in this jurisdiction. The components of the future income tax assets are as follows: As at December 31, Non-capital losses Share issue costs carried forward Properties-tax basis over carrying value Exploration expenses Future income tax assets before allowance Valuation allowance Future income tax assets 2012 83,952 815 1,279 809 86,855 (86,855) - 2011 104,218 1,098 1,279 784 107,379 (107,379) - 39 SHAMARAN PETROLEUM CORP. Notes to the Consolidated Financial Statements For the year ended December 31, 2012 (Expressed in thousands of United States Dollars unless otherwise stated) ______________________________________________________________________________ (b) Tax losses carried forward The Company has tax losses and costs which are available to apply to future taxable income as follows: Canadian losses from operations Canadian exploration expenses Canadian unamortized share issue costs Dutch losses from operations U.S. Federal losses from operations U.S. Federal tax basis in excess of carrying values of properties Total tax losses carried forward As at December 31, 2012 17,834 3,234 3,259 103,345 168,069 3,654 299,395 2011 15,948 3,134 4,199 207,138 168,008 3,654 402,081 The Canadian losses from operations may be used to offset future Canadian taxable income and will expire over the period from 2017 to 2032. The Canadian exploration expenses may be carried forward indefinitely to offset future taxable Canadian income. Canadian unamortized share issue costs may offset future taxable Canadian income of years 2013 to 2016. The U.S. Federal losses are available to offset future taxable income in the United States through 2032. 13. Discontinued operations During May of 2009 the Company sold to a third party substantially all of its oil and gas properties located in the United States in the Gulf of Mexico. The results of the discontinued operations included in the consolidated statement of comprehensive income are as follows: Expenses General and administrative, other Revision to asset retirement obligation provision Operating loss Gain on disposal of assets Net loss attributable to discontinued operations For the year ended December 31, 2011 2012 61 - 61 - 61 201 1,078 1,279 1,078 201 The major classes of assets and liabilities included in the consolidated balance sheet are as follows: Assets Prepaid expenses Liabilities Trade payables and accrued expenses Asset retirement obligation provision Net liabilities As at December 31, 2012 3 3 355 1,586 1,941 1,938 2011 21 21 539 2,074 2,613 2,592 40 SHAMARAN PETROLEUM CORP. Notes to the Consolidated Financial Statements For the year ended December 31, 2012 (Expressed in thousands of United States Dollars unless otherwise stated) ______________________________________________________________________________ The provision relates to site restoration costs pertaining to the remaining interests the Company holds in petroleum properties located in the United States. The provision was determined based on the Company’s remaining net ownership interest in the corresponding wells and facilities, estimated costs to abandon and reclaim the wells and facilities and the estimated timing of the costs to be incurred in future periods. 14. Intangible assets At January 1, 2011 Cost Accumulated amortisation Net book value For the year ended December 31, 2011 Opening net book value Additions Amortisation expense Impairment losses Exchange differences Net book value At December 31, 2011 Cost Accumulated amortisation Impairment losses Net book value For the year ended December 31, 2012 Opening net book value Additions including fair value adjustment Disposal Amortisation expense Adjustment to impairment losses Net adjustment on currency translation Net book value At December 31, 2012 Cost Accumulated amortization Impairment losses Net book value Exploration and evaluation assets Other intangible assets 149,692 - 149,692 149,692 101,894 - (205,861) - 45,725 251,586 - (205,861) 45,725 45,725 307,022 (51,571) - 2,347 - 303,523 507,037 - (203,514) 303,523 270 (70) 200 200 1 (97) - 7 111 271 (160) - 111 111 3 (1) (88) - 1 26 280 (254) - 26 Total 149,962 (70) 149,892 149,892 101,895 (97) (205,861) 7 45,836 251,857 (160) (205,861) 45,836 45,836 307,025 (51,572) (88) 2,347 1 303,549 507,317 (254) (203,514) 303,549 In December 2011 the Company took the decision to relinquish to the KRG the Pulkhana and Arbat Block PSCs and immediately suspend all operations associated with those two production sharing contracts. The Company has recorded impairment losses to expense all exploration and evaluation assets, which includes acquisition costs, capacity building payments to the KRG, costs of acquiring seismic data, and drilling and testing costs which have been incurred by the Company on these two Blocks up to December 31, 2011. The relinquishment was completed on January 17, 2012. Refer also to notes 7 and 8. The Company revised an estimate of costs relating to the Pulkhana Block which were reported as