Heritage Oil · PDF file83 Financial Calendar ... Annual Report & Accounts 2008 Heritage Oil...

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Heritage Oil LimitedAnnual Report & Accounts 2008

Heritag

e Oil Lim

ited A

nnual Report &

Accounts 2008

Heritage Oil Limited is an independent oil and gas exploration and production company with a primary listing on the Main Market of the London Stock Exchange (symbol HOIL) and Exchangeable Shares listed on the Toronto Stock Exchange (symbol HOC) and London Stock Exchange (symbol HOX). The Company currently focuses on operations in Africa, the Middle East and Russia.

Overview01 Highlights02 Chairman’s Statement04 Chief Executive’s Review08 Chief Executive’s Q&A10 Operations Review 10 Uganda 14 Kurdistan Region of Iraq 16 Tanzania 18 Democratic Republic

of Congo 20 Mali 22 Malta 24 Pakistan 26 Russia

Financial Review28 Committed to Generating Value

Corporate Social Responsibility32 Co-operative Relationships

Board of Directors34 Board of Directors

Corporate Governance36 Corporate Governance Report41 Remuneration Report47 Directors’ Report51 Responsibility Statement of the

Directors52 Independent Auditors’ Report

to the Members of Heritage Oil Limited

Financial Statements53 Consolidated Income Statement54 Consolidated Statement

of Recognised Income and Expense

55 Consolidated Balance Sheet56 Consolidated Cash Flow

Statement57 Notes to Consolidated Financial

Statements

Other81 Glossary of Technical Terms

and Definitions82 List of Advisers83 Financial Calendar

Cover page shows Miran Block in Kurdistan Region of Iraq

Head Office and Directors’ Business Address:Fourth Floor, Windward House La Route de la Liberation Jersey JE1 1BG Channel Islands

Tel +44 1534 873000Fax +44 1534 873344

www.heritageoilltd.com

A Balanced Portfolio of Diverse Assets

Near term focus on the core activity areas >of Uganda and Kurdistan

High impact exploration plays which can >transform the Company

Sufficient oil volumes have been found in >the Albert Basin, Uganda, to justify a major commercial development

Medium and longer term focus is Tanzania, >where seismic acquisition has recently been completed, the DRC, Malta, Mali and Pakistan

Production asset in Russia >

Experienced Management

Solid understanding of local geology and >politics in all areas of operations

Track-record of finding valuable world-class >discoveries

Extensive network of contacts >

Strong oil and gas experience >

Proven Track-Record

Discovered the M’Boundi field in the >Republic of Congo in 2001

Raised approximately $100 million from >the sale of assets in the Republic of Congo between 2002 and 2006

Funds re-invested to acquire current >portfolio

Pioneering entry into the Albert Basin, >Uganda, in 1997 – we have now unlocked a multi-billion barrel basin

Sold Oman holdings in April 2009 for >$28 million to fund acceleration of work programmes in core areas

Strategic Positioning

Focus on high impact exploration plays >

First mover advantage – as demonstrated >by success with significant holdings in Uganda and the Kurdistan Region of Iraq

Core areas are Africa, Middle East >and Russia

Exploration ( Operated)Democratic Republic of Congo (“DRC”)Kurdistan Region of IraqMaliMaltaPakistanTanzaniaUganda

Production ( Operated)Russia

Where we operate

Highlights

OperationalSufficient oil volumes have been >discovered in the Albert Basin, Uganda, to exceed the commercial threshold for development

Discovered the world-class >Buffalo-Giraffe field in Block 1, Uganda

Kingfisher-3 well, Block 3A, >Uganda, discovered oil in the three main reservoirs structurally higher than anticipated, increasing the areal extent of the field

Miran West-1 well in the Kurdistan >Region of Iraq encountered oil over an interval of 1,100 metres in 2009 and is currently being tested

Collected 2D seismic over the >Kimbiji and Kisangire Blocks in Tanzania, where Heritage farmed-in earlier in the year

Expanded the portfolio of >properties: Farmed-in to two licences in Mali; four blocks in Tanzania and one licence in Pakistan

FinancialPrimary listing on the Main Market >of the London Stock Exchange completed on 31 March 2008

Joined the FTSE 250 Index on >23 June 2008

Net production increased by 26% >year-on-year

Strong balance sheet with cash >position of $91 million as at 31 December 2008

Sale of holdings in Oman, >subsequent to the year end, realised cash of $28 million to fund acceleration of work programmes in core activity areas

In April 2009, third party back-in >rights for 25% were exercised on the Miran Licence in the Kurdistan Region of Iraq. Heritage received $6.7 million (25% of back costs)

Termination of a refinery >commitment for over $140 million in return for making payments out of future oil and gas sales from the Miran Licence in the Kurdistan Region of Iraq

Independent research analyst >coverage increased from one party to twelve

OutlookTesting of the Miran West-1 well >in the Kurdistan Region of Iraq is being undertaken during April 2009

Further drilling on the Miran >Licence in 2009 will be considered following test results from the Miran West-1 well

A further exploration and appraisal >drilling programme is planned to commence in Block 1, Uganda, in the second half of 2009

All dollars are US$ unless otherwise stated

Heritage Oil Limited Annual Report & Accounts 200802

Potential for Growth

Chairman’s Statement

I am pleased to report that 2008 was another year of very strong progress for Heritage both operationally and in terms of positioning the Company for steady near- and long-term growth in shareholder value.

Our strategy of seeking out and investing in exploration and early development opportunities with high-impact potential, while also expanding our exposure to European capital markets and the international oil and gas sector, is proving to be effective.

OperationsOperating highlights include world-class discoveries in the Albert Basin, Uganda, and commencement of drilling of the Miran West-1 well in the Kurdistan Region of Iraq, which is now in the process of being tested.

Our considerable achievements in Uganda include continued drilling success in Block 3A, highlighted by Kingfisher-2 testing at a combined rate of 14,364 bopd, and successful drilling in Block 1. Our discovery of the Buffalo-Giraffe field in Block 1, Uganda, is believed, by management, to be the largest onshore oil field discovered in Sub-Saharan Africa in the last 20 years. Exceptional results from Uganda drilling have established a gross resource of approximately 600 million barrels. This is above the volume considered necessary for major infrastructure development for the Albert Basin. Our Albert Basin results indicate the outstanding potential of this region. This could transform the Company, especially as we continue with further exploration and development. Having operated in Uganda since 1997, Heritage, as operator with a 50% equity interest in Blocks 1 and 3A, is strongly positioned to be a major participant in the future development of this world-class resource.

Another notable highlight of 2008 was the excellent progress made in the Kurdistan Region of Iraq, a highly prospective, and as yet under-developed, oil-prone region. The undiscovered potential of the region has been estimated at 40 billion barrels of oil and 60 trillion cubic feet of natural gas, ranking it as one of the most highly prospective untapped energy resource regions in the world. It is

Michael J. HibberdChairman

reported that the exploration success rate in Iraq has historically averaged over 80%. Heritage has been active in Kurdistan since 2004 and we are strongly committed to the region. We were the second of 21 companies that have been awarded Production Sharing Contracts (“PSCs”) by the Kurdistan Regional Government (“KRG”) since their petroleum law was passed in August 2007.

On 25 March 2009 we announced drilling of the Miran West-1 well had completed and had reached a total depth of 2,935 metres. The well encountered oil shows over an interval of 1,100 metres with excellent oil shows in the three principal known productive reservoir formations in the region. We are in the process of undertaking a series of drill stem tests over a gross interval of approximately 500 metres. We believe our operations in this region also have the potential to transform the Company. Our commitment and enthusiasm for the Kurdistan Region of Iraq is reflected in the acceleration of our programmes.

London ListingOur most significant corporate achievement of 2008 was the primary listing of our shares on the Main Market of the London Stock Exchange, which was completed at the end of March, a move that was overwhelmingly supported by our shareholders. This listing initiative was undertaken to increase liquidity, unlock additional value creation for shareholders and also to enhance the Company’s status and profile among European investors and within the international oil and gas sector as a whole.

The London listing, which was followed by the Company’s inclusion as a member of the prestigious FTSE 250 Index, was accompanied by a reorganisation that saw the establishment of a new parent company, Heritage Oil Limited, in Jersey. Given the geographic spread of Heritage’s operational activities and licences,

Heritage Oil Limited Annual Report & Accounts 2008 03

Workers at the Miran West-1 well, >in the Kurdistan Region of Iraq

2008 was a year of exceptional progress for Heritage, and the outlook for 2009 and beyond is very encouraging.

we believed that it was appropriate for the Company to be domiciled in the British Isles, where a substantial number of investors and the Company’s management reside.

Also, as part of the corporate reorganisation, the Company’s shares were effectively split on a ten-for-one basis. This was designed to further enhance trading volumes and liquidity of our shares for the benefit of all shareholders.

FinancialAfter the Company’s success in raising significant amounts of capital in 2007, no additional financing was required in 2008. Heritage finished the year with a strong balance sheet and cash to finance planned operations in 2009. Nevertheless, our recent exceptional success means that we now intend to accelerate work programmes in Uganda and Kurdistan. With this in mind, we made a decision to dispose of our non-core interests in Oman. Oman disposal proceeds of $28 million, plus $400,000 in working capital adjustments, are to be used to fund accelerated programmes in our core areas. In regard to financing large-scale infrastructure programmes in Uganda, I am pleased to report that we have been approached by a number of parties. Initial proposals involve terms that would significantly reduce our financing requirements.

Social ResponsibilityAs a company that operates in remote and comparatively undeveloped regions of the world, we recognise that our responsibilities to local communities go beyond simply providing funds and local employment. We are committed to implementing community programmes in health, education, public facility and environmental awareness, and we work actively with local communities to secure trust and mutual co-operation. Over the course of the last 18 months we have undertaken a significant investment in the Carl Nefdt Memorial Primary School, in Block 3A, Uganda. We intend

to undertake similar projects in our other core interest areas as our operational activities expand.

Board of DirectorsDuring 2008 we were delighted to welcome Salim Hassan Macki and General Sir Michael Wilkes KCB, CBE to the Group as Non-Executive Directors. Both appointments are outstanding additions to the Board and both are already making valuable contributions to the Company.

OutlookAs always, I am very grateful to our talented management team and employees for their dedication and contribution to the remarkable growth Heritage has enjoyed this past year. 2008 was a year of exceptional progress for Heritage and the outlook for 2009 and beyond is highly encouraging. Operations in Uganda and the Kurdistan Region of Iraq are particularly promising and we continue to look for further strong results from investments and activities in other operating areas. I would add that in the future, as in the past, our overriding objective is to create real and lasting value for our shareholders.

Michael J. HibberdChairman

MilestonesApril 2009 > Sale of Oman holdingsApril 2009 > Commenced testing the Miran West-1 well in the Kurdistan Region of IraqApril 2009 > Termination of a refinery commitment in the Kurdistan Region of IraqJanuary 2009 > Successful completion of the Kingfisher-3A well, Uganda January 2009 > Successful Giraffe-1 exploration well in Block 1, Uganda – a world class discoveryDecember 2008 > Commenced drilling the Miran West-1 well in the Kurdistan Region of IraqDecember 2008 > Successful completion of the Kingfisher-3 wellDecember 2008 > Successful Buffalo-1 well in Block 1, UgandaOctober 2008 > Successful Warthog-1 exploration well in Block 1, UgandaSeptember 2008 > Commenced three well exploration programme in Block 1, Uganda September 2008 > Commenced drilling Kingfisher-3 and -3A wells in Block 3A, UgandaSeptember 2008 > Obtained government approval and completed farm-in documentation in TanzaniaAugust 2008 > Reported record test results in Uganda with the Kingfisher-2 wellJune 2008 > FTSE 250 Index InclusionApril 2008 > Commenced drilling the Kingfisher-2 well in UgandaMarch 2008 > Dealings commenced on the London Stock ExchangeFebruary 2008 > Completion of the Mali farm-in documentation for two licencesFebruary 2008 > Announced corporate reorganisation


First Mover Advantage

Chief Executive’s Review

Operational success has dramatically transformed Heritage. Our outstanding drilling successes in Blocks 1 and 3A in the Albert Basin, Uganda, mean we are now confident that sufficient volumes have been discovered to justify a major development.

The work programme on the Miran Block in the Kurdistan Region of Iraq was accelerated following the completion of a seismic survey in the second quarter of 2008. The Miran West-1 well, which commenced drilling on 21 December 2008, reached a total depth of 2,935 metres on 25 March 2009. This well encountered oil shows over an interval of 1,100 metres with excellent oil shows over the three targeted reservoir intervals. A series of tests is being performed over a gross interval of approximately 500 metres. These achievements, coupled with listing on the Main Market of the London Stock Exchange and the corporate reorganisation that raised the Company’s profile as a significant player in the international oil and gas industry, puts us in excellent shape for the achievement of near- and long-term growth in production and reserves and also in shareholder value.

2008 was a year of extreme volatility in international crude oil markets, with price fluctuations of a magnitude never seen before. Fortunately, as primarily an exploration company with international projects in proven light oil basins, Heritage was not dramatically affected by short-term price volatility and we remain confident that the longer-term outlook for oil and gas is positive. The world will continue to need hydrocarbons which will require new production from remote and challenging regions. At Heritage we remain committed to seeking out such opportunities and managing political and operational risk with a diverse portfolio and a prudent mix of exploration, development and production.

Our long-standing strategy of being an early entrant in prospective regions, demonstrating our management and technical expertise, and our commitment to building working relationships with local and international companies and governments, gives us the flexibility to react quickly to changing circumstances.

Anthony Buckingham Chief Executive Officer

The combination of aggressive investment, prudent risk management and operating excellence has yielded exceptional results throughout 2008 and into 2009. This includes our discovery of the world-class Buffalo-Giraffe field in Block 1, Uganda where we are the operator with a 50% interest.

AfricaUgandaThe world-class Kingfisher field in Block 3A was discovered in 2007. This significant discovery was surpassed with the discovery of the large Buffalo-Giraffe field, in Block 1, in January 2009. On current estimates, the Buffalo-Giraffe field has an area of approximately 48 square kilometres and an oil column of 140 metres. The structure may extend even further to include the Buffalo East prospect, creating a very large structure of up to 90 square kilometres. Initial estimates for the Buffalo-Giraffe field are recoverable resources of approximately 350 million barrels (gross), which is not only a major field in itself, but also significantly de-risks the many other potential targets in the block.

Operations in this basin have continued to achieve a 100% success rate as, to date, 21 successful exploration and appraisal wells have been drilled with all encountering hydrocarbons. Further appraisal work on the Kingfisher discovery produced some exciting results in 2008 with a record production test, for any well drilled in Uganda, of 14,364 bopd. Additionally, the same three reservoir intervals were encountered in all of the wells and, significantly, the areal extent of the field was increased as oil was found structurally higher than anticipated in the Kingfisher-3 appraisal well.

The Albert Basin will remain a high corporate priority in coming years as the recent drilling successes have raised the estimated


Drilling operations at Buffalo site, >Block 1, Uganda

resources of the basin above the threshold required for commercial development. This is transformational for Heritage. With a gross licence area in Uganda and the DRC in excess of 12,000 square kilometres – equivalent to approximately 55 North Sea blocks – the Albert Basin is now estimated to have multi-billion barrel reserve potential. We are considering a number of fast-track development scenarios for the Albert Basin, including the possibility of a phased development with first production in 2011 by utilising the existing railway network in East Africa. We are also considering an export pipeline to the coast as well as a scheme to service local markets.

In addition to the Kingfisher drilling activity, mapping of recent seismic data has identified a number of prospects offshore in Lake Albert within the Heritage operated Block 3A, including the structurally attractive Pelican prospect and the large Crane prospect. An offshore drilling programme that will include the Crane and Pelican prospects is currently expected to begin in the first half of 2010.

TanzaniaHeritage farmed-in to four licence areas in Tanzania in mid-2008, with a total area of approximately 25,000 square kilometres. In early 2009, Heritage completed the acquisition of 2D seismic in-fill data on two blocks in Tanzania. Future drilling locations will be identified once the data has been processed and interpreted.

The Middle EastKurdistan Region of IraqThe Kurdistan Region of Iraq is another primary focus area for Heritage, with the potential to find multi-billion barrels of oil. Based on excellent quality seismic data acquired by Heritage during 2008, management has confirmed that the Miran Block contains two anticlines that have the

potential to contain billions of barrels of oil in place from multiple potential reservoir targets. Drilling of the Miran West-1 well began in December 2008, a significant accomplishment given that Heritage was awarded the licence less than 15 months prior, in October 2007.

In March 2009, we announced drilling of the Miran West-1 well had completed and reached a total depth of 2,935 metres. The well encountered oil shows over an interval of 1,100 metres, with excellent oil shows in the three principal proven reservoir formations in the region (the Shiranish, Kometan and Qamchuqua). Good quality light sweet oil was recovered to surface as part of the drilling operations. A series of drill stem tests over a gross interval of approximately 500 metres are being conducted during April 2009. A further announcement will be made when all tests have been completed.

The operating environment for oil and gas companies in the Kurdistan Region of Iraq remains relatively stable and secure, and

Heritage management believes that any outstanding issues between the government of Iraq and the Kurdistan Regional Government will be resolved satisfactorily. To that end, the two parties formed a series of committees to resolve issues. There has been considerable progress recently with the likelihood that first oil from Kurdistan will be exported this year.

OmanFollowing our exceptional success in Uganda and very encouraging drilling results in the Kurdistan Region of Iraq, we decided to sell our non-core 10% interest in Block 8 in Oman for $28 million, plus $400,000 in working capital adjustments. We believe that greater value can be generated by using this cash to finance accelerated work programmes in Uganda and the Kurdistan Region of Iraq.


First Mover Advantage

Chief Executive’s Review continued

Recent drilling successes have raised the estimated resources of the Albert Basin, Uganda, above the threshold required for commercial development.

PakistanIn December 2008, Heritage received government approval for a farm-in to the Zamzama North Block in the Sindh Zone (Zone lll) in southern Pakistan. Heritage is the operator and was awarded a 48% participating interest in the block. This has extended Heritage’s operations in Pakistan, which also include a 54% interest in, and operatorship of, the Sanjawi Block in the Baluchistan Zone (Zone II) in Pakistan. This block contains a number of large anticlinal structures which could be potentially significant drilling targets.

RussiaDevelopment of the Zapadno Chumpasskoye Licence in western Siberia, in which Heritage holds a 95% equity interest, continued during 2008. A third exploration and appraisal well was completed in the first half of 2008, and average daily oil production increased to 379 bopd in 2008. Peak production of 900 bopd was achieved but the field was shut-in between December 2008 and February 2009 following a temporary reduction in the domestic oil price in Russia. Production has since recommenced at a level of approximately 150 bopd but we expect this to increase over the year.

In summary, Heritage has achieved tremendous operating success during 2008 and early 2009, leading to a world-class oil discovery in Uganda and very encouraging results from the Miran West-1 well in the Kurdistan Region of Iraq, which is currently being tested. We also achieved increases in production and expanded our portfolio of properties. Looking ahead, we believe we have the financial and technical capability, combined with the management flexibility, to pursue opportunities to enhance the interests of our shareholders. We look forward to making substantial further progress and increasing shareholder value in both the near- and the long-term.

I would like to thank our staff, my fellow Directors and our shareholders for their continuing support.

Anthony BuckinghamChief Executive Officer


Kingfisher-3 drill site, Block 3A, >Uganda

Strategy Strengths

The Group aims to continue to generate growth in shareholder value by focusing on high-impact international plays that provide multiple targets with the potential to discover substantial hydrocarbon reserves. The Group’s growth strategy is to acquire and invest in exploration and early development opportunities throughout the world, with a particular emphasis on its core areas of Africa, the Middle East and Russia.

To be successful, the Group has developed a highly effective network of influential industry, political and institutional relationships. These enable the Group to gain access to a wide variety of new oil and gas business opportunities.

The Company’s competitive strengths include:

Our ability to expand a portfolio of high- >impact international plays; in 2008 we extended our portfolio to include assets in Tanzania, Mali and Pakistan

Experienced management and >technical teams with a track-record of finding valuable oil discoveries; we announced in January 2009 the world- class Buffalo-Giraffe discovery

Our position in the Albert Basin of >Uganda is considered by management to have the potential to contain over two billion barrels of oil reserves

Our demonstrated success as a first- >mover in acquiring assets in territories such as Uganda and the Kurdistan Region of Iraq

Our proven record of realising value >through asset sales; $28 million was raised in April 2009 through the sale of Eagle Energy (Oman) Limited, a wholly-owned subsidiary of Heritage

The Group aims to continue to generate growth in shareholder value by focusing on high-impact international plays.


Chief Executive’s Q&A

Heritage remains committed to generating shareholder value by focusing on high-impact exploration.

What, for you, were the highlights of 2008?2008 was a year of tremendous achievements for Heritage, both operationally and corporately. Operationally, we continued with the 100% success rate in Uganda where we discovered the Buffalo-Giraffe field which management considers to be the largest onshore discovery in Sub-Saharan Africa for 20 years. This discovery, in our operated Block 1, pushed the Albert Basin over the threshold required for a commercial development.

In the Kurdistan Region of Iraq we accelerated our work programme and within only 15 months of signing our licence we commenced drilling the prospective Miran West-1 well – a remarkable achievement highlighting the technical and managerial capabilities of Heritage.

Corporately, Heritage listed on the Main Market of the London Stock Exchange in March 2008 and joined the FTSE 250 Index. This has been very advantageous for the Company, increasing the visibility of the Company and the liquidity of our shares.

How has your strategy evolved over the last year?Heritage remains committed to generating shareholder value by focusing on high-impact exploration with the potential to discover substantial hydrocarbon reserves. Our strategy of realising value for shareholders within our own portfolio has recently been demonstrated by the sale of our Oman holdings for $28 million. With this asset, Heritage had a minority interest in a non-operated licence with negligible reserves which was no longer considered integral to the portfolio. We believe that the proceeds will generate greater value through reinvestment in our core activity areas of Uganda and the Kurdistan Region of Iraq.

How does the Company engage with shareholders?One of the aims of moving to the Main Market of the London Stock Exchange was to enhance the Company’s status and profile among European investors and within the international oil and gas sector as a whole. Communication with shareholders is given a high priority and we ensure there is regular dialogue with institutional investors, as well as general presentations to analysts. As a result we have broadened our investor base and increased the research coverage, giving Heritage an increased profile. We have also redesigned our website which is continually updated to keep investors informed of our activities. We also employed a full time investor relations specialist for the first time who has coordinated an effective investor relations programme.

What values define Heritage?Heritage has many core values that run through all our activities. These include:

respecting the laws and customs of •the countries in which we operate; supporting the communities in areas •where we operate; promoting long-term relationships with •stakeholders; encouraging and supporting employees •to play their part in creating a better environment; motivating staff to retain and attract •experienced employees; andthe belief that shareholders’ long-term •interests are best served by the pursuit of businesses with high standards of responsibility.

What distinguishes Heritage from other companies within the sector?The Company has many competitive strengths, including:

experienced management and technical •team with a track-record of finding valuable oil discoveries;a geographically diversified portfolio of •high-impact exploration plays;our demonstrated success as a first-mover •in being awarded assets in territories such as Uganda and the Kurdistan Region of Iraq; andour proven track-record of realising value •through asset sales.

What does 2009 hold for Heritage?2009 will be another exciting year for Heritage as we continue with high-impact exploration in our focus areas of Uganda and Kurdistan. We are planning on returning to Block 1 in Uganda later in the year with an exciting exploration and appraisal programme in this prolific basin. The Kurdistan Region of Iraq will also feature prominently in 2009 as we are currently testing the Miran West-1 well.

Do you have a message for shareholders?Exceptional exploration success has begun to transform the Company within the last year and we have delivered on promises made in our Annual Report last year. Namely, we have exceeded the volume threshold required to justify development in Uganda and we have commenced a high-impact drilling campaign in the Kurdistan Region of Iraq. Heritage has the ability to grow significantly over the coming years and we believe that we have the management, technical expertise and strategy to achieve this.


Heritage has the ability to grow significantly over the coming years.


Operations Review: Exploration

Uganda

In 2008 the Buffalo-Giraffe field was discovered – this is the largest discovery in Uganda to date


Map of licences in Uganda >

Area Date Heritage Licence (sq km) Awarded Equity Partners Operator

Block 1 3,659 July 2004 50%1 Tullow Heritage

Block 3A 2,024 September 2004 50%1 Tullow Heritage

1 Third party back-in rights exist which, if exercised fully, could result in a minimum holding of 42.5%.

In 1997, the Group became the first oil and gas company to actively explore in Uganda in almost 60 years after being awarded a licence covering the original Block 3 in the Albert Basin of western Uganda. In 2001, the Group farmed out 50% of the licence to Energy Africa, which was subsequently acquired by Tullow Oil plc (“Tullow”). Heritage is one of only two international oil companies with licences in the vast Albert Basin, which has an area in Uganda of over 9,000 square kilometres.

A total of 21 wells have been drilled in the Albert Basin since the beginning of 2006 and all have found hydrocarbons.

Block 3AThe original Block 3 was reconfigured and re-licenced in 2004, as Block 3A, for a term of six years. Block 3A is located in the southern portion of the Albert Basin and covers an area of 2,024 square kilometres. Heritage holds a 50% interest in Block 3A, is the operator and drilled two successful appraisal wells during 2008 in this block.

The Kingfisher-2 well was drilled to a total measured depth of 3,906 metres (3,197 metres true vertical depth) in 2008. Three reservoir intervals were encountered which had a cumulative test rate of 14,364 bopd, surpassing the rate from the same three intervals encountered in Kingfisher-1A, which flowed at a combined rate of 9,773 bopd, in 2007.

The Kingfisher-3 well, located three kilometres south of Kingfisher-2, commenced drilling in September 2008. This well was drilled to evaluate the south-west portion of the Kingfisher structure and encountered a gross vertical hydrocarbon bearing interval of 123 metres, with net vertical pay of 41 metres, based on evaluation of the wireline log data. In addition to finding oil, the well also confirmed that this part of the field was approximately 100 metres structurally higher than expected.

The more extensive oil accumulation and the greater structural elevation of the reservoir in the south-west part of the field gives confidence the discovery is larger than initially estimated. The Kingfisher-3A sidetrack, which was drilled as a development well and completed in February 2009, encountered a gross vertical oil-bearing interval of 90 metres with net vertical oil pay of 22 metres.

The discovered oil in Block 3A is good quality, light (between 30º and 32º API) and sweet with a low gas-oil ratio and some associated wax. The reservoirs are highly permeable sandstones with an estimated permeability of up to 3,000 miliDarcies. The same three sandstone reservoir intervals were encountered in all of the Kingfisher wells highlighting the continuity and the large lateral extent of the reservoirs. All three Kingfisher wells have been suspended as future producers.