impairment losses in the previous year resulting in a $2.3 million adjustment to impairment losses in the current year. 41 SHAMARAN PETROLEUM CORP. Notes to the Consolidated Financial Statements For the year ended December 31, 2012 (Expressed in thousands of United States Dollars unless otherwise stated) ______________________________________________________________________________ In August 2012 the Company sold its 20% direct interest in the Taza Block resulting in the disposal of $51.6 million in related intangible assets. Refer also to note 9. On December 31, 2012 the Company acquired control of General Exploration Partners Inc resulting in the addition of $300.5 million of exploration and evaluation assets relating to the Atrush Block PSC. Refer also to note 16. The net book value of exploration and evaluation assets at December 31, 2012 relates directly to the Atrush Block in the amount of $300.5 million (2011: $nil. The interest in the Atrush Block was previously held through the investment in associate) and an amount of $3.0 million (2011: $4.8 million) of other costs associated with ongoing operations in Kurdistan. Other intangible assets comprise computer software licenses. The amortisation charge is presented as part of general and administrative expenses within the Company’s consolidated statement of comprehensive income. 15. Property, plant and equipment At January 1, 2011 Cost Accumulated depreciation Net book value For the year ended December 31, 2011 Opening net book value Additions Disposals Depreciation expense Impairment losses Exchange differences Net book value At December 31, 2011 Cost Accumulated depreciation Impairment losses Net book value For the year ended December 31, 2012 Opening net book value Additions Disposals Depreciation expense Impairment recovery / (losses) Exchange differences Net book value At December 31, 2012 Cost Accumulated depreciation Impairment losses Net book value Oil and gas equipment Computer equipment Furniture and office equipment - - - - 678 (171) (160) (174) - 173 445 (98) (174) 173 173 758 (781) (31) 46 - 165 199 (29) (5) 165 203 (66) 137 137 36 (7) (78) (17) 5 76 232 (139) (17) 76 76 - (9) (62) 4 - 9 199 (190) - 9 217 (24) 193 193 13 (19) (46) (10) 2 133 203 (60) (10) 133 133 - (14) (32) (6) 2 83 165 (82) - 83 Total 420 (90) 330 330 727 (197) (284) (201) 7 382 880 (296) (201) 382 382 758 (804) (125) 44 2 257 563 (301) (5) 257 42 SHAMARAN PETROLEUM CORP. Notes to the Consolidated Financial Statements For the year ended December 31, 2012 (Expressed in thousands of United States Dollars unless otherwise stated) ______________________________________________________________________________ As a result of the relinquishment of the Pulkhana and Arbat PSCs the Company has determined that there is impairment in value of certain property plant and equipment employed in the exploration operations associated with these production sharing contracts and has recorded impairment losses on these assets. Refer also to note 8. In August 2012 the Company sold its 20% direct interest in the Taza Block PSC resulting in the disposal of $0.6 million in related property, plant and equipment. Refer also to note 9. The impairment provision remaining at year end reflects the impairment losses incurred during the year less the book value of those impaired assets disposed of during the year. 16. Acquisition of General Exploration Partners Inc. General Exploration Partners Inc. ("GEP") completed two principal transactions in December 2012 (the “Transactions”) resulting in the December 31, 2012 sale of a 53.2% participating interest in the Atrush Block to Abu Dhabi National Energy Company PJSC ("TAQA") and the December 31, 2012 repurchase from Aspect Energy International, LLC (“Aspect”) of the entire 66.5% shareholding interest which Aspect held in GEP. As a result of the Transactions ShaMaran Ventures B.V., a wholly owned subsidiary of ShaMaran, became the sole remaining shareholder of GEP and the Company has therefore acquired control of GEP. The Company has recorded a deferred liability relating to funds held in trust in the amount of $5 million which will be paid to Aspect on June 30, 2013 in respect of the repurchase of Aspect shares subject to the satisfactory conclusion of certain closing conditions. The acquisition has been accounted for using the acquisition method in accordance with IFRS 3 which requires that the Company records the fair value on the date of acquisition of the net identifiable assets and liabilities of GEP and consolidates these amounts with the other assets and liabilities of the Company. As the acquisition date coincides with the balance sheet date there has been no incremental income or expense associated with the acquisition in the current year. Had the Company acquired GEP on January 1, 2012 no material difference would have resulted in the amount of consolidated income and expenses. The acquisition costs to the Company associated with the Transactions