Management believes that successful drilling of the Kingfisher field has lowered the exploration risk of other exploration targets identified within

Block 3A. These will be explored in a lake drilling programme scheduled to commence in 2010. 550 kilometres of 2D seismic, which was acquired in mid-2007, was further interpreted during 2008 and identified a number of additional prospects in the lake including the large Crane prospect. The Front End Engineering and Design (“FEED”) study for an offshore drilling programme commenced last year following completion of feasibility and pre-FEED studies and is expected to be completed in the first half of 2009.

Block 1Heritage holds a 50% interest in and is the operator of Block 1, which was awarded in 2004. Block 1 is located at the northern end of Lake Albert, and encompasses an area of 3,659 square kilometres. A successful 2008 drilling campaign discovered the Warthog accumulation and the Buffalo-Giraffe field, which is considered by management to be the largest onshore oil discovery in Sub-Saharan Africa in over 20 years.


Uganda continued



A seismic survey comprising approximately 670 kilometres of 2D data was completed on Block 1 in February 2008 which identified many encouraging Direct Hydrocarbon Indicators (“DHIs”). A three well exploration programme commenced in September 2008 targeting the Warthog, Buffalo and Giraffe prospects.

The Warthog-1 well commenced drilling in September 2008 and encountered 46 metres of net hydrocarbon pay. Wireline logging and formation pressure measurements indicated 31 metres of net oil pay in the principal oil-bearing section, overlain by 15 metres of additional net hydrocarbon pay comprising, most probably, volatile oil, condensate and liquids rich gas. In addition to the oil discovered, further potential for oil exists in the overlying reservoir section downdip of the Warthog well location and there is additional potential in the adjacent Warthog North prospect.

The Buffalo-1 well commenced drilling in November 2008 and encountered 43 metres of net hydrocarbon pay with 28 metres of net oil pay. In December 2008, the Giraffe-1 well commenced drilling 5.5 kilometres from Buffalo-1 and encountered a gross oil-bearing interval of 89 metres with 38 metres of net oil pay.

Pressure and seismic data indicate that the Giraffe discovery is structurally connected to the Buffalo discovery, creating the Buffalo-Giraffe field covering approximately 48 square kilometres with an oil column of approximately 140 metres. Based on current mapping, the Company’s initial estimate of gross recoverable resources for the Buffalo-Giraffe field is over 350 million barrels. The Buffalo-Giraffe field may extend into the Buffalo-East prospect which would result in one very large structure, covering up to 90 square kilometres.

All the wells drilled in Block 1 were relatively shallow with target depths between 600 and 920 metres. Downhole pressure testing and sampling and the recovery of oil to surface have confirmed the presence of moveable oil in the Block 1 discoveries. Log interpretation and core analysis has confirmed excellent reservoir quality with porosities of up to 35%. Recent testing of the Kasamene-1 well, close by in neighbouring Block 2, gives further confidence as a maximum flow rate of 3,500 bopd was achieved. All three wells in Block 1 have been suspended as future producers.

Management estimates that there is potentially a billion barrels of oil recoverable from Block 1 as many other prospects and leads have been mapped and exploration risk has been significantly reduced by the recent drilling success. All these prospects and leads are characterised by encouraging seismic DHIs similar to those seen over the successful Warthog, Buffalo and Giraffe discoveries. Heritage plans to undertake further drilling in Block 1 in the second half of 2009.

Potential DevelopmentThe exceptional results from recent drilling programmes in Blocks 1 and 3A mean that management now believes that a gross recoverable resource of approximately 600 million barrels has been proved up. This is significantly greater than the threshold considered necessary for major infrastructure development in the Albert Basin. Other leads and prospects have the potential to significantly add to these estimates.

Development studies are currently being undertaken to optimise and fast-track development of the basin. Options include using the existing rail infrastructure which will enable commercial production to begin as early as 2011, as well as an export pipeline to the coast. It is planned to present these plans to the government of Uganda in late 2009. The costs of a pipeline will be significant, but Heritage has been approached by a number of parties who are interested in financing and building the pipeline, as well as other infrastructure. Discussions with these parties are ongoing.



Kurdistan Region of Iraq

Heritage drilled its first well in Kurdistan in 2008, less than 15 months after being awarded the licence


Map showing the Miran Block in >the Kurdistan Region of Iraq


Miran 1,015 October 2007 75%1, 2 Genel Energy Heritage

1 Third party back-in rights exist which, if exercised fully, could result in a minimum holding of 56.25%

2 Heritage equity reduced from 100% following exercise of back-in rights in April 2009

In October 2007, the Group signed a PSC with the Kurdistan Regional Government (“KRG”) covering the Miran Block in the southern part of the Kurdistan Region of Iraq. The Kurdistan Region of Iraq is an autonomous northern region in federal Iraq bordering Syria, Iran and Turkey. Since the passing of the Petroleum Law in Kurdistan, in August 2007, the KRG has awarded 21 PSCs with Heritage’s PSC being the second awarded. Being an early entrant in this region, the Group is strongly positioned to benefit from development of this significant hydrocarbon-prone region especially as the already-stable security situation continues to improve. Other oil and gas companies have been operating in this area for several years without major interruption. There is believed to be huge undiscovered potential in the region, estimated, by the US Geological Survey, at approximately 40 billion barrels of oil and 60 trillion cubic feet of gas. Additionally, it has been reported that 80% of all wells drilled in Iraq have encountered hydrocarbons.

The Miran Block covers an area of 1,015 square kilometres and is located approximately 65 kilometres from the Kirkuk oil field where remaining reserves are estimated to be in excess of 10 billion barrels. The Miran structures are on trend with the Taq Taq field.

In the second quarter of 2008, Heritage acquired 332 kilometres of good quality 2D seismic which showed two very large anticlines, Miran West and Miran East, which together cover an area of approximately 330 square kilometres. The seismic data also indicates that the reservoirs are fractured in a radial pattern which appears similar to the neighbouring Taq Taq field.

After interpreting the seismic data, Heritage accelerated the Miran work programme and contracted a rig in October 2008. Drilling commenced on Miran West-1 in December 2008, targeting the three main known producing reservoirs in the region; Shiranish,

Kometan and Qamchuqua. Both the Miran structures have the potential to contain billions of barrels of oil from multiple potential zones. Heritage has demonstrated its operational efficiency and commitment to the region by completing the seismic survey and commencing a drilling programme less than 15 months after the licence was awarded for a previously unexplored block.

In March 2009, the Company announced that drilling of the Miran West-1 well had been completed and reached a total depth of 2,935 metres. The well encountered oil shows over an interval of 1,100 metres, with excellent oil shows in the three principal proven reservoir formations in the region. Good quality, light sweet oil was recovered to surface. We are in the process of undertaking a series of drill stem tests over a gross interval of approximately 500 metres.

Based on the encouraging seismic evaluation and drilling results of the Miran West-1 well, Heritage is formulating plans for further drilling on Miran in 2009 in order to plan for a fast track development.



Tanzania

Seismic data, combined with encouraging hydrocarbon shows, identify the licences as being within a highly desirable exploration province


Map showing licences in Tanzania >


Kisangire 7,280 May 2005 55% Dominion Heritage

Lukuliro 8,828 May 2005 55% Dominion Heritage

Kimbiji 4,298 September 2006 70% Petrodel Heritage1

Latham 5,056 September 2006 29.9% Petrodel Heritage1

1 Heritage is operator of the work programme.

Heritage farmed-in to four blocks in Tanzania in East Africa in 2008 and has already completed two seismic acquisition programmes.

In April 2008, Heritage entered into farm-in agreements on two licences in eastern Tanzania, comprising four blocks (Latham, Kimbiji, Kisangire and Lukuliro Areas). Government approval for the farm-ins was received in the second half of 2008. The four blocks are located in eastern Tanzania and cover a total area of approximately 25,000 square kilometres. The Kimbiji and Latham Areas cover approximately 9,300 square kilometres and are held under one Production Sharing Agreement (“PSA”), whilst the Kisangire and Lukuliro Areas cover approximately 16,100 square kilometres and are held under a second PSA.

All four licences are close to the Mkuranga-1 gas discovery which was drilled in 2007 and reportedly flowed gas at a rate of 20 mmcf/d from an Upper Cretaceous reservoir. This well is located approximately 25 kilometres to the east of the Kisangire licence area. The large Songo Songo producing gas field is located to the south-east of the licence areas. The Wingayongo oil seep is present in the Kisangire licence area, indicating the presence in the region of a working hydrocarbon system that has generated both oil and gas. Previous seismic data acquired in these licence areas, combined with encouraging hydrocarbon shows in wells drilled in the licences, identify them as highly desirable exploration licences.

Latham and KimbijiThe Latham and Kimbiji licence areas, covering 5,056 square kilometres and 4,298 square kilometres respectively, encompass onshore (1,882 square kilometres), near shore (2,981 square kilometres) and deep water (4,491 square kilometres) areas. The PSA was awarded to Petrodel Resources Ltd (“Petrodel”) by the Tanzanian government in September

2006 with an exploration period of four years, followed by two extensions of four years and three years, respectively, with the right to a development licence with a term of 25 years.

Under the terms of the farm-in agreement with Petrodel, the Group has the right to earn a 70% working interest in the Kimbiji licence area, and a 29.9% working interest in the Latham licence area, by funding all seismic costs of the required work programmes on both blocks, comprising the acquisition of both 2D and 3D seismic data, and the drilling of two exploration wells within the Kimbiji Area. Heritage is initially acting as contract operator, being responsible for all technical and operational aspects of the work programmes, and will be appointed operator upon drilling the second exploration well in the Kimbiji Area.

Kisangire and LukuliroThe onshore Kisangire and Lukuliro licences cover an area of 7,280 square kilometres and 8,828 square kilometres, respectively. The PSA was originally awarded to Dominion Oil & Gas Limited (“Dominion”) in May 2005, with an exploration period of four years. The Company

has applied for an extension to the initial exploration period, which the government has advised it is favourably considering. This is followed by one extension of four years, a further extension of three years and the right to a development licence with a term of 25 years.

Under the terms of the farm-in agreement with Dominion, the Group has the right to initially earn a working interest of 55% in both the Kisangire and Lukuliro licences. In order to earn the working interests, Heritage will fund all costs to acquire a minimum of 150 kilometres of 2D seismic data and the costs of the first commitment well. The Group also has an option to earn an additional working interest of 15%, thereby increasing its participating interest to 70%, by funding 87.5% of the costs of a second well.

The acquisition of 198 kilometres of 2D seismic commenced in the Kisangire licence area in September 2008 and was followed by the acquisition of 207 kilometres of 2D seismic in the onshore part of the Kimbiji licence area. The data is currently being analysed after which drilling locations will be determined.



Democratic Republic of Congo

Blocks I and II cover more than 6,000 square kilometres in the highly prospective Albert Basin


Area Date Heritage Licence (sq km) Awarded Equity Partners

Block I 3,825 Signed July 2006 39.5% Tullow Oil1, (awaiting presidential decree) COHYDRO

Block II 2,634 Signed July 2006 39.5% Tullow Oil1, (awaiting presidential decree) COHYDRO

1 Operator

In addition to its licences in Uganda, Heritage holds a 39.5% non-operated interest in two blocks in the Albert Basin on the DRC side of Lake Albert – Blocks I and II. These blocks, which include the entire DRC side of Lake Albert, cover more than 6,000 square kilometres and are adjacent to Block 3A and Block 2 in Uganda. The combination of licences in both the DRC and Uganda gives the Group a very strong acreage position in this highly prolific sedimentary basin.

In 2006 the Group, with its partners in these licences, executed a PSA with the government of the DRC. The initial exploration term is five years, during which seismic data will be acquired and exploration wells drilled. However, work will only commence following the receipt of a Presidential Decree, the timing of which is still uncertain. The validity of the licences was disputed during 2008, however, Heritage and the operator are working closely with the government of the DRC and both continue to be confident that title will be confirmed.

Given the proximity of the DRC licences to the Ugandan licences in the Albert Basin, management anticipates being able to realise cost benefits in operating, capital and infrastructure development costs.

Map showing licences in the >Democratic Republic of Congo



Mali

The two licences have a gross area of over 72,000 square kilometres


Map showing licence areas in Mali >

Heritage announced in March 2008 that the government of Mali had approved a farm-in on two exploration licences. The two licences have a gross area of over 72,000 square kilometres. Heritage has been appointed operator with the right to earn a 75% working interest in each of Blocks 7 and 11 by financing 100% of the minimum work programme of seismic acquisition and the drilling of one exploration well. The Group’s partner is Mali Oil Development SARL, a wholly-owned subsidiary of Centric Energy Corporation.

Blocks 7 and 11 are located in the east of the country and include the Gao Graben, a Mesozoic basin that management considers geologically similar to other Mesozoic interior-rift basins within North Africa, such as the Muglad Basin of Sudan and the Doba Basin of Chad. The Graben has been delineated by various surveys conducted since the early 1970s, including over 2,000 kilometres of 2D seismic and a comprehensive gravity and magnetic survey. The data shows the presence of tilted fault-blocks and indicate the possible presence of up to 4,000 metres of sediments above basement.

Previous drilling in the Gao Graben has encountered oil and gas shows. The Tin Bergoui water well, which lies approximately 30 kilometres to the west of Block 11, was drilled to a depth of 350 metres and encountered oil and gas shows in a number of horizons, indicating the potential for a working hydrocarbon system.

A two year extension to the licences on both blocks was awarded in January 2009 giving the Group a better opportunity to refine the work programme. Over the next couple of years, the Group will proceed with a programme of seismic acquisition and reprocessing to support the selection of initial drilling locations.


Block 7 39,804 July 2006 75% Centric Energy Heritage

Block 11 32,810 June 2005 75% Centric Energy Heritage



Malta

Areas 2 and 7 are considered, by management, to be similar play types to producing fields in the western Mediterranean


Map showing licence areas in Malta >

In December 2007, the Group entered into a PSC with the Maltese government for a 100% interest in Areas 2 and 7 in the south-eastern offshore region of Malta. The licences cover almost 18,000 square kilometres and are situated approximately 80 kilometres and 140 kilometres, for Area 2 and Area 7, respectively, from the south eastern Maltese coast in water depths of approximately 300 metres. The two areas are considered, by management, to be similar play types to producing fields in the western Mediterranean. Initial seismic interpretation, based on the current extensive data set of almost 3,500 kilometres acquired in 2000, indicates the presence of a variety of potential prospects. Primary targets are Lower Eocene and Cretaceous carbonates that are already recognised as major hydrocarbon producing plays in the western part of the Mediterranean.

Area Date Heritage Licence (sq km) Awarded Equity

Area 2 9,190 December 2007 100%

Area 7 8,778 December 2007 100%

The licences are under-explored with only one well previously drilled in Area 2; the Medina Bank 1 in 1980. The well was drilled to a depth of 1,225 metres, but failed to reach the target horizons, estimated to be between 1,500 and 4,500 metres. The well did, however, encounter gas shows in porous, fractured carbonates.

Heritage has agreed to a minimum contractual work programme comprising the acquisition of a further 1,000 kilometres of seismic data and the drilling of an exploration well. The work programme has commenced with the reinterpretation of existing seismic which will be followed by the acquisition of a 2D seismic programme in either 2009 or 2010.



Pakistan

The licences cover a total area of 3,487 square kilometres


Map showing licence areas >in Pakistan

Pakistan covers approximately 800,000 square kilometres and has proved reserves reported to be in the region of 289 million barrels of oil and 760 billion cubic metres of gas.

The Sanjawi Block (number 3067–2) in Zone II (Baluchistan) was awarded in November 2007. Heritage has a 54% interest and is the operator. This onshore exploration licence covers a gross area of 2,258 square kilometres and encompasses a variety of terrains ranging from relatively flat desert and cultivated valley floors to a series of rugged hills. The block is considered highly prospective due to the presence of oil seeps to the south of the licence. The block is dominated by a series of broad east-west trending surface features including the Dabbar and Warkan Shah anticlines. These are large structures with the Dabbar anticline alone being some 300 square kilometres in area.

In December 2008, Heritage obtained a 48% interest in the Zamzama North Block (number 2667–8) and has been appointed operator. The Zamzama North Block is located in the south of Pakistan in the western part of Sindh Province approximately 200 kilometres northwest of Hyderabad and has an area of 1,229 square kilometres. The block is situated only 10 kilometres from the eastern flanks of the Kirthar Fold Belt and forms part of the associated compressive foreland. The eastern portion of the block is composed of the riverine, rich, flat, low lying and intensively cultivated flood plain of the Southern Indus Basin, whilst the western area is uncultivated and covered by the low, flat alluvial outwash from the Kirthar Hills. The current seismic database used to map the Zamzama North Block comprises some 750 kilometres of fair to good quality, recent 2D seismic.


Sanjawi Permit 2,258 November 54% Hycarbex Heritage 2007 American Energy, Sprint Energy, Trakker Energy

Zamzama North 1,229 December 48% Hycarbex Heritage 2008 American Energy, Sprint Energy, Trakker Energy

Any discovered hydrocarbons could be readily connected to the existing infrastructure as the main Sui-Karachi pipeline is situated only about six kilometres to the east of the block. To the immediate south of this block is the large Zamzama gas field.

Initial interpretation of seismic has identified several prospects and leads.


Operations Review: Production

Russia

This licence is in the hydrocarbon-rich Western Siberian province of Khanty-Mansiysk, accessible to existing infrastructure and facilities


Map showing licence area >in Russia

Net Working Net Net Interest Entitlement Present Reserves Interest Value MMboe MMboe $ millions

Proved 23.1 23.1 20.7

Probable Additional 37.3 37.3 214.2

Total Proved + Probable 60.4 60.4 234.9

Zapadno Chumpasskoye, located within the Western Siberian province of Russia which accounts for approximately 60% of Russia’s total crude oil production, is an example of the Group’s strategy of acquiring assets in both highly-prospective and established hydrocarbon-prone parts of the world.

Since 2005, the Group has held a 95% equity interest in ChumpassNefteDobycha Limited, a Russian Company whose sole asset is the Zapadno Chumpasskoye Licence. This licence, which expires in 2024, is in the hydrocarbon-rich Western Siberian province of Khanty-Mansiysk, approximately 100 kilometres from the city of Nizhnevartovsk and in the area of the region’s prolific Samotlor oil field, which makes it accessible to existing production infrastructure and facilities. The licence covers an area of about 200 square kilometres and contains the Zapadno Chumpasskoye field, discovered in 1997. A total of nine wells were drilled on the licence prior to 2005, and the Group has drilled a further three wells. The producing reservoir is a late Jurassic sandstone, at a depth of approximately 2,700 metres, and is the same producing horizon present in a number of neighbouring fields.

Since 2006 the Company has acquired 200 kilometres of seismic data, began constructing pilot production facilities and re-entered existing well #226. Production facilities were commissioned and production commenced in May 2007. Three additional exploration and appraisal wells were drilled by Heritage and the third well was completed in the first half of 2008. A fracture stimulation was completed and artificial lift installed on one well. In 2008, production peaked at over 900 bopd and averaged 379 bopd which was an increase of 80% on 2007 levels. The field was shut-in between December 2008 and February 2009 following a temporary reduction in the domestic oil price in Russia. The crude is light

and sweet, 42º API crude oil, with moderate gas-to-oil ratios.

RPS Energy independently estimated that Zapadno Chumpasskoye contains proved plus probable reserves of 60.4 million barrels of oil, net to the Group, with a Net Present Value, discounted at 10%, of $234.9 million as at 31 December 2007. During 2008 another independent review was undertaken by Sibtechneft, a noted Russian reserves agency, as a requirement of the licence following completion of work commitments. The C1+C2 reserves were determined to be closely in line with those estimated by RPS Energy; 63.4 million barrels gross or 60.2 million barrels net to the Group. The review was accepted by the Ministry of Natural Resources of the Russian Federation in November 2008.

Independent Reserves at Zapadno Chumpasskoye RPS Energy, an independent geoscience consultancy, estimated Zapadno Chumpasskoye’s net working and entitlement interest reserves and value to the Group as at 31 December 2007, using money of the day prices, discounted at 10%, to be as follows:


Committed to Generating Value

Financial Review

Corporate PerformanceProductionAverage daily production increased by 26% from 356 bopd in 2007 to 450 bopd in 2008. The increase in production was attributable to higher levels of production from Zapadno Chumpasskoye in Russia despite being shut-in during December 2008. This was offset by a 51% decline in production of condensate and LPG in Oman due to the temporary cessation of production in the second half of 2008. This was in part due to upgrading the Bukha platform to handle new production from the West Bukha field. The West Bukha field commenced production in February 2009.

RevenuePetroleum and natural gas revenue increased by 38% to $5.1 million, due to higher sales volumes in Russia offset by lower condensate and LPG sales from the Bukha field in Oman. Condensate sales from the Bukha field in Oman decreased by 38% to $1 million due to the shut-in of Bukha production in the second half of 2008. Revenue from oil production in Russia increased by 124% to $3.8 million.

The average realised price of $32.1 per barrel in 2008 was 5% higher than in 2007, attributable to higher average commodity prices in Russia, offset by lower average condensate and LPG sales prices in Oman.

Operating ResultsPetroleum and natural gas operating costs increased by 22% to $2.3 million in 2008, due to almost a full year of production in Russia compared to only seven and a half months of production in 2007. The increase is in line with the higher sales volumes but additionally some volume efficiencies were achieved. Average operating costs per barrel sold declined by $0.69 to $14.18 in 2008, compared to $14.87 in 2007.

Production tax in Russia increased from $1.1 million in 2007 to $2.3 million in 2008. This increase was due to an increase in volumes of oil production in Russia and higher average commodity prices in 2008 used in the calculation of production tax.

Paul Atherton Chief Financial Officer

Selected Operational and Financial Data 2008 2007 Change

Production bopd 450 356 26%

Sales volume bopd 435 333 31%

Average realised price $/bbl 32.1 30.5 5%

Petroleum and natural gas revenue $ million 5.1 3.7 38%

Net loss $ million (41.3) (83.2) 50%

Net loss per share – basic and diluted $ (0.16) (0.37) 57%

Total cash capital expenditures $ million (103.2) (75.3)

Year end cash balance $ million 90.6 230.1


General and administrative expenses decreased from $41.3 million in 2007 to $30.7 million in 2008, due principally to lower non-cash share-based compensation expenses arising from stock options granted or approved in 2007. General and administrative expenses in 2008 were also inflated by one- off expenses of $9.7 million relating to the corporate reorganisation and subsequent listing on the London Stock Exchange.

If share-based compensation and the one-off corporate reorganisation and subsequent listing expenses are excluded, net general and administrative expenses increased from $12.2 million in 2007 to $13.6 million in 2008. This 11% increase resulted from the Group employing additional staff and incurring increased expenses to support higher levels of exploration and development activities in the Group’s activity areas.

In 2008, the Group capitalised $6.3 million (2007 – $10.3 million) of directly attributable general and administrative costs relating to exploration and development activities, including stock-based compensation of $4.6 million (2007 – $9.0 million).

Depletion, depreciation and amortisation expenses increased by 24% to $2.3 million in 2008, primarily due to higher oil and liquids sales volumes.

Exploration expenditures expensed and not capitalised in the year decreased by 85% from $5.4 million in 2007 to $0.8 million in 2008. Exploration expenditures in 2008 related principally to potential new ventures in Russia ($0.3 million) and activities in Tanzania ($0.2 million). Exploration expenditures in 2007 related mainly to activities in the Kurdistan Region of Iraq ($2.3 million) and potential new ventures in Russia ($1.5 million).

In 2008, the Group recognised an impairment write-down of property, plant and equipment of $4 million (2007 – $1.8 million) comprised of two elements; the disposal of the Oman holdings and the write-down of a drilling rig. Subsequent to year end, the entire share capital of the Oman holdings was sold for $28 million in cash and a working capital adjustment of approximately $0.4 million. The Group wrote down the carrying value of interest in Oman to its year end fair value resulting in a charge of $3.2 million. The carrying value of the Group’s 50% interest in a drilling rig was written down to nil, resulting in a charge of $0.7 million (2007 – $1.8 million).

In 2008, interest income was $4.0 million (2007 – $4.0 million). Cash and cash equivalents are typically held in interest bearing treasury accounts. Cash generating this income was raised by a private placement of shares for gross proceeds of $186.4 million (Cdn$181.5

million) in November 2007 and the issue of $165 million of 8% unsecured convertible bonds in February 2007.

Convertible bonds are separated into liability and derivative liability components (being the bondholders’ conversion option) and each component is recognised separately. The change in the fair value of the convertible bonds’ conversion options, which is primarily due to the performance of Heritage’s share price, resulted in a gain of $11 million in 2008 compared to a loss of $21.3 million in 2007.

Other finance costs decreased from $12.0 million in 2007 to $11.3 million in 2008. These costs are mainly comprised of interest and accretion expenses relating to the issue of $165 million of 8% unsecured convertible bonds in February 2007.

The Group had foreign exchange losses of $5.6 million in 2008, primarily related to an intercompany US dollar denominated loan provided by the Group to the Russian subsidiary for the development of Zapadno Chumpasskoye. The revaluation of this loan in Russian roubles (the functional currency of the Russian subsidiary) created the foreign exchange loss due to the weakening of the Russian rouble against the US dollar during 2008. In accordance with the Group’s accounting policy, the revaluation loss was recognised in the financial statements of the Russian subsidiary in Russian roubles and translated into US dollars at consolidation and recognised in the income statement.

Heritage recognised an unrealised loss of $1.7 million in 2008 (2007 – $0.9 million gain), in the fair value of its investment in Afren Plc (“Afren”) warrants. The gain or loss is determined by the performance of the share price of Afren. Heritage holds 1,500,000 warrants in Afren with an exercise price of £0.60 per warrant, received as partial consideration from the sale of Heritage Congo in 2006. The warrants have a term until 22 December 2011. At 31 December 2008, Afren’s share price was £0.26 per share.

Heritage’s net loss in 2008 was $41.3 million, compared to $83.2 million in 2007. The adjusted net loss in 2008 was $23.7 million compared to $29.7 million in the previous year if certain non-cash items (share-based compensation expense, gain/loss on derivative financial liability, property, plant and equipment impairment write-down, foreign exchange loss/gain and unrealised loss/gain on revaluation of Afren warrants) and the one-off reorganisation costs are excluded. In 2008 the basic and diluted loss per share was $0.16, compared to basic and diluted loss per share of $0.37 in 2007.

Work programmes continued to be accelerated in Uganda with five exploration wells drilled.


Financial Review continued

Cash Flow and Capital ExpendituresCash used in operating activities was $32.8 million in 2008 compared to $2.5 million in 2007. Total cash capital expenditures in 2008 were $103.2 million compared to $75.3 million in 2007. The following work was undertaken in 2008:

Work programmes continued to be •accelerated in Uganda with five exploration wells drilled at a total net cost of approximately $45.3 million ($8.8 million in 2007);The successful Kingfisher-2 and -3 appraisal •wells were drilled in Block 3A, Uganda, with the successful Kingfisher-3A sidetracked over the year end and completed in February 2009;A three well exploration programme was •undertaken in Block 1, Uganda. The Warthog-1 well spud on 30 September 2008, followed by the Buffalo-1 well in December 2008 and the Giraffe-1 well at the end of December. The programme was completed in January 2009 and all three wells discovered oil; A 2D seismic programme of approximately •330 kilometres was acquired over the Miran Block, in the Kurdistan Region of Iraq, between April and June 2008 and the Miran West-1 exploration well spud on 22 December 2008; Development of the West Bukha field in •Oman continued. Production commenced in February 2009 at a rate of 15,000 boepd. The West Bukha-3 development well was drilled in 2008, the existing West Bukha-2 well was deepened, the platform was installed and the sub-sea pipeline completed;The drilling of Heritage’s third exploration and •appraisal well in the Zapadno Chumpasskoye field in Russia was completed in the first half of 2008. This well was brought into production later in the year. Production in Russia increased to a peak of 900 bopd and averaged 379 bopd for the year; andHeritage farmed-in to two licences, covering •four exploration blocks, in Tanzania in 2008.

Heritage commenced acquiring 2D seismic in the Kimbiji and Kisangire blocks in September 2008 and the programmes were completed in February 2009. The data is currently being processed.

The net decrease in cash and cash equivalents during 2008 was $139.5 million for a year end cash balance of $90.6 million.

Financial PositionLiquidityAt 31 December 2008, Heritage had a working capital surplus of $43.2 million, including cash and cash equivalents of $90.6 million. As for most oil and gas exploration companies, Heritage raises financing for its activities from time to time using a variety of sources. Based on its current plans and knowledge and its projected capital expenditure and operating cash requirements, the Group has sufficient cash to finance its current plans for at least 12 months from the date of approval of the financial statements, but further financings are likely to be required to meet expenditures planned for the second half of 2010. Sources of funding for future exploration and development programmes will be derived from, inter alia, new credit facilities, reinvesting funds from operations, using existing treasury resources, disposal proceeds from the sale of non-core assets, such as the sale of the Company’s holdings in Oman in 2009, farm-outs and, when considered appropriate, issuing debt and additional equity. Accordingly the Group has a number of different sources of finance available and the Directors are confident that additional finance will be raised as and when needed. In addition, development of the Group’s successful exploration projects may be financed separately.

Capital StructureHeritage’s financial strategy has been to fund its capital expenditure programmes and any potential acquisitions by selling non-core

Production in Russia peaked at 900 bopd and averaged 379 bopd for the year.

Miran Block in the Kurdistan Region >of Iraq


assets, reinvesting funds from operations, using existing treasury resources, finding new credit facilities and, when considered appropriate, either issuing unsecured convertible bonds or equity. Heritage raised cash of over $350 million in 2007. $165 million was raised in February 2007 by the issue of 8% unsecured convertible bonds, of which $82.5 million plus interest was used to redeem existing 10% convertible bonds and the remainder was available for general corporate funding purposes. Gross proceeds of $186.4 million (Cdn$181.5 million) were received in November 2007 from an issue of 3,000,000 Common Shares by Heritage Oil Corporation (“HOC”) at a price of Cdn$60.50 per share. In October 2007, Heritage received a loan of $9.5 million to refinance the acquisition of a corporate jet. Interest on the loan is at a rate of London Interbank Offered Rate (“LIBOR”) plus 1.6%. In January 2005, the Company received a sterling denominated loan of £4.5 million to refinance the acquisition of a corporate office. Interest on the loan is fixed at 6.515% for the first five years and is then variable at a rate of LIBOR plus 1.35%. Heritage had net debt of $146.8 million and gearing of 47% at 31 December 2008 compared with net cash of $13.7 million and nil gearing at 31 December 2007. Net debt and gearing are defined in note 3b to the financial statements on page 65.

Important Events Since the Year EndFollowing a strategic review the entire share capital of Eagle Energy (Oman) Limited, a wholly-owned subsidiary that owned a 10% working interest in Block 8, Oman, was sold to RAK Petroleum for $28 million, plus $0.4 million in working capital adjustments, on 7 April 2009.

In April 2009, in accordance with the option outlined in the PSC in the Kurdistan Region of Iraq the KRG nominated a third party participant in the Miran Licence. Additionally, the KRG has released the Company from the obligation to build a refinery in exchange for making payments totalling $35 million from future oil and gas sales from the licence. The minimum financial commitment for the Company for building the refinery was $140 million. The Company remains the operator with a 75% working interest in the Miran Licence and will receive the pro-rata share of 25% of all past work programme expenditures. The transaction was completed upon the receipt of approximately $6.7 million in costs incurred by the Company to 31 January 2009. The third party participant is responsible for funding its share of all work programme expenditures.

The Group is not required to obtain a reserve report annually or to publish reserves data under the listing rules. No reserves report at 31 December 2008 was obtained as the

Group’s previous independent reserves report effective at 31 December 2007 is not considered to have changed significantly due to the relatively small production during 2008. Additionally, the Group was undertaking significant work programmes in Uganda and Kurdistan at the year end, which would not have been incorporated in a report at that date. Management is planning to update the reserve report in the second half of 2009 when the results from the recent drilling programmes in Uganda and the Kurdistan Region of Iraq have been completed and results analysed and interpreted.

Risk and Internal Controls Primary Risks and Uncertainties Facing the BusinessThe primary risks and uncertainties facing the business which could have a material adverse impact on the Group include:

Exploration and development expenditure •and success rates – the Company has experienced management and technical teams with a track-record of finding attractive oil discoveries and has a diversified portfolio of exploration, development and production assets;Factors associated with operating in •developing countries, political and regulatory instability – the Company maintains close contact with governments in the areas within which it operates and where appropriate gets involved in community projects;Heritage cannot completely protect itself •against title disputes – in many of the countries in which the Group operates, land title systems are not developed to the extent found in many industrialised countries. Notwithstanding potential challenges in the DRC, the Kurdistan Region of Iraq and Malta, the Group believes that it has good title to its oil and gas properties. However, it cannot control or completely protect itself against the risk of title disputes or challenges and there can be no assurance that claims or challenges by third parties against the Group’s properties will not be asserted at a future date;Oil and gas sales volumes and prices – •whilst not under the direct control of the Company a material movement could impact on the Group;Loss of key employees – remuneration •packages are regularly reviewed to ensure key executives and senior management are properly remunerated; andGenerally, it is the Company’s policy to •conduct and manage its business in US dollars, which is its reporting currency. Cash balances in Group subsidiaries are primarily held in US dollars but small amounts may be held in other currencies in order to meet immediate operating or

administrative expenses or to comply with local currency regulations.

The Board will continue to review its approach to commodity prices, interest rates and currency fluctuations in light of the Company’s future capital commitments and ongoing obligations. Heritage may use derivative instruments to mitigate against its exposure to volatility in oil prices and foreign currency movements. In 2007 and 2008 the Group did not enter into any hedging arrangements.

There is further information on the risks facing the Company in the Directors’ Report on pages 47 to 50 and also in note 3 of the financial statements on pages 64 and 65.

Internal ControlsA system of internal controls was designed and tailored to ensure key risks are appropriately addressed and to provide assurance regarding the reliability of financial reporting and preparation of financial statements. Risk and internal controls are continually assessed. One possible weakness has been identified, concerning accounting for complex transactions, although the Company seeks third party advice to mitigate against this weakness.

As part of the Company’s internal controls, any transactions with related parties are identified, scrutinised and appropriately disclosed in the financial statements.

Heritage maintains insurance policies in accordance with industry standards. Heritage believes that the level of insurance cover it maintains is adequate based on various factors such as the cost of the policies, industry standard practice and the risks associated with the exploration and development of oil and gas properties in the countries in which it operates. Heritage does not insure against political risk and, therefore, provides shareholders with full exposure to the risks and rewards of investing in its territories.

Heritage maintains a detailed financial model which allows the Company to plan future operating and capital activities in the most efficient manner.

Paul AthertonChief Financial Officer


Corporate Social Responsibility

Heritage has always been committed to responsible and respectful conduct towards the diverse communities affected by our activities. Heritage’s Corporate Social Responsibility (“CSR”) encompasses the management of relationships with shareholders, employees, contractors and most importantly the communities in areas where we work, together with the impact on society and the environment, especially where we are the operator. We recognise we have specific responsibilities in each of these areas and consider adherence to CSR values to be a key factor in securing long-term success.

Heritage today faces a wide range of both opportunities and challenges in the area of CSR. This is particularly so given the nature of the industry and the geographic location of our operations, many of which are in countries with complex social, political and economic challenges and/or particular environmental sensitivities.

Heritage’s objective is to minimise our impact on the environment and to support development in local communities. We recognise the importance of engaging with local stakeholders and take seriously their concerns regarding oil and gas development. Heritage believes that by working closely with our host communities we are better enabled to meet potential challenges. Heritage works with the communities within which we operate to ensure their needs are fully considered when projects are being planned.

Effective management of CSR allows Heritage to identify potential risks and respond to areas of performance where improvement is needed. Effective CSR can help in attracting and retaining the best staff, making us a partner of choice and realising value for shareholders. The CSR agenda is to inspire, challenge and empower staff to make a positive contribution to local communities and the environment.

Heritage is committed to integrating CSR into everything it does – from being a great place to work, investing in local communities, minimising environmental impacts and working closely with partners and contractors.

EnvironmentThere were no environmental issues encountered by Heritage during 2008. Heritage is aware that many parts of our business could potentially impact upon the environment and ecosystems within which we operate. We pledge to restore sites where we operate to their original state and to comply with conditions imposed by bodies such as the National Environment Management Authority (“NEMA”) in Uganda. Before any well is drilled we conduct a seismic survey which uses reflected sound waves to generate data. This information, together with other geological data, enables our technical team to establish where to drill for the best chance of a discovery. In 2008, five wells were drilled in Uganda and all encountered hydrocarbons. The drill sites are all in the process of being restored under government supervision. Heritage adheres to a strict clean environment philosophy with a comprehensive waste management practice. We contain site drilling effluents which are disposed of in dedicated environmentally accepted areas.

Heritage provides support to the Ugandan Wildlife Authority (“UWA”) and has recently financed a major overhaul of a ferry which is used to transport both vehicles and people in the Block 1 area in Uganda. We have also provided scrambler motorcycles for UWA rangers and a vehicle for UWA nature wardens.

SocietyOur community development strategies in all areas are designed and implemented through consulting and working with local communities and local governments. This is done from an early stage to ensure that the community has a

Heritage’s objective is to minimise its impact on the environment and to support development in local communities.

Co-operative Relationships


sense of ownership of the project and is able to continue the implementation of the project on a sustainable basis.

In Block 3A, Uganda, the inauguration ceremony of the Carl Nedft Memorial Primary School at Buhuka was organised by Heritage. This was a major project for which we made available $500,000 and will endow the school for many years to come with teaching facilities and learning opportunities for the children of the remote Buhuka area.

Other community work in which we lead programmes includes:

paving or mending roads providing better •access for villagers to local markets;providing fresh water by drilling water wells;•supplying carpets to a local mosque in •the Kurdistan Region of Iraq;providing tremendous opportunities for •employment for the local population;sponsoring pupils to attend university. We •are currently sponsoring 12 in Uganda;sponsoring various community aid and •womens’ projects, including a community radio station and the Watoto Child Care Project in Uganda; andsponsoring civil servants in Uganda to •attend courses on oil legislation and contract terms.

Health and SafetyHeritage is committed to achieving and maintaining the highest standards of safety for its employees and the communities within which we operate. In line with our policy, Heritage is committed to:

championing safety to everyone our •activities touch;playing a role in promoting best practice •in our industry;sharing openly information on our health •and safety performance; andmanaging health and safety matters •as a critical business activity.

Training contractors in health and safety matters was a priority in 2008. Our personnel in Uganda, the Kurdistan Region of Iraq and Russia attended, or were offered, courses on safety issues such as oil spill and HAZMAT (Hazardous Materials) operational training and fire fighting training. In both the Kurdistan Region of Iraq and Uganda, Heritage provides nearby villagers with medical checks and access to the site clinic. A senior member of staff is directly responsible for health and safety matters and refers any issues to the Board.

Malaria remains the biggest health care issue in Uganda and Heritage is determined to help address this risk. A total of 42 workers were treated for Malaria in Block 1 and 115 in Block 3A, out of total of 786 patients seen which included residents from the local communities. None of the patients progressed to complicated Malaria and no Malaria related deaths were reported, showing that the current Malaria prevention and treatment programme is working.

In Uganda we have appointed an HIV and AIDS Co-ordinator who leads related training on the project locations.

In 2008 we sponsored two local Ugandan students to attend the Basic Life Support Paramedical Course in Rustenburg, South Africa. Both of these students passed the course and are now employed on projects as part of the internal training programmes to obtain further paramedical qualifications.

EmployeesWe aim to attract, develop and retain talented and committed people in order to maintain the capability to deliver our business objectives and make Heritage an employer of choice. We ensure that all of our employees understand and appreciate our business strategy, goals and values. It is important to Heritage that our staff feel valued, safe and free to raise any concerns. There are equal opportunities in

career development for all employees and with a geographically diversified portfolio we believe that the workforce should reflect the communities in which we operate. It is important that our employees create and maintain our business culture within the communities where our operations impact. Heritage employs local resources wherever possible and also encourages all seismic contractors to do the same and to run a programme of training for those with potential to take on technical roles within future surveys.

Government and PartnersRelationships are key to the development of any business and our success would not be possible without the support of all stakeholders including governments and regulators. We work hard to continuously engage with these groups to generate support and understanding of our operations.

The Tanzanian National Environmental Management Council twice made visits to the crew’s seismic operations in both the Kimbiji and Kisangire licence areas and senior officers fed back a report which is detailed in our separate CSR report on page 5. Business EthicsThe Group encourages the highest standards of integrity and honesty in all business dealings. The objective is to maintain and enhance the reputation of the Company and enforce ethical dealings within our areas of operation. The Board has established a “whistleblowing” policy which has been distributed to employees and is available in all offices. The policy details procedures for any employee to raise in confidence any concerns they may have about possible improprieties with either the Chairman or the Chief Executive Officer.

Opening of the Carl Nedft Memorial >Primary School in Buhuka, Uganda


1. Michael J. HibberdChairman and Non-Executive Director Mr. Hibberd has extensive international energy project planning and capital markets experience. He has been President and CEO of MJH Services Inc., a corporate finance advisory company, since 1995, prior to which he spent 12 years with ScotiaMcLeod in corporate finance and held the position of Director and Senior Vice President, Corporate Finance. He is Co-Chairman of Sunshine Oilsands Ltd. and currently serves on the boards of directors of AltaCanada Energy Corp., Canacol Energy Ltd., Challenger Energy Corp., Iteration Energy Ltd., Pan Orient Energy Corp., Ramtelecom Inc. and Zapata Energy Corporation. Mr. Hibberd also served as a Director of Rally Energy Corp. until October 2007 and as a Director of Deer Creek Energy Limited until December 2005. Mr. Hibberd joined the Group in March 2006.

2. Anthony BuckinghamChief Executive OfficerMr. Buckingham is the founder of the Group. He commenced his involvement in the oil industry as a North Sea diver and subsequently became a concession negotiator acting for several companies including Ranger Oil Limited and Premier Oil plc. He was previously a security adviser to various governments.

3. Paul Atherton Chief Financial OfficerMr. Atherton is a qualified accountant, having qualified with Deloitte & Touche, and holds a degree in geology from Imperial College London. He has a corporate finance background with specific experience in the international mining and resource sectors. He joined the Group in 2000 and joined the Board of Directors in 2005.

4. Salim Hassan Macki Non-Executive DirectorMr. Macki was a Member of the State Council, Former Ambassador, Government of Sultanate of Oman and has been a Director of Oman Oil (a wholly owned Government Company) since 1996. Mr. Macki holds a Master’s degree in Petrochemical Engineering and has spent most of his working life in the oil industry, where he is highly regarded internationally. He holds, or has previously held, many senior executive positions in various private and state owned entities in Oman and internationally. He joined the Group on 12 August 2008.

5. General Sir Michael Wilkes KCB, CBE Non-Executive DirectorGeneral Sir Michael Wilkes retired from the British Army in 1995 as Adjutant General and Middle East Adviser to the British Government on defence matters. As Adjutant General, Sir Michael was the most senior administrative officer within the Army and a member of the Army Board. During his distinguished career, he has seen active service across the world while also commanding at every level from Platoon to Field Army including commanding the 22 Special Air Service Regiment and serving as the Director of Special Forces. Sir Michael is a Non-Executive Director of AIM listed Stanley Gibbons Group. In addition he holds non-executive positions on a number of private companies including Britam Defence and Trico Ltd and chairs the Advisory Board of PegasusBridge Fund Management Limited, a homeland security Company. He joined the Group on 18 March 2008.

Board of Directors

6. Gregory Turnbull Non-Executive DirectorMr. Turnbull is the Regional Managing Partner of the Calgary office of the law firm of McCarthy Tétrault LLP. Mr. Turnbull has extensive knowledge of corporate governance issues and has acted for many boards of directors and special committees in that regard. Mr. Turnbull started his career with the law firm of MacKimmie Matthews in 1979. From 1987 to 2001, he was a partner with Gowlings LLP (formerly Code Hunter LLP). In 2001 and 2002, he was a partner with the law firm of Donahue LLP. Mr. Turnbull has been a partner with the law firm of McCarthy Tétrault LLP since July 2002. He joined the Group in 1997.

7. John McLeod Non-Executive DirectorMr. McLeod is a Professional Engineer with over 38 years of varied domestic and international oil and gas experience. He is the President of McLeod Petroleum Consulting Limited, President, CEO and a Director of Tuscany Energy Ltd., Paris Energy Inc. and California Oil and Gas Corporation. He has held positions and served on various boards including Constellation Oil & Gas Ltd. and CanArgo Energy Inc., as President and CEO of Arakis Energy Company, as VP, Operations of Pengrowth Gas Company, CEO and director of Rally Energy Corp. and Canoro Resources. Currently, Mr. McLeod serves as a director of Diaz Resources Ltd. and March Resources Ltd. He is immediate Past-President of the Association of Professional Engineers, Geologists and Geophysicists of Alberta. He joined the Group in 1998.


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The Directors recognise the importance of maintaining good corporate governance practices and are committed to applying the highest industry standards of business ethics, health and safety, environment, risk management and corporate and social responsibility throughout the Group.

To this end, the Board is continuing to put in place policies and procedures within which it will conduct its activities along with working practices and a business culture to ensure openness and full accountability.

As described below, the Company intends in due course to comply with the new June 2008 Combined Code on Corporate Governance as issued by the UK Financial Reporting Council (the “Code”) in all material respects.

Compliance with the CodeThe Company was incorporated on 6 February 2008 and listed on the main market of the London Stock Exchange on 31 March 2008 (the “Listing”).

This report describes the extent to which the Company has complied with the principles set out in Section 1 of the Code and how it intends to apply those principles (to the extent relevant to the June 2008 code) going forward.

Prior to the Listing, the Board took a number of steps, and continues to do so, to comply with the Code. The majority of the Board previously served as Directors of Heritage Oil Corporation (“HOC”) whose shares were listed on the Toronto Stock Exchange. The Board is, therefore, already accustomed to operating in a highly regulated corporate governance environment and as a result has adopted a number of its processes. It is the Board’s intention to work towards full compliance with the Code in all material respects. However, in light of its recent Listing, certain principles of the Code have not been applied during the reporting period, either because it is not appropriate to do so at this stage in the Company’s development or because of the short period of time that has elapsed since Listing.

Between 31 March and 31 December 2008, the Board considers that the Company complied with Section 1 of the Code, save in the following respects:

Code Provision A.1.3:• The Chairman’s performance has not yet been appraised due to the short time elapsed since listing. It is anticipated that the Chairman’s performance will be appraised for the first time as part of the Board evaluation process during the second half of 2009;Code Provision A.2.1:• The division of responsibilities between the Chairman and Chief Executive Officer were agreed in writing after the end of the reporting period;Code Provision A.3.2:• For part of the year until the appointment of Salim Hassan Macki in August 2008 at least half the Board (excluding the Chairman) were not considered to be independent Non-Executive Directors;Code Provision A.3.3:• The Board has yet to appoint a Senior independent Non-Executive Director. Communication between the Chairman, Executive and Non-Executive Directors is open and frank and the Board believes that little would be added by the appointment of a Senior Independent Director at this stage. In addition, shareholders have access to all of the Directors to raise concerns. The appointment of a Senior Independent Director will be kept under review;

Code Provision A.5.1:• A formal induction process was not in place during the period. However, it is considered more appropriate that the induction of an individual Director is tailor made to suit the needs and experience of that Director;Code Provision A.6.1:• Board evaluation has not yet been undertaken due to the short time elapsed since Listing. The Board believes that a meaningful evaluation can only take place once the Board has had a reasonable amount of time to work together. A Board evaluation process will be developed and implemented during the next year;Code Provision B.1.6:• Notice periods for the Executive Directors are 24 months. The contracts for the Executive Directors were in place before the Listing of the Company. There is no current intention to amend the notice periods but this will be kept under review by the Remuneration Committee; andCode Provision C.3.1:• The Chairman of the Company, Michael Hibberd, is a Non-Executive Director and Chairman of the Audit Committee. However, the Board believes that his recent and relevant financial experience, including his experience on corporate financial matters, is invaluable in supporting the Audit Committee to perform its role.

Board of DirectorsThe initial Board was composed of six Directors which included a Non-Executive Chairman, two Executive Directors and a further three Non-Executive Directors (as noted below). The Board is now comprised of seven Directors, a further independent Non-Executive Director being appointed during the year. The Chairman and three of the Non-Executive Directors are deemed to be independent under the terms of the Code. All of the Directors bring either extensive experience of the oil industry or a broad range of business, commercial and corporate governance experience to the Board. The Executive Directors have close involvement with the operations of the business through their operational roles. The Board is supported by a strong and experienced senior management team. The biographies of the Board are set out on page 34.

The Board is accountable to shareholders for the creation and delivery of strong sustainable financial performance, guidance, perspective and long-term shareholder value. The Board is responsible for ensuring the effectiveness of the system of internal controls including effectively managing and considering the commercial risks and financing needs, the disposal of businesses and assessing the most appropriate balance between acquisition led growth and organic growth. Individual Directors constantly evaluate and challenge the Company’s business strategy to ensure they identify areas where improvements can be made or where new opportunities exist so that the strategies remain appropriate and relevant to the Company’s business. In order to ensure that the Company complies with its obligations as a listed Company, the Board also has responsibility for communications with shareholders, health and safety policy and the review of the Company’s management and financial performance. Further details of compliance with these obligations are set out below.

The Board was formed early in 2008 and met five times between the Listing on 31 March 2008 and 31 December 2008. The Board will continue to meet sufficiently regularly to discharge its duties by way of formal Board meetings as well as ad-hoc meetings. The Board intends to meet at least four times a year. A formal schedule detailing matters specifically reserved for its decision has been agreed.

Corporate Governance Report


Audit Remuneration Nomination Board Committee Committee Committee (5 meetings) (3 meetings) (3 meetings) (1 meeting)

Michael Hibberd 5/5 3/3 3/31 1/1Anthony Buckingham 4/5 – – 1/1Paul Atherton 5/5 – – –John McLeod 5/5 3/3 3/3 –Salim Hassan Macki 2/22 –4 1/33 –Gregory Turnbull 5/5 – – –General Sir Michael Wilkes 5/5 3/3 3/3 1/1

1 Mr. Hibberd resigned from the Remuneration Committee in December 2008.2 Mr. Macki was appointed to the Board in August 2008.3 Mr. Macki was appointed to the Remuneration Committee in December 2008.4 Mr. Macki was appointed to the Audit Committee in April 2009.

The Company Secretary is a corporate entity based in Jersey that deals with the normal statutory compliance for the Company. The Board and its Committees are, therefore, serviced by the Company Secretary or its nominee. The other duties that would normally be carried out by the Company Secretary such as the provision of information flows to the Board are dealt with by either the Chairman or Chief Financial Officer or their nominee. In terms of corporate governance issues, the Board is advised by McCarthy Tétrault, Registered Foreign Lawyers & Solicitors, in London. The Board will monitor the provision of Company Secretarial duties and take any action as appropriate to ensure its requirements are met. The appointment or removal of the Company Secretary is a matter for the Board as a whole.

The Board shall ensure that all Directors and Committee members have access to independent professional advice whenever it is required and at the Company’s expense.

Non-Executive Directors have executed letters of appointment setting out their respective terms of appointment including the expected time commitment which has been agreed and confirmed with them. Further details can be found in the Remuneration Report on pages 41 to 46.

The Directors are aware of their responsibilities and feel able to raise any concerns at Board meetings which are minuted accurately in the Board meeting minutes.

As required by the Code, the Company maintains Directors’ and Officers’ liability insurance cover, in respect of any legal action taken against the Directors, which is reviewed annually.

Chairman and Chief Executive Officer There is a clear division of responsibility between the Chairman and Chief Executive Officer to ensure an appropriate balance of responsibility and accountability. These responsibilities have been formalised in writing and approved by the Board.

The Chairman’s role is to ensure the effective running of the Board in all aspects of its roles and setting its agenda. His other key responsibilities include leading the Board, overseeing effective communication with shareholders, ensuring constructive relations between all Directors and that all Directors are encouraged to participate fully in the activities and decision making processes of the Board. The Chairman also ensures that the Directors receive accurate, timely and clear information with all Board and Committee meeting information being issued to members in advance. At each meeting there is an update on operational and financial performance including a review of the performance and future potential of all material assets. The Chairman’s other significant appointments are disclosed to the Board and may be found in the Directors’ biographies on page 34.

The Chief Executive Officer is responsible for managing the Group’s business, proposing and developing the Group’s strategy and overall commercial objectives in consultation with the Board and, as leader of the executive team, implementing the decisions of the Board and its Committees.

The Board has delegated some of its responsibilities to certain committees in line with recommendations of the Code and to facilitate the business of the Company. These are the Audit, Remuneration and Nomination Committees. Further details of these committees and their activities can be found later in this report and also in the Remuneration Report on pages 41 to 46.