were not material. The Company has recorded a gain on the fair valuation of net assets of subsidiary in the amount of $102.7 million which is the difference between the $299.7 million fair value of net identifiable assets acquired and liabilities assumed and the $197.0 million book value of investment in associate at acquisition of control. The fair values of assets acquired and liabilities assumed in the acquisition of GEP are as follows: Fair value of previously held equity interest in GEP Cash Other current assets Property, plant and equipment Intangible assets - exploration and evaluation Accounts payable and accrued expenses Provisions Deferred liability Fair value of net identifiable assets acquired and liabilities assumed Refer also to notes 14 and 15. 299,680 10,137 117 163 300,523 (6,140) (120) (5,000) 299,680 43 SHAMARAN PETROLEUM CORP. Notes to the Consolidated Financial Statements For the year ended December 31, 2012 (Expressed in thousands of United States Dollars unless otherwise stated) ______________________________________________________________________________ Prior to acquisition of control the Company held 33.5% of the fully diluted share capital of GEP and accounted for this interest as investment in associate, included in the balance sheet as follows: Cash contributions Common share contributions Acquisition costs Share of income / (losses) since acquisition Recovery of costs from partner Book value of investment in associate Book value of investment in associate transferred at acquisition of control Total investment in associate As at December 31, 2012 63,937 5,000 204 128,702 (898) 196,945 (196,945) - 2011 47,827 5,000 204 (298) (898) 51,835 - 51,835 The share of income / (loss) from associate included in the statement of comprehensive income is as follows: Total income / (loss) of associate Company’s 33.5% share of income / (loss) of associate For the year ended December 31, 2011 2012 385,076 129,000 (809) (271) The income of associate in the current year substantially relates to the sale of a 53.2% interest in the Atrush Block PSC. 17. Inventories Drilling and downhole equipment Impairment losses Total inventories As at December 31, 2012 497 (299) 198 2011 4,570 (1,242) 3,328 The impairment in the value of certain inventory items relates to the termination of the drilling programs in the Pulkhana and Arbat Blocks. Refer also to note 8. 18. Accounts payable and accrued expenses Trade accounts payable Accrued expenses Net payables to joint venture partners Total accounts payable and accrued expenses As at December 31, 2012 811 5,494 722 7,027 2011 17,409 4,379 1,457 23,245 44 SHAMARAN PETROLEUM CORP. Notes to the Consolidated Financial Statements For the year ended December 31, 2012 (Expressed in thousands of United States Dollars unless otherwise stated) ______________________________________________________________________________ 19. Share capital The Company is authorized to issue an unlimited number of common shares with no par value. The Company’s issued share capital is as follows: Balance at January 1, 2011 Private placements, net of issuance costs Share options exercised Balance at December 31, 2011 Shares issued as equity based financing fee Balance at December 31, 2012 Refer also to note 10. Earnings per share The earnings per share amounts were as follows: Continuing operations: Net income / (loss) from continuing operations, in dollars Weighted average common shares outstanding during the year Basic and diluted earnings / (loss) per share from continuing operations, in dollars Discontinued operations: Net loss from discontinued operations, in dollars Weighted average common shares outstanding during the year Basic and diluted loss per share from discontinued operations, in dollars Continuing and discontinued operations: Net income / (loss) from continuing and discontinued operations, in dollars Weighted average common shares outstanding during the year Basic and diluted earnings / (loss) per share from continuing and discontinued operations, in dollars Number of shares 623,182,194 183,500,000 1,301,666 807,983,860 3,000,000 810,983,860 $000 432,506 99,778 1,065 533,349 719 534,068 For the year ended December 31, 2011 2012 205,421,406 810,221,565 0.25 (61,300) 810,221,565 - (210,738,707) 677,001,536 (0.31) (201,189) 677,001,536 - 205,360,106 810,221,565 (210,939,896) 677,001,536 0.25 (0.31) 20. Share based payments expense The Company has an established share purchase option plan whereby a committee of the Company’s board of directors may, from time to time, grant up to a total of 10% of the issued share capital to directors, officers, employees or consultants. The number of shares under option at any specific time to any one option holder shall not exceed 5% of the issued and outstanding common shares of the Company. The term of any options granted under the plan will be fixed by the Board of Directors and may not exceed five years from the date of grant. A four month