A table of attendance of members of the Board and Board Committees at meetings between 31 March 2008 and 31 December 2008 is set out below:


Board Balance and IndependenceThe Board is comprised of the following Directors:Michael Hibberd Chairman and Non-Executive DirectorAnthony Buckingham Chief Executive OfficerPaul Atherton Chief Financial OfficerSalim Hassan Macki Non-Executive DirectorGeneral Sir Michael Wilkes Non-Executive DirectorGregory Turnbull Non-Executive DirectorJohn McLeod Non-Executive Director

The Board is satisfied that its composition will ensure that no individual or group of individuals will dominate the decision-making process and that there is a strong presence on the Board of both Executive and Non-Executive Directors.

The Board considers John McLeod, Salim Hassan Macki and General Sir Michael Wilkes are independent in character and judgement and free from relationships or circumstances which may affect their judgement. On appointment, the Chairman was also considered to be independent.

Gregory Turnbull does not meet the independence criteria set out by the Code as he is a partner of McCarthy Tétrault LLP, the Canadian legal advisers to the Company.

Albion Energy Limited (“Albion”), the Company’s largest shareholder, and Anthony Buckingham entered into a relationship agreement with the Company on 28 March 2008 (the “Relationship Agreement”) as part of the Listing. The ultimate owner of Albion Energy Limited is Anthony Buckingham. The purpose of the Relationship Agreement is to ensure that transactions and relationships between the Group, Albion and Anthony Buckingham are at arm’s length and on normal commercial terms. The Relationship Agreement prescribes that at all times, the Board shall comprise of a majority of Directors who are all independent of Anthony Buckingham.

Board CommitteesAs mentioned above, the Board has three committees, being the Remuneration, Audit and Nomination Committees. The duties of these Committees are set out in formal terms of reference that were adopted by the Board on 18 March 2008 and are available on the Company website. Membership of the Committees was reviewed during the year.

Audit Committee and Internal ControlsAudit Committee ReportThe members of the Audit Committee are Michael Hibberd (Chairman), John McLeod, General Sir Michael Wilkes and Salim Hassan Macki who was appointed on 7 April 2009. All members, including the Chairman, are independent Non-Executive Directors. Other members of the Board may also be invited to attend as and when appropriate. The auditors are also invited to attend regularly.

The Chairman of the Company, Michael Hibberd, is a member of the Audit Committee which is not in line with the recommendations made in the Smith Guidance on the Combined Code. However, the Board believes that his recent and relevant financial experience, including his experience on corporate financial matters, is invaluable in supporting the Audit Committee to perform its role.

The Audit Committee engages in numerous ad-hoc discussions and formally meets at least twice a year to discharge its

responsibilities which are set out in its terms of reference and include responsibility for:

integrity of financial statements, including annual and interim •reports, results announcements and any other formal announcement relating to its financial performance;considering the establishment of an internal audit function;•making recommendations to the Board on the appointment, •review and removal of external auditors;monitoring external auditors’ independence; and•policy on external auditors’ non-audit services.•

The Audit Committee also oversees the Company’s relationship with its external auditors and reviews the effectiveness of the external audit process. The Audit Committee pre-approves all audit and non-audit services undertaken by the external auditor, to ensure that the independence of the external auditors is not impaired. The Audit Committee was satisfied throughout the year that the objectivity and independence of the external auditor were not in any way impaired by either the nature of the non-audit work undertaken by the external auditor during the year, the level of non-audit fees charged for such work or any other facts or circumstances. The split between audit and non-audit fees is shown on page 49 of the Directors’ Report.

In fulfilling its responsibility of monitoring the integrity of financial reports to shareholders, the Audit Committee reviews the accounting principles, policies and practices adopted in the preparation of public financial information and will examine documentation in relation to the Annual Report and annual financial report announcements. The ultimate responsibility for reviewing and approving the interim and annual financial statements remains with the Board.

During the year the Audit Committee considered the following main items of business:

review of operations;•review and approval of corporate budgeting;•review of the integrity of the financial statements and formal •announcements relating to the Group’s financial performance;report of the external auditors, KPMG Audit Plc;•review of interim financial statements;•review of the effectiveness of internal controls;•review of whistleblowing policy;•management representation letters;•audit engagement letter; and•2008 audit plan and key audit risks.•

At present there is no internal audit function. The Board believes that the current control systems in place and management oversight are sufficient to highlight any areas of weaknesses in the financial reporting systems. The need for an internal audit function is kept under review.

Internal ControlsThe Audit Committee has responsibility for reviewing the effectiveness of the Company’s system of internal controls and risk management systems. The Board has taken into account the relevant provisions of the Code in formulating the systems and procedures in operation in the Company. It currently maintains the existing system of internal controls based on that used by HOC which was subject to compliance with relevant rules and regulations in Canada. The Audit Committee considers the system to be effective.

Corporate Governance Report continued


The system of internal controls is designed to manage, rather than eliminate, the risk of failure to achieve business objectives and can only provide reasonable and not absolute assurance against material misstatement or loss. The Board will continue to review and improve its system of internal controls.

The Board recognises the need for effective internal controls and for evaluating and managing the risks of the Company. Such matters are brought to the attention of the Board at its formal Board meetings, ad-hoc discussions or via the whistleblowing policy.

High level controls in operation include:review of management accounts with comparison of actual •performance against prior periods and budget;approval of orders, authorisation of invoices and two signatories •required to make a transfer on the principal bank accounts;quarterly reconciliation of all control accounts;•approval by the Board for major investments; and•segregation of duties between relevant functions and •departments.

The Company has implemented a whistleblowing policy and information has been sent to all employees advising them that they can raise concerns in confidence about possible wrong doing by contacting the Chairman of the Audit Committee. In addition, whistleblowing is an agenda item at Board and Audit Committee meetings with procedures established for appropriate action to be taken as required.

The Board is aware of the need to conduct regular risk assessments to identify any deficiencies in the controls currently operating over all aspects of the Company. A formal risk assessment is conducted periodically during the year on internal controls to cover material controls, both financial and operational, and risk management systems.

The risk assessment and a review of the effectiveness of the Group’s system of internal controls are performed in accordance with the Turnbull guidance and they were in place for the year end review process.

Financial reporting procedures were reviewed as part of the Listing process and a Board memorandum prepared. Having considered the findings, the Directors were able to confirm that the financial reporting procedures established provided them with a reasonable basis on which to make proper judgements on the financial position and prospects of the Company on an ongoing basis. However, one main weakness was noted, concerning accounting for complex transactions, although the Company seeks third party advice to mitigate against this weakness.

The Directors recognise the need to maintain financial reporting procedures, to review them on an ongoing basis and to adapt them to changing circumstances and will use the Board memorandum as a basis for further developing the Board processes.

Details of other principal risks and uncertainties are discussed in the Financial Review on page 31.

Remuneration Committee ReportThe members of the Remuneration Committee are John McLeod (Chairman), Salim Hassan Macki and General Sir Michael Wilkes.

Following his appointment to the Board Salim Hassan Macki replaced Michael Hibberd as a member on the Remuneration Committee. All the members are independent Non-Executive Directors. The Chief Executive Officer, Chief Financial Officer and external advisers may also be invited to attend. Further information on the Committee can be found in the Remuneration Report on pages 41 to 46.

The Remuneration Committee engages in numerous ad-hoc discussions and formally meets at least once a year and has responsibility for making recommendations to the Board on the framework, or broad Company policy, for the remuneration of the Chairman and the specific remuneration packages including pension rights and any compensation payments for each of the Executive Directors, the senior management and such other members of the executive management as it is designated to consider. The Committee will also ensure compliance with the Code and Companies Act 2006 in this respect. No Director may be involved in any decisions as to their own remuneration.

Nomination Committee ReportThe members of the Nomination Committee are Michael Hibberd (Chairman), General Sir Michael Wilkes and Anthony Buckingham. The majority of the members are independent Non-Executive Directors and Anthony Buckingham is the Chief Executive Officer. External advisers may also be invited to attend meetings as and when required.

The Nomination Committee engages in numerous ad-hoc discussions and formally meets at least once a year and has responsibility for making recommendations to the Board on its composition (including the skills, knowledge and experience), structure and size and that of its Committees, as well as on retirements and appointments of additional and replacement Directors taking into account the challenges and opportunities facing the Company. In due course, as the Company develops, the Nomination Committee will review requirements to formalise succession planning and the process for new appointments.

During the year the Nomination Committee considered the following items of business:

terms of reference;•board structure and committees;•succession planning; and•process for new appointments.•

The majority of the Board have previously served as Directors of HOC and they were judged on their merit before being appointed to the Board. Future re-elections of Directors will be subject to satisfactory performance reviews and refreshing of the Board.

Two new Non-Executive Directors, Salim Hassan Macki and General Sir Michael Wilkes, were appointed during 2008. An external consultancy was not used in the appointment process as this was not felt appropriate to the circumstances of the recruitments. Both appointments are an outstanding addition to the Board providing a wealth of corporate experience and Mr Macki is highly regarded internationally in the oil industry. The Board approved the appointments recognising that their knowledge will be invaluable in assisting the Company to achieve its planned goals in its core areas.


Information and Professional DevelopmentThe Board believes that the Directors possess a wealth of diverse experience and business skills. Non-Executive Directors are actively encouraged to take up opportunities for questioning, examining and reviewing the Group’s businesses and to undertake training applicable to their roles.

The Directors who were members of the Board at the time of Listing received a full and tailored induction from the Company’s lawyers as part of the Listing process.

The Company will make the necessary resources available for any Director’s development needs including access to independent professional advice, services and any other resources including Company Secretarial services as may be necessary to discharge their responsibilities.

Re-ElectionAll Directors appointed, other than by shareholders, are subject to election by shareholders at the first Annual General Meeting (“AGM”) following their appointment.

One-third or the nearest to one-third of the Directors shall retire at subsequent AGMs. Details of Directors retiring, but subject to re-appointment, at the forthcoming AGM will be detailed in the AGM circular.

Shareholder Relations and Constructive Use of the AGMThe Chairman is responsible for ensuring effective communication of shareholders’ views to the Board as a whole and will update the rest of the Board accordingly. Board members will use their best endeavours to attend meetings with a broad range of shareholders or otherwise keep in touch with shareholder opinion and discuss strategy and corporate governance issues with them as time progresses. In addition, the Company has appointed an investor relations specialist who has co-ordinated an investor relations programme to meet with major shareholders and analysts.

The Chairman will also ensure that the respective chairmen of the Remuneration, Audit and Nomination Committees attend the AGM to answer questions and that the other Directors also attend.

Corporate information including the Annual Report and other financial presentations and announcements (including the Prospectus) are available on the Company’s website at www.heritageoilltd.com.

Michael J. HibberdChairman28 April 2009

Corporate Governance Report continued


IntroductionThis report has been prepared having regard to The Directors’ Remuneration Report Regulations 2002 (the “regulations”) and meets the relevant requirements of the Financial Services Authority’s Listing Rules.

In preparing this report consideration has also been given to the Combined Code on Corporate Governance and the Guidelines of the Association of British Insurers on Executive Remuneration Policies and Practices.

A resolution to approve the report will be put to shareholders at the AGM on 18 June 2009.

Remuneration Committee The members of the Remuneration Committee during the year were John McLeod (Chairman), General Sir Michael Wilkes and Michael Hibberd who was replaced by Salim Hassan Macki in December 2008. Independent advisers, the Chief Executive and the Chief Financial Officer may also attend meetings at the Remuneration Committee’s invitation except where matters associated with their own remuneration are being discussed.

The Remuneration Committee’s main responsibilities are to:advise on remuneration policy for the Chairman, Executive •Directors and Senior Executives;assess and determine total compensation packages available •to the Executive and Non-Executive Directors;determine policy and scope for pension rights and any •compensation payments and ensure compliance with the Combined Code in this respect; andmake recommendations to the Board for its approval, and that •of shareholders, on the design of long-term incentive plans and make recommendations for the grant of awards to executives under such plans.

The Remuneration Committee has clearly defined terms of reference which are available on the Company’s website. No Director is involved in deciding his own remuneration.

During the year the Remuneration Committee appointed independent executive reward consultants, the Hay Group, to advise on executive reward arrangements with particular reference to the UK marketplace and UK best practice. No other services were provided to the Company by the Hay Group during the year.

Executive Reward Policy Review In conjunction with its independent executive reward consultants, the Hay Group, specifically appointed for the purpose, the Remuneration Committee conducted a review of the executive reward policy during the year. The objectives of the review were:

to ensure that the Company has an executive reward framework •to help drive future value growth;to ensure the Company retains and, when necessary, recruits •management talent of the required ability and experience;to ensure that the overall levels of reward were appropriate for •the Company given its listing in London, international operations and the global nature of the oil and gas industry; andto ensure that any new arrangements required were in line with •UK as well as Canadian standards of corporate governance in as much as that such standards support and enhance the Company’s ability to generate value for shareholders.

The central conclusion of the review was that the current executive reward policy and long-term incentive arrangements were inappropriate for the UK marketplace. The market benchmarking exercise conducted by the Hay Group also indicated that overall levels of reward were low compared to the international marketplace and that performance-related reward would need to increase if the Company were to maintain the emphasis on the performance-related components of reward appropriate for the UK.

Furthermore the review found that the legacy share option arrangement, approved by shareholders of HOC in 2004, was inappropriate for the UK marketplace because it allowed for annual vesting of a proportion of the option grant, did not have a performance condition determining vesting and did not reflect current market practice in the UK. The Remuneration Committee has determined that no further options will be issued, although existing arrangements will be honoured.

New Executive Reward PolicyThe Remuneration Committee has addressed the findings of this review by ensuring that the levels of total reward are competitive and that the balance between fixed (base package and benefits) and variable reward (short- and long-term incentives) is appropriate (see chart overleaf).

It is the Remuneration Committee’s opinion that an upper quartile level of reward is appropriate in light of the areas where the Company operates, the relatively small number of Executive Directors at the Company and the roles conducted by the Executive Directors. However, upper quartile levels of reward are only available (mainly through participation in the Long Term Incentive Plan (“LTIP”)) for truly exceptional levels of performance.

Overall levels of reward are benchmarked against three relevant comparator groups:

UK listed oil and gas companies (excluding those significantly •larger than the Company); an international comparator group comprising companies of •a similar size and scale to Heritage; andthe FTSE 250 Index. •

The Remuneration Committee determined that the current annual bonus structure for Executive Directors was appropriate for the business and has also implemented a two year base package freeze for Executive Directors with effect from 31 March 2008. In addition, a new LTIP was proposed by the Remuneration Committee and approved by shareholders at the Company’s AGM on 19 June 2008 (see page 42).

Remuneration Report

CEO 36% 64%

43% 57%CFO

Fixed Reward Variable Reward


Balance Between Fixed and Performance-Related Reward The charts below show the balance between fixed (base package and benefits) and variable (bonus and long-term incentives) elements of reward for each of the Executive Directors.

Fixed Reward includes 2008 base package and value of benefits (including pension).

Variable Reward includes 2008 bonus and the annualised fair value of long-term incentive awards (apportioned over the life of the LTIP).

Components of Executive Directors’ Reward Base PackageThe table below shows the annual base packages of the Executive Directors on listing on the main market of the London Stock Exchange. Following the introduction of the LTIP the Remuneration Committee has implemented a two year base package freeze for the Executive Directors and therefore salaries will not be increased in 2009.

Name 2008 2009 Increase

Anthony Buckingham £675,000 £675,000 0%Paul Atherton £500,000 £500,000 0%

Annual bonus Executive Directors are entitled to an annual performance related bonus, determined by the Remuneration Committee. In determining the appropriate bonus level, the Remuneration Committee takes into account progress made towards the Company’s long-term goals, the level of commitment of the Chief Executive Officer and Chief Financial Officer in advancing the interests of the Company and share performance.

Long Term Incentives 2008 Long Term Incentive Plan (“LTIP”) The LTIP was approved by shareholders in June 2008. The main features of the awards to Executive Directors are:

one-off awards of performance shares reflecting the equivalent of •three years of award;a face value of 1,200% of base package for the CEO and 800% •of base package for the CFO, reflecting the equivalent of three years’ annual awards;the performance conditions, measured over the three-year •period starting with the date of the award, are relative total shareholder return (“TSR”) versus a group of international oil companies and a requirement for the share-price to increase by at least 20% between the date of the award and the end of the vesting period;

none of the awards will vest until comparative TSR performance •is close to the upper quartile level of the comparator group detailed on page 43; andthere is an additional holding period of one year following the •vesting of the awards.

Awards vest according to the following schedule:

Proportion of award vesting

Typical UK TSR performance vs comparator group of 18 companies Heritage practice

3rd place (the Upper Decile) and above 100% 100%4th place 80% 100%5th place (the Upper Quartile) 50% 100%6th place 30% 85%7th place 0% 70%8th place 0% 55%9th place 0% 40%10th place (the Median) 0% 25%Below 10th place 0% 0%

Long-term incentive award levels have been set with reference to the upper quartile of the Company’s comparator groups. However, the vesting schedule is designed to only deliver the whole value of the award for truly exceptional performance, at a standard higher than that which is normal for the UK. The additional performance condition, requiring the share price to increase by 20% or more, is also above and beyond what is common in both the UK and Canada.

In light of the performance conditions described above, the Remuneration Committee believes that the award levels, which reflect the equivalent of three years’ annual awards, are appropriate for the Executive Directors because:

a one-off award provides better alignment of the Executive •Directors with current and potential shareholders following the Company’s reorganisation and listing on the main market of the London Stock Exchange than annual rolling awards;a one-off award encourages sustained performance over the •next three key years for the Company. Annual awards can have the effect of encouraging “staggered” or “delayed” performance e.g. not maximising investments and performance as soon as possible in any given year so as to ensure that new awards benefit from any uplift such investments and performance will create. The Remuneration Committee believes that it is in the best possible interest of shareholders for maximum value to be accrued as soon as possible;a one-off award to cover three years of annual grant provides a •greater retentive effect than annual grants and ensures continuity in management following the Company’s listing in London; andwhilst the Remuneration Committee is keen to move to UK •standard annual grant patterns as soon as practicable, provided to do so is in the best interests of shareholders, providing a one-off award equivalent to three years of annual awards counterbalances the Remuneration Committee’s decision to remove annual vesting for long-term incentives, replacing it with a three-year vesting period and an additional one year holding period.

Remuneration Report continued


The comparator group of companies was selected on the basis of their size and scale of operations, market capitalisation and geographic spread. The comparator group comprises:

Aminex plc Imperial Energy plc Premier Oil plcBowLeven plc JKX Oil & Gas plc SOCO International plcDana Petroleum plc Mariner Energy Inc. Stone Energy Corp.Dominion Petroleum Ltd. McMoran Exploration Co Swift Energy Co.Gulf Keystone Petroleum Ltd. Melrose Resources plc Tullow Oil plcHunting plc Oilexco Inc. Venture Production plc

It is not planned to make any further awards to existing members of the LTIP scheme before 2011, although awards may be made to new senior members of staff between 2009 and 2011. 2008 Replacement Share Option SchemeHOC implemented The Heritage Oil Corporation Plan (the “Original Plan”) following approval by its shareholders in 2004 and granted options under the Original Plan to its Executive and Non-Executive Directors and other employees and consultants at that time. The grant of options included all the then current Executive and Non-Executive Board members which excluded General Sir Michael Wilkes and Salim Hassan Macki. As a result of the Group reorganisation and subsequent listing on the main market of the London Stock Exchange, all the Board members were entitled to retain their options under the Original Plan and exchange them for options to acquire 10 Ordinary Shares of the Company for every one Common Share they held under option consistent with the Company’s 10-for-1 share split. The Original Plan was then cancelled and on 18 March 2008, the Company adopted The Heritage Oil Limited 2008 Replacement Share Option Scheme (“Replacement Scheme”) which is substantially in the same form as the Original Plan. The purpose of the Replacement Scheme is to act as a replacement to the Original Plan and to honour the options granted under it by granting holders the option to purchase Ordinary Shares. The Replacement Scheme is administered by the Board and no further options will be granted under it.

The maximum number of Ordinary Shares that may be issued under the Replacement Scheme was 24,545,340, being the equivalent number of shares required to replace the options granted under the Original Plan that were still in existence prior to their cancellation.

The Company will not grant any further options under this share scheme.

Pensions Executive Directors receive pension contributions of an annual amount equal to 10% of their base package into a personal pension scheme nominated by the executive.

Other Benefits The Company’s policy is to provide Executive Directors with certain benefits in kind including private medical insurance and life assurance. In addition, both Executive Directors are entitled to allowances of £100,000 (Anthony Buckingham) and £77,500 (Paul Atherton) to cover their living expenses.

Service Agreements The Executive Directors’ service agreements with the Company are for no fixed term. In normal circumstances, the agreements may be terminated by the Company giving no less than 24 months’ notice and the Executive Director giving six months’ notice. These arrangements were in place during their time as Executive Directors of HOC and were inherited by the Company on listing in London. The Board feels that these notice periods were appropriate to recruit and retain the Executive Directors, and whilst it has no present intention of changing them, it will continue to keep them under review.

Executive Director Date of contract Unexpired term Notice period by Company Notice period by Director

Anthony Buckingham 28 March 2008 Rolling Contract 24 months 6 monthsPaul Atherton 28 March 2008 Rolling Contract 24 months 6 months

In the event of a change of control of the Company, if the Executive Directors resign or the Company terminates their appointment within 24 months of such an event, they will each be entitled to an immediate payment in lieu of notice of a sum equivalent to three times their annual base package. In addition, they will be entitled to a payment of $75,000 in the event they are asked to resign from the Board of HOC in any event other than as a result of a change of control. The Company also may terminate the agreements and make payments in lieu of notice.

Currently the Executive Directors’ service contracts do not provide for mitigation in the event of early termination. The Executive Directors do not have service contracts with any Group subsidiary.


Non-Executive Directors The remuneration of Non-Executive Directors is a matter for the Remuneration Committee. The Company’s policy is to set levels for Non-Executive Directors’ remuneration so as to ensure that they are sufficient to attract, retain and motivate high quality Directors.

Non-Executive Directors’ annual fee levels for 2008 and 2009 are set out below. Fees were paid from 28 March 2008, the date of the Company’s reorganisation and listing on the Main Market of the London Stock Exchange, or the date of appointment if later. Actual fees paid or accrued for the year ended 31 December 2008 are shown in the Directors’ Emoluments table on page 45.

2008 2009

Michael Hibberd £80,000 £80,000Salim Hassan Macki £80,000 £80,000General Sir Michael Wilkes £80,000 £80,000Gregory Turnbull £50,000 £50,000John McLeod £50,000 £50,000

Additional fee for each day worked in excess of the agreed 20 days per annum £2,000 £2,000

Michael Hibberd, Gregory Turnbull and John McLeod also receive fees of Cdn$22,500 per annum from HOC for acting as Directors of that company.

Messrs. Hibberd, Turnbull, McLeod and Wilkes are entitled to additional fees of £20,000 in 2008 for the work they undertook in connection with the Company’s reorganisation and listing on the London Stock Exchange.

The Non-Executive Directors’ terms of appointment may be terminated by each party giving three months’ notice in writing. Michael Hibberd and Gregory Turnbull will be entitled to a change of control bonus of $75,000 plus a pro-rata amount of their previous year’s bonus multiplied by a stock price performance factor in the event that HOC changes control.

With the exception of General Sir Michael Wilkes and Salim Hassan Macki all the Non-Executive Directors will be entitled to a payment of $75,000 in the event they are asked to resign from the Board of HOC in any event other than as a result of a change of control. General Sir Michael Wilkes received a payment of £50,000 on joining the Board of the Company. No other Director received this form of payment on joining the Board of the Company. Initial term of Subsequent term Non-Executive Director Date of contract Notice period appointment of appointment

Michael Hibberd 28 March 2008 3 months 2010 AGM 3 yearsGregory Turnbull 28 March 2008 3 months 2009 AGM 3 yearsJohn McLeod 28 March 2008 3 months 2009 AGM 3 yearsGeneral Sir Michael Wilkes 28 March 2008 3 months 2011 AGM 3 yearsSalim Hassan Macki 12 August 2008 3 months 2009 AGM 3 years

Non-Executive Directors do not participate in the Company’s pension arrangements. Although some of these Directors have previously received grants of options, they will not receive any further grants or participate in any other long-term incentive arrangements.


130.00

120.00

110.00

100.00

90.00

80.00

70.00

60.00

50.00

40.00March 2008 June 2008 September 2008 December 2008

Cumulative TSR rebased to 100

Heritage Oil Ltd FTSE 250 Index


Performance GraphThe following graph shows the Company’s TSR since trading of the Company’s shares began on the London Stock Exchange on 31 March 2008 against the FTSE 250 Index. The Remuneration Committee has selected the FTSE 250 Index as it represents a broad equity market index which includes the Company and therefore provides a good indication of the Company’s general performance.

Directors’ Emoluments for the Year Ended 31 December 2008 Base Annual Package/ bonus/ 20082 2008 20072

Fees Benefits1 other Total Pensions Total £000 £000 £000 £000 £000 £000

Executive DirectorsAnthony Buckingham 675.0 134.8 300.0 1,109.8 50.6 1,038.3 Paul Atherton 495.37 119.6 262.5 877.4 37.5 808.0

Non-Executive DirectorsMichael Hibberd3 74.9 – 20.06 94.9 58.5 Gregory Turnbull3 46.4 – 20.06 66.4 27.7 John McLeod3 47.4 – 20.06 67.4 27.7 General Sir Michael Wilkes4 96.7 – 20.06 116.7 –Salim Hassan Macki5 31.8 – – 31.8 –

Total 1,467.5 254.4 642.5 2,364.4 88.1 1,960.2

1 Shows the taxable value of benefits, comprising private medical insurance, school fees for Paul Atherton’s children and life insurance. The figures also include living allowances of £100,000 (Anthony Buckingham) and £77,500 (Paul Atherton) but exclude pension contributions.

2 The Directors became entitled to emoluments payable by the Company from 28 March 2008. Prior to this date the Directors were only entitled to emoluments payable by HOC which was then the parent company of the Group.

3 Michael Hibberd, Gregory Turnbull and John McLeod receive fees of Cdn$22,500 per annum paid by HOC as Directors of that company. These fees have been included in the above table.

4 General Sir Michael Wilkes received a payment of £50,000 on joining the board in 2008.5 Mr. Macki was appointed on 12 August 2008.6 Michael Hibberd, Gregory Turnbull, John McLeod and General Sir Michael Wilkes are entitled to an additional fee of £20,000 in 2008 for the work they undertook in connection

with the Company’s reorganisation and listing on the London Stock Exchange. 7 The difference from the base package of £500,000 mentioned above is due to the foreign exchange differences.


Performance Shares Conditional awards of Performance Shares were granted to Executive Directors on 19 June 2008 under the LTIP, subsequent to the Plan’s approval at the Company’s AGM, as shown below.

Executive Directors’ Interests in Performance Shares As at 31 December 2008(Audited information) Number Earliest Share price at Director of shares vesting date date of grant

Anthony Buckingham 2,347,826 18 June 2011 345pPaul Atherton 1,159,420 18 June 2011 345p

Executive Directors’ Interests in Share Options Held Under the Replacement SchemeAs at 31 December 2008(Audited information) Options Exercise Director Date of grant At 31/03/08 exercised At 31/12/08 prices Vesting periods Expiry date

Michael Hibberd 23 Jun 06 150,000 150,000 £0.81 23 Jun 06–23 Jun 08 23 Jun 11 14 Dec 06 750,000 750,000 £1.43 14 Dec 06–14 Dec 08 14 Dec 11 21 Dec 06 250,000 250,000 £2.45 21 Dec 07–21 Dec 09 21 Dec 12Anthony Buckingham 20 May 05 500,000 500,000 £0.48 20 May 05–20 May 07 20 May 10 14 Dec 06 9,129,510 9,129,510 £1.43 14 Dec 06–14 Dec 08 14 Dec 11 21 Dec 07 500,000 500,000 £2.45 21 Dec 07–21 Dec 09 21 Dec 12Paul Atherton 20 May 05 1,250,000 1,250,000 £0.48 20 May 05–20 May 07 20 May 10 14 Dec 06 1,125,000 1,125,000 £1.43 14 Dec 06–14 Dec 08 14 Dec 11 21 Dec 06 500,000 500,000 £2.45 21 Dec 07–21 Dec 09 21 Dec 12Gregory Turnbull 20 May 05 150,000 150,000 £0.48 20 May 05–20 May 07 20 May 10 14 Dec 06 300,000 300,000 £1.43 14 Dec 06–14 Dec 08 14 Dec 11 21 Dec 07 150,000 150,000 £2.45 21 Dec 07–21 Dec 09 21 Dec 12John McLeod 20 May 05 100,000 100,0001 0 £0.48 20 May 05–20 May 07 20 May 10 14 Dec 06 300,000 300,000 £1.43 14 Dec 06–14 Dec 08 14 Dec 11 21 Dec 07 150,000 150,000 £2.45 21 Dec 07–21 Dec 09 21 Dec 12

Note: The final exercise prices were converted into pounds sterling on the Company’s reorganisation and listing on the main market of the London Stock Exchange using the exchange rate in effect on that date.

1 The share price on the date of exercise was £1.72.

No options were granted or lapsed during 2008.

The closing share price on 31 December 2008 was £2.05. During the period the highest share price was £3.50 and the lowest was £1.38.

This report was approved by the Board on 28 April 2009 and signed on its behalf by:

John McLeodChairman of the Remuneration Committee28 April 2009



Directors’ Report

The Directors of Heritage Oil Limited (the “Company”) submit their report together with the consolidated audited financial statements for the year ended 31 December 2008 for the Company and its subsidiaries (the “Group”).

The Company was incorporated on 6 February 2008 in Jersey under the Companies (Jersey) Law 1991, as amended (the “Jersey Companies Law”) to become the ultimate holding company of the Group. It changed its status to a public company on 25 February 2008 in preparation for the listing of its ordinary shares on the Main Market of the London Stock Exchange (the “LSE”) on 31 March 2008 (the “Listing”). The Company’s registered office is in Jersey.

Prior to the Listing, the holding company of the Group was HOC, a Canadian registered company whose common shares (“Common Shares”) were traded on the Toronto Stock Exchange (“TSX”). As part of the Listing, the Group was reorganised and HOC became an indirect wholly-owned subsidiary of the Company (the “Reorganisation”). The Reorganisation culminated in the Common Shares being de-listed from the TSX and a new class of exchangeable shares being created and issued by HOC (“Exchangeable Shares”). Subject to the terms of the reorganisation, holders of Common Shares could exchange their Common Shares for either Ordinary Shares of the Company (“Ordinary Shares”) which are traded on the LSE or for Exchangeable Shares that are traded on both the LSE and the TSX. Further details of the Listing and Reorganisation can be found in the prospectus dated 28 March 2008 (the “Prospectus”) available on the Company’s website at www.heritgageoilltd.com.

Principal Activities and Business Review The Group is an independent, international oil and gas exploration, development and production Group with a focus on Africa, the Middle East, Russia and South Asia. It has exploration projects in Uganda, the Kurdistan Region of Iraq, the DRC, Malta, Pakistan, Tanzania and Mali, and a producing property in Russia. Producing assets in Oman were sold on 7 April 2009. The Group operates through a number of subsidiaries which are set out on page 57.

A review of the business including future developments and performance of the Group is contained in:

the Chairman’s Statement on pages 2 to 3;•the Chief Executive’s Review on pages 4 to 6;•the Operations Review on pages 10 to 27;•the Financial Review on pages 28 to 31; and•the Corporate Social Responsibility report on pages 32 to 33.•

In addition, the Company has published a separate Corporate Social Responsibility report to be sent to shareholders with this Annual Report.

A description of the significant risk factors and uncertainties facing the Group is set out in the Financial Review on page 31 and also in the Directors’ Report on page 49.

Key Performance IndicatorsHeritage uses a number of financial and operating Key Performance Indicators (“KPIs”) against which it monitors performance. Due to being listed on the LSE for less than one year there are no year-on-year comparisons but comparative data will be built up and reported on in future years. Additionally the KPIs will also be developed as the Company’s operations evolve. Year to 31 December 2008

LTIFR1 0.03Staff turnover 3%Production from continuing operations (%)2 +80%Reserves and Resources Additions (%)3 +272%Average realised price +5%

1 Lost Time Injury Frequency Rate per 10,000 hours worked.2 Excludes production from Block 8, Oman which was sold in April 2009. 3 Management estimates.

Results and Dividends The Group’s financial statements for the year ended 31 December 2008 are set out on pages 53 to 56.

The Company and HOC have not declared or paid any dividends since their incorporation and do not intend to pay dividends in the foreseeable future. The future payment of dividends will depend on the earnings and financial condition of the Company and such other factors as the Board of Directors of the Company consider appropriate.

Capital Structure The Company has two classes of shares, namely the Ordinary Shares and a special voting share of HOC (the “Special Voting Share”). As described previously, the Company’s indirect subsidiary, HOC, has Exchangeable Shares outstanding that are convertible into Ordinary Shares of the Company.

The Ordinary Shares and the Special Voting Share carry no right to fixed income.

The Ordinary Shares have a right to one vote for every share at general meetings whilst the holders of Exchangeable Shares have rights through the Special Voting Share held by the trustee of the Voting and Exchange Trust to one vote at general meetings for every Exchangeable Share on the same basis as if they had exchanged them for Ordinary Shares. For clarity, the Voting and Exchange Trust is a Canadian trust that holds the Special Voting Share for the benefit of the registered holders of the Exchangeable Shares pursuant to the terms of a Voting and Exchange Trust Agreement dated 27 February 2008.

Details of how to vote and deadlines for exercising voting rights will be set out in the Notice of AGM.

Subject to the Articles, any member may transfer certificated shares by an instrument of transfer in writing in any usual form or in any other form acceptable to the Directors. The Directors may refuse to register any transfer of certificated shares which are not fully paid or where the register of transfer is not in the acceptable form.


Directors’ Report continued

The issued share capital of the Company and total voting rights of the Company as at 31 March 2009 are as follows:

252,083,374 Ordinary Shares of the Company are issued and •outstanding, which constitutes 98.8% of the total voting rights of the Company.3,024,108 Exchangeable Shares of HOC each carrying one •voting right in the Company, are issued and outstanding, which constitutes 1.2% of the total voting rights of the Company.

Directors’ interests in the Ordinary Shares, Exchangeable Shares, options granted under the employee share scheme and interests in the LTIP are set out in the Directors’ Remuneration Report on page 46.

The Company did not purchase any of its own shares during the year.

After Listing, in the period between 31 March 2008 and 31 December 2008, a total of 1,182,012 Exchangeable Shares were exchanged into Ordinary Shares.

Major ShareholdersIn accordance with Rule 5 of the Disclosure and Transparency Rules, the shareholders listed below have notified the Company of their interests in the Ordinary Shares of the Company as at 31 March 2009: Ordinary Shares Name held % Held1

Albion Energy Limited3 84,540,3402 33.14Capital Research and Management Company 18,683,814 7.32Lansdowne Partners Limited 17,901,624 7.02Firebird Global Master Fund, Ltd 14,384,000 5.64Harrier Holdings Ltd re LCAM 12,241,395 4.80

1 Includes voting rights attaching to the Special Voting Share as well as the Ordinary Shares.

2 Number of Ordinary Shares held by both Albion Energy Limited and Anthony Buckingham.

3 The ultimate owner of Albion Energy Limited is Anthony Buckingham.

Albion Energy Limited (“Albion”) and Anthony Buckingham entered into a relationship agreement with the Company on 28 March 2008 (the “Relationship Agreement”) as part of the Listing. The purpose of the Relationship Agreement is to ensure that transactions and relationships between the Group, Albion and Anthony Buckingham are at arm’s length and on normal commercial terms.

DirectorsThe following Directors held office during the reporting period:

Appointment dates

Michael Hibberd (Chairman) 18 March 2008Anthony Buckingham (CEO) 25 February 2008Paul Atherton (CFO) 6 February 2008Gregory Turnbull 18 March 2008Salim Hassan Macki 12 August 2008John McLeod 18 March 2008General Sir Michael Wilkes 18 March 2008

Biographical details of all directors can be found on page 34.

With the exception of General Sir Michael Wilkes and Salim Hassan Macki, all the Directors were previously, and continue to be, Directors of HOC.

Directors’ Election and RotationWith regard to retirement and re-election of Directors, the Company is governed by its Articles of Association (the “Articles”), the Combined Code of Corporate Governance and the Jersey Companies Law. The Directors have the power to appoint a Director during the year but any person so appointed must stand for election at the next AGM. One-third of the Directors must retire from office at each AGM. A retiring Director is eligible to stand for re-election.

In accordance with the above provisions, Salim Hassan Macki, having been appointed since the last AGM, will retire, and being eligible, offer himself for election at the forthcoming AGM. In addition, Gregory Turnbull and John McLeod will retire and, being eligible, offer themselves for re-election.

Powers of the DirectorsSubject to the Company’s Articles, relevant statutory law and any direction that may be given by the Company in general meeting, the business of the Company is managed by the Directors who may exercise all powers of the Company.

Directors’ Indemnity ProvisionsUnder the Company’s Articles the Directors are indemnified out of the assets of the Company against any loss or liability incurred by reasons of having been a Director of the Company.

Annual General MeetingThe AGM will be held at 22 Grenville Street, St Helier, Jersey on 18 June 2009. Formal notice of the Annual General Meeting including details of special business will be set out in the Notice of the Annual General Meeting and on the Company’s website at www.heritageoilltd.com.

RegistrarThe Company’s share registrar is Computershare Investor Services (Channel Islands) Limited, Ordnance House, 31 Pier Road, St Helier, Jersey, JE4 8PW, Channel Islands.

Creditors’ Payment PolicyIt is the Company and Group’s policy to settle all debts with creditors on a timely basis and in accordance with the terms of credit agreed with each supplier. Average creditor payment days for the period under review were approximately 45 days.

Employees As at 31 December 2008, the Group had 132 employees (including full-time contractors, consultants and Directors) based in the following locations:

Jersey 2Canada 5Russia 40Europe 27Uganda 28Kurdistan Region of Iraq 14Tanzania 10South Africa 6

Total 132


Significant Risk Factors and Uncertainties A variety of material risk factors have been identified that could have an impact on the Company, including risks relating to operations, countries in which the Group operates, the Group structure and risks relating to the Ordinary Shares and the Exchangeable Shares. The most significant risk factors impacting on the Group are considered to be:

exploration and development expenditure and success rates;•factors associated with operating in developing countries, •political and regulatory instability;title disputes;•oil and gas sales volumes and prices; and•reliance on key employees.•

The above risk factors could adversely affect the cash flows to a material extent that the Group may, in certain circumstances, need to obtain further debt or equity financing in the future.

Further information on risks and internal controls can be found in the Financial Review on page 31.

Financial Risks and Financial InstrumentsInformation on financial risk management, including credit and liquidity risks and information about financial instruments are set out in the note to the financial statements on pages 64 to 65 and page 66, respectively.

Political and Charitable DonationsThe Group has undertaken a wide range of community schemes, including public health, education, environment, public facility and community relations based programmes, further details of which can be found in the Corporate Social Responsibility Report on pages 34 to 35. The Group did not make any political donations during 2008.

Change of Control AgreementsThe Company confirms that there are no significant agreements to which it is party that would take effect, alter or terminate upon a change of control following a takeover bid except those disclosed below:

the Executive Directors’ service contracts contain certain •provisions in relation to change of control as disclosed in the Remuneration Report;the Long Term Incentive Plan rules contain a provision whereby •in the event of a change of control all awards will vest in their entirety subject to the achievement or otherwise of the performance conditions; andon 16 February 2007, HOC issued 1,650 $100,000 convertible •bonds at par to raise $165,000,000 by way of a private placement. Issue costs amounted to $6,979,268 resulting in net proceeds of $158,020,732. The bonds have a maturity of five years and one day and an annual coupon of 8.00%. Bondholders have the right to convert bonds into Ordinary Shares at a price of $4.70 per share. $9,900,000 of bonds have been converted, leaving 1,551 $100,000 bonds outstanding. Bondholders have a put option requiring the Company to redeem the bonds at par, plus accrued interest, in the event of a change of control of the Company, together with a cash payment of up to $19,700 on each bond will be made to the bondholder, the amount of which depends upon the date of redemption and market value at the date of any change of control event.

In April 2009, bondholders with $5.9 million of bonds gave notice of the exercise of 59 bonds. These bondholders received 1,255,317 Ordinary Shares.

Important Events Since the Year EndEvents since the balance sheet date are summarised in note 26 to the financial statements on page 80.

Audit and Auditors The Directors who held office at the date of approval of this Directors’ Report confirm that, so far as they are each aware, there is no relevant audit information of which the Company’s auditors are unaware; and each Director has taken all the steps that they ought to have taken as a Director to make themselves aware of any relevant audit information and to establish that the Company’s auditors are aware of that information.

A resolution to reappoint KPMG Audit Plc as auditors of the Company will be proposed at the upcoming AGM.

Fees billed by KPMG, the Company’s auditors and its associates, during 2007 and 2008, may be summarised as follows:

2008 2007 US$ US$

Audit and audit related services: Group audit of annual and review of interim statements 276,900 456,135 Prospectus and information circular 97,087 –

373,987 456,135Non-audit services: Tax compliance and advisory 110,124 8,704 Transaction services 537,900 –

648,024 8,704

Statement of Directors’ ResponsibilitiesThe Directors are responsible for preparing the Annual Report and the financial statements for the Group in accordance with applicable law and regulations.

Company law requires the Directors to prepare Group financial statements for each financial year. Under that law they are required to prepare the Group financial statements in accordance with International Financial Reporting Standards (“IFRS”) as adopted by the EU and applicable law.

The Group financial statements are required by law and IFRS as adopted by the EU to present fairly the financial position of the Group and the performance for that period.

In preparing the financial statements the Directors are required to:select suitable accounting policies and then apply them •consistently;present information, including accounting policies, in a manner •that provides relevant, reliable, comparable and understandable information;provide additional disclosures when compliance with the specific •requirements in IFRS is insufficient to enable users to understand the impact of particular transactions, other events and conditions on the entity’s financial position and financial performance; state whether they have been prepared in accordance with IFRS •as adopted by the EU; and


prepare the financial statements on a going concern basis •unless, having assessed the ability of the Company to continue as a going concern, it is inappropriate to presume the Company will continue in business.

The Directors are responsible for keeping proper accounting records which disclose with reasonable accuracy at any time the financial position of the Group and enable them to ensure that its financial statements comply with the Companies (Jersey) Law 1991.They have general responsibility for taking such steps as are reasonably open to them for safeguarding the assets of the Group and to prevent and detect fraud and other irregularities.

Under applicable law and regulations, the Directors are also responsible for the preparation of a Directors’ Report, Remuneration Report and Corporate Governance Statement.

The Directors are responsible for the maintenance and integrity of the statutory and audited information on the Company’s website. Jersey legislation and United Kingdom regulation, governing the preparation and dissemination of financial statements, may differ from requirements in other jurisdictions.

Going Concern After making due enquiries, the Directors have made an informed judgement at the time of approving the financial statements, that there is a reasonable expectation that the Group has adequate resources to continue in operational existence for the foreseeable future. For this reason, the Directors continue to adopt the going concern basis in preparing the financial statements.

Approved by the Board on 28 April 2009.

Anthony BuckinghamChief Executive Officer28 April 2009

Directors’ Report continued


Responsibility Statement of the Directors

We confirm on behalf of the Board that to the best of our knowledge:(a) the financial statements prepared in accordance with the

applicable set of accounting standards give a true and fair view of the assets, liabilities, financial position and profit and loss of the Company and the undertakings included in the consolidation taken as a whole; and

(b) the management report, comprising the Chairman’s Statement, Chief Executive’s Review, Operations Review, Financial Review and Corporate Social Responsibility report on pages 2 to 33, includes a fair review of the development and performance of the business, and the principal risks and uncertainties that it faces.

For and on behalf of the Board.

Michael J. Hibberd Paul AthertonChairman Chief Financial Officer28 April 2009 28 April 2009


Independent Auditors’ Report to the Members of Heritage Oil Limited

We have audited the Group financial statements of Heritage Oil Limited for the year ended 31 December 2008 which comprise the consolidated income statement, consolidated statement of recognised income and expense, consolidated balance sheet, consolidated cash flow statement and related notes. These financial statements have been prepared under the accounting policies set out therein.

This report is made solely to the Company’s members, as a body, in accordance with Article 110 of the Companies (Jersey) Law 1991 and, in respect of our work on the Corporate Governance Report, on terms that have been agreed with the Company. Our audit work has been undertaken so that we might state to the Company’s members those matters we are required to state in an auditors’ report and, in respect of our work on the Corporate Governance Report, those matters that we have agreed to state to them in our report, and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the Company and the Company’s members as a body, for our audit work, for this report, or for the opinions we have formed.

Respective Responsibilities of Directors and AuditorsAs described in the Statement of Directors’ Responsibilities on pages 49 to 50, the Company’s Directors are responsible for preparation of the financial statements in accordance with applicable law and International Financial Reporting Standards (“IFRS”) as adopted by the European Union.

Our responsibility is to audit the financial statements in accordance with the relevant legal and regulatory requirements and International Standards on Auditing (UK and Ireland).

We report to you our opinion as to whether the financial statements give a true and fair view and are properly prepared in accordance with the Companies (Jersey) Law 1991. We also report to you if, in our opinion, the Company has not kept proper accounting records or if we have not received all the information and explanations we require for our audit.

We read the Directors’ Report accompanying the financial statements and consider the implications for our report if we become aware of any apparent misstatements within it.

We review whether the Corporate Governance Report reflects the Company’s compliance with the nine provisions of the 2006 Combined Code specified for our review by the Listing Rules of the Financial Services Authority, and we report if it does not. We are not required to consider whether the Board’s statements on internal control cover all risks and controls, or form an opinion on the effectiveness of the Group’s corporate governance procedures or its risk and control procedures.

Basis of Audit OpinionWe conducted our audit in accordance with International Standards on Auditing (UK and Ireland) issued by the Auditing Practices Board. An audit includes examination, on a test basis, of evidence relevant to the amounts and disclosures in the financial statements. It also includes an assessment of the significant estimates and judgements made by the Directors in the preparation of the financial statements, and of whether the accounting policies are appropriate to the Company’s circumstances, consistently applied and adequately disclosed.

We planned and performed our audit so as to obtain all the information and explanations which we considered necessary in order to provide us with sufficient evidence to give reasonable assurance that the financial statements are free from material misstatement, whether caused by fraud or other irregularity or error. In forming our opinion we also evaluated the overall adequacy of the presentation of information in the financial statements.

OpinionIn our opinion:

the Group’s financial statements give a true and fair view, in •accordance with IFRS as adopted by the European Union, of the state of the Group’s affairs as at 31 December 2008 and of its loss for the year then ended; andthe financial statements have been properly prepared in •accordance with the Companies (Jersey) Law 1991.

KPMG Audit PlcChartered Accountants8 Salisbury SquareLondon EC4Y 8BBUnited Kingdom28 April 2009


Consolidated Income StatementYears Ended 31 December 2008 and 2007

2008 2007 $ $

RevenuePetroleum and natural gas 5,095,808 3,709,503

ExpensesPetroleum and natural gas operating (2,250,771) (1,843,540)Production tax (2,618,806) (1,092,423)General and administrative (30,686,764) (41,271,960)Depletion, depreciation and amortisation (2,349,484) (1,892,290)Exploration expenditures (note 2e) (786,398) (5,415,696)Impairment of property, plant and equipment (note 11) (3,997,033) (1,799,762)

Operating loss (37,593,448) (49,606,168)

Gain on disposal of subsidiaries (note 9) – 1,077,132

Finance income (costs)Interest income 3,954,749 3,958,219Loss on redemption of liability component of convertible bonds – (7,155,622)Gain/(loss) on derivative financial liability relating to convertible bonds (note 2q) 10,954,514 (21,279,964)Other finance costs (note 6) (11,257,187) (11,997,748)Foreign exchange (losses)/gains (5,648,179) 931,913Unrealised (loss)/gain on other financial assets (note 12) (1,713,700) 906,643

(3,709,803) (34,636,559)

Net loss for the year attributable to equity holders of the Company (41,303,251) (83,165,595)

Net loss per shareBasic and diluted (note 20) (0.16) (0.37)

The notes are an integral part of these consolidated financial statements.


Consolidated Statement of Recognised Income and ExpenseYears Ended 31 December 2008 and 2007

2008 2007 $ $

Changes in the fair value of available-for-sale financial assets (note 19) – 168,000Exchange differences on translation of foreign operations (note 19) (651,364) 434,583

Net (expense)/income recognised directly in equity (651,364) 602,583Net loss for the year (41,303,251) (83,165,595)

Total recognised loss for the year (41,954,615) (82,563,012)



Consolidated Balance SheetAs at 31 December 2008 and 2007

2008 2007 $ $

ASSETSNon-current assetsIntangible exploration assets (note 10) 211,346,037 102,862,754Property, plant and equipment (note 11) 88,039,218 64,225,918Other financial assets (note 12) 3,330,501 5,044,201

302,715,756 172,132,873

Current assetsInventories 395,110 199,465Prepaid expenses 664,759 447,271Trade and other receivables (note 13) 6,901,511 6,759,261Cash and cash equivalents (note 14) 90,620,385 230,089,323

98,581,765 237,495,320

401,297,521 409,628,193

LIABILITIESCurrent liabilitiesTrade and other payables (note 15) 54,751,768 24,646,531Borrowings (note 16) 595,418 623,640

55,347,186 25,270,171

Non-current liabilitiesBorrowings (note 16) 155,609,982 154,253,701Derivative financial liability (note 22) 25,785,476 36,739,990Provisions (note 17) 719,808 170,899

182,115,266 191,164,590

237,462,452 216,434,761

Net assets 163,835,069 193,193,432

SHAREHOLDERS’ EQUITY ATTRIBUTABLE TO EQUITY HOLDERS OF THE COMPANYShare capital (note 18) 218,283,881 217,672,243Reserves (note 19) 54,511,609 43,178,359Retained deficit (note 19) (108,960,421) (67,657,170)

163,835,069 193,193,432



Consolidated Cash Flow StatementYears Ended 31 December 2008 and 2007

2008 2007 $ $

Cash provided by (used in) operating activitiesNet loss from operations for the year (41,303,251) (83,165,595) Items not affecting cash Depletion, depreciation and amortisation 2,349,484 1,892,290 Finance costs – accretion expenses 4,183,874 3,619,198 Foreign exchange losses/(gains) 320,580 (153,174) Share-based compensation 7,595,542 31,300,295 Loss on redemption of convertible bonds – 7,155,622 (Gain)/loss on derivative financial liability (10,954,514) 21,279,964 Gain on disposal of subsidiaries – (1,077,132) Loss/(gain) on other financial assets 1,713,700 (906,643) Impairment of property, plant and equipment 3,997,033 1,799,762 Decrease in trade and other receivables 1,136,624 5,195,888 (Increase)/decrease in prepaid expenses (217,488) 84,002 Increase in inventory (195,645) (100,544) (Decrease)/increase in trade and other payables (1,432,138) 10,585,162

(32,806,199) (2,490,905)

Investing activitiesProperty, plant and equipment expenditures (29,610,908) (27,236,018) Intangible exploration expenditures (73,608,271) (48,095,422) Intangible development expenditures – (64,931) Investment in shares – (200,000)

(103,219,179) (75,596,371)

Financing activities Shares issued for cash 361,537 187,106,476Share issue costs – (10,473,386) Convertible bonds – 165,000,000Convertible bonds issue costs – (6,979,268) Redemption of convertible bonds – (83,022,752) Long-term debt – 9,450,000Long-term debt issue costs – (314,897) Repayment of long-term debt (616,118) (155,537)

(254,581) 260,610,636

(Decrease)/increase in cash and cash equivalents (136,279,959) 182,523,360Cash and cash equivalents – beginning of year 230,089,323 46,861,146Foreign exchange (loss)/gain on cash held in foreign currency (3,188,979) 704,817

Cash and cash equivalents – end of year 90,620,385 230,089,323

Non-cash investing and financing activities (note 25)Supplementary informationThe following have been included within cash flows for the year under operating activities Interest received 4,477,227 3,504,866 Interest paid 13,636,178 8,546,840



Notes to Consolidated Financial Statements

1 Reporting EntityHeritage Oil Limited (the “Company”) was incorporated under the Companies (Jersey) Law 1991 (as amended) on 6 February 2008. Its primary business activity is the exploration, development and production of petroleum and natural gas in Africa, the Middle East, Russia and South Asia. The Company was established in order to implement a corporate reorganisation of Heritage Oil Corporation (“HOC”, the “Corporation”).

On 24 March 2008, HOC entered into a corporate reorganisation (the “Reorganisation”) which resulted in the Company becoming the parent company of HOC and its subsidiaries. The Company’s corporate head office is now located in the Channel Islands. In connection with the Reorganisation, the Company listed its Ordinary Shares (“Ordinary Shares”) on the Official List of the United Kingdom Listing Authority (the “UKLA”) and trades on the Main Market of the London Stock Exchange plc (the “LSE”) (collectively, “Admission”). HOC delisted its existing Common Shares (“Heritage Shares”) from the Toronto Stock Exchange (the “TSX”) and obtained a listing for a new class of Exchangeable Shares (the “Exchangeable Shares”) on the TSX. As part of the Reorganisation, implemented by way of a court-approved plan of arrangement (the “Arrangement”) under the Business Corporations Act (Alberta), HOC split its stock such that each existing HOC Share was exchanged for either ten Ordinary Shares or 10 Exchangeable Shares in accordance with the terms of the Arrangement.