hold period may be imposed by the stock exchange from the date of grant. Vesting terms are at the discretion of the Board of Directors. All issued share options have terms of three to five years and vest over periods of up to three years. The exercise prices reflect trading values of the Company’s shares at grant date. 45 SHAMARAN PETROLEUM CORP. Notes to the Consolidated Financial Statements For the year ended December 31, 2012 (Expressed in thousands of United States Dollars unless otherwise stated) ______________________________________________________________________________ Movements in the Company’s share options outstanding are explained as follows: Outstanding at January 1, 2011 Granted Exercised Forfeited Outstanding at December 31, 2011 Expired Forfeited Outstanding at December 31, 2012 Share options exercisable: At December 31, 2011 At December 31, 2012 Number of share options Weighted average exercise price CAD 4,560,000 25,000 (1,301,666) (50,000) 3,233,334 (450,000) (160,000) 2,623,334 2,803,335 2,615,001 0.65 0.80 0.49 0.43 0.72 1.52 0.67 0.59 0.75 0.59 The Company recognizes compensation expense on share options granted to both employees and non-employees using the fair value method at the date of grant, which the Company records as an expense. The share based payments expense is calculated using the Black-Scholes option pricing model. The weighted average fair value of options granted and the assumptions used in their determination are as follows: Expected dividend yield Risk-free interest rate (weighted average) Expected share price volatility (weighted average) Expected option life in years (weighted average) Grant date fair value (weighted average) For the year ended December 31, 2011 2012 0% 3.20% 86.94% 4.12 CAD 0.53 0% 3.20% 86.94% 4.12 CAD 0.53 Share based payments expense for the year ended December 31, 2012 was $8 (2011: $264) Option pricing models require the input of highly subjective assumptions including the expected price volatility. Changes in the subjective input assumptions can materially affect the fair value estimate, and therefore the existing models do not necessarily provide a reliable single measure of the fair value of the Company’s share options. 21. Commitments Atrush Block Production Sharing Contract (“PSC”) ShaMaran holds 100% of the issued shares of General Exploration Partners Inc (“GEP”) which held on December 31, 2012 a 26.8% direct interest in the Atrush Block PSC. TAQA Atrush B.V., a subsidiary of Abu Dhabi National Energy Company PJSC, held a 53.2% interest and Marathon Oil KDV B.V. held the remaining 20% interest with the KRG then holding an option to acquire up to a 25% interest in the PSC prior to 180 days after declaration of a commercial discovery. On March 12, 2013 the Contractor entities to the PSC were notified by the KRG that it had exercised its option to acquire a 25% interest in the PSC. Subsequent to the exercise of the option by the KRG the Company holds a 20.1% direct interest in the PSC. At December 31, 2012 GEP was responsible for 26.8% of the costs incurred in executing the exploration and development work programs on the Atrush Block. 46 SHAMARAN PETROLEUM CORP. Notes to the Consolidated Financial Statements For the year ended December 31, 2012 (Expressed in thousands of United States Dollars unless otherwise stated) ______________________________________________________________________________ The PSC contemplates minimum financial commitments during the first exploration sub-period and also requires the Contractor to fund certain community development, personnel, training, environmental, and technological assistance projects during the period over which the contract is in effect. All qualifying petroleum costs incurred by the Contractor shall be recovered from a portion of available petroleum production, defined under the terms of the PSC. All modifications to the PSC are subject to the approval of the KRG. As at December 31, 2012, the outstanding commitments of the Company were as follows: 2013 4,767 103 4,870 As at December 31, 2014 2015 Thereafter - - - - - - - - - Total 4,767 103 4,870 Atrush Block Office and other Total commitments 22. Financial instruments Financial assets The financial assets of the Company on the balance sheet dates are as follows: Other receivables Other current assets, excluding prepaid expense Cash and cash equivalents Total financial assets Cash, loans and receivables 2011 2012 204 - 41,216 41,420 105 68 49,085 49,258 Financial assets classified as loans and receivables are initially recognized at fair value and are subsequently measured at amortized cost using the effective interest method less any provision for impairment. Financial assets classified as available-for sale are recognized at fair value with gains and losses arising from changes in fair value recognized in other comprehensive income. The carrying amount of the Company’s financial assets approximates their fair value and none of which are past due. Financial liabilities The financial liabilities of the Company on the balance sheet dates are as follows: Accounts payable and accrued expenses Deferred liability Financial liabilities associated with discontinued operations Current tax liabilities Long term liabilities Total financial liabilities Note 18 13 2012 7,027 5,000 1,941 90 120 14,178 2011 23,245 - 2,613 122 - 25,980 Financial liabilities are initially recognized at the fair value of the amount expected to be paid and are subsequently measured at amortized cost using the effective interest rate method. 47 SHAMARAN PETROLEUM CORP. Notes to the Consolidated Financial Statements For the year ended December 31, 2012 (Expressed in thousands of United States Dollars unless otherwise stated) ______________________________________________________________________________ Capital risk management The Company manages its capital to ensure that entities within the Company will be able to continue as a going concern, while maximizing return to shareholders. The Company is not exposed to externally imposed capital requirements. The capital structure of the Company consists of cash and cash equivalents and equity, comprising issued share capital, reserves and retained earnings as disclosed in the consolidated statement of changes in equity. The Company has no debt at December 31, 2012 (2011: $nil). Significant accounting policies Details of the significant accounting policies and methods adopted, including the criteria for recognition, basis of measurement and the basis on which income and expenses are recognized in respect of each class of financial assets and liability are disclosed in note 3. Financial risk management objectives The Company’s management monitors and manages the Company’s exposure to financial risks facing the operations. These financial risks include market risk (including commodity price, foreign currency and interest rate risks), credit risk and liquidity risk. The Company does not presently hedge against these risks as the benefits of entering into such agreements is not considered to be significant enough as to outweigh the significant cost and administrative burden associated with such hedging contracts. Commodity price risk The prices that the Company receives for its oil and gas production may have a significant impact on the Company’s revenues and cash flows provided by operations. World prices for oil and gas are characterized by significant fluctuations that are determined by the global balance of supply and demand and worldwide political developments and in particular the price received for the Company’s oil and gas production in Kurdistan is dependent upon the Kurdistan government and its ability to export production outside of Iraq. A significant decline in the price at which the Company can sell future oil and gas production could adversely affect the amount of funds available for capital reinvestment purposes as well as the Company’s value in use calculations for impairment test purposes. The Company does not hedge against commodity price risk, however given that the Company is in the exploration and development stage, it is not exposed to significant commodity price risk. Foreign currency risk management The Company maintains a portion of its cash and cash equivalents in Canadian dollars; however, the Company’s operations are conducted predominantly in United States dollars. As a result, the Company is exposed to foreign currency risk due to exchange rate fluctuations between the Canadian dollar (“CAD”) and the reporting currency of the Company, the United States dollar (“USD”). In addition, Company entities undertake certain transactions denominated in foreign currencies, being any currency other than the functional currency of the Company entity. The Company has elected not to hedge its exposure to the risk of changes in foreign currency exchange rates. The carrying amounts of the Company’s principal monetary assets and liabilities denominated in foreign currency at the reporting date are as follows: Canadian dollars in thousands (“CAD 000”) Swiss francs in thousands (“CHF 000”) Assets Liabilities 2012 2011 2012 2011 168 268 42,165 685 274 279 618 346 48 SHAMARAN PETROLEUM CORP. Notes to the Consolidated Financial Statements For the year ended December 31, 2012 (Expressed in thousands of United States Dollars unless otherwise stated) ______________________________________________________________________________ Foreign currency sensitivity analysis The Company is exposed to movements in CAD against the USD, the presentational currency of the Company. In 2011, funds were raised through the issuance of equity instruments in CAD and are held in CAD until they are required to fund operations at which time they are converted into USD. Sensitivity analyses have been performed to indicate how the profit or loss would have been affected by changes in the exchange rates between the USD and CAD. The analysis below is based on