On 2 April 2008, HOC and the Company collectively, together with their subsidiaries and affiliates, announced that Articles of Arrangement implementing the previously announced Arrangement involving HOC and the Company had been filed with the Registrar of Corporations for the Province of Alberta with an effective date of 31 March 2008. As a result, former holders of Common Shares of HOC were entitled to either 10 Ordinary Shares of the Company or ten Exchangeable Shares of HOC for each Common Share held depending on the elections previously made by such shareholders. Effective at the opening of business on 3 April 2008, the Exchangeable Shares were listed and posted for trading in substitution for the previously listed Common Shares of HOC which were delisted at that time. The Exchangeable Shares were also admitted to trading on the Main Market of the LSE on 2 April 2008. Trading of Ordinary Shares commenced on the LSE on 31 March 2008.

The Exchangeable Shares are designed to have rights as near as possible equivalent to the Ordinary Shares of the Company. Each Exchangeable Share is exchangeable on a one-for-one basis for an Ordinary Share. The holders of Exchangeable Shares are entitled to Voting Rights equivalent to Ordinary Shares through the Special Voting Share (see below). Dividends to Ordinary Shareholders can only be declared or paid simultaneously with the declaration or payment of an identical dividend to Exchangeable Shareholders. On liquidation, dissolution or winding-up of HOC, the Exchangeable Shareholders will be given one Ordinary Share per Exchangeable Share held.

The Company has issued one Special Voting Share. The Special Voting Share has the number of votes, which may be cast at any meeting at which holders of Ordinary Shares are entitled to vote, equal to the number of Exchangeable Shares of HOC outstanding at the relevant time. The holders of Exchangeable Shares are entitled to Voting Rights through the Special Voting Share held by the trustee of the Voting and Exchange Trust by the Company, and have the right to receive notice of, speak and vote at the general meetings of the Company (on the basis of one vote for every Exchangeable Share) on the same basis as if they had exchanged their Exchangeable Shares for Ordinary Shares.

In connection with this Reorganisation the Company has agreed that the 2007 convertible bonds outstanding were convertible into Ordinary Shares of the Company rather than Common Shares of HOC.

These consolidated financial statements include the results of the Company and all subsidiaries over which the Company exercises control. The Company together with its subsidiaries are referred to as the Group. The subsidiaries consolidated within these financial statements include, inter alia, Heritage Oil Corporation, Heritage Oil & Gas Limited, Eagle Energy (Oman) Limited, Heritage Oil and Gas (U) Limited, Heritage Energy Middle East Limited, Heritage DRC Limited, Coatbridge Estates Limited, ChumpassNefteDobycha, Neftyanaya Geologicheskaya Kompaniya, Heritage Oil & Gas (Austria) GesmbH, Heritage Mali Block 7 Limited, Heritage Mali Block 11 Limited, Heritage Energy Holding GesmbH, Heritage Oil & Gas (Gibraltar) Limited, TISE Heritage Neftegaz, Begal Air Limited, Heritage International Holding GesmbH, Heritage Oil & Gas Holdings Limited, Eagle Drill Limited, Heritage Oil (Barbados) Limited, Heritage Oil & Gas (Switzerland) SA, Heritage Oil International Malta Limited, 1381890 Alberta ULC, Heritage Oil Cooperatief U.A, Heritage Oil Holdings Limited, Heritage International VOF, Heritage (International) Holding (Gibraltar) Limited, Heritage Tanzania Kimbiji-Latham Limited and Heritage Tanzania Kisangire Limited.

The Company’s consolidated financial statements are presented in US dollars, which is the Company’s functional and presentation currency.

The financial statements were approved by the Board and authorised for issuance on 28 April 2009.

2 Significant Accounting PoliciesThe principal accounting policies applied in the preparation of these consolidated financial statements are set out below. These policies have been consistently applied to all the years presented, unless otherwise stated.


Notes to Consolidated Financial Statementscontinued

2 Significant Accounting Policies continueda) Basis of PreparationThe consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (“IFRS”) as adopted by the European Union.

The Reorganisation, which is not a business combination, was accounted for with reference to the principles of reverse acquisition accounting as in accounting terms, the substance of the Reorganisation is that the underlying economics of the business have remained unchanged. Accordingly, the Reorganisation has been accounted for on a carry over basis of the historical cost of assets and liabilities of HOC and the consolidated financial history of HOC becomes that of the Company.

Certain prior year balances have been reclassified to conform to the current year’s presentation.

The consolidated financial statements have been prepared under the historical cost convention, as modified by the revaluation of certain financial assets and liabilities at fair value.

As for most oil and gas exploration companies, the Company raises financing for its activities from time to time using a variety of sources. Based on its current plans and knowledge, its projected capital expenditure and operating cash requirements, the Group has sufficient cash to finance its current plans for at least 12 months from the date of approval of the financial statements, but further finance is likely to be required to meet expenditure planned for the second half of 2010. Sources of funding for future exploration and development programmes will be derived from, inter alia, new credit facilities, reinvesting funds from operations, using existing treasury resources, disposal proceeds from the sale of non-core assets, farm-outs and, when considered appropriate, issuing debt and additional equity. Accordingly, the Group has a number of different sources of finance available and the Directors are confident that additional finance will be raised as and when needed.

After making enquiries, the Directors have a reasonable expectation that the Group has adequate resources to continue in operational existence for the foreseeable future. Accordingly, they continue to adopt the going concern basis in preparing the annual report and accounts.

The Group’s business activities, together with the factors likely to affect its future development, performance and position are set out in the Operations Review of the Annual Report on pages 10 to 27. The financial position of the Group, its cash flows and liquidity position are described in the Chief Financial Officer’s Financial Review on pages 28 to 31. In addition, note 3 to the financial statements includes the Group’s policies and processes for managing its capital, its financial risk management, and its exposure to foreign exchange risk, commodity price risk, credit risk and liquidity risk.

The preparation of financial statements in conformity with IFRS requires the use of certain critical accounting estimates. It also requires management to exercise its judgement in the process of applying the Company’s accounting policies. The areas involving a higher degree of judgement or complexity, or areas where assumptions and estimates are significant to the consolidated financial statements are disclosed in note 4.

b) ConsolidationThe consolidated financial statements incorporate the assets and liabilities of all subsidiaries of the Company as at 31 December 2008 and 2007 and the results of all subsidiaries for the years then ended.

Subsidiaries are all entities (including special purpose entities) over which the Company has the power to govern the financial and operating policies, so as to obtain benefits from its activities, generally accompanying a shareholding of more than one half of the voting rights. The existence and effect of potential voting rights that are currently exercisable or convertible are considered when assessing whether the Company controls another entity. Subsidiaries are fully consolidated from the date on which control is transferred to the Company. They are de-consolidated from the date that control ceases.

The purchase method of accounting is used to account for the acquisition of subsidiaries by the Group. The cost of an acquisition is measured as the fair value of the assets given, equity instruments issued and liabilities incurred or assumed at the date of exchange, plus costs directly attributable to the acquisition. Identifiable assets acquired and liabilities and contingent liabilities assumed in a business combination are measured initially at their fair values at the acquisition date, irrespective of the extent of any minority interest. The excess of the cost of acquisition over the fair value of the Group’s share of the net fair value of the identifiable assets, liabilities and contingent liabilities acquired is recorded as goodwill. If the cost of acquisition is less than the fair value of the net assets of the subsidiary acquired, the difference is recognised immediately in the income statement.

Inter-company transactions, balances and unrealised gains on transactions between Group entities (the Company and its subsidiaries) are eliminated. For the purposes of consolidation, the accounting policies of subsidiaries have been changed where necessary to ensure consistency with the policies adopted by the Company.


2 Significant Accounting Policies continuedc) Segment ReportingThe Company’s primary segment reporting format is geographical. A geographical segment is engaged in providing products or services within a particular economic environment, that are subject to risks and returns, that are different from those of segments operating in other economic environments.

d) Joint ArrangementsThe majority of exploration, development and production activities are conducted jointly with others under contractual arrangement and, accordingly, the Group only reflects its proportionate interest in such assets, liabilities, revenues and expenses.

e) Exploration and Evaluation ExpendituresThe Group applies a modified full cost method of accounting for exploration and evaluation (“E&E”) costs, having regard to the requirements of IFRS 6 “Exploration for and Evaluation of Mineral Resources”. Under the modified full cost method of accounting, costs of exploring for and evaluating oil and gas properties are capitalised on a licence or prospect basis and the resulting assets are tested for impairment by reference to appropriate cost pools. Such cost pools are based on geographic areas and are not larger than a segment. The Group had nine cost pools in 2007 and 2008: Uganda, Kurdistan Region of Iraq, Russia, Oman, DRC, Pakistan, Malta, Mali and Tanzania.

E&E costs related to each licence/prospect are initially capitalised within “Intangible exploration assets”. Such E&E costs may include costs of licence acquisition, technical services and studies, seismic acquisition, exploration drilling and testing, the projected costs of retiring the assets (if any) and directly attributable general and administrative expenses, but do not include costs incurred prior to having obtained the legal rights to explore an area, which are expensed directly to the income statement as they are incurred.

Where the Company farms-in to licences and incurs costs in excess of its own share of licence costs as consideration, these costs are capitalised as its own share.

Tangible assets acquired for use in E&E activities are classified as property, plant and equipment; however, to the extent that such a tangible asset is consumed in developing an intangible E&E asset, the amount reflecting that consumption is recorded as part of the cost of the intangible asset.

Intangible E&E assets related to each exploration licence/prospect are not depreciated and are carried forward until the existence (or otherwise) of commercial reserves has been determined. The Group’s definition of commercial reserves for such purpose is proved and probable reserves on an entitlement basis.

Proved and probable reserves are the estimated quantities of crude oil, natural gas and natural gas liquids which geological, geophysical and engineering data demonstrate with a specified degree of certainty (see below) to be recoverable in future years from known reservoirs and which are considered commercially producible. There should be a 50% statistical probability that the actual quantity of recoverable reserves will be more than the amount estimated as proved and probable and a 50% statistical probability that it will be less. The equivalent statistical probabilities for the proved component of proved and probable reserves are 90% and 10%, respectively.

Such reserves may be considered commercially producible if management has the intention of developing and producing them and such intention is based upon:

a reasonable assessment of the future economics of such production;•a reasonable expectation that there is a market for all or substantially all the expected hydrocarbon production; and•evidence that the necessary production, transmission and transportation facilities are available or can be made available.•

Furthermore:(i) Reserves may only be considered proved and probable if producibility is supported by either actual production or a conclusive formation

test. The area of reservoir considered proved includes: (a) that portion delineated by drilling and defined by gas-oil and/or oil-water contacts, if any, or both: and (b) the immediately adjoining portions not yet drilled, but which can be reasonably judged as economically productive on the basis of available geophysical, geological and engineering data. In the absence of information on fluid contacts, the lowest known structural occurrence of hydrocarbons controls the lower proved limit of the reservoir; and

(ii) Reserves which can be produced economically through application of improved recovery techniques (such as fluid injection) are only included in the proved and probable classification when successful testing by a pilot project, the operation of an installed programme in the reservoir, or other reasonable evidence (such as, experience of the same techniques on similar reservoirs or reservoir simulation studies) provides support for the engineering analysis on which the project or programme was based.

If commercial reserves have been discovered, the related E&E assets are assessed for impairment on a cost pool basis as set out below and any impairment loss is recognised in the income statement. The carrying value, after any impairment loss, of the relevant E&E assets is then reclassified as development and production assets within property, plant and equipment.



2 Significant Accounting Policies continuedE&E assets are assessed for impairment when facts and circumstances suggest that the carrying amount may exceed its recoverable amount. Such indicators include the point at which a determination is made as to whether or not commercial reserves exist. Where the E&E assets concerned fall within the scope of an established full cost pool, the E&E assets are tested for impairment together with all development and production assets associated with that cost pool, as a single cash generating unit. The aggregate carrying value is compared against the expected recoverable amount of the pool, generally by reference to the present value of the future net cash flows expected to be derived from production of commercial reserves. Where the E&E assets to be tested fall outside the scope of any established cost pool, there will generally be no commercial reserves and the E&E assets concerned will be written-off in full.

f) Property, Plant and Equipmenti) Development and Production AssetsThe Group had two interests at the development and production stage during the years covered by these financial statements; Russia and Oman.

Development and production assets are accumulated on a field-by-field basis and represent the cost of developing the commercial reserves discovered and bringing them into production, together with the E&E expenditures incurred in finding commercial reserves transferred from intangible E&E assets as outlined above, the projected cost of retiring the assets and directly attributable general and administrative expenses.

The net book values of producing assets are depleted on a field-by-field basis using the unit of production method by reference to the ratio of production in the year to the related proved plus probable reserves of the field, taking into account estimated future development expenditures necessary to bring those reserves into production.

An impairment test is performed whenever events and circumstances arising during the development or production phase indicate that the carrying value of a development or production asset may exceed its recoverable amount. The aggregate carrying value is compared against the expected recoverable amount of the cash generating unit, generally by reference to the present value of the future net cash flows expected to be derived from the production of commercial reserves. The cash generating unit applied for impairment test purposes is generally the field, except that a number of field interests may be grouped as a single cash generating unit where the cash flows generated by the fields are interdependent.

ii) Other AssetsOther property, plant and equipment are stated at cost less accumulated depreciation and any impairment in value. The assets’ useful lives and residual values are assessed on an annual basis.

Furniture and fittings are depreciated using the reducing balance method at 20% per year.

Land is not subject to depreciation.

Drilling rig equipment is depreciated using the unit-of-production method based on 2,740 drilling days with a 20% residual value.

The corporate jet is depreciated over its expected useful life of 69 months. Depreciation is charged so as to write-off the cost, less estimated residual value of corporate jet on a straight-line basis.

Corporate capital assets are depreciated on a straight-line basis over their estimated useful lives. The building is depreciated on a straight-line basis over 40 years with nil residual value. The land is not depreciated.

g) Cash and Cash EquivalentsCash and cash equivalents include cash on hand, deposits held at call with banks and other short-term highly liquid investments with original maturities of three months or less. Cash and cash equivalents are stated at amortised cost using the effective interest rate method.

h) Trade and Other ReceivablesTrade and other receivables are recognised initially at fair value and subsequently measured at amortised cost using the effective interest method, less provision for impairment. A provision for impairment of trade receivables is established when there is objective evidence that the Group will not be able to collect all amounts due according to the original terms of the receivables.

i) InventoriesInventories consist of petroleum, condensate, liquid petroleum gas and materials that are recorded at the lower of weighted average cost and net realisable value. Cost comprises direct materials, direct labour, depletion and those overheads that have been incurred in bringing the inventories to their present location and condition. Net realisable value is the estimated selling price in the ordinary course of business, less applicable variable selling expenses. Provision is made for obsolete, slow-moving or defective items where appropriate.


2 Significant Accounting Policies continuedj) Intangible Development CostsDevelopment costs are recognised as intangible assets when it is probable that the project will, after considering its commercial and technical feasibility, be completed and generate future economic benefits and its costs can be measured reliably. All other research and development costs are charged to earnings in the year incurred.

k) InvestmentsThe Group classifies its investments in the following categories: financial assets at fair value through the income statement and available- for-sale financial assets. The classification depends on the purpose for which the investments were acquired. Management determines the classification of its investments at initial recognition. During the years covered by these financial statements the Group did not have any investments classified as “loans and receivables” or “held to maturity investments”.

i) Financial Assets at Fair Value Through the Income StatementFinancial assets held for trading are carried at fair value with changes in fair value recognised in the income statement. A financial asset is classified in this category if acquired principally for the purpose of selling in the short term. Derivatives are classified as held for trading unless they are designated as hedges.

Gains or losses arising from changes in the fair value of the “financial assets at fair value through the income statement” category are presented in the income statement within “Unrealised gain/(loss) on other financial assets” in the year in which they arise.

ii) Available-For-Sale Financial AssetsAvailable-for-sale financial assets, comprising principally marketable equity securities, are non-derivatives that are either designated in this category or not classified. They are included in non-current assets unless management intends to dispose of the investment within 12 months of the balance sheet date.

Changes in the fair value of monetary and non-monetary securities classified as available-for-sale (other than impairment losses and foreign exchange gains and losses which are recognised in the income statement) are recognised in equity. Upon sale of a security classified as available-for-sale, the cumulative gain or loss previously recognised in equity is recognised in the income statement.

The Group assesses at each balance sheet date whether there is objective evidence that a financial asset or a group of financial assets is impaired. Measurement is assessed by reference to the fair value of the financial asset or group of financial assets.

l) Non-Current Assets Held for SaleNon-current assets (or disposal groups) are classified as assets held for sale and stated at the lower of their carrying amount and fair value less costs to sell if their carrying amount will be recovered principally through a sale transaction rather than through continuing use.

Non-current assets (including those that are part of a disposal group) are not depreciated or amortised while they are classified as held for sale. Interest and other expenses attributable to the liabilities of a disposal group classified as held for sale continue to be recognised.

Non-current assets classified as held for sale and the assets of a disposal group classified as assets held for sale are presented separately, as current assets, from the other assets in the balance sheet. The liabilities of a disposal group classified as held for sale are presented separately, as current liabilities, from other liabilities in the balance sheet.

m) Trade and Other PayablesThese amounts represent liabilities for goods and services provided to the Group prior to the end of the financial year which are unpaid.

n) BorrowingsBorrowings are initially recognised at fair value, net of transaction costs incurred. Borrowings are subsequently measured at amortised cost. Any difference between the proceeds (net of transaction costs) and the redemption amount is recognised in the income statement over the period of the borrowings using the effective interest method.

Convertible bonds are separated into liability and derivative liability components (being the bondholders’ conversion option) and each component is recognised separately. On initial recognition, the fair value of the liability component of a convertible bond is determined using a market interest rate for an equivalent non-convertible bond. This amount is recorded as a liability on an amortised cost basis using the effective interest method until extinguished on conversion or maturity of the bonds. The fair value of the derivative liability component (see note 2q) is determined using a Black-Scholes option pricing model, and this amount is recorded as a liability.

Borrowings are removed from the balance sheet when the obligation specified in the contract is discharged, cancelled or expired. The difference between the carrying amount of a financial liability that has been extinguished or transferred to another party and the consideration paid, including any non-cash assets transferred or liabilities assumed, is recognised in finance income or costs.

Borrowings are classified as current liabilities unless the Group has an unconditional right to defer settlement of the liability for at least 12 months after the balance sheet date.



2 Significant Accounting Policies continuedo) Borrowing CostsBorrowing costs incurred for the construction of any qualifying asset are capitalised during the period of time that is required to complete and prepare the asset for its intended use or sale. Other borrowing costs are expensed.

The capitalisation rate used to determine the amount of borrowing costs to be capitalised is the weighted average interest rate applicable to the Group’s outstanding borrowings during the year. For the year ended 31 December 2008, this was 12.01% (31 December 2007 – 10.70%).

p) ProvisionsAsset Retirement ObligationsProvision is made for the estimated cost of any asset retirement obligations when the Group has a present legal or constructive obligation as a result of past events, it is probable that an outflow of resources will be required to settle the obligation and the amount has been reliably estimated. Provisions are not recognised for future operating losses. Asset retirement obligation expense is capitalised in the relevant asset category unless it arises from the normal course of production activities.

Provisions are measured at the present value of management’s best estimate of expenditure required to settle the present obligation at the balance sheet date. The discount rate used to determine the present value reflects current market assessments of the time value of money and the risks specific to the liability.

Subsequent to the initial measurement of the asset retirement obligation, the obligation is adjusted at the end of each year to reflect the passage of time and changes in the estimated future cash flows underlying the obligation. The increase in the provision due to the passage of time is recognised as finance costs whereas increase due to changes in the estimated future cash flows are capitalised.

q) Derivative Financial LiabilitiesDerivatives are initially recognised at fair value on the date a derivative contract is entered into and are subsequently remeasured to their fair value at each reporting date. Changes in the fair value are recognised immediately in the income statement.

r) Revenue RecognitionRevenue from the sale of petroleum and natural gas is recognised at the fair value received or receivable and is recorded when the significant risks and rewards of ownership of the product are transferred to the buyer. For sales of oil and gas this is usually when legal title passes to the external party which occurs on shipment of oil and gas to the buyer. Interest income is recognised on a time proportion basis using the effective interest method.

s) Income TaxesCurrent income tax is based on taxable profit for the year. Taxable profit differs from profit as reported in the income statement because it excludes items that are never taxable or deductible. The Group’s current tax assets and liabilities are calculated using tax rates that have been enacted or substantively enacted by the balance sheet date.

Deferred income tax is provided in full, using the balance sheet method, on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the consolidated financial statements. Deferred income tax is determined using tax rates (and laws) that have been enacted or substantively enacted by the balance sheet date and are expected to apply when the related deferred income tax asset is realised or the deferred income tax liability is settled.

Deferred tax assets are recognised for deductible temporary differences and unused tax losses only if it is probable that future taxable amounts will be available to utilise those temporary differences and losses.

Deferred tax assets and liabilities are offset when there is a legally enforceable right to offset current tax assets and liabilities and when the deferred tax balances relate to the same taxation authority.

t) Foreign Currency TranslationItems included in the financial statements of each of the Company’s consolidated subsidiaries are measured using the currency of the primary economic environment in which the subsidiary operates (“the functional currency”). The Company’s consolidated financial statements are presented in US dollars, which is the Company’s functional and presentation currency.

Foreign currency transactions are translated into the respective functional currencies of Group entities using the exchange rates prevailing at the dates of the transactions. Foreign exchange gains and losses resulting from the settlement of such transactions and from the translation at year end exchange rates of monetary assets and liabilities denominated in foreign currencies are recognised in the income statement.


2 Significant Accounting Policies continuedThe results and financial position of all the Company’s consolidated subsidiaries (none of which has a functional currency that is the currency of a hyperinflationary economy) that have a functional currency different from the presentation currency are translated into the presentation currency as follows:i) assets and liabilities for each balance sheet presented are translated at the closing rate at the date of that balance sheet;ii) income and expenses for each year are translated at average exchange rates (unless this is not a reasonable approximation of the

cumulative effect of the rates prevailing on the transaction dates, in which case income and expenses are translated at the dates of the transactions); and

iii) all resulting exchange differences are recognised as either income or expense in a separate component of equity.

Foreign currency loans and overdrafts are designated as, and are considered to be, hedges of the exchange rate exposure inherent in foreign currency net investments and, to the extent that the hedge is effective, exchange differences giving rise to changes in the carrying value of foreign currency loans are also recognised as income or expense directly in equity. All other exchange differences giving rise to changes in the carrying value of foreign currency loans and overdrafts are recognised in the income statement.

When a foreign operation is sold, a proportionate share of the cumulative exchange differences previously recognised in equity are recognised in the income statement, as part of the gain or loss on sale where applicable.

u) Share-Based Compensation PlansThe Group applies the fair value method of accounting to all equity classified share-based compensation arrangements for both employees and non-employees. Compensation cost of equity classified awards to employees are measured at fair value of the awards at the time when the services are rendered at the grant date and recognised over the periods during which the employees become unconditionally entitled to the options. The compensation cost is charged to the income statement with a corresponding increase in equity. The amount recognised as an expense is adjusted to reflect the actual number of share options that vest.

The compensation cost of equity classified awards to non-employees is initially measured at fair value, and periodically remeasured to fair value until the non-employees’ performance is complete, and recognised over their vesting period with a corresponding increase to share-based payment reserve. Upon the exercise of the award, consideration received is recognised in equity. See note 21.

v) Share CapitalOrdinary and Exchangeable Shares are classified as share capital. Incremental costs directly attributable to the issue of new shares or options are shown in equity as a deduction, net of tax, from the proceeds.

If the Company re-acquires its own equity instruments the cost is deducted from equity and the associated shares are cancelled.

w) Earnings per ShareBasic earnings per share is calculated by dividing the profit attributable to equity holders of the Company by the weighted average number of Ordinary Shares outstanding during the financial period. The rights of different classes of shares are the same and therefore economically equivalent. As such, Ordinary and Exchangeable Shares are treated as one class of shares for the earnings per share calculation.

Diluted earnings per share adjusts the figures used in the determination of basic earnings per share to take into account the after income tax effect of interest and other financing costs associated with dilutive potential Ordinary Shares and the weighted average number of shares assumed to have been issued for no consideration in relation to dilutive potential Ordinary Shares.

The if-converted method used in the calculation of diluted earnings per share assumes the conversion of convertible securities at the later of the beginning of the reported period or issuance date, if dilutive. In all cases, the weighted average number of shares used has been adjusted to reflect the effective one for ten share split that took place as part of the corporate reorganisation described in note 1.

x) New Accounting Standards and InterpretationsCertain new accounting standards and interpretations have been published that are not mandatory for the year ended 31 December 2008. The Company’s assessment of the impact of these new standards and interpretations which have not been adopted is set out below.

i) IFRS 8, “Operating segments” (effective from 1 January 2009), replaces International Accounting Standard (“IAS”) 14 and aligns segment reporting with the requirements of the US standard Statement of Financial Accounting Standards (“SFAS”) 131, “Disclosures about segments of an enterprise and related information”. The new standard requires a “management approach”, under which segment information is presented on the same basis as that used for internal reporting purposes. The expected impact is still being assessed by management, but is expected to only impact the disclosures of the Group.

The following standard is assessed not to have any impact on the Company’s financial statements:i) IAS 23 (Amendment), “Borrowing costs” (effective from 1 January 2009), requires the Group to capitalise borrowing costs directly

attributable to the acquisition, construction or production of a qualifying asset (one that takes a substantial period of time to get ready for use or sale) as part of the cost of that asset. The Group currently applies the capitalisation approach to borrowing costs.



2 Significant Accounting Policies continuedThe following amendments have been published, but have not been applied in these financial statements:i) IFRS 2 (Amendment), Share-based payment – Vesting Conditions and Cancellations: effective for accounting periods commencing on or

after 1 January 2009;i) IFRS 3 (Amendment) Business Combinations: effective for accounting periods commencing on or after 1 July 2009;iii) IAS 1 (Amendment), Presentation of Financial Statements: effective for accounting periods commencing on or after 1 January 2009; andiv) IAS 27 (Amendment), Consolidated and Separate Financial Statements: effective for accounting periods commencing on or after

1 July 2009.

The Directors do not anticipate that the adoption of these amendments will have a material impact on the Group’s financial statements in the period of initial application.

3 Risk ManagementThe Group’s activities expose it to a variety of financial risks that arise as a result of its exploration, development, production, and financing activities. The Group’s overall risk management programme focuses on the unpredictability of financial markets and seeks to minimise potential adverse effects on the Group’s financial performance.

a) Financial Risk Managementi) Foreign Exchange RiskForeign exchange risk arises when transactions and recognised assets and liabilities of the Group entity concerned are denominated in a currency that is not the Company’s functional currency. The Group operates internationally and is exposed to foreign exchange risk arising from currency exposures to the US dollar.

There are no forward exchange rate contracts in place at, or subsequent to, 31 December 2008.

At 31 December 2008, if the Canadian dollar had strengthened/weakened by 10% against the US dollar with all other variables held constant, the loss for the year would have been $122,403 (31 December 2007 – $2,978,702) higher/(lower), mainly as a result of foreign exchange gains/losses on translation of Canadian dollar denominated general and administrative expenses and cash in bank. Profit is more sensitive to movement of Canadian/US dollar exchange rates in 2007 than 2008 because of significantly higher general and administrative expenses in 2007 in comparison with 2008.

At 31 December 2008, if the Russian rouble had strengthened/weakened by 10% against the US dollar with all other variables held constant, the loss for the year would have been $(513,633) (31 December 2007 – $(329,361)) higher/(lower), mainly as a result of foreign exchange gains/losses on translation of Russian rouble denominated cash in bank and monetary assets and liabilities.

At 31 December 2008, if the Pounds Sterling had strengthened/weakened by 10% against the US dollar with all other variables held constant, the loss for the year would have been $605,907 (31 December 2007 – $343,011) higher/(lower), mainly as a result of Pounds Sterling denominated general and administrative expenses and foreign exchange gains/losses on translation of Pounds Sterling denominated long-term loan.

At 31 December 2008, if the Swiss franc had strengthened/weakened by 10% against the US dollar with all other variables held constant, the loss for the year would have been $(299,806) (31 December 2007 – $(420,274)) higher/(lower), mainly as a result of foreign exchange gains/losses on translation of Swiss franc denominated cash at bank.

ii) Commodity Price RiskThe Company is exposed to commodity price risk to the extent that it sells its entitlement to petroleum, condensate and liquid petroleum gas production on a floating price basis. The Company may consider partly mitigating this risk in the future.

The table below summarises the impact of increases/decreases of the relevant oil/condensate/LPG benchmark on the Company’s loss for the year. The analysis is based on the assumption that commodity prices had increased/decreased by 5% with all other variables held constant: Year ended 31 December

2008 2007 $ $

Brent light crude 191,850 85,886Condensate 48,190 77,831LPG 14,751 21,759

254,791 185,476

The loss for the year would increase/decrease as a result of commodity revenues received.


3 Risk Management continuediii) Interest Rate RiskThe Group had fixed rate long-term debt and fixed rate convertible bonds in the years under review, therefore, it was not exposed to interest rate risk with respect to these fixed-rate borrowings. In October 2007, a wholly-owned subsidiary of the Company received a long-term loan of $9,450,000 with a variable rate of LIBOR plus 1.6% (note 16). An increase/decrease of LIBOR by 1% would result in an increase/decrease of the Company’s loss for the year by $73,375 (31 December 2007 – $17,325).

iv) Credit RiskAll of the Company’s production was derived from Russia and Oman. In 2007 and 2008, the Company made all of its production sales, at any point in time, in each country to a single customer for each commodity. Accordingly, substantially all the Company’s accounts receivables from petroleum and natural gas sales were from a maximum of three customers during these years.

Trade debtors of the Company are subject to internal credit review to minimise the risk of non-payment. The Company does not anticipate any defaults as it transacts with creditworthy counterparties. No credit limits were exceeded during the reporting years and management does not expect any losses from non-performance by these counterparties.

The Company is also exposed to credit risk in relation to regular joint venture billings which are typically outstanding for one month and in relation to its cash balances held with the reputable banks.

v) Liquidity RiskLiquidity risk is the risk that the Group will not have sufficient funds to meet liabilities. Cash forecasts identifying liquidity requirements of the Group are produced quarterly. These are reviewed regularly to ensure sufficient funds exist to finance the Company’s current operational and investment cash flow requirements.

Management monitors rolling forecasts of the Company’s cash position on the basis of expected cash flow.

The Group had available cash of $91 million at 31 December 2008. Based on its current plans and knowledge, its projected capital expenditure and operating cash requirements, the Group has sufficient cash to finance its current plans for at least 12 months from the date of approval of the financial statements, but further financing is likely to be required to meet expenditures planned for the second half of 2010.

The Company’s financial liabilities consist of trade and other payables and borrowings. Trade and other payables are due within 12 months, and borrowings fall due as outlined in note 24.

b) Capital Risk ManagementThe Company’s objectives when managing capital are to safeguard the Company’s ability to continue as a going concern in order to provide returns for shareholders and benefits for other stakeholders and to maintain an optimal capital structure to reduce the cost of capital. In accordance with the terms of the convertible bonds, the Company shall not, over the life of the convertible bonds (note 16), make any dividend payment or share repurchase.

The Company monitors capital on the basis of the gearing ratio. This ratio is calculated as net debt divided by total capital. Net debt is calculated as total borrowings (including “borrowings” and “trade and other payables” as shown in the consolidated balance sheet) less cash and cash equivalents. Total capital is calculated as ‘equity’ as shown in the consolidated balance sheet plus net debt.

As at 31 December

2008 2007 $ $

Total borrowings 237,462,452 216,434,761Less cash and cash equivalents (note 14) (90,620,385) (230,089,323)

Net debt (cash) 146,842,067 (13,654,562)Total equity 163,835,069 193,193,432

Total capital 310,677,136 193,193,432

Gearing ratio 47% 0%

This increase in the gearing ratio during 2008 resulted primarily from an increase in accounts payable at 31 December 2008 due to the significant exploration activities at the end of the year and a decrease in equity due to the net loss incurred during 2008.



4 Critical Accounting Estimates, Assumptions and JudgementsIn the process of applying the Company’s accounting policies, which are described in note 2, management makes estimates and assumptions concerning the future. The resulting accounting estimates will, by definition, seldom equal the related actual results. The estimates and assumptions that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year are discussed below:

a) Recoverability of Exploration and Evaluation CostsUnder the modified full cost method of accounting for E&E costs, certain costs are capitalised as intangible assets by reference to appropriate cost pools, and are assessed for impairment when circumstances suggest that the carrying amount may exceed its recoverable value.

Such circumstances include, but are not limited to:i) the period for which the entity 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;ii) substantive expenditure on further exploration for and evaluation of mineral resources in the specific area is neither budgeted nor

planned;iii) exploration for, and evaluation of, mineral resources in the specific area have not led to the discovery of commercially viable quantities of

mineral resources and the entity has decided to discontinue such activities in the specific area; andiv) sufficient data exist to indicate that, although a development in the specific area is likely to proceed, the carrying amount of the

exploration and evaluation asset is unlikely to be recovered in full from successful development or by sale.

This assessment involves judgement as to: (i) the likely future commerciality of the asset and when such commerciality should be determined; (ii) future revenues and costs pertaining to any wider cost pool with which the asset in question is associated; and (iii) the discount rate to be applied to such revenues and costs for the purpose of deriving a recoverable value. Note 10 discloses the carrying amounts of the Group’s E&E assets. Consequently, major uncertainties affect the recoverability of these costs which is dependent on the Group achieving commercial production or the sale of the assets. Note 24 discloses contingencies relating to the title risks. The Company assessed whether these risks are contingencies or indicators of impairment and concluded that they are contingencies.

b) Reserve EstimatesEstimates of recoverable quantities of proven and probable reserves include assumptions regarding commodity prices, exchange rates, discount rates, production and transportation costs for future cash flows. It also requires interpretation of complex and difficult geological and geophysical models in order to make an assessment of the size, shape, depth, and quality of reservoirs and their anticipated recoveries. The economic, geological and technical factors used to estimate reserves may change from period to period. Changes in reported reserves can impact asset carrying values and the asset retirement obligation due to changes in expected future cash flows. Reserves are integral to the amount of depletion charged to the income statement and the calculation of inventory.

The level of estimated commercial reserves is also a key determinant in assessing whether the carrying value of any of the Group’s development and production assets has been impaired.

c) Fair Value of Financial InstrumentsThe Group’s accounting policies and disclosures require the determination of the fair value of financial instruments. Fair values have been determined for measurement and/or disclosure purposes based on the following methods:

i) Non-Derivative Financial InstrumentsThese comprise investments in equity and debt securities, trade and other receivables, cash and cash equivalents, loans and borrowings and trade and other payables. Non-derivative financial instruments are recognised initially at fair value plus, for instruments not at fair value through the income statement, any directly attributable transaction costs.

Fair value is calculated based on the present value of future principal and interest cash flows, discounted at the applicable market rate of interest at the reporting date.

ii) DerivativesDerivatives are recognised initially at fair value; attributable transaction costs are recognised in the income statement when incurred. Subsequent to initial recognition, derivatives are measured at fair value. Embedded derivatives are separated from the host contract and accounted for separately if the economic characteristics and risks of the host contract and the embedded derivative are not closely related, a separate instrument with the same terms as the embedded derivative would meet the definition of a derivative, and the combined instrument is not measured at fair value through the income statement.

The fair value of derivative financial instruments is based on their listed market prices, if available. If a listed market price is not available, then fair value is estimated by discounting the difference between the contractual forward price and the current forward price for the residual maturity of the contract using a risk-free interest rate (based on government bonds).


4 Critical Accounting Estimates, Assumptions and Judgements continuediii) Compound Financial InstrumentsCompound financial instruments issued by the Group comprise convertible bonds that can be converted to share capital at the option of the holder, and the number of shares to be issued does not vary with changes in their fair value.

The convertible bonds are separated into liability and derivative liability components (being the bondholders’ conversion option). The liability component of a compound financial instrument is recognised initially at fair value, determined by reference to market interest rates for equivalent bonds which do not contain conversion features. Subsequent to initial recognition, the liability component is measured at amortised cost using the effective interest method. The fair value of the derivative liability component is determined using a Black-Scholes option-pricing model and this amount is recorded as a liability. The Black-Scholes model contains assumptions and determinations pertaining to volatility, risk-free interest rates, and the terms of the options (see note 22).

5 Segment InformationThe Group has a single class of business which is international exploration, development and production of petroleum oil and natural gas.

In 2007 and 2008, the Group operated in a number of geographical areas based on the location of operations and assets; Russia, Oman, Uganda, DRC, Kurdistan Region of Iraq, Pakistan, Tanzania, Malta and Mali.

Year ended 31 December 2008

Depreciation, External Segment Total Total Capital depletion and revenue result assets liabilities additions amortisation $ $ $ $ $ $

Russia 3,836,991 (7,643,812) 48,123,180 446,935 4,674,969 1,070,410Oman 1,258,817 (2,850,270) 28,065,282 3,279,402 17,983,358 264,003Uganda – – 154,684,138 30,485,069 55,791,804 –DRC – – 1,606,765 – 760,545 –Kurdistan Region of Iraq – – 43,774,646 6,467,567 41,781,416 –Pakistan – – 1,560,330 – 607,924 –Tanzania – (204,515) 13,785,019 659,604 13,129,738 –Mali – – 1,682,381 – 1,012,320 –Malta – (14,831) 8,685,637 3,469 2,052,831 –Unallocated – Corporate – (30,589,823) 99,330,143 196,120,406 870,924 1,015,071

5,095,808 (41,303,251) 401,297,521 237,462,452 138,665,829 2,349,484

Year ended 31 December 2007

Depreciation, External Segment Total Total Capital depletion and revenue result assets liabilities additions amortisation $ $ $ $ $ $

Russia 1,717,717 (2,653,941) 46,384,681 2,874,575 24,306,477 558,604Oman 1,991,786 1,027,069 13,817,039 331,379 4,408,453 370,868Uganda1 – (38,359) 92,398,347 6,036,508 32,993,911 –DRC – – 1,296,220 – 710,751 –Kurdistan Region of Iraq2 – (2,273,220) 1,622,934 – 1,622,934 –Pakistan – (311,778) 952,406 – 952,406 –Mali – (159,947) 213,145 – 213,146 –Malta – (32,846) 6,517,779 – 6,517,779 –Unallocated – Corporate – (78,722,573) 246,425,642 207,192,299 11,765,343 962,818

3,709,503 (83,165,595) 409,628,193 216,434,761 83,491,200 1,892,290

1 Uganda includes exploration activity as well as operating expenses relating to drilling services.2 Kurdistan Region of Iraq information was not a separate geographic segment as defined in note 2c until October 2007. However, information is presented to conform with the

current year presentation.

Exploration expenditures in respect of E&E assets relate to pre-licence costs which are expensed in accordance with IFRS 6.



6 Other Finance Costs Year ended 31 December

2008 2007 $ $

Interest on long-term debt 963,965 678,199Interest on convertible bonds 12,640,000 12,573,959Accretion of convertible debt 4,161,215 3,601,636Accretion of asset retirement obligation 22,659 7,636

17,787,839 16,861,430Amount capitalised (6,530,652) (4,863,682)

Finance costs expensed 11,257,187 11,997,748

Finance costs are capitalised in various balance sheet categories.

7 Income Tax ExpenseThe Group is subject to income taxes in Canada, Uganda and Russia. All of the Group’s operating activities are outside of Jersey.

In Oman, the tax rate applicable to the Group’s operations is considered to be nil as in this jurisdiction the Group is subject to a production sharing agreement.

In Canada, Uganda and Russia, the Group has available tax deductions of $31,438,808 (31 December 2007 – $37,624,932) and tax losses of $93,531,776 (31 December 2007 – $77,749,022), of which $50,915,869 expires from 2009 to 2028, and the remaining $42,615,907 does not have an expiry period. No deferred tax assets have been recognised for the benefit of tax deductions and tax losses because realisation of the deferred tax assets in the foreseeable future is not sufficiently likely.

Factors affecting current tax charge for the year: Year ended 31 December

2008 2007 $ $

Net loss before tax (41,303,251) (83,165,595)Standard tax rate 0% 32.12%Tax on loss at standard rate – (26,712,789)Effect of (higher)/lower tax rates in foreign jurisdiction (5,436,526) 215,472Effective weighted average tax rate 13.16% 31.86%Change in statutory tax rate 626,190 1,165,447Expenses not deductible for tax purposes 117,112 22,010,883Foreign exchange gains/(losses) 2,055,325 (687,333)Effect of tax losses not recognised 2,637,899 4,008,320

Current tax charge – –

As at 31 December

2008 2007 $ $

The balance comprises temporary differences attributable to: Available tax losses and deductions 26,649,554 24,011,654

Deferred tax asset (unrecognised) 26,649,554 24,011,654


8 Staff CostsThe average number of employees (including Directors) and consultants employed/contracted by the Group during the year, analysed by category was: Year ended 31 December

2008 2007

Jersey 2 –Canada 5 5Switzerland – 3Russia 40 41Europe 27 14Uganda 28 21Kurdistan Region of Iraq 14 5Tanzania 10 –South Africa 6 4

Total 132 93

The aggregate payroll expenses of those employees were as follows: Year ended 31 December

2008 2007 $ $

Salaries and other short-term benefits 15,573,451 12,871,099Share-based compensation 12,080,813 39,001,420

Total employee remuneration 27,654,264 51,872,519

Capitalised portion of total remuneration 11,435,283 14,217,495

Key management compensation was: Year ended 31 December

2008 2007 $ $

Salaries and other short-term benefits 4,448,302 4,263,647Share-based compensation 7,498,703 28,313,954

11,947,005 32,577,601

9 DisposalsOn 9 March 2007, the Group disposed of its previously consolidated 65% interests in Natural Pipelay Worldwide Limited (“NPWL”) and Naturalay Technologies Limited (“Naturalay”) in consideration for 605,000 Common Shares in a private company named SeaDragon. The fair value of the Common Shares consideration received of $2,420,000, which was based on the most recent private placement by SeaDragon in October 2006, resulted in a gain of $1,077,132 on the disposal. The Group’s CFO is a director and CFO of SeaDragon.

Below is an analysis of the assets and liabilities of NPWL and Naturalay as at 9 March 2007, the date of sale completion: 9 March 2007 $

AssetsIntangible development costs 1,642,868

LiabilitiesTrade and other payables 300,000

Net assets 1,342,868

The gain on disposal of the previously consolidated subsidiary has been derived as follows: $

Consideration received Fair value of shares 2,420,000Total disposal consideration 2,420,000

Less: carrying amount of net assets sold 1,342,868

Gain on disposal of subsidiaries 1,077,132



10 Intangible Exploration Assets 31 December

2008 2007 $ $

Balance – beginning of year 102,862,754 54,767,332Exchange differences (1,448,654) 251,338Additions 115,136,798 57,337,190Assets transferred to property, plant and equipment (note 11) (5,204,861) (9,493,106)

Balance – end of year 211,346,037 102,862,754

No assets have been pledged as security.

The balances at the end of the years are as follows: 31 December

2008 2007 $ $

Russia 11,365,662 18,019,174Oman 551,083 550,867Uganda 130,032,034 74,240,229DRC 1,506,765 746,219Kurdistan Region of Iraq 43,404,350 1,622,934Pakistan 1,560,330 952,406Malta 8,570,610 6,517,779Mali 1,225,465 213,146Tanzania 13,129,738 –


In many of the countries in which the Group operates, land title systems are not developed to the extent found in many industrial countries and there may be no concept of registered title. The risk of title disputes associated with the Kurdistan Region of Iraq, the DRC and Malta is described in note 24.


11 Property, Plant and Equipment 31 December

2008 2007 $ $

Petroleum and natural gas interests 68,121,295 42,056,745Drilling and barge equipment 3,544,969 3,544,969Land and building 11,984,701 11,984,701Other 15,323,857 14,452,933

Property, plant and equipment, at cost 98,974,822 72,039,348Accumulated depletion, depreciation and amortisation (10,935,604) (7,813,430)

Net book amount 88,039,218 64,225,918

Reconciliation of movements during the yearPetroleum and natural gas interestsCost – beginning of year 42,056,745 18,091,216 Accumulated depletion and depreciation – beginning of year (3,981,438) (3,051,966)

Net book amount – beginning of year 38,075,307 15,039,250

Net book value – beginning of year 38,075,307 15,039,250Exchange differences (3,426,524) 335,094Additions 27,533,291 14,137,329Assets transferred from intangible exploration (note 10) 5,204,861 9,493,106Depletion and depreciation (1,290,992) (929,472) Write-down of proved petroleum and natural gas interests (3,247,078) –

Net book amount – end of year 62,848,865 38,075,307

Cost – end of year 68,121,295 42,056,745Accumulated depletion and depreciation – end of year (5,272,430) (3,981,438)


Drilling and barge equipment Cost – beginning of year 3,544,969 3,544,969Accumulated depletion and depreciation – beginning of year (2,147,503) (347,741)


Net book amount – beginning of year 1,397,466 3,197,228Additions – – Depletion and depreciation – – Impairment (749,955) (1,799,762)

Net book amount – end of year 647,511 1,397,466


Net book amount – end of year 647,511 1,397,466

Land and building Cost – beginning of year 11,984,701 11,984,701Accumulated depletion and depreciation – beginning of year (452,329) (313,151)


Net book amount – beginning of year 11,532,372 11,671,550Depletion and depreciation (139,178) (139,178)


Cost – end of year 11,984,701 11,984,701Accumulated depletion and depreciation – end of year (591,507) (452,329)


Other Cost – beginning of year 14,452,933 2,687,590Accumulated depletion and depreciation – beginning of year (1,232,160) (408,520)




11 Property, Plant and Equipment continued 31 December

2008 2007 $ $

Net book amount – beginning of year 13,220,773 2,279,070Additions 870,924 11,765,343Depletion and depreciation (942,049) (823,640)




The corporate office which represents the land and building category and the corporate jet included in the other category serve as security for long-term loans (note 16).

The carrying value of the drilling rig was written down to nil because management does not expect that there will be significant drilling services revenues generated from the use of the drilling rig. This resulted in an impairment write-down of $749,955 (2007 – $1,799,762) recognised in the income statement during the year ended 31 December 2008. Impairment tests were performed for development and producing assets for a variety of scenarios using after tax discount rates in the range from 10% to 15%. The trigger for the impairment tests was a decline in oil and gas prices during 2008. As a result of the impairment test, the carrying value of the petroleum and natural gas interest in Oman was written down to its fair value of $28 million. This resulted in an impairment write-down of $3,247,078 (2007 – nil) recognised in the income statement during the year ended 31 December 2008. The impairment tests indicated that the fair value of the Company’s development and producing assets in Russia significantly exceeds its book value.

12 Other Financial Assets 31 December

2008 2007 $ $

Investment in warrants 107,501 1,821,201Investment in unlisted securities (note 9) 3,223,000 3,223,000

3,330,501 5,044,201

The investment in Afren Plc warrants is classified as held for trading. The investment in unlisted securities represents common shares in a private company named SeaDragon, which is classified as available-for-sale.

There were no other disposals or impairment losses on held for trading or available-for-sale financial assets in the reporting years under these financial statements.

The Company owns 805,832 of the unlisted shares of SeaDragon, representing approximately 15% of the shares outstanding. These are carried at a value of $4 per share, based on the most recent private placement of SeaDragon on 26 October 2006. At year end, the value of the shares could not be measured reliably as SeaDragon is in the process of financial reorganisation and there is a wide range of possible values for the shares and the resulting outcome of the alternatives cannot be determined. Management of the Company has no reason to believe that the value of the investment in the shares of SeaDragon is lower than the carrying value and, therefore, there is no need for an impairment write-down of the Company’s investment in the shares of SeaDragon. The Company does not plan to dispose of its investment in shares of SeaDragon in the forseeable future.

13 Trade and Other Receivables 31 December

2008 2007 $ $

Trade receivables 3,087 318,417Other receivables 6,898,424 6,440,844

6,901,511 6,759,261

Trade receivables are due within 30 days from the invoice date. Joint ventures billings are typically paid within 30 days from the invoice date. No interest is charged on the receivables. The carrying amount of trade and other receivables approximates to their fair value.

The maximum exposure to credit risk at the reporting date is the fair value of each class of receivable.


13 Trade and Other Receivables continuedAs of 31 December 2008, trade and other receivables of $6,901,511 (31 December 2007 – $6,759,261) were neither past due nor impaired. Trade and receivables relate to independent customers and joint ventures partners for whom there is no recent history of default. The ageing analysis of these trade and other receivables is as follows: 31 December

2008 2007 $ $

Up to 3 months 5,978,468 4,964,4803 to 6 months 704,588 1,794,7816 to 12 months 218,455 –

6,901,511 6,759,261

Trade and other receivables analysed by category are as follows: 31 December

2008 2007 $ $

US dollars 6,185,267 4,050,828Russian roubles 567,052 2,064,084Swiss francs 109,968 528,035Canadian dollars 5,073 100,032GB pounds sterling 9,987 16,282Euros 24,164 –

6,901,511 6,759,261

14 Cash and Cash Equivalents 31 December

2008 2007 $ $

Cash at bank and in hand 90,620,385 230,089,323

Cash at bank and in hand includes cash held in interest-bearing accounts.

15 Trade and Other Payables Due Within One Year 31 December

2008 2007 $ $

Trade payables 45,714,400 14,055,027Other payables and accrued liabilities 9,037,368 10,591,504

54,751,768 24,646,531

Trade and other payables and accrued liabilities comprise current amounts outstanding for trade purchases and ongoing costs. The carrying amount of trade and other payables approximates to their fair value.

16 Borrowings 31 December

2008 2007 $ $

Non-current borrowingsConvertible bonds – unsecured 141,319,489 137,213,274Non-current portion of long-term debt 14,290,493 17,040,427

155,609,982 154,253,701

Long-term debt – securedCurrent 595,418 623,640Non-current 14,290,493 17,040,427

14,885,911 17,664,067



16 Borrowings continued2007 Convertible BondsOn 16 February 2007, the Company raised $165,000,000 by completing a private placement of convertible bonds. Issue costs amounted to $6,979,268 resulting in net proceeds of $158,020,732. The Company issued 1,650 unsecured convertible bonds at par, which have a maturity of five years and one day and an annual coupon of 8% payable semi-annually on 17 August and 17 February of each year. Bondholders have the right to convert the bonds into Ordinary Shares at a price of $4.70 per share (after one for ten split (note 1)) at any time. The number of Ordinary Shares receivable on conversion of the bonds is fixed. The Company had the right to redeem, in whole or part, the bonds for cash at any time on or before 16 February 2008, at 150% of par value. This right was not exercised. Proceeds were used to finance the redemption of all outstanding 10% convertible bonds issued on 26 March 2006, at a premium of 150% and for general corporate funding purposes.

Bondholders have a put option requiring the Company to redeem the bonds at par, plus accrued interest, in the event of a change of control of the Company or revocation or surrender of the Zapadno Chumpasskoye Licence in Russia. In the event of a change of control and redemption of the bonds or exercise of the conversion rights, a cash payment of up to $19,700 on each $100,000 bond will be made to the bondholder, the amount of which depends upon the date of redemption and market value of shares at the date of any change of control event. The bonds included conversion features which in certain circumstances could be settled in cash and so these features represent a derivative financial instrument which is classified as a liability.

The fair value of the liability component of the bonds (net of issue costs) was estimated at $140,154,215. The fair value of the derivative financial liability representing the bondholders’ conversion feature (note 22) (net of issue costs) was estimated at $17,866,517 on 16 February 2007. The difference between the $165,000,000 due on maturity and the initial liability component is accreted using the effective interest method and is recorded as finance costs. The derivative financial instrument is recorded at fair value with resulting gains and losses recorded in finance income and costs.

In July 2007, a bondholder with $7 million of bonds gave notice of the exercise of 70 bonds and received 148,937 Common Shares in August 2007. As a result of this conversion, $8,944,487 was transferred to Share Capital from convertible bonds, derivative liability component of convertible bonds and accrued liabilities.

In April 2009, bondholders with $5.9 million of bonds gave notices of the exercise of 59 bonds. These bondholders received 1,255,317 Ordinary Shares (see note 26).

Long-Term DebtIn January 2005, a wholly-owned subsidiary of the Company received a sterling denominated loan of £4.5 million to refinance the acquisition of a corporate office. Interest on the loan is fixed at 6.515% for the first five years and is then variable at a rate of London Interbank Offered Rate (“LIBOR”) plus 1.35%. The loan, which is secured on the property, is scheduled to be repaid by 240 instalments of capital and interest at monthly intervals, subject to a residual debt at the end of the term of the loan of $3.5 million (£1,860,000). The current principal balance outstanding as at 31 December 2008 was $6,155,882 (£4.2 million) (31 December 2007 – $8,519,037 (£4.3 million)).