a strengthening of the USD by 1% against the USD in which the Company has significant assets and liabilities at the end of respective period. A movement of 1% reflects a reasonably possible sensitivity when compared to historical movements over a three to five year timeframe. The sensitivity analysis includes only outstanding foreign currency denominated monetary items and adjust their translation at the period end for a 1% change in foreign currency rates. A positive number in the table below indicates an increase in profit where USD weakens 1% against the CAD on the basis of the CAD assets and liabilities held by the Company at the balance sheet dates. For a 1% strengthening of the USD against the CAD there would be an equal and opposite impact on the profit or loss. Statement of comprehensive income Interest rate risk management Assets 2012 2 2011 408 Liabilities 2012 (3) 2011 (6) The Company earns interest income at variable rates on its cash and cash equivalents and is therefore exposed to interest rate risk due to a fluctuation in short-term interest rates. The Company’s policy on interest rate management is to maintain a certain amount of funds in the form of cash and cash equivalents for short-term liabilities and to have the remainder held on relatively short-term deposits. Interest rate sensitivity analysis: Based on exposure to the interest rates for cash and cash equivalents at the balance sheet date a 0.5% increase or decrease would not have a material impact on the Company’s profit or loss for the year. A rate of 0.5% is used as it represents management’s assessment of the reasonably possible changes in interest rates. Credit risk management Credit risk is the risk that a counterparty will default on its contractual obligations resulting in financial loss to the Company. The Company is primarily exposed to credit risk on its cash and cash equivalents and trade and other receivables. Trade and other receivables are primarily with joint venture partners in the oil and gas industry and are subject to normal industry credit risks. Joint venture receivables are typically collected within one to two months of the joint venture bill being issued to the partner. The Company mitigates risks arising from joint venture receivables by obtaining partner approval of capital expenditures prior to starting a project. The Company manages credit risk by monitoring counterparty ratings and credit limits and by maintaining excess cash and cash equivalents on account in instruments having a minimum credit rating of R-1 (mid) or better (as measured by Dominion Bond Rate Services) or the equivalent thereof according to a recognized bond rating service. The carrying amounts of the Company’s financial assets recorded in the consolidated financial statements represent the Company’s maximum exposure to credit risk. 49 SHAMARAN PETROLEUM CORP. Notes to the Consolidated Financial Statements For the year ended December 31, 2012 (Expressed in thousands of United States Dollars unless otherwise stated) ______________________________________________________________________________ Liquidity risk management Liquidity risk is the risk that the Company will have difficulties meeting its financial obligations as they become due. In common with many oil and gas exploration companies, the Company raises financing for its exploration and appraisal activities in discrete tranches in order to finance its activities for limited periods. The Company seeks to raise additional funding as and when required. The Company anticipates making substantial capital expenditures in the future for the acquisition, exploration, development and production of oil and gas reserves and as the Company’s project moves into the development stage, specific financing, including the possibility of debt, may be required to enable future development to take place. The financial results of the Company will impact its access to the capital markets necessary to undertake or complete future drilling and development programs. There can be no assurance that debt or equity financing, or future cash generated by operations, would be available or sufficient to meet these requirements or, if debt or equity financing is available, that it will be on terms acceptable to the Company. The Company manages liquidity risk by maintaining adequate cash reserves and by continuously monitoring forecast and actual cash flows. Annual capital expenditure budgets are prepared, which are regularly monitored and updated as considered necessary. In addition, the Company requires authorizations for expenditure on both operating and non-operating projects to further manage capital expenditures. The maturity profile of the Company’s financial liabilities are indicated by their classification in the consolidated balance sheet as “current” or “non-current”, and further information relevant to the Company’s liquidity position is disclosed in the Company’s going concern assessment in note 2. 