In October 2007, a wholly-owned subsidiary of the Company received a loan of $9,450,000 to refinance the acquisition of the corporate jet. Interest on the loan is variable at a rate of LIBOR plus 1.6% The loan, which is secured on the corporate jet, is scheduled to be repaid by 19 consecutive quarterly installments of principal. Each installment equals to $117,500 with the final installment being $7,217,500. The Corporation provided a corporate guarantee to the lender.

Fair ValuesAt 31 December 2007 and 31 December 2008, the fair values of borrowings are approximately equal to their carrying amounts as the facilities bear interest at market rates of interest.

17 ProvisionsThe Group’s asset retirement obligation results from net ownership interests in petroleum and natural gas assets including well sites and gathering systems. The Group estimates the total undiscounted inflation adjusted amount of cash flows required to settle its asset retirement obligation to be approximately $1,331,359, which is expected to be incurred in the period between 2012 and 2024. A cost pool specific discount rate, related to the liability, of 9% was used to calculate the fair value of the asset retirement obligation in Uganda and Russia (2007 – 9%) and 10% in the Kurdistan Region of Iraq in 2008 (2007 – N/A).

A reconciliation of the asset retirement obligation is provided below: 31 December

2008 2007 $ $

Balance – beginning of year 170,899 62,322Additions 526,250 97,737Revision (due to change in discount rate) – 3,204Accretion expense (note 6) 22,659 7,636

Balance – end of year 719,808 170,899


18 Share CapitalThe Company was incorporated under the Companies (Jersey) Law 1991 (as amended) on 6 February 2008. The Company’s authorised share capital is an unlimited number of Ordinary Shares without par value. At incorporation, there was one Ordinary Share issued at $42. On 22 February 2008, a second Ordinary Share was issued at $41.

As part of the Reorganisation (note 1), the Corporation split its stock such that each existing Common Share of the Corporation was exchanged for either ten Ordinary Shares or ten Exchangeable Shares. The Corporation was a US dollar functional currency entity as is the Company and therefore the balance of Share Capital was carried forward at its historical amount into the financial statements of the Company. The rights of different classes of shares are the same and therefore economically equivalent. As such, Ordinary and Exchangeable Shares were treated as one class of shares for loss per share calculation.

Information about movements in share capital issued before the Reorganisation is presented in the table below on the after split basis, i.e. taking into account, the one for ten split.

Ordinary Shares Year ended Year ended 31 December 2008 | 31 December 2007

Number Amount Number Amount $ $

Balance – beginning of year 254,877,480 217,672,243 220,090,330 24,580,984Issue of shares 2 83 30,000,000 175,963,414Exchange of the Common Shares for Exchangeable Shares (4,431,120) (3,784,296) – – Exchange of the Exchangeable Shares for Ordinary Shares 1,182,012 1,009,470 – – Issued on exercise of stock options (note 21) 230,000 611,555 520,000 1,079,031Issued on conversion of bonds – – 4,267,150 16,048,814

Balance – end of year 251,858,374 215,509,055 254,877,480 217,672,243

Special Voting Share Year ended Year ended 31 December 2008 | 31 December 2007


Balance – beginning of year – – – –Issued during the year 1 – – –Balance – end of year 1 – – –

Exchangeable Shares of Heritage Oil Corporation each carrying one voting right in the Company

Year ended Year ended 31 December 2008 | 31 December 2007


Balance – beginning of year – – – –Exchange of Common Shares for Exchangeable Shares 4,431,120 3,784,296 – –Exchange of Exchangeable Shares for Ordinary Shares (1,182,012) (1,009,470) – –

Balance – end of year 3,249,108 2,774,826 – –

Balance of Ordinary Shares of the Company and Exchangeable Shares of HOC – end of year 255,107,482 218,283,881 254,877,480 217,672,243



19 Reserves and Retained Earnings/(Deficit)(a) Reserves 31 December

2008 2007 $ $

Available-for-sale investments revaluation reserve 168,000 168,000Foreign currency translation reserve (220,784) 430,580

(52,784) 598,580Share-based payments reserve 54,564,393 42,579,779

54,511,609 43,178,359

Movements Available-for-sale investments revaluation reserve Balance – beginning of year 168,000 – Revaluation – 168,000

Balance – end of year 168,000 168,000

Foreign currency translation reserve Balance – beginning of year 430,580 (4,003)Currency translation differences arising during year (651,364) 434,583

Balance – end of year (220,784) 430,580

Share-based payments reserve Balance – beginning of year 42,579,779 2,641,061Compensation costs – options issued 12,234,715 40,491,888Transfer to share capital on exercise of options (250,101) (409,363)Options forfeited – (143,807)


(b) Retained Earnings/(Deficit) 31 December

2008 2007 $ $

Balance – beginning of year (67,657,170) 15,508,425Net loss for the year (41,303,251) (83,165,595)

Balance – end of year (108,960,421) (67,657,170)

(c) Nature and Purpose of Reservesi) Available-for-Sale Investments Revaluation ReserveChanges in the fair value and exchange differences arising on translation of available-for-sale investments such as equities, classified as available-for-sale financial assets, are taken to the available-for-sale investments revaluation reserve, as described in note 2k. Amounts are recognised in the income statement when the associated assets are sold or impaired.

ii) Foreign Currency Translation ReserveExchange differences arising on translation of the foreign controlled entity are taken to the foreign currency translation reserve, as described in note 2t. The reserve will be recognised in the income statement when the net investment is disposed.

iii) Share-Based Payments ReserveThe share-based payments reserve, as described in note 2u, is used to recognise the fair value of options and LTIP awards issued, but not exercised, to employees.

20 Loss per ShareThe following table summarises the weighted average Ordinary and Exchangeable Shares used in calculating net earnings per share:

Year ended 31 December

2008 2007

Weighted average Ordinary and Exchangeable SharesBasic 254,969,021 227,504,282Diluted 256,257,622 237,562,982


20 Loss per Share continuedThe weighted average number of shares has been adjusted to reflect the effective one for ten share split that took place as part of the corporate reorganisation described in note 18. The reconciling item between basic and diluted weighted average number of Ordinary Shares is the dilutive effect of stock options. A total of 22,232,010 options (31 December 2007 – nil), 4,926,429 of shares relating to the LTIP (31 December 2007 – nil) and 33,617,020 of shares relating to the convertible bonds (31 December 2007 – 33,617,020) were excluded from the above calculation, as they were anti-dilutive.

21 Share-Based PaymentsStock OptionsThe Company had a stock option plan whereby certain Directors, officers, employees and consultants of the Group have been granted options to purchase Ordinary Shares. Under the terms of the plan, options granted normally vest one-third immediately and one-third in each of the years following the date granted and have a life of 5 years.

As part of the Reorganisation (note 1) the 2008 Replacement Share Option Scheme (the “2008 Scheme”) was adopted. The 2008 Scheme served as a replacement of the Stock Option Plan of HOC which was cancelled just after the Reorganisation of HOC and its subsidiaries companies which occurred on 31 March 2008. Pursuant to the Reorganisation, the HOC optionholders exchanged each outstanding option to acquire a Common Share in the capital of HOC for ten options to acquire ten Ordinary Shares in the capital of the Company. The HOC optionholders were put in substantially the same economic position in the Company that they were in prior to the Reorganisation. The exercise prices of the options to acquire Ordinary Shares in the capital of the Company are expressed in Pounds Sterling and represent the exercise prices of the HOC’s options, expressed in Canadian dollars, translated at the exchange rate at 31 March 2008.

Information about stock options granted before the Reorganisation is presented in the tables below on the same basis as it is stipulated by the 2008 Scheme, i.e. after taking into account the one for ten exchange and translation of exercise prices to Pounds Sterling.

Ordinary Share options outstanding and exercisable: Year ended Year ended 31 December 2008 | 31 December 2007

Average Average exercise exercise Number price Number price of options (GBP) £ of options (GBP) £

Balance – beginning of year 24,612,010 1.51 8,316,670 1.06Granted – – 17,232,010 1.43Exercised (note 18) (230,000) 0.89 (520,000) 0.65Forfeited – – (416,670) 0.48

Balance – end of year 24,382,010 1.51 24,612,010 1.51

Exercisable – end of year 23,040,343 1.45 15,693,010 1.38

Number of options

Remaining Exercise price (GBP) Outstanding Exercisable life (years)

£0.48 2,000,000 2,000,000 1.39£0.81 150,000 150,000 2.48£1.08–£1.43 18,207,010 18,207,010 2.95£2.45–£2.51 4,025,000 2,683,333 3.93

24,382,010 23,040,343 2.98

The share-based payment recognised with respect to the stock options in the period ended 31 December 2008 was $9,805,167 (2007 – $40,344,181) out of which $3,671,537 (2007 – $9,043,886) was capitalised.

Long Term Incentive Plan (“LTIP”)On 19 June 2008, the AGM of the Company approved the 2008 LTIP. Under the terms of the plan, the LTIP awards will be in the form of full-value shares (Performance Shares), subject to performance and time-vesting conditions. Eligible employees will normally be considered by the Remuneration Committee for an award once each year. Awards, made, to the Executive Directors of the Company under the LTIP are called First Awards. Participants in the First Award, however, will not be entitled to any further awards until the 2011 financial year. Awards will normally be made during the period of 42 days following the announcement of year end or half-year financial results. Exceptionally, the First Awards under the plan, on 19 June 2008, were permitted to be made within 42 days following approval of the LTIP at the June 2008 AGM.

The plan is intended to apply to Executive Directors and other employees in senior management or leadership roles. By exception, other higher performing and high potential employees may be considered for awards. Participants in the LTIP will not be entitled to any further awards under the 2008 Scheme.



21 Share-Based Payments continuedThe vesting of shares under award are subject to performance conditions agreed by the Remuneration Committee when the award is made. For the First Awards made in 2008 the performance conditions are relative TSR (capital gain plus dividends) performance of the Company versus that of a comparator group of international oil companies and a requirement for the share price of the Company to have increased by 20% over the vesting period of three years. Furthermore there is an additional holding period of one year following the awards vesting.

The Remuneration Committee in consultation with executive reward consultants, approved grants of shares to Executive Directors, senior management and other employees in leadership roles under the LTIP. The maximum annual, individual award for participants who are not executive directors is 250% of base package (expressed as the “face value” of the shares). The First Award to executive directors is 1,200% of base package for the CEO and 800% of base package for the CFO.

The First Awards vest after three years provided that the performance conditions are met. The awards granted to senior management and other employees in leadership roles are in three tranches that vest after three, four and five years respectively, provided that the performance condition is met at that time.

The award would vest in line with the following schedule: Senior management and other First Awards employees in leadership role TSR Performance vs Comparator Group of 18 companies proportion vesting award proportion vesting

3rd place and above 100% of the award 100% of the award4th place 80% 100%5th place 50% 100%6th place 30% 100%7th place and below 0% 100%9th place (median) 0% 100%10th place and below 0% 0%

TSR is measured in comparison to a peer group of 18 oil companies selected based on one of, or a combination of, size (market capitalisation, revenue, turnover, cash expenditure or a combination thereof), area of operations and country of domicile. The TSR measurement is conducted by independent consultants in discussion with the Remuneration Committee.

Since there are market-related conditions the awards of the shares under LTIP were fair valued using the Monte Carlo model which takes into account the market-based performance conditions which effectively estimate the number of shares expected to vest. No subsequent adjustment is made to the fair value charge for shares that do not vest in the event that these performance conditions are not met. Adjustments are, however, made for leavers. The fair value of the awards is recognised as an employee expense with the corresponding increase in equity. The total amount to be expensed is spread over the vesting period during which the employees become unconditionally entitled to the shares and options.

The table below summarises the main assumptions used to fair value the awards made under the above LTIP and the fair values of the shares granted. First Awards Award date 19 June 2008 19 June 2008 19 June 2008 19 June 2008

Vesting period 3 3 4 5Exercise price nil nil nil nilShare price at date of grant £3.45 £3.45 £3.45 £3.45Expected volatility 40% 40% 40% 40%Expected dividend yield 0% 0% 0% 0%Fair value as at grant date £1.55 £2.49 £2.61 £2.70Number of shares granted 3,507,246 473,061 473,061 473,061

The share-based payment recognised with respect to the awards granted in the period ended 31 December 2008 was $2,429,547 out of which $967,632 was capitalised.


22 Derivative Financial Liability 31 December

2008 2007 $ $

Convertible bond – conversion option 25,785,476 36,739,990

For details of the convertible bonds, refer to note 16.

The fair value of the convertible bonds conversion option has been estimated using the Black-Scholes option-pricing model at each period end, with changes in the fair value of the conversion option recognised in income during the period. The volatility used in the fair value calculation is 56.13% (31 December 2007 – 53.85%).

23 Related Party TransactionsDuring the year ended 31 December 2008, the Company incurred transportation costs of $134,978 (31 December 2007 – nil) with respect to the services provided by a company indirectly owned by Mr. Anthony Buckingham, CEO and a Director of the Company.

Mr. Atherton, a Director and CFO of the Company, is also a Director and CFO of SeaDragon. The Group acquired 605,000 Common Shares of SeaDragon on 9 March 2007 through the sale of its 65% interest in Pipelay and Naturalay Technologies.

24 Commitments and ContingenciesHeritage’s net share of outstanding contractual commitments at 31 December 2008 was estimated at:

Less than After Total 1 year 1-3 years 4-5 years 5 years $000 $000 $000 $000 $000

Long-term debt 15,136 595 1,190 7,820 5,531Convertible bonds3 158,000 – – 158,000 –

Total repayments of borrowings 173,136 595 1,190 165,820 5,531

Operating leases 8,782 406 649 649 7,078Other long-term obligations1 140,000 – 140,000 – –Work programme obligations2 166,053 17,446 116,863 31,744 –

Total contractual obligations 314,835 17,852 257,512 32,393 7,078

1 Other long-term obligations represent the minimum financial commitment for the Group to build a refinery in the Kurdistan Region of Iraq in accordance with the PSC in the Kurdistan Region of Iraq. On 19 April 2009, the Group was released from the obligation to build a refinery (note 26).

2 Work programme obligation includes minimum required financial commitment for the Group to fulfill the requirements of licences and production sharing contracts. A two year extension to the licences on two blocks in Mali was awarded in January 2009. The Company has applied for an extension to the initial exploration period for two blocks in Tanzania, which the Tanzanian government has advised it is favourably considering. The Company included $58.8 million relating to Tanzania work programme obligations in column “1–3 years”.

3 In April 2009, bondholders with $5.9 million of bonds gave notice of the exercise of 59 bonds. These bondholders received 1,255,317 Ordinary Shares (note 26).

The Company may have a potential residual obligation to satisfy any shortfall in officers’ and former officers’ secured real estate borrowings in the event of default, a shortfall on the proceeds from the disposal of the properties and the individuals being unable to repay the balance. The value of the residual obligation was estimated as insignificant.

In many of the countries in which the Group operates, land title systems are not developed to the extent found in many industrial countries and there may be no concept of registered title. Although the Group believes that it has title to its oil and gas properties, it cannot control or completely protect itself against the risk of title disputes or challenges. There can be no assurance that claims or challenges by third parties against the Group’s properties will not be asserted at a future date. The Group received a letter from the Iraq Ministry of Oil dated 17 December 2007 stating that the PSC signed with the KRG without the prior approval of the Iraqi government is considered to be void by the Iraqi government as they have stated it violates the “prevailing Iraqi law”. The Directors believe that the PSC is valid and effective pursuant to the applicable laws.

In addition, the DRC work programme pursuant to the PSC cannot be commenced prior to the grant of a Presidential Decree from the DRC government. There can be no assurance that final approval or ratification will ever be received in respect of the PSC or that the pre-agreed fiscal terms will not be re-negotiated at a later date by the DRC government. The Directors are confident that title will be confirmed.

Furthermore, the Group received a letter from the chairman of the Management Committee of the National Oil Company of Libya dated 28 February 2008 stating that the Block 7 licence area lies within the Libyan continental shelf and a portion of this area has already been licenced to Sirte Oil Company. This letter also demands that the Group refrain from any activities over, or concerning, the Block 7 licence area and asserts the Libyan government’s right to invoke Libyan and international law to protect its rights in the Block 7 licence area. The Directors believe that the Libyan government’s claims are unfounded.



25 Non-Cash Investing and Financing Activities Supplementary Information Year ended 31 December

2008 2007 $ $

Capitalised portion of share-based compensation (4,639,169) (9,043,886)Non-cash property, plant and equipment additions relating to the capitalised portion of share-based compensation 4,639,169 9,043,886Disposal of subsidiaries (note 9) – (1,342,868)Gain on disposal of subsidiaries (note 9) – (1,077,132)Receipt of SeaDragon shares as a proceeds for disposal of subsidiaries (note 9) – 2,420,000Receipt of SeaDragon shares as a result of the issuance of the Company’s guarantee for a third party’s debt – 435,000Accrual of payable representing the fair value of the Company’s guarantee issued for a third party’s debt – (435,000)

26 Subsequent EventsOn 7 April 2009, the Company entered into an agreement to sell Eagle Energy (Oman) Limited which held a 10% interest in Block 8, Oman, for approximately $28 million plus a working capital adjustment. Cash was received on 7 April 2009 and the transaction was completed on that day.

In April 2009, in accordance with the option outlined in the PSC in the Kurdistan Region of Iraq the KRG nominated a third party participant in the Miran Licence. The Company remains the operator with a 75% working interest in the Miran Licence and will receive the pro-rata share of 25% of all past work programme expenditures and the third party is responsible for paying its share of future costs. The transaction was completed upon the receipt of approximately $6.7 million in costs incurred by the Company to 31 January 2009. Additionally, the KRG has released the Company from the obligation to build a refinery in exchange for making a payment of $35 million from future oil and gas sales from the licence. The minimum financial commitment for the Company was $140 million.

In April 2009, bondholders with $5.9 million of bonds gave notice of the exercise of 59 bonds. These bondholders received 1,255,317 Ordinary Shares.


Glossary of Technical Terms and Definitions

$ US dollars unless otherwise stated

API a specific gravity scale developed by the American Petroleum Institute for measuring the relative density of various petroleum liquids, expressed in degrees

bbl/bbls barrel/barrels

bopd barrels of oil per day

Bcf billion cubic feet

boe barrels of oil equivalent1

boe/d or boepd barrels of oil equivalent per day

Company or Heritage Oil Limited a company incorporated Heritage in Jersey on 6 February 2008 and the

ultimate holding company of HOC and the other group subsidiaries

condensate low density, high API hydrocarbon liquids that are present in natural gas fields where it condensates out of the raw gas if the temperature is reduced to below the hydrocarbon dew point temperature of the raw gas

DRC the Democratic Republic of Congo

FEED Front End Engineering and Design

Gj gigajoules

Group the Company and all of its subsidiaries

HOC or Heritage Oil Corporation, incorporated in Corporation Canada and a wholly-owned subsidiary of

the Company

KRG Kurdistan Regional Government

Lead Potential drilling target that is less well defined than a prospect and requires further data before being considered a prospect for drilling

LPG liquid petroleum gas

LSE London Stock Exchange

m3 cubic metres

Mbbls thousand barrels

MMbbls million barrels

Mboe thousands of barrels of oil equivalent

MMboe millions of barrels of oil equivalent

Mcf thousand cubic feet

Mcf/d thousand cubic feet per day

MMBtu million British thermal units

MMcf million cubic feet

MMcf/d million cubic feet per day

MMstb million stock tank barrels

N/A not applicable

NGLs natural gas liquids

Petroleum any mineral, oil or relative hydrocarbon (including condensate and natural gas liquids) and natural gas existing in its natural condition in strata (but not including coal or bituminous shale or other stratified deposits from which oil can be extracted by destructive distillation)

Possible Reserves those additional reserves that are less certain to be recovered than Probable Reserves. It is unlikely that the actual remaining quantities recovered will exceed the sum of the estimated Proved plus Probable plus Possible Reserves

Probable Reserves those additional reserves that are less certain to be recovered than Proved Reserves. It is equally likely that the actual remaining quantities recovered will be greater or less than the sum of the estimated Proved plus Probable Reserves

Prospect Potential drilling target that is well defined, usually by seismic data

Proved Reserves those reserves that can be estimated with a high degree of certainty to be recoverable. It is likely that the actual remaining quantities recovered will exceed the estimated Proved Reserves

PSC or PSA production sharing contract or production sharing agreement

psi pounds per square inch

psia pounds per square inch absolute

SPE Society of Petroleum Engineers

WTI West Texas Intermediate

1. Boes may be misleading, particularly if used in isolation. A boe conversion ratio of 6 Mcf:1 Bbl is based on an energy equivalency conversion method primarily applicable at the burner tip and does not represent a value equivalency at the wellhead.

ConversionThe following table sets forth standard conversions from Standard Imperial Units to the International System of Units (or metric units).

To convert from To Multiply by

boes Mcfs 6Mcf m3 28.174m3 Cubic feet 35.494bbls m3 0.159m3 bbls oil 6.290Feet Metres 0.305Metres Feet 3.281Miles Kilometres 1.609Kilometres Miles 0.621Acres Hectares 0.405


List of Advisers

Company Secretary Woodbourne Secretaries (Jersey) Limited

Ordnance House 31 Pier Road St. Helier Jersey JE4 8PW Channel Islands

Registered Office Ordnance Houseof the Company 31 Pier Road St. Helier Jersey JE4 8PW Channel Islands

Head Office and Fourth FloorDirectors’ Windward HouseBusiness Address La Route de la Liberation Jersey JE1 1BG Channel Islands

UK Office 34 Park Streetof the Company London W1K 2JD United Kingdom

Financial Advisers JP Morgan Cazenove Limited 20 Moorgate London EC2R 6DA United Kingdom

English Legal Advisers McCarthy Tétraultto the Company Registered Foreign Lawyers & Solicitors 2nd Floor 5 Old Bailey London EC4M 7BA United Kingdom

Canadian Legal Advisers McCarthy Tétrault LLPto the Company Suite 3300 421-7th Avenue SW Calgary, Alberta T2P 4K9 Canada

Jersey Legal Advisers Mourant du Feu & Jeuneto the Company 22 Grenville Street St. Helier Jersey JE4 8PX Channel Islands

Auditors of the Company KPMG Audit Plc 8 Salisbury Square London EC4Y 8BB United Kingdom

Registrars of the Computershare Investor ServicesCompany (Channel Islands) Limited Ordnance House 31 Pier Road St. Helier Jersey JE4 8PW Channel Islands

Principal Bankers Standard Bank (Europe)of the Company Bank of Scotland (Europe) Barclays Bank

Independent Petroleum RPS EnergyEngineering Consultants Goldsworth Houseto the Company Denton Way Goldsworth Park Woking, Surrey GU21 3LG United Kingdom

Press Agents Bell Pottinger Group 6th Floor, Holborn Gate 330 High Holborn London WC1V 7QD United Kingdom


Financial Calendar

Group results for the year to 31 December are announced in April. The AGM is held during the second quarter. Half year results to 30 June are announced in August. Additionally, the Group will issue an Interim Management Statement between 10 weeks after the beginning and six weeks before the end of each half year period.



Notes

A Balanced Portfolio of Diverse Assets

Near term focus on the core activity areas >of Uganda and Kurdistan

High impact exploration plays which can >transform the Company

Sufficient oil volumes have been found in >the Albert Basin, Uganda, to justify a major commercial development

Medium and longer term focus is Tanzania, >where seismic acquisition has recently been completed, the DRC, Malta, Mali and Pakistan

Production asset in Russia >

Experienced Management

Solid understanding of local geology and >politics in all areas of operations

Track-record of finding valuable world-class >discoveries

Extensive network of contacts >

Strong oil and gas experience >

Proven Track-Record

Discovered the M’Boundi field in the >Republic of Congo in 2001

Raised approximately $100 million from >the sale of assets in the Republic of Congo between 2002 and 2006

Funds re-invested to acquire current >portfolio

Pioneering entry into the Albert Basin, >Uganda, in 1997 – we have now unlocked a multi-billion barrel basin

Sold Oman holdings in April 2009 for >$28 million to fund acceleration of work programmes in core areas

Strategic Positioning

Focus on high impact exploration plays >

First mover advantage – as demonstrated >by success with significant holdings in Uganda and the Kurdistan Region of Iraq

Core areas are Africa, Middle East >and Russia

Exploration ( Operated)Democratic Republic of Congo (“DRC”)Kurdistan Region of IraqMaliMaltaPakistanTanzaniaUganda

Production ( Operated)Russia

Where we operate

Pantone 541 background

Recommend a sealer coat ora lamination with an open window around the embossed logo.

Heritage LogoSilver Foil Embossed

Heritage Oil LimitedAnnual Report & Accounts 2008

Heritag

e Oil Lim

ited A

nnual Report &

Accounts 2008

Heritage Oil Limited is an independent oil and gas exploration and production company with a primary listing on the Main Market of the London Stock Exchange (symbol HOIL) and Exchangeable Shares listed on the Toronto Stock Exchange (symbol HOC) and London Stock Exchange (symbol HOX). The Company currently focuses on operations in Africa, the Middle East and Russia.

Overview01 Highlights02 Chairman’s Statement04 Chief Executive’s Review08 Chief Executive’s Q&A10 Operations Review 10 Uganda 14 Kurdistan Region of Iraq 16 Tanzania 18 Democratic Republic

of Congo 20 Mali 22 Malta 24 Pakistan 26 Russia

Financial Review28 Committed to Generating Value

Corporate Social Responsibility32 Co-operative Relationships

Board of Directors34 Board of Directors

Corporate Governance36 Corporate Governance Report41 Remuneration Report47 Directors’ Report51 Responsibility Statement of the

Directors52 Independent Auditors’ Report

to the Members of Heritage Oil Limited

Financial Statements53 Consolidated Income Statement54 Consolidated Statement

of Recognised Income and Expense

55 Consolidated Balance Sheet56 Consolidated Cash Flow

Statement57 Notes to Consolidated Financial

Statements

Other81 Glossary of Technical Terms

and Definitions82 List of Advisers83 Financial Calendar

Cover page shows Miran Block in Kurdistan Region of Iraq

Head Office and Directors’ Business Address:Fourth Floor, Windward House La Route de la Liberation Jersey JE1 1BG Channel Islands

Tel +44 1534 873000Fax +44 1534 873344


Heritage Oil · PDF file83 Financial Calendar ... Annual Report & Accounts 2008 Heritage Oil...

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Transcript of Heritage Oil · PDF file83 Financial Calendar ... Annual Report & Accounts 2008 Heritage Oil...