23. Related party transactions Transactions with corporate entities Namdo Management Services Ltd. Mile High Holdings Ltd. McCullough O’Connor Irwin LLP Vostok Naphta Investment Ltd. Lundin family Lundin Petroleum AB Total Purchases of services during the year 2012 314 37 95 26 719 524 1,715 2011 361 103 56 24 - 2,176 2,720 Amounts owing at the reporting dates 2011 2012 28 19 22 - - 75 144 7 19 14 - - 78 118 Namdo Management Services Ltd. is a private corporation owned by a shareholder of the Company which has provided corporate administrative support and investor relation services to the Company. Mile High Holdings Ltd. is a private corporation associated with a shareholder of the Company which has provided transportation services to the Company in relation to its fundraising activities. McCullough O’Connor Irwin LLP is a law firm in which an officer of the Company is a partner which has provided legal services to the Company. Vostok Naphta Investment Ltd. is a corporation traded on the NASDAQ OMX Nordic Exchange in Stockholm (trading symbol VNIL SDB) associated with a shareholder of the Company and which has provided investor relations services to the Company in relation to its fundraising activities in Sweden. 50 SHAMARAN PETROLEUM CORP. Notes to the Consolidated Financial Statements For the year ended December 31, 2012 (Expressed in thousands of United States Dollars unless otherwise stated) ______________________________________________________________________________ The Company received a $10 million loan from the Lundin family through two investment companies who jointly are principal shareholders of the Company (the "Lenders"). In connection with the loan the Company has issued to the Lenders an aggregate of 3,000,000 common shares of the Company. The fair value of the shares issued has been expensed as a finance cost. The loan was repaid in full in August 2012. Refer also to notes 10 and 19. The Company receives services from various subsidiary companies of Lundin Petroleum AB (“Lundin”), a shareholder of the Company. Lundin charges during the year ended December 31, 2012 of $524 (2011: $2,176) were comprised of G&G and other technical service costs of $138 (2011: $195), reimbursement for Company travel and related expenses of $1 (2011: $611), office rental, administrative and building services of $385 (2011: $455). In the year 2011 the Company paid $915 to Lundin relating to a guarantee provided to the KRG on behalf of the Company. Included within general and administrative expenses for the year 2011 are contributions totaling $1,025 made to a charitable foundation whose chairman is a major shareholder of the Company. Funds from this charity, in part, are used for community investment activity in Kurdistan. No contributions were made by the Company to this charitable foundation in the year 2012. Key management compensation The Company’s key management was comprised of its five directors and two executive officers consisting of seven individuals who have been remunerated as follows: Management’s salaries Management’s short-term benefits Management’s share based payments Directors’ fees Directors’ share based payments Total For the year ended December 31, 2011 2012 774 156 12 130 - 1,072 787 203 105 131 40 1,265 Short-term employee benefits include non-equity incentive plan compensation and other short-term benefits. Share-based payments compensation represents the portion of the Company’s share based payments expense incurred during the year attributable to the key management, accounted for in accordance with IFRS 2 ‘Share Based Payments’. All transactions with related parties are in the normal course of business and are made on the same terms and conditions as with parties at arm’s length. 51 SHAMARAN PETROLEUM CORP. DIRECTORS CORPORATE INFORMATION Keith C. Hill Director, Chairman Vancouver, British Columbia Pradeep Kabra Director, President & Chief Executive Officer CORPORATE OFFICE 885 West Georgia Street Suite 2000 Vancouver, British Columbia V6C 3E8 Telephone: +1-604-689-7842 Facsimile: +1-604-689-4250 Geneva, Switzerland Website: www.shamaranpetroleum.com Brian D. Edgar Director Vancouver, British Columbia Gary S. Guidry Director Calgary, Alberta Alexandre Schneiter Director Anieres, Switzerland J. Cameron Bailey Director Calgary, Alberta OPERATIONS OFFICE 5 Chemin de la Pallanterie 1222 Vésenaz Switzerland Telephone: +41-22-560-8600 Facsimile: +41-22-560-8601 BANKER HSBC Bank Canada Vancouver, British Columbia INDEPENDENT AUDITORS PricewaterhouseCoopers LLP London, UK TRANSFER AGENT OFFICERS Computershare Trust Company of Canada Brenden Johnstone Chief Financial Officer Geneva, Switzerland Kevin E. Hisko Corporate Secretary Vancouver, British Columbia Vancouver, British Columbia STOCK EXCHANGE LISTINGS TSX Venture Exchange and NASDAQ OMX First North Exchange Trading Symbol: SNM INVESTOR RELATIONS Sophia Shane Vancouver, British Columbia